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, 2002
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
---- ----
As of April 30, 2002, 109,036,756 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,
----------------------------
2002 2001
---- ----
Net sales $ 402 $ 498
Cost of sales (Note 6) 243 326
Selling, general and administrative expenses 88 101
Research and development 10 15
Goodwill and intangible asset amortization (Note 4) 2 7
Other operating expense, net (Note 7) 5 3
--------- ---------
Profit from operations 54 46
Interest and debt expense (Note 8) 36 55
Preferred security distributions of subsidiary trusts 15 15
Other expense, net (4) (2)
--------- ---------
Loss before income taxes and equity loss (1) (26)
Provision (benefit) for income taxes 2 (10)
--------- ---------
Loss before equity loss (3) (16)
Equity loss of affiliated companies, net of tax (Note 4) -- (3)
--------- ---------
Net loss from continuing operations before discontinued
operations and cumulative effect of change in accounting principle (3) (19)
Discontinued operations (Note 3)
(Loss) income from operations of discontinued business
(including loss on disposal of $155 million) (120) 15
Provision for income taxes 89 6
--------- ---------
Net (loss) income on discontinued operations (209) 9
Net loss before cumulative effect of change
in accounting principle (212) (10)
Cumulative effect of change in accounting principle, net of tax (Note 4) (368) --
--------- ---------
Net loss $ (580) $ (10)
========= =========
Basic and diluted (loss) earnings per share (Note 5)
Continuing operations $ (0.03) $ (0.17)
Discontinued operations $ (1.92) $ 0.08
Cumulative effect of change in accounting principle $ (3.37) $ -
Net loss $ (5.32) $ (0.09)
Weighted average number of shares (millions) 109.0 107.9
See accompanying notes to financial statements.
2
HERCULES INCORPORATED
CONSOLIDATED BALANCE SHEET
(Dollars in millions) (Unaudited)
March 31, December 31,
2002 2001
---- ----
ASSETS
Current assets
Cash and cash equivalents $ 52 $ 76
Accounts and notes receivable, net 318 506
Inventories
Finished products 83 127
Materials, supplies, and work in process 78 106
Deferred income taxes -- 27
Assets of business held for sale (Note 3) 1,914 --
--------- ---------
Total current assets 2,445 842
Property, plant, and equipment 1,866 2,234
Accumulated depreciation and amortization (1,208) (1,331)
--------- ---------
Net property, plant, and equipment 658 903
Goodwill and other intangible assets, net (Note 4) 610 2,476
Other assets 775 828
--------- ---------
Total assets $ 4,488 $ 5,049
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 131 $ 203
Accrued expenses 515 463
Short-term debt (Note 10) 205 251
Liabilities of business held for sale (Note 3) 280 --
--------- ---------
Total current liabilities 1,131 917
Long-term debt (Note 10) 1,984 1,959
Deferred income taxes 191 334
Postretirement benefits and other liabilities 478 503
Commitments and contingencies (Note 12)
Company-obligated preferred securities of subsidiary trusts (Note 11) 624 624
Stockholders' equity
Series preferred stock -- --
Common stock (shares issued: 2002 - 159,984,444;
2001 - 159, 984,444) 83 83
Additional paid-in capital 691 697
Unearned compensation (104) (104)
Other comprehensive losses (273) (218)
Retained earnings 1,520 2,099
--------- ---------
1,917 2,557
Reacquired stock, at cost (shares: 2002 - 50,964,488;
2001 - 51,196,972) (1,837) (1,845)
--------- ---------
Total stockholders' equity 80 712
--------- ---------
Total liabilities and stockholders' equity $ 4,488 $ 5,049
========= =========
See accompanying notes to financial statements.
3
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF CASH FLOW
(Dollars in millions) (Unaudited)
Three Months Ended March 31,
----------------------------
2002 2001
---- ----
Net cash used in operating activities of continuing
operations $ (15) $ (20)
--------- ---------
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (5) (21)
Proceeds of investment and fixed asset disposals 11 --
Other, net -- (2)
--------- ---------
Net cash provided by (used in) investing activities
of continuing operations 6 (23)
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds 155 147
Long-term debt repayments (178) (3)
Change in short-term debt 2 (28)
Common stock issued 2 8
--------- ---------
Net cash (used in) provided by financing activities
of continuing operations (19) 124
Net cash provided by discontinued operations 7 27
Effect of exchange rate changes on cash (3) (1)
--------- ---------
Net (decrease) increase in cash and cash equivalents (24) 107
Cash and cash equivalents - beginning of period 76 54
--------- ---------
Cash and cash equivalents - end of period $ 52 $ 161
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 22 $ 38
Preferred security distributions of subsidiary trusts 14 18
Income taxes 71 5
Non-cash investing and financing activities:
Incentive and other employee benefit stock plan -- 5
See accompanying notes to financial statements.
4
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS
(Dollars in millions)
(Unaudited)
Three Months Ended March 31,
----------------------------
2002 2001
---- ----
Net loss $ (580) $ (10)
Foreign currency translation (55) (45)
--------- ---------
Comprehensive loss $ (635) $ (55)
========= =========
See accompanying notes to financial statements.
5
HERCULES INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. These condensed consolidated financial statements of Hercules Incorporated
("Hercules" or the "Company") are unaudited, 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, 2001.
Certain prior period amounts have been reclassified to conform to the current
period presentation.
