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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 quarter ended March 31, 2003
Commission file number 1-13879
-----------------
OCTEL CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 98-0181725
(State or other (IRS Employer
jurisdiction of Identification No.)
incorporation or
organization)
Global House
Bailey Lane
Manchester
United Kingdom M90 4AA
(Address of principal
executive offices) (Zip Code)
Registrant's telephone number, including area code: 011-44-161-498-8889
-----------------
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 of 1934). Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the close of the period covered by this report.
Outstanding as of April
Class 30, 2003
----- --------
Common Stock, par value
$0.01 11,883,262
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TABLE OF CONTENTS
PART 1. Financial information
Consolidated balance sheets - March 31, 2003 and December 31, 2002.......................... 3
Consolidated statements of income - three months ended March 31, 2003 and March 31, 2002.... 5
Consolidated statements of cash flows - three months ended March 31, 2003 and March 31, 2002 6
Consolidated statement of stockholders' equity.............................................. 7
Consolidated statements of comprehensive income............................................. 7
Notes to unaudited consolidated financial statements........................................ 8
Management's discussion and analysis of financial condition and results of operations....... 14
Recent developments...................................................................... 14
Factors affecting our results............................................................ 14
Results of operations.................................................................... 14
Liquidity and financial condition........................................................ 15
Critical accounting policies............................................................. 16
Quantitive and qualitative disclosures about market risk................................. 17
Controls and procedures.................................................................. 17
PART II. Other information
Exhibit 99. Certification................................................................... 21
CAUTIONARY STATEMENT RELATIVE TO FORWARD-LOOKING STATEMENTS
Certain written and oral statements made by our Company and subsidiaries or
with the approval of an authorized executive officer of our Company, including
statements made in the Management's Discussion and Analysis of Financial
Condition and Results of Operations or elsewhere in this report and in other
filings with the Securities and Exchange Commission, may constitute
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. Generally, the words "believe," "expect," "intend,"
"estimate," "anticipate," "project," "will" and similar expressions identify
forward-looking statements, which generally are not historical in nature. All
statements which address operating performance, events or developments that we
expect or anticipate will occur in the future--including statements relating to
volume growth, share of sales or earnings per share growth, and statements
expressing general optimism about future operating results--are forward-looking
statements. Forward-looking statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from our
Company's historical experience and our present expectations or projections. As
and when made, management believes that these foward-looking statements are
reasonable. However, caution should be taken not to place undue reliance on any
such forward-looking statements since such statements speak only as of the date
when made. Although we believe that our expectations are based on reasonable
assumptions within the bounds of our knowledge of our business and operations,
moreover, there can by no assurance that actual results will not differ
materially from our expectations. Factors which could cause actual results to
differ from expectations include, without limitation, the timing of orders
received from customers, the gain or loss of significant customers, competition
from other manufacturers and changes in the demand for our products, including
the rate of decline in demand for TEL. In addition, increases in the cost of
product, changes in the market in general and significant changes in new
product introduction could result in actual results varying from expectations.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
2
PART 1--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
OCTEL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31 December 31
2003 2002
----------- -----------
(Unaudited)
(millions of dollars except
share and per share data)
ASSETS
Current assets
Cash and cash equivalents............................... $ 31.3 $ 26.7
Accounts receivable, less allowance of $2.6 (2002--$3.1) 72.3 80.7
Other receivable--Veritel............................... 3.2 3.2
Inventories
Finished goods........................................ 35.3 25.3
Raw materials and work-in-progress.................... 21.0 30.4
------ ------
Total inventories................................. 56.3 55.7
Prepaid expenses........................................ 2.1 5.5
------ ------
Total current assets.............................. 165.2 171.8
Property, plant and equipment (note 9)................... 94.0 88.9
Less accumulated depreciation........................... (38.7) (32.1)
------ ------
Net property, plant and equipment....................... 55.3 56.8
Goodwill................................................. 350.6 352.8
Intangible asset......................................... 49.6 50.9
Deferred finance costs................................... 3.9 4.4
Prepaid pension cost..................................... 105.5 105.2
Other assets............................................. 6.0 5.9
------ ------
$736.1 $747.8
====== ======
The accompanying footnotes are an integral part of these unaudited interim
consolidated financial statements.