Pursuant to Securities and Exchange Commission ("SEC") Regulation S-X,
Rule 3-10, the Company is required to provide condensed consolidating financial
information on the Company and its subsidiaries in a prescribed format in all
periodic reports filed with the SEC. The information necessary to present all of
the required disclosures was not available in time to be included in this Form
10-Q filing. The Company is in the process of preparing the required condensed
consolidating financial information and intends to file a Form 10-Q/A, which
will include this information, as soon as it is available.
2. In June 2001, the FASB approved the issuance of Statement of Financial
Accounting Standards No. 143, "Accounting for Asset Retirement Obligations"
("SFAS 143"). SFAS 143 establishes accounting standards for the recognition and
measurement of legal obligations associated with the retirement of tangible
long-lived assets. SFAS 143 will become effective for the Company on January 1,
2003 and requires recognition of a liability for an asset retirement obligation
in the period in which it is incurred. Management is in the process of
evaluating the impact this standard will have on the Company's financial
statements.
On January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"). SFAS 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets.
In April 2002, the FASB issued Statement of Financial Accounting
Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
to FASB Statement No. 13, and Technical Corrections." The Company does not
believe this statement will have a material effect on its financial statements.
3. Discontinued Operations
On April 29, 2002, Hercules completed the sale of the BetzDearborn
Water Treatment Business ("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 10). Pursuant to SFAS 144, the Water Treatment
Business has been treated as a discontinued operation as of February 12, 2002,
and accordingly, 2001 financial information has been restated.
The Paper Process Chemicals Business, representing approximately
one-third of the business originally acquired with BetzDearborn Inc. in 1998,
was fully integrated into and continues to be reported within the Pulp and Paper
Division.
Summarized below are the results of operations for the three months
ended March 31, 2002 and 2001. 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.
6
(Dollars in Millions)
Three Months Ended March 31,
2002 2001
---- ----
Net Sales $ 192 $ 204
--------- ---------
Profit from operations 33 16
--------- ---------
Income before income taxes 35 15
Tax provision 14 6
--------- ---------
Income from operations 21 9
Loss from disposal of business, including taxes of $75 million (230) --
--------- ---------
(Loss) income from discontinued operations $ (209) $ 9
========= =========
The major classes of assets and liabilities included in the
consolidated balance sheet at March 31, 2002 under the captions "Assets
of Business Held for Sale" and "Liabilities of Business Held for Sale"
are as follows:
(Dollars in millions)
Assets of Business Held For Sale:
Accounts receivables, net $ 160
Inventory 76
Fixed assets 216
Goodwill and other intangible assets 1,419
Other assets 43
------
$1,914
======
Liabilities of Business Held For Sale:
Accounts payable $ 57
Accrued expenses 46
Deferred income taxes 171
Other liabilities 6
------
$ 280
======
4. Goodwill and Other Intangible Assets
Effective January 1, 2002 the Company adopted the provisions of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill and intangible assets
with indefinite useful lives are not amortized but instead are reviewed for
impairment at least annually and written down only in periods in which it is
determined that the fair value is less than the recorded value. SFAS 142 also
requires the transitional impairment review for goodwill, as well as an annual
impairment review, to be performed on a reporting unit basis. The Company has
identified the following reporting units: BetzDearborn, Pulp and Paper, Aqualon,
FiberVisions and Resins. In connection with the Company's transitional review,
recorded goodwill was determined to be impaired in the BetzDearborn and
FiberVisions reporting units. The Company completed its transitional impairment
review of 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
relating to the Company's equity investment in CP Kelco, which will also have an
impairment under SFAS 142. After recognition of this impairment, the carrying
value for the Company's investment in CP Kelco is zero.
The following table reflects the effect of the adoption of SFAS 142 on
net income and net income per share as if SFAS 142 had been in effect for the
period presented.
(Dollars in Millions,
except per share)
March 31, 2002 March 31, 2001
-------------- --------------
Net loss before cumulative effect of change in accounting principle
As reported $ (212) $ (10)
Goodwill amortization -- 12
-------------- --------------
Adjusted net (loss)/earnings before cumulative effect of change in
accounting principle $ (212) $ 2
============== ==============
Basic net loss per share before cumulative effect of change
in accounting principle
As reported $(1.95) $(0.09)
Goodwill amortization -- 0.11
-------------- --------------
Adjusted basic (loss)/earnings per share before cumulative
effect of change in accounting principle $(1.95) $ 0.02
============== ==============
Diluted net loss per share before cumulative effect of change
in accounting principle
As reported $(1.95) $(0.09)
Goodwill amortization -- 0.11
-------------- --------------
Adjusted diluted (loss)/earnings per share before cumulative
effect of accounting principle $(1.95) $ 0.02
============== ==============
Net loss
As reported $(580) $(10)
Goodwill amortization -- 12
-------------- --------------
Adjusted net (loss)/earnings $(580) $2
============== ==============
Basic net loss per share:
As reported $(5.32) $(0.09)
Goodwill amortization -- 0.11
-------------- --------------
Adjusted basic (loss)/earnings per share $(5.32) $0.02
============== ==============
Diluted net loss per share:
As reported $(5.32) $(0.09)
Goodwill amortization -- 0.11
-------------- --------------
Adjusted diluted (loss)/earnings per share $(5.32) $0.02
============== ==============
7
Accumulated amortization for goodwill upon adoption of SFAS 142 was
$185 million. The following table shows changes in the carrying amount of
goodwill for the quarter ended March 31, 2002, by operating segment.
Engineered
Performance Materials
Products and Additives Total
-------- ------------- -----
(Dollars in millions)
Balance at January 1, 2002 $ 1,715 $ 172 $ 1,887
Discontinued Operations
BetzDearborn (981) -- (981)
--------- --------- ---------
Total Discontinued Operations (981) -- (981)
--------- --------- ---------
Impairment losses
BetzDearborn, discontinued
operations (113) -- (113)
BetzDearborn, cumulative effect (267) -- (267)
FiberVisions, cumulative effect -- (87) (87)
--------- --------- ---------
Total impairment losses (380) (87) (467)
--------- --------- ---------
Balance at March 31, 2002 $ 354 $ 85 $ 439
========= ========= =========
8
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, January 1, 2002 $ 330 $ 250 $ 140 $ 720
Discontinued operations - BetzDearborn (241) (180) (70) (491)
Foreign currency translation (1) (1) (1) (3)
----------- ----------- ----------- -----------
Balance, March 31, 2002 88 69 69 226
----------- ----------- ----------- -----------
Accumulated Amortization
Balance, January 1, 2002 (26) (21) (59) (106)
Current year amortization (1) (1) -- (2)
Discontinued operations - BetzDearborn 21 16 16 53
Foreign currency translation -- -- -- --
----------- ----------- ----------- -----------
Balance, March 31, 2002 (6) (6) (43) (55)
----------- ----------- ----------- -----------
Net Carrying Amount
Balance, January 1, 2002 304 229 81 614
Current year amortization (1) (1) -- (2)
Discontinued operations - BetzDearborn (220) (164) (54) (438)
Foreign currency translation (1) (1) (1) (3)
----------- ----------- ----------- -----------
Balance, March 31, 2002 $ 82 $ 63 $ 26 $ 171
=========== =========== =========== ===========
Total amortization expense for each of the three month periods ended
March 31, 2002 and 2001 for other intangible assets was $4 million and $7
million, respectively, of which $2 and $3 million, was included in income from
continuing operations for the three months ended March 31, 2002 and 2001,
respectively. Total goodwill amortization expense for the three months ended
March 31, 2001 was $12 million, of which $4 million was included in income from
continuing operations. Estimated amortization expense for 2002 and the five
succeeding fiscal years is as follows: 2002 through 2006 - $9 million per year,
2007 - $8 million.
9
5. The following table shows the amounts used in computing (loss) earnings per
share and the effect on income and the weighted-average number of shares of
dilutive potential common stock:
(In millions, except per share data) Three Months Ended March 31,
----------------------------
2002 2001
---- ----
(Loss) (Loss)
(Loss) earnings per (Loss) earnings per
income share income share
------ ----- ------ -----
BASIC AND DILUTED:
Continuing operations $ (3) $ (0.03) $ (19) $ (0.17)
Discontinued operations (209) (1.92) 9 0.08
Cumulative effect of change in accounting principle (368) (3.37) -- --
Net loss (580) (5.32) (10) (0.09)
Weighted average number of basic shares (millions) 109.0 107.9
6. Cost and expenses include depreciation related to continuing operations of
$18 million and $20 million for the three months ended March 31, 2002 and 2001,
respectively.
7. Other operating expenses for the three months ended March 31, 2002 and 2001
include environmental charges of approximately $1 million and $3 million,
respectively. The three months ended March 31, 2002 includes additional
non-recurring restructuring charges of $4 million associated with the
comprehensive cost reduction and work process redesign program announced in
September 2001 (see Note 9).
8. Interest and debt costs are summarized as follows:
(Dollars in millions) Three Months Ended March 31,
----------------------------
2002 2001
---- ----
Costs incurred $ 36 $ 57
Amount capitalized -- (2)
--------- ---------
Interest expense $ 36 $ 55
========= =========
9. The consolidated balance sheet reflects liabilities for employee severance
benefits and other exit costs of $36 million and $43 million, respectively, at
March 31, 2002 and December 31, 2001. 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. The Company incurred restructuring
charges of $51 million, which includes charges of $46 million for employee
termination benefits and $5 million for exit costs related to facility closures.
During the first quarter of 2002, as a result of additional employee
terminations, the estimate for severance benefits pertaining to the 2001 plan
increased by $4 million. Under this plan, approximately 1,050 employees have
left or will leave the Company. The plan includes reductions throughout the
Company with the majority of them from support functions as well as the
BetzDearborn and Pulp and Paper Divisions.
The restructuring liabilities also include amounts relating to the 1998
plan initiated upon the acquisition of BetzDearborn and additional plans that
the Company committed to in 2000 relating to the restructuring of the
BetzDearborn and Pulp and Paper Divisions and corporate realignment due to the
divestiture of non-core businesses. The total number of employee terminations
relating to the 1998 plan is 889. The total number of employee terminations
relating to the 2000 plan is 212. Actions under the 1998 and 2000 plans are
complete.
Pursuant to the 2001 plan described above, approximately 796 employees
were terminated through March 31, 2002. Cash payments during the first quarter
of 2002 included $11 million for severance benefits and other exit costs.