3
OCTEL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
March 31 December 31
2003 2002
----------- -----------
(Unaudited)
(millions of dollars except
share and per share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Bank overdraft........................................................ $ 1.7 $ 4.0
Accounts payable...................................................... 42.0 55.2
Other payable--Veritel................................................ 10.0 10.0
Accrued liabilities................................................... 47.1 45.9
Accrued income taxes.................................................. 11.8 13.7
Current portion of plant closure provisions (note 6).................. 6.0 --
Current portion of long-term debt..................................... 38.6 56.8
Current portion of deferred income.................................... 2.0 2.0
------ ------
Total current liabilities......................................... 159.2 187.6
Plant closure provisions (note 6)........................................ 26.0 36.4
Deferred income taxes.................................................... 41.5 41.7
Deferred income.......................................................... 7.9 8.4
Long-term debt........................................................... 120.1 102.4
Other liabilities........................................................ 2.8 4.2
Minority interest........................................................ 5.5 4.6
Stockholders' Equity
Common stock, $0.01 par value (authorized 40,000,000 shares, issued
14,777,250 shares).................................................. 0.1 0.1
Additional paid-in capital............................................ 276.7 276.7
Treasury stock (2,898,195 and 2,934,420 shares at cost, respectively). (34.1) (34.5)
Retained earnings..................................................... 168.8 157.9
Accumulated other comprehensive income................................ (38.4) (37.7)
Total stockholders' equity........................................ 373.1 362.5
------ ------
$736.1 $747.8
====== ======
The accompanying footnotes are an integral part of these unaudited interim
consolidated financial statements.
4
OCTEL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31
--------------------------
2003 2002
------- -------
(millions of dollars except
share and per share data)
Net sales................................................... $ 97.7 $ 114.5
Cost of goods sold.......................................... (57.7) (65.2)
------- -------
Gross profit................................................ 40.0 49.3
Operating expenses
Selling, general and administrative...................... (17.2) (15.9)
Research and development................................. (1.2) (1.4)
Amortization of intangible assets........................ (2.6) (2.1)
------- -------
(21.0) (19.4)
------- -------
Operating income............................................ 19.0 29.9
Interest expense............................................ (2.5) (4.0)
Other expenses.............................................. (0.7) (0.7)
Interest income............................................. 0.1 0.2
------- -------
Income before income taxes and minority interest............ 15.9 25.4
Minority interest........................................... (0.9) (0.8)
------- -------
Income before income taxes.................................. 15.0 24.6
Income taxes (note 5)....................................... (4.6) (6.2)
Cumulative effect of change in accounting principle (note 9) 0.5 --
------- -------
Net income........................................... $ 10.9 $ 18.4
======= =======
Earnings per share (note 3):
Basic.................................................... $ 0.92 $ 1.56
======= =======
Diluted.................................................. $ 0.88 $ 1.47
======= =======
Weighted average shares outstanding (in thousands) (note 3):
Basic.................................................... 11,825 11,756
======= =======
Diluted.................................................. 12,351 12,454
======= =======
The accompanying footnotes are an integral part of these unaudited interim
consolidated financial statements.
5
OCTEL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months
Ended March 31
--------------------
2003 2002
------ ------
(millions of dollars)
Cash Flows from Operating Activities
Net income................................................................... $ 10.9 $ 18.4
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization............................................... 5.8 5.4
Deferred income taxes....................................................... (0.2) 1.7
Other....................................................................... (0.9) --
Profit on disposal of equipment............................................. (0.5) --
Changes in operating assets and liabilities:
Accounts receivable and prepaid expenses.................................. 12.5 15.0
Inventories............................................................... (0.1) 3.2
Accounts payable and accrued liabilities.................................. (13.4) 1.4
Income taxes and other current liabilities................................ (2.0) 0.2
Other non-current assets and liabilities.................................. (6.6) (1.3)
------ ------
Net cash provided by operating activities............................. 5.5 44.0
Cash Flows from Investing Activities
Capital expenditures......................................................... (1.2) (1.6)
Veritel...................................................................... -- (11.8)
Other........................................................................ (0.3) (0.5)
------ ------
Net cash used in investing activities........................................ (1.5) (13.9)
Cash Flows from Financing Activities
Repayment of long-term borrowings............................................ (0.4) (42.9)
Other........................................................................ (0.2) --
Minority interest............................................................ 0.9 0.7
------ ------
Net cash used in financing activities........................................ 0.3 (42.2)
Effect of exchange rate changes on cash...................................... 2.6 (5.5)
------ ------
Net change in cash and cash equivalents...................................... 6.9 (17.6)
Cash and cash equivalents at beginning of period............................. 22.7 43.0
------ ------
Cash and cash equivalents at end of period................................... 29.6 25.4
====== ======
The accompanying footnotes are an integral part of these unaudited interim
consolidated financial statements.