Severance benefits paid during the first quarter represent the continuing
benefit streams of previously terminated employees under all three plans as well
as those terminated in the current year. Severance benefits were paid in
10
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,
--------- ------------
2002 2001
---- ----
Balance at beginning of year $ 43 $ 34
Additional termination benefits and other exit costs 4 51
Cash payments (11) (25)
Reversals against goodwill -- (10)
Reversals against earnings -- (7)
--------- ---------
Balance at end of period $ 36 $ 43
========= =========
The balance at the end of the period represents severance benefits and
other exit costs of which $28 million pertains to the 2001 restructuring plan,
$5 million pertains to the 1998 BetzDearborn plan and $3 million relates to
other restructuring plans initiated in 2000.
10. A summary of short-term and long-term debt follows:
(Dollars in millions)
March 31, December 31,
2002 2001
---- ----
SHORT-TERM:
Banks $ 11 $ 9
Current maturities of long-term debt 194 242
--------- ---------
$ 205 $ 251
========= =========
At March 31, 2002, the Company had $39 million of unused lines of
credit that may be drawn as needed. Lines of credit in use at March 31, 2002,
were $11 million.
(Dollars in millions)
March 31, December 31,
2002 2001
---- ----
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 loan tranche A due in varying amounts through 2003 436 543
Term loan tranche D due 2005 370 372
Revolving credit agreement due 2003 605 516
ESOP debt 83 84
Term notes at various rates from 5.23% to 9.60% due in varying
amounts through 2006 49 52
Other 7 6
--------- ---------
$ 2,178 $ 2,201
Current maturities of long-term debt (194) (242)
--------- ---------
Net long-term debt $ 1,984 $ 1,959
========= =========
11
In 1998, the Company entered into a $3,650 million credit facility with
a syndicate of banks which includes varying maturity term loans totaling $2,750
million, of which $436 million was outstanding at March 31, 2002. In addition,
the facility includes a $900 million revolving credit agreement, of which $605
million was outstanding at March 31, 2002. As of March 31, 2002, $295 million of
the multi-currency revolver was available for use, however, the Company's
incremental borrowing capacity was approximately $61 million. Actual
availability under the revolving credit agreement is constrained by the
Company's ability to meet covenants in its senior credit facility.
Both the Company's senior credit facility and its ESOP credit facility
require quarterly compliance with certain financial covenants, including a
debt/EBITDA ratio ("leverage ratio"), an interest coverage ratio and minimum net
worth. Effective March 6, 2002, the facilities were amended to (i) modify
certain financial covenants (ii) change the mandatory prepayment provisions;
(iii) permit the reorganization of the Company in order to effect the separation
of the Water Treatment Business; and (iv) permanently reduce the revolving
committed amount under the credit facility to $200 million. The amendment to the
credit facility also included provisions that became effective upon the
consummation of the sale of the Water Treatment Business and the prepayment of
the credit facility, which occurred on April 29, 2002. These additional
provisions include the following: (i) the release of the subsidiary stock
pledged to the collateral agent; (ii) the elimination of the requirement that
stock of any additional subsidiaries be pledged in the future; and (iii) the
revision of the permitted amount of asset purchases and dispositions.
The Company used the net proceeds of approximately $1.7 billion from
the sale of the Water Treatment Business (see Note 3) to permanently reduce
long-term debt, repaying in full the following borrowings: Term Loan Tranche A,
Term Loan Tranche D, the Revolving Credit Agreement and the ESOP credit
facility. A portion of the net proceeds ($73 million) was used to collateralize
the Company's outstanding letters of credit.
Effective with the consummation of the sale of the Water Treatment
Business and the application of the net proceeds, the revolving credit facility
was permanently reduced from $900 million to $200 million. Of the $200 million
revolving credit facility, $170 million can be used for multi-currency
denominated borrowings and $30 million is restricted to U.S. dollar-denominated
debt. The amendment also resulted in the cancellation of the Canadian revolving
credit facility. In addition, as a result of these repayments, in the second
quarter of 2002 the Company will recognize an extraordinary loss of
approximately $45 million.
11. Company-obligated Preferred Securities of Subsidiary Trusts consists of:
(Dollars in millions)
March 31, December 31,
2002 2001
---- ----
9.42% Trust Originated Preferred Securities $ 362 $ 362
6 1/2% CRESTS Units 262 262
--------- ---------
$ 624 $ 624
========= =========
12. Commitments and Contingencies
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 estimated range of the reasonably possible share of costs
for the investigation and cleanup is between $80 million and $254 million. The
Company believes that the actual cost will more likely approximate $80 million
based on its estimation methods and prior experience. 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 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 or other government agencies or from previously
named PRPs, who either request information or notify the Company of its
potential liability. The Company
12
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 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 by the Court. Both prior to and following the abandonment of the
site, the U.S. Environmental Protection Agency (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 for and the 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 in 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 a
determination of whether the harms at the site giving rise to the government's
claims were divisible, as well as other findings of the District Court. 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 and continued through
October 19, 2001, and resumed on December 11, 2001, concluding 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. Should the Company prevail on
remand, any liability to the government will be either eliminated or reduced.
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
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
13
Supreme Court reversed the trial court was the trial court's application of pro
rata allocation to determine the extent of the insurers' liability. At this
time, proceedings at the trial court have not yet commenced.