6
OCTEL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
Accumulated
Additional Other Total
Common Treasury Paid-In Retained Comprehensive Stockholders'
Stock Stock Capital Earnings Income Equity
------ -------- ---------- -------- ------------- -------------
(millions of dollars)
Balance at December 31, 2002 $0.1 $(34.5) $276.7 $157.9 $(37.7) $362.5
Net income.................. -- -- -- 10.9 -- 10.9
Derivatives(1).............. -- -- -- -- 0.1 0.1
Net CTA change(2)........... -- -- -- -- (0.8) (0.8)
Treasury stock issue........ -- 0.4 -- -- -- 0.4
---- ------ ------ ------ ------ ------
Balance at March 31, 2003... $0.1 $(34.1) $276.7 $168.8 $(38.4) $373.1
==== ====== ====== ====== ====== ======
- --------
1. Changes in unrealized exchange gains/(losses) on derivative instruments
2. Changes in cumulative translation adjustment
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Total comprehensive income for the three months end March 31:
2003 2002
----- -----
Net income for the period.............................................. $10.9 $18.4
Changes in foreign currency translation adjustment..................... (0.8) (8.9)
Changes in unrealized exchange gains/(losses) on derivative instruments 0.1 --
----- -----
Total comprehensive income.......................................... $10.2 $ 9.5
===== =====
The accompanying footnotes are an integral part of these unaudited interim
consolidated financial statements.
7
OCTEL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements have
been prepared in accordance with generally accepted accounting principles in
the United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all the information and footnotes necessary for a comprehensive
presentation of financial position, results of operations and cash flows.
It is our opinion, however, that all material adjustments (consisting of
normal recurring accruals) have been made which are necessary for a fair
financial statement presentation. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Form 10-K filed on March 28, 2003.
The results for the interim period are not necessarily indicative of the
results to be expected for the full year.
We adopted FAS 146, Accounting for Costs Associated with Exit or Disposal
Activities, effective January 1, 2003, and any restructuring activities
initiated after that date will be accounted for in accordance with FAS 146.
Adoption did not have any effect on our financial position, results of
operations or liquidity.
We adopted FAS 143, Accounting for Asset Retirement Obligations, effective
January 1, 2003. The gross cost and accumulated depreciation of property, plant
and equipment have been increased by $7.0 million and $6.5 million,
respectively. The effect on the income statement, reflecting the net book value
of costs previously written off but now capitalized, was $0.5 million and has
been disclosed separately on the face of the income statement.
NOTE 2--STOCKHOLDERS' EQUITY AND STOCK OPTIONS
At March 31, 2003, we had authorised common stock of 40 million shares
(December 31, 2002 - 40 million). Issued shares at March 31, 2003, were
14,777,250 (December 31, 2002 - 14,777,250) and treasury stock amounted to
2,898,195 (December 31, 2002 - 2,934,420).
Movements in stock options in the first quarter, 2003 were as follows:-
No.
---------
Outstanding at December 31, 2002 1,477,723
Granted at $13.91............... 159,500
Granted at zero cost............ 167,892
Exercised....................... (36,225)
Cancelled....................... (1,381)
---------
Outstanding at March 31, 2003... 1,767,509
=========
The weighted average prices of options exercised and cancelled in the
quarter were $12.33 and $15.25, respectively.
8
OCTEL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the effect on net income and earnings per
share had we recorded compensation expense consistently with the method
prescribed by FAS 123:
Earnings per
share
-------------
Net income Basic Diluted
---------- ----- -------
(in millions, except
per share data)
2003
As disclosed........................... $10.9 $0.92 $0.88
Compensation, net of tax, included..... 0.1
Compensation, net of tax, FAS 123 basis (0.3)
-----
Proforma............................... $10.7 $0.90 $0.86
-----
2002
As disclosed........................... $18.4 $1.56 $1.47
Compensation, net of tax, included..... 0.1
Compensation, net of tax, FAS 123 basis (0.4)
-----
Proforma............................... $18.1 $1.54 $1.45
-----
The fair value of options was calculated using the Black-Scholes model with
the following assumptions:
2003 2002
------- -------
Dividend yield......... 3% 3%
Expected life.......... 4 years 4 years
Volatility............. 35% 35%
Risk free interest rate 3.59% 3.59%
NOTE 3--EARNINGS PER SHARES
Basic earnings per share is based on the weighted average number of common
shares outstanding during the period, while diluted earnings per share includes
the effect of options and restricted stock that are dilutive and outstanding
during the period. Per share amounts are computed as follows:
2003 2002
------- -------
(Millions of dollars)
Numerator:
Net income available to common shares....... $ 10.9 $ 18.4
======= =======
Denominator:
Weighted average common shares outstanding.. 11,825 11,756
Dilutive effect of stock options and awards. 526 698
------- -------
Denominator for diluted earnings per share.. 12,351 12,454
======= =======
Net income per share.................... $ 0.92 $ 1.56
======= =======
Net income per share, diluted........... $ 0.88 $ 1.47
======= =======
179,062 options were anti-dilutive in quarter one and have been excluded
(2002 - 40,663 options).