The Allegany Ballistics Laboratory ("ABL") is a government owned
facility which was operated by Hercules from 1945 to 1995. The United States
Department of the Navy has notified Hercules that the Navy 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 that
it 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 Company's contracts with the government
pursuant to which the Company operated ABL may insulate the Company from some or
all of the amounts 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, 2002, the accrued liability of $80 million for
environmental remediation represents management's best estimate of the probable
and reasonably estimable costs related to environmental remediation. The extent
of liability is evaluated quarterly. The measurement of the liability is
evaluated 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 a
regular 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 will be 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 a regular basis, with the
number of new claims averaging approximately 2,200 per year during the past two
years. As of February 2002, the Company had pending approximately 5,170
unresolved claims, of which approximately 625 are premises claims. In addition,
as of February 2002, there were pending approximately 5,830 unpaid claims which
have been settled or are subject to the terms of a settlement agreement. In
accordance with the terms of the previously mentioned agreement with several
insurance carriers, as well as agreements with two other excess insurance
carriers, the majority of the amounts paid and to be paid to resolve those
claims will be insured.
The Company anticipates that the primary and first level excess
insurance policies referenced above will exhaust over the next 12 to 24 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 presently pays to resolve those claims,
and anticipated future claims (the Company's assumption being that the number of
future claims filed per year and claim resolution payments remain relatively
consistent with the Company's past experience, and that these matters cease to
be an ongoing liability after ten years), the Company believes that it and its
former subsidiary together have sufficient additional insurance to cover the
majority of its current and future asbestos-related liabilities. 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 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 sometime in 2003, the Company might be required to completely fund
these matters while it seeks reimbursement from its carriers.
14
Based on the assumptions set forth in the preceding paragraph, the
reasonably possible future financial exposure for these matters is estimated to
be less than $200 million. As stated above, the Company presently believes that
the majority of this financial exposure will be funded by insurance proceeds.
Cash payments related to this exposure are expected to be made over an extended
number of years.
Due to the dynamic nature of asbestos litigation and the present
uncertainty concerning the participation of its excess insurance carriers,
however, the Company's estimates are inherently uncertain, and these matters may
present significantly greater and longer lasting financial exposures than
presently anticipated. As a result, the Company's liability with respect to
asbestos-related matters could exceed the amount noted above. If the Company's
liability does exceed that amount, 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 Company has estimated and, therefore, recorded a gross liability
for asbestos-related matters in its March 31, 2002 balance sheet of $80 million.
The Company believes that it is probable that $63 million of that amount will be
funded by or recovered from insurance carriers. Accordingly, the Company has
recorded an asset in this amount in its March 31, 2002 balance sheet.
In June 1998, Hercules and David T. Smith Jr., a former Hercules
employee and a former 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 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. Although venue had been removed to the United States District Court for
the Northern District of Georgia, the case was ultimately remanded back to state
court. Both the Coley and the Erica Nicole Sullivan cases are in the early
stages of motion practice and discovery. The Company denies any liability to
plaintiffs, and it will vigorously defend both of these cases.
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 in the early stages of motion practice and discovery. On March 11, 2002, the
Court tentatively granted plaintiffs' Motion to Certify Class. That Order was
made final on May 2, 2002. The Company is named in connection with its former
Composites Products Division, which was sold to Hexcel Corporation in 1996, has
denied liability and will vigorously defend this action.
Beginning in 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
Proceedings 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.
By letter dated April 22, 2002, the Company and others were placed on
notice of a potential consumer class action which may be filed in Massachusetts
alleging damages relating to the alleged price fixing of carbon fiber. No
action, however, has yet been filed. Further, the Company has learned that in
early April 2002, the US District Court for the Southern District of California
unsealed an action captioned Randall M. Beck, et al. v. Boeing Defense and Space
Group, Inc., et al. (Civil Action No. 99 CV 1557 JM JAH). That action had been
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
15
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 has not yet been
served with process in this action.
In connection with the grand jury investigation noted above, 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.
In December 1999, an action was filed in the U.S. District Court for
the Eastern District of Pennsylvania on behalf of two classes of individuals:
(1) veterans of the South Korean military who claim they were exposed to Agent
Orange and other chemical defoliants used in the demilitarized zone between
North and South Korea between 1967 and 1970 and (2) veterans of the United
States military who claim to have been similarly exposed. This case is captioned
Chang Ok-Lee, Individually and as Representative of a Class, and Thomas Wolfe,
Individually and as Representative of a Class v. Dow Chemical Co., et al., Civil
Action No. 99-6127 (U.S. District Court, Eastern District of Pennsylvania).
During 2000, this case was transferred by the Multi-District Litigation (MDL)
Panel to the United States District Court for the Eastern District of New York,
where Agent Orange cases have previously been consolidated. In late 2001, this
case was dismissed voluntarily by the plaintiffs, with plaintiffs retaining the
right to re-file in the future.