9
OCTEL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4--SEGMENTAL REPORTING
The Company presently has one dominant industry segment, petroleum
additives. The Company has three businesses for management purposes--TEL,
Petroleum Specialties and Performance Chemicals. Because of operational and
economic similarities, Petroleum Specialties and Performance Chemicals have
been aggregated for reporting purposes as the Specialty Chemicals business
segment.
The Chlorine operation closed at the end of 2002.
This segmentation basis is consistent with the 2002 Annual Report. There has
been no material change in total assets or liabilities by segment since
December 31, 2002.
The following table presents a summary of the Company's reportable segments
for the three months ended March 31, 2003 and 2002:
Three months ended
March 31
-----------------
2003 2002
----- ------
(millions of dollars)
Net Sales
TEL--ongoing........... $47.8 $ 64.7
TEL--Chlorine.......... -- 3.6
----- ------
TEL--total.......... 47.8 68.3
Specialty Chemicals. 49.9 46.2
----- ------
Total........... $97.7 $114.5
===== ======
Gross Profit
TEL--ongoing........... $24.0 $ 32.6
TEL--Chlorine.......... -- --
----- ------
TEL--total.......... 24.0 32.6
Specialty Chemicals. 16.0 16.7
----- ------
Total........... $40.0 $ 49.3
===== ======
Operating Income
TEL--ongoing........... $18.3 $ 28.0
TEL--Chlorine.......... -- --
----- ------
TEL--total.......... 18.3 28.0
Specialty Chemicals. 3.1 4.5
Corporate Costs..... (2.4) (2.6)
Restructuring....... -- --
----- ------
Total........... $19.0 $ 29.9
===== ======
10
OCTEL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5--INCOME TAXES
A reconciliation of the U.S. federal statutory tax rate to the effective
income tax rate is as follows:-
Three Months
Ended March 31
------------
2003 2002
----- ----
Statutory rate..................... 35.0% 35.0%
Increase (decrease) resulting from:
Foreign tax rate differential... (22.0%) (9.8%)
Permanent differences........... 10.9% --
Other........................... 6.1% --
----- ----
Effective rate..................... 30.0% 25.2%
===== ====
The full year effective tax rate for 2002 was 31.0%.
NOTE 6 - PLANT CLOSURE PROVISIONS
The liability for estimated closure costs of Octel's TEL manufacturing
facilities includes costs for personnel reductions (severance) and
decontamination and environmental remediation activities (remediation) when
demand for TEL diminishes. Costs related to our ongoing restructuring program
are analyzed separately.
Movements in the provisions for the period are set out below:
2003 2003 2003 2003 2002
------------- --------- ----------- ----- -----
Restructuring Severance Remediation Total Total
------------- --------- ----------- ----- -----
(millions of dollars)
Total at January 1... $ 5.1 $ 0.6 $30.7 $36.4 $39.5
Exchange effect...... (0.4) -- (0.9) (1.3) (0.8)
Charge for the period -- -- -- -- --
Expenditure.......... (0.9) (0.6) (1.6) (3.1) (1.8)
----- ----- ----- ----- -----
Total at March 31.... 3.8 28.2 -- 32.0 36.9
Due within one year.. (3.8) (2.2) -- (6.0) --
----- ----- ----- ----- -----
Balance at March 31.. $ -- $26.0 $ -- $26.0 $36.9
===== ===== ===== ===== =====
Amounts due within one year refer to provisions for which expenditure is
expected to be incurred within one year from the balance sheet date.
Restructuring
Severance Other Total
--------- ----- -----
(millions of dollars)
Total at January 1.... $ 3.7 $ 1.4 $ 5.1
Exchange effect....... (0.4) -- (0.4)
Charge for the period. -- -- --
Release for the period -- -- --
Expenditure........... (0.7) (0.2) (0.9)
----- ----- -----
Total at March 31..... 2.6 1.2 3.8
Due within one year... (2.6) (1.2) (3.8)
----- ----- -----
Balance at March 31... $ -- $ -- $ --
===== ===== =====
11
OCTEL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Severance payments of $0.7 million in the period related to 5 Italian Specialty
Chemical and 9 UK Chlorine employees who left the company. All restructuring
amounts provided are expected to crystallize within one year. The provision at
March 31, 2003 relates to amounts payable to 28 current or former employees.
Severance and remediation
Severance expenditure of $0.6 million related to severance costs in Germany,
utilizing all (non-restructuring) severance provisions at 2002 year end.
Remediation expenditure of $1.6 million was associated with remediation work in
the UK and in Germany.
NOTE 7--RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In November 2002, FASB Interpretation No. (FIN) 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others was issued. FIN 45 clarifies disclosures that are
required to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees. FIN 45 also establishes a
requirement to record a liability at fair value for certain guarantees that are
entered into or modified after December 31, 2002. We do not anticipate that the
adoption of FIN 45 will have a material impact on our interim or annual
financial statements.
In January 2003, FASB Interpretation No. (FIN) 46, Consolidation of Variable
Interest Entities was issued. FIN 46 requires that companies that control
another entity through interests other than voting interests should consolidate
the controlled entity. FIN 46 applies to variable interest entities created
after January 31, 2003, and to variable interest entities in which an
enterprise obtains an interest after that date. The related disclosure
requirements are effective immediately. We do not anticipate that the adoption
of FIN 46 will have a material impact on our interim or annual financial
statements.
NOTE 8--DEBT
Our principal credit facility comprises a term loan with a remaining balance
of $117 million and a revolving facility of $40 million of which $30 million
had been drawn down at March 31, 2003. This credit facility contains terms
which, if breached, would result in the loan becoming repayable on demand. It
requires, among other matters, compliance with certain financial ratio
covenants, specifically an operating cash/net finance charge ratio, EBITDA/net
interest expense ratio and net debt/EBITDA ratio, on a rolling twelve month
basis calculated quarterly.
We had been concerned about the uncertainties in Venezuela in the last
quarter of 2002 and the first quarter of 2003, and on their impact on our
ability to meet the covenant requirements of the facility in the short term. We
took the opportunity to review with the bank syndicate the covenant
requirements and scheduled repayments under the facility. On March 27, 2003 we
obtained agreement to a rescheduling of debt repayments originally scheduled to
take place during 2003 until later in 2003 and 2004, and to amendments to the
parameters of some covenant ratios for 2003.
Under the previous debt repayment profile $55 million would have been
repayable in 2003. The revision means that $30 million has been deferred to
2004. 2003 installments are $5 million (paid) in March and $20 million in
December, 2003.
12
OCTEL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The revised overall debt profile at March 31, 2003 is set out below:
(in millions)
-------------
2003...... $ 21.3
2004...... 131.4
2005...... 1.7
2006...... 1.7
2007...... 1.7
Thereafter 0.9
------
$158.7
======
NOTE 9--ASSET RETIREMENT OBLIGATIONS
Effective January 1, 2003 we adopted FAS 143, Accounting for Asset
Retirement Obligations. This applies to legal obligations associated with the
construction, acquisition and operation of a long-lived asset. Under FAS 143
the amount recorded as a liability is capitalized by increasing the carrying
amount of the related long-lived asset, which is then depreciated over its
useful life. If the liability is settled for an amount other than the recorded
balance, either a gain or loss will be recognized at settlement
We have obligations related to the cost of decontamination and environmental
remediation work required once our TEL and Specialty Chemicals plants cease
operations. We have made provision for these in prior years, based on our best
current estimate of the program of work and the related costs to meet the
requirements of environmental legislation in the country where each operation
is located.
The amounts recorded as liabilities in our balance sheet were unchanged by
FAS 143 because all qualifying costs had been fully provided under our
pre-existing environmental compliance and remediation accounting policy (see
Critical Accounting Policies). However, we had previously expensed these costs
in full, so the change brought about by FAS 143 has been the retrospective
capitalization and depreciation of those costs. As a result, a total of $7.0
million of costs were added to the carrying amount of property, plant and
equipment. Since most of the relevant plant is nearing the end of its useful
life, the cumulative depreciation uplift was $6.5 million.