In 1999, the Company was sued by Hexcel Corporation (Hexcel) in a case
captioned Hexcel Corporation v. Hercules Incorporated, Index No. 602293/99,
Supreme Court of New York, County of New York. In that case, Hexcel sought
recovery of a total of approximately $8,422,000 (plus interest) in alleged
"post-closing" adjustments to the purchase price paid by Hexcel for Hercules'
former Composite Products Division. The basis for these alleged "adjustments"
derive from the Sale and Purchase Agreement between Hercules and Hexcel dated as
of April 15, 1996. In June 2000, the Court granted Hexcel's motion for summary
judgment as to liability, finding the Company liable to Hexcel on technical
grounds, but reserved ruling on the amount of damages. The Court then referred
the damages determination to a Special Referee. In January 2001, the Special
Referee issued a report, recommending that the Company be found liable to Hexcel
for a total of approximately $7,300,000 plus interest, costs and expenses. In
February 2001, Hexcel moved to confirm the Special Referee's Report and the
Company moved to confirm in part and reject in part the Special Referee's
Report. The Company specifically challenged the majority of the Special
Referee's findings, and argued that a $2,000,000 indemnity "basket" established
by the terms of the April 1996 Sale and Purchase Agreement should apply,
reducing any award to Hexcel by $2,000,000. In May 2001, the Court accepted the
Special Referee's Report and rejected the Company's position. As a result,
judgment was entered against the Company in the amount of $10,219,685, which
included pre-judgment interest, costs and expenses. The Company appealed to the
Supreme Court, Appellate Division, First Department. On February 5, 2002, the
Supreme Court of New York, Appellate Division, First Department, affirmed the
decision of the trial court, entering judgment in favor of Hexcel in the full
amount. Interest continues to accrue. The Company continues to believe that the
decision of the trial and intermediate appellate courts is incorrect, and has
filed a Motion for Reargument or for Leave to Appeal to the Court of Appeals.
That motion was denied on March 19, 2002. On April 8, 2002, Hercules filed a
motion for Leave to Appeal to the New York Court of Appeals directly with the
Court of Appeals. The granting of a motion for an appeal to the Court of Appeals
is discretionary and there can be no assurance that it will be granted. In
addition to the foregoing, in October 2000, Hexcel brought an action against
Hercules to compel arbitration to determine the proper "Working Capital
Adjustment" under the terms of the Sale and Purchase Agreement. Hexcel claimed
it was owed approximately $1,500,000, while the Company claimed that it was owed
approximately $129,000. In late 2001, this matter was submitted to binding
arbitration. In December 2001, the arbitrator found in the Company's favor and
awarded damages to the Company of $129,000.
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 senior debt by the securities markets. The
complaint seeks over $430 million in direct damages, as well as punitive
damages. 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
16
be awarded to CP Kelco U.S. in its action against Pharmacia. The Company
believes that the third-party lawsuit against it and Lehman is without merit.
The Company has denied any liability to Pharmacia and is vigorously defending
this action.
At March 31, 2002, the consolidated balance sheet reflects a current
liability of approximately $52 million and a long-term liability of
approximately $51 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 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.
13. Segment Information
Upon the decision to divest the Water Treatment Business, the
Company realigned its reportable segments. The new reportable segments are
Performance Products and Engineered Materials and Additives. The Performance
Products segment is comprised of the Pulp and Paper Division and the Aqualon
Division; the Engineered Materials and Additives segment is composed of
FiberVisions and the Rosin and Terpenes Division.
(Dollars in millions)
Three Months Ended March 31,
----------------------------
2002 2001 (a)
---- --------
Net Sales:
Performance Products $ 327 $ 334
Engineered Materials and Additives (b) 75 164
--------- ---------
Consolidated $ 402 $ 498
========= =========
Profit from Operations:
Performance Products $ 58 $ 38
Engineered Materials and Additives (b) 3 13
Reconciling Items (c) (7) (5)
--------- ---------
Consolidated $ 54 $ 46
========= =========
(a) Net sales and Profit from operations in 2001 have been reclassified to
conform to the current year presentation. As discussed above, the
reportable segments of the Company have been realigned subsequent to
the sale of the BetzDearborn Water Treatment Business. In addition,
substantially all the reconciling items have been allocated to the
segments. The reconciling items primarily include corporate expenses
and intangible asset amortization.
(b) Net sales and Profit from operations in 2001 include the results of
hydrocarbon resins, select rosin resins and the peroxy chemicals
businesses which were divested in May 2001.
(c) Reconciling items for the three months ended March 31, 2002 include
restructuring charges and other corporate costs not allocated to the
businesses. Reconciling items for the three months ended March 31, 2001
include environmental costs and other corporate costs not allocated to
the businesses.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
RESULTS OF OPERATIONS
Within the following discussion, unless otherwise stated, "quarter" and
"three-month period" refer to the first quarter of 2002 and the three months
ended March 31, 2002. All comparisons are with the corresponding periods in the
previous year, unless otherwise stated.
The tables below reflect Net sales and Profit from operations for the three
months ended March 31, 2002 and 2001.
On April 29, 2002, the Company completed the sale of its BetzDearborn
Water Treatment Business ("Water Treatment Business"). Accordingly, the Water
Treatment Business has been treated as a discontinued operation. Following the
divestiture, the Company realigned its reportable segments. The new reportable
segments are Performance Products, consisting of
17
the Pulp and Paper and Aqualon Divisions, and Engineered Materials and
Additives, consisting of the FiberVisions and Rosin and Terpenes Divisions. In
addition, substantially all reconciling items have been allocated to the
segments. The reconciling items primarily include corporate expenses and
goodwill and intangible asset amortization. Results of operations for 2001 have
been restated to conform to the current year presentation.
Effective January 1, 2002, with the adoption of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets," the
Company ceased amortization of goodwill and other indefinite lived intangible
assets. Goodwill amortization totaled $12 million in the quarter ended March 31,
2001, of which approximately $4 million related to continuing operations and $8
million related to discontinued operations.