The effect on the income statement, reflecting the net book value of costs
previously written off but now capitalized, was $0.5 million and has been
disclosed separately on the face of the income statement as "cumulative effect
of change in accounting principles". The impact is not sufficiently significant
to merit the disclosure of earnings in respect of the first quarter, 2002 on a
pro forma basis had FAS 143 been adopted.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2003
RECENT DEVELOPMENTS
The political situation in Venezuela, the location of our biggest customer,
prevented any TEL shipments to that country in the last quarter of 2002. Our
expectations were that shipments would resume in March or April of 2003. There
were no sales to Venezuela in the first quarter, but deliveries resumed in
April.
FACTORS AFFECTING OUR RESULTS
In the third and fourth quarters of 2002, we recorded a $19.5 million
restructuring charge as part of a group-wide program to reduce the TEL asset
and cost base in line with declining demand and to ensure that the correct
infrastructure and systems exist to globalize the Specialty Chemicals business.
While there have been no increases in the provision in the first quarter of
2003, we still expect additional restructuring charges of up to $20 million in
aggregate in 2003 and 2004 across both businesses.
Our critical accounting policies are discussed on page 16 below.
RESULTS OF OPERATIONS
Group net income for the first quarter was $10.9 million or $0.88 per share
(diluted), compared with $18.4 million or $1.47 per share in the comparable
period last year. Group sales and gross profit for the quarter were $97.7
million and $40.0 million, respectively, compared with $114.5 million and $49.3
million, respectively, for the first quarter of 2002. Specialty Chemicals
comprised 51% of total sales (2002-40%) and 40% of gross profit (2002-34%).
This change of mix reflected lower net sales in the TEL market, which has a
higher gross margin percentage of net sales, combined with an improved sales
performance year on year in the Specialty Chemicals segment. Factors
influencing these two segments are discussed separately below. The decline in
operating income from $29.9 million to $19.0 million was principally due to TEL
market conditions in the period, and performance was slightly better than our
expectations. Overall operating expenses of $18.4 million were $1.1 million
above 2002 levels, reflecting continued investment to support our objectives of
reducing the TEL asset and cost base in line with declining demand and ensuring
that the correct infrastructure and systems exist to globalize the Specialty
Chemicals business.
We account for pensions in accordance with FAS 87, and in the first quarter
of 2002 we recorded a total pension credit of $2.8 million in our income
statement. A credit of $2.3 million has been recognized in the three months
ended March 31, 2003 based on advice received from our independent advisors. A
full actuarial valuation of the pension fund has commenced in the second
quarter.
Interest expense fell from $4.9 million to $2.5 million, reflecting a
reduction in the average debt outstanding over the period and improved interest
rates. Our effective tax rate at 30.0 % is above the 25.2% applied in quarter
one, 2002 but in line with the 2002 full year rate of 31.0%. The rate used in
the first quarter was based on certain assumptions as to the disposition of
pre-tax profits between the geographical areas in which the group operates, and
the increase in the full year rate reflects differences between the actual mix
and expectations during the year.
Effective January 1, 2003 we adopted FAS 143, Accounting for Asset
Retirement Obligations. This requires the fair value of asset retirement
obligations to be recorded as a liability, capitalized with the related
long-lived asset and depreciated over the useful life of that asset. We had
previously made full provision for liabilities, so the adoption of FAS 143
resulted in an adjustment of $0.5 million arising from the element of the
obligation which is to be depreciated in the future.
14
Specialty Chemicals sales at $49.9 million were up 8% on the comparable
period last year. Reduced profitability in the detergent business caused gross
profit to fall from 36.1% to 32.1%, reducing gross profit by $0.7 million to
$16.0 million. Operating income for the first quarter, 2003 was $3.1 million
compared to $4.5 million in 2002, the reduction of $1.4 million including the
gross profit decline noted above.
Total TEL sales in the three months ended March 31, 2003 were $47.8 million
compared with $68.3 million in the first quarter, 2002. Chlorine sales in 2002
were $3.6 million, but the plant ceased operation at the end of 2002 and
therefore there are no equivalent sales in 2003. The decline in ongoing sales
of $16.9 million, or 26%, reflects a 32% decrease in volumes partly offset by
an improved price mix. The shortfall in volumes was mainly due to the political
situation in Venezuela, which prevented any deliveries in the quarter.
Continuing cost control measures delivered a gross profit of 50.2%, which is in
line with first quarter, 2002 levels. Operating income at $18.3 million was
$9.7 million below 2002 due to the effect of Venezuelan volume lost and price
mix as noted above.
LIQUIDITY AND FINANCIAL CONDITION
The political situation in Venezuela meant that there were no sales to that
country in the last quarter of 2002 or the first quarter of 2003. This has
impacted our net income, working capital and operating cash flow significantly,
and cash generated by operating activities was $5.5 million compared with $44.0
million in the first quarter of 2002. Movement on non-current assets and
liabilities includes expenditure of $3.1 million (2002- $1.8 million) in
respect of remediation, severance and restructuring provisions.
In January we drew down an additional $5 million under our revolving credit
facility, and in March we repaid $5 million of term loan. These are both
classified as long-term debt and offset each other, so the net movement in the
quarter was not significant.
In March we entered into discussions with our bank syndicate and were
successful in deferring some of the term loan repayments originally planned for
this year until next year. Under the previous profile a total of $55 million
would have been due for repayment in 2003. Under the revised schedule total
repayments for 2003 are $25 million, of which $5 million has been repaid in
March. The remaining $20 million is repayable in December. The revised overall
debt profile as at March 31, 2003 is set out below:
(in millions)
-------------
2003...... $ 21.3
2004...... 131.4
2005...... 1.7
2006...... 1.7
2007...... 1.7
Thereafter 0.9
------
$158.7
======
At the end of December, 2001, we were notified, under the terms of our
marketing, supply and service agreement with Veritel Chemicals B.V., of a
permanent source interruption in the supply of TEL by reason of their
supplier's inability to manufacture TEL. This triggered phased payments to
Veritel of $70 million, of which 32% is recoverable under a separate agreement
from Ethyl Corporation. Payments of $60 million had been made as at December
31, 2002 and Ethyl's contribution to all payments to date had been received.
The final $10 million is expected to be paid in the second quarter of 2003.
15
CRITICAL ACCOUNTING POLICIES
The policies that we consider the most critical in terms of complexity and
subjectivity of assessment are those related to environmental liabilities,
impairment of goodwill and intangible assets, pension accounting, restructuring
costs and our marketing agreements with Ethyl. Any adverse variance between
actual results and our projections in these areas may impact on results of
operations and financial condition.
We record environmental liabilities when they are probable and costs can be
estimated reasonably. Remediation provisions at March 31, 2003 amounted to
$28.2 million and relate principally to our sites in the UK and Germany. We
have to anticipate the program of work required and the associated future
costs, and we have to comply with environmental legislation in the relevant
countries. We also view the costs of vacating our main UK site ($27.6 million
at 2002 year end) as a contingent liability because we have no present
intention to exit the site.
We have significant goodwill and intangible assets in our balance sheet,
with net amounts of $350.6 million and $49.6 million, respectively, at March
31, 2003. These are accounted for in accordance with FAS 142. We regularly
review carrying values by reference to future income and cash flows as set out
in the group's strategic long-term plan, but this involves anticipating trading
circumstances that will apply in future years. We do expect, based on current
projections, to begin to impair goodwill for our TEL business segment in 2004.
We account for pensions in accordance with FAS 87 and the disclosure
requirements of FAS 132. The prepaid pension cost is material to our balance
sheet, the net prepayment being $105.5 million at March 31, 2003. The
underlying plan asset value and Projected Benefit Obligation were $580.7
million and $583.3 million, respectively, at the end of 2002. Movements in
these are dependent on actual return on investments and pay awards, as well as
our assumptions as to future trends in these areas. The continuation of the
prepayment depends on the carrying value of the plan assets exceeding the
Accumulated Benefit Obligation. This surplus at
December 31, 2002 was $8.9 million. In the event of a deficit, a creditor would
be created equal to the sum of the prepayment and the deficit, and the related
charge would be written off to accumulated other income. A full actuarial
valuation of the pension plan has commenced in the first half of 2003, with the
full results reported later in the year. We will continue to monitor the status
of the plan on a quarterly basis.
We commenced a major program of restructuring during the latter half of
2002. Restructuring activities initiated on or after January 1, 2003 are now
accounted for in accordance with FAS 146. Restructuring provisions at March 31,
2003 were $3.8 million. Where appropriate we have restated 2002 comparative
amounts linked to ongoing projects, mainly the closure of the UK Chlorine plant
which was announced in 2001 but occurred at 2002 year end. Over recent years
there has been an ongoing program of severance and other costs as the decline
in the TEL market caused plant closures and downsizing of operations. We have
considered whether these should be separated for disclosure, and concluded that
there would be no value added to the exercise by including costs which are, in
effect, a fact of life in a declining market. We have not, therefore, included
any further retrospective analysis of restructuring activity, but have focused
on clear disclosure of the activities presently in hand.