In May 2001, the Company completed divestitures of its hydrocarbon
resins business, select portions of its rosin resins business, and its peroxy
chemicals business (the "Resins Divestitures").
(Dollars in millions)
Add Back of
Non-Recurring Divested Goodwill
Reported Items Businesses Amortization Total
-------- ----- ---------- ------------ -----
THREE MONTHS ENDED MARCH 31, 2002:
Net Sales by Industry Segment
Performance Products $ 327 $ -- $ -- $ -- $ 327
Engineered Materials and Additives 75 -- -- -- 75
Reconciling Items -- -- -- -- --
--------- --------- --------- --------- ---------
Total $ 402 $ -- $ -- $ -- $ 402
========= ========= ========= ========= =========
Profit from Operations by Industry Segment
Performance Products $ 58 $ -- $ -- $ -- $ 58
Engineered Materials and Additives 3 -- -- -- 3
Reconciling Items (7) 2 -- -- (5)
--------- --------- --------- --------- ---------
Total $ 54 $ 2 $ -- $ -- $ 56
========= ========= ========= ========= =========
THREE MONTHS ENDED MARCH 31, 2001:
Net Sales by Industry Segment
Performance Products $ 334 $ -- $ -- $ -- $ 334
Engineered Materials and Additives 164 -- (82) -- 82
Reconciling Items -- -- -- -- --
--------- --------- --------- --------- ---------
Total $ 498 $ -- $ (82) $ -- $ 416
========= ========= ========= ========= =========
Profit from Operations by Industry Segment
Performance Products $ 38 $ -- $ -- $ 3 $ 41
Engineered Materials and Additives 13 -- (6) 1 8
Reconciling Items (5) 1 -- -- (4)
--------- --------- --------- --------- ---------
Total $ 46 $ 1 $ (6) $ 4 $ 45
========= ========= ========= ========= =========
Consolidated net sales decreased $96 million, or 19%, and profit from
operations increased $8 million, or 17%, versus 2001. The decline in net sales
primarily reflects the effects of the Resins Divestitures. Unfavorable foreign
currency exchange translation, principally due to the weaker Euro, contributed
approximately $9 million to the decrease in net sales. In addition, FiberVisions
net sales decreased approximately 11% largely driven by contractual customer
pass through of lower polypropylene costs. The improvement in profit from
operations is due primarily to the cost reductions generated by the work process
redesign programs. Prospectively, the Company anticipates normal seasonal pickup
in its businesses in the second quarter, however, demand in the underlying
markets for these businesses remains weak. The Company expects that earnings
improvements will be generated primarily by continued cost savings realized from
the implementation of work process improvements.
In the Performance Products segment, net sales were down 2% while
profit from operations increased 52%. In the Pulp and Paper Division, net sales
declined 2% and profit from operations improved 31%. The sales decline in Pulp
and Paper resulted from lower volumes and unfavorable exchange translation.
Excluding goodwill amortization from first quarter 2001 results, current year
profit from operations improved in Pulp and Paper 13% over the same period last
year due to cost improvements and favorable sales mix. In the Aqualon Division,
net sales declined 3% and profit from operations improved 74%. Excluding the
impact of the weaker Euro, net sales were flat in the first quarter versus the
first quarter 2001. The increase in profit from operations was driven by lower
manufacturing costs and favorable volume mix.
In the Engineered Materials and Additives segment, excluding divested
businesses, net sales declined 9% and profit from operations declined $5
million, or 57%. In the FiberVisions Division, net sales declined 11% and profit
from
18
operations declined 52%. Lower sales in the quarter were largely driven by
contractual customer pass through of lower polypropylene costs. The unfavorable
variance in profit from operations versus the first quarter 2001 is largely due
to an accrual reversal favorably benefiting the first quarter 2001. Excluding
divested businesses, Rosin and Terpenes net sales were essentially flat and
profit from operations declined about $1 million.
Interest and debt expense and preferred security distributions of
subsidiary trusts decreased $19 million, primarily due to lower outstanding debt
balances, reflecting the application of proceeds from 2001 assets sales, and
lower interest costs. The Company used proceeds from asset sales to reduce debt
balances by approximately $336 million in 2001. Following the sale of the
Water Treatment Business, the Company expects interest expense to
be reduced by approximately $20 million per quarter.
Other expense, net increased $2 million due to lower interest income
and higher miscellaneous charges.
The effective tax rate for the quarter for continuing operations was
200% versus 40% for the same period 2001. The anticipated tax rate for 2002 is
45%. The rate for the 2002 quarter is unfavorably impacted by a lower pre-tax
loss from continuing operations.
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. 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 10).
Pursuant to SFAS 144, the Water Treatment Business has been treated as a
discontinued operation as of February 12, 2002, and accordingly, 2001 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. originally acquired in 1998, was
fully integrated into and continues to be reported within the Pulp and Paper
Division.
ADOPTION OF SFAS NO. 142
The Company implemented Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142") during the first
quarter 2002. Under the provisions of this standard, goodwill and intangible
assets with indefinite useful lives are not amortized but instead are reviewed
for impairment at least annually and written down only in periods in which it is
determined that the fair value is less than the recorded value. In connection
with the Company's transitional review, recorded goodwill was determined to be
impaired in the BetzDearborn and FiberVisions reporting units. The Company
recognized after tax impairment charges of $262 million in the BetzDearborn
reporting unit and $87 million in the FiberVisions reporting unit. In addition,
an after tax impairment charge of $19 million was recognized for the Company's
equity investment in CP Kelco. After recognition of this impairment charge, the
Company's book carrying value in CP Kelco is zero.
FINANCIAL CONDITION
Liquidity and Financial Resources: Net cash used in continuing
operations was $15 million for the first quarter 2002 compared to cash used in
continuing operations of $20 million in the first quarter 2001. The increase
primarily reflects lower working capital requirements and a lower net loss
offset by less depreciation and amortization. Current and quick ratios,
excluding assets and liabilities of business held for sale, have decreased to
..62 and .43, respectively, at March 31, 2002, compared with .92 and .66,
respectively, at December 31, 2001. As of March 31, 2002, the Company has $295
million available under its revolving credit agreement and $39 million of
short-term lines of credit. The Company's incremental borrowing capacity at
March 31, 2002 was $61 million. The Company expects to meet short-term cash
requirements from operating cash flow and availability under lines of credit.
However, actual availability is constrained by the Company's ability to meet
covenants in its senior credit facility. Future compliance with debt covenants
is dependent upon generating sufficient EBITDA and cash flow which are, in turn,
impacted by business performance, economic climate, competitive uncertainties
and possibly the resolution of contingencies.
Effective March 6, 2002, the Company amended its senior credit facility
and ESOP credit facility to (i) modify certain financial covenants; (ii) change
the mandatory prepayment provisions; (iii) permit the reorganization of the
Company in order to effect the separation of the Water Treatment Business; and
(iv) permanently reduce the revolving committed amount under the credit facility
to $200 million. The amendment to the credit facilities also included provisions
that became effective upon the consummation of the sale of the Water Treatment
Business and the prepayment of the credit facility, both of which were completed
on April 29, 2002. These additional provisions include the following: (i) the
release of the
19
subsidiary stock pledged to the collateral agent; (ii) the elimination of the
requirement that stock of any additional subsidiaries be pledged in the future;
and (iii) the revision of the permitted amount of asset purchases and
dispositions. The Company used the net proceeds of approximately $1.7 billion
from the Water Treatment Business sale to permanently reduce long-term debt,
repaying in full the following borrowings: Term Loan Tranche A, Term Loan
Tranche D, the Revolving Credit Agreement and the ESOP credit facility. A
portion of the net proceeds ($73 million) was used to collateralize the
Company's outstanding letters of credit. The revolving credit facility was
permanently reduced from $900 million to $200 million. Of the $200 million
revolving credit facility, $170 million can be used for multi-currency
denominated borrowings and $30 million is restricted to U.S. dollar-denominated
debt. The amendment also resulted in the cancellation of the Canadian revolving
credit facility. In addition, as a result of these repayments, in the second
quarter of 2002 the Company will recognize an extraordinary loss of
approximately $45 million.
Capital Structure and Commitments: Total capitalization (stockholders'
equity, Company obligated preferred securities of subsidiary trusts and debt)
decreased to $2.9 billion at March 31, 2002, from $3.5 billion at year-end 2001.
The ratio of debt-to-total capitalization increased to 76% at March 31, 2002
from 62% at December 31, 2001. After the application of the proceeds from the
Water Treatment Business sale, the debt-to-total capitalization ratio was
approximately 50% at March 31, 2002.
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 over a one-year period, 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 consist of debt instruments, interest rate swaps and currency
swaps. At March 31, 2002, net market value of these combined instruments was a
liability of $2.7 billion. The sensitivity analysis assumes an 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, 2002 would result in a $67 million decrease in the net market value of the
liability. A 100-basis point decrease in interest rates at March 31, 2001 would
result in an $72 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 forwards and options and represent a
net asset position of $.5 million at March 31, 2002. The following sensitivity
analysis assumes an instantaneous 10% change in foreign currency exchange rates
from year-end levels, with all other variables held constant. A 10%
strengthening of the U.S. dollar versus other currencies at March 31, 2002 would
result in an $8 million increase in the net asset position, while a 10%
weakening of the dollar versus all currencies would result in a $10 million
decrease in the 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 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 SFAS 133 and, accordingly, changes in the fair value of derivatives are
recorded each period in earnings.
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 $80 million and $254 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 12 in Notes
to Financial Statements).
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.
20
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, labor-related
matters, patent infringement, environmental proceedings, property damage and
personal injury matters. 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 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 12 in Notes to
Financial Statements).
FORWARD-LOOKING STATEMENT
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 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: inability to
generate cash and reduce debt, 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, 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, and adverse changes in economic and political climates around the
world. 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 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.
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
Results of Operations and Financial Condition.
21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For information related to Legal Proceedings, see Notes to
Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during
the first quarter 2002, through the solicitation of proxies or
otherwise.
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 12, 2002 5,7 No
22
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 23, 2002
By: /s/ Fred G. Aanonsen
----------------------------------
Fred G. Aanonsen
Vice President and Controller
(Principal Accounting Officer and
duly authorized signatory)
May 23, 2002
23
EXHIBIT INDEX
Number Exhibit
------ -------
10.1 Eighth Amendment with respect to Note Purchase Agreement,
dated as of March 6, 2002, among Hercules Incorporated,
Putnam Fiduciary Trust Company, and The Prudential Insurance
Company of America.
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