We have entered into a number of sales and marketing agreements with Ethyl
for the sale of TEL in all areas of the world except North America through
December 31, 2009. Under these agreements we produce the TEL and all marketing
and sales effort is in the Octel name. Ethyl provides bulk distribution,
marketing and other services. The net proceeds are paid to Ethyl and Octel on
an agreed formula, with Octel receiving 68% of the total. The net proceeds are
in the main calculated and settled on a monthly basis, but there is an element
receivable by us from Ethyl which is computed annually in arrears. In prior
years the amounts involved were not significant, but because of increases in
the value of this retrospective element we have decided that it is more
appropriate from 2002 onward to recognize a prudent accrual during the year,
based on best current estimates of the expected outcome.
16
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We operate manufacturing and blending facilities, offices and laboratories
around the world, though the largest manufacturing facility is located in the
UK. We sell a range of TEL and Specialty Chemicals to customers around the
world. We use floating rate debt to finance these global operations.
Consequently, we are subject to business risks inherent in non-US activities,
including political and economic uncertainty, import and export limitations,
and market risk related to changes in interest rates and foreign exchange
rates. Our political and economic risks are mitigated by the stability of the
countries in which our largest operations are located. Credit limits, ongoing
credit evaluation and account monitoring procedures are used to minimize bad
debt risk. Collateral is not generally required.
Over half of our sales are in US dollars. Foreign currency sales, primarily
in UK pounds sterling, offset most of our costs, which are also in UK pounds
sterling. To the extent required, US dollars are sold forward to cover local
currency needs
We use derivatives, including interest rate swaps and foreign currency
forward exchange contracts, in the normal course of business to manage market
risks. The derivatives used in hedging activities are considered risk
management tools and are not used for trading purposes. In addition, we enter
into derivative instruments with a diversified group of major financial
institutions in order to monitor the exposure to non-performance of such
instruments. Our objective in managing exposure to changes in interest rates is
to limit the impact of such changes on earnings and cash flow and to lower
overall borrowing costs. Our objective in managing the exposure to changes in
foreign exchange rates is to reduce volatility on earnings and cash flow
associated with such changes.
There has been no material change in our exposure to market risk as
described in the Form 10-K filed on March 28, 2003.
CONTROLS AND PROCEDURES
Within 90 days of the filing date of this 10-Q Report, we carried out an
evaluation under the supervision and with the participation of our management,
including the Chief Executive Officer and the Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on that evaluation, the Chief Executive Officer and the Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in alerting them, on a timely basis, to material information that is
required to be included in the periodic reports that we must file with the
Securities and Exchange Commission. There have been no significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of that evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
17
PART II--OTHER INFORMATION
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.2 and 3. Certifications pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the quarter. A Form 8-K was
filed on April 28, 2003 related to the first quarter press release. A Form
8-K was filed on May 6, 2003 in respect of a dividend payment of 5 cents per
share payable on June 17, 2003.
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 authorised.
Date: By: /s/ DENNIS J KERRISON
May 9, 2003 ----------------------------------
Dennis J Kerrison
President and Chief Executive
Officer
Date: By: /s/ PAUL W JENNINGS
May 9, 2003 ----------------------------------
Paul W Jennings
Vice President and Chief Financial
Officer
18
CERTIFICATION BY DENNIS J KERRISON PURSUANT TO
SECURITIES EXCHANGE ACT 1934 RULE 13a - 14 and 15d-14
I, Dennis J Kerrison, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Octel Corp.
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 officer 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 officer 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):
d) 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
e) 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 officer 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.
By: /s/ DENNIS J KERRISON
-----------------------------
Dennis J Kerrison
President and Chief Executive
Officer
Date: May 9, 2003
19
CERTIFICATION BY PAUL W JENNINGS PURSUANT TO
SECURITIES EXCHANGE ACT 1934 RULE 13a - 14 and 15d-14
I, Paul W Jennings, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Octel Corp.
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 officer 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 officer 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):
d) 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
e) 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 officer 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.
By: /s/ PAUL W JENNINGS
-----------------------------
Paul W Jennings
Vice President and Chief
Financial Officer
Date: May 9, 2003
20