Capital additions
Our capital additions for the three years ended December 31, 2005, 2004, and 2003, respectively, were $14,059, $12,447, and $12,527. The capital expenditures in 2005, 2004, and 2003 were primarily for maintenance capital and building our plant in Suzhou, China. Capital expenditures in 2004 also included additions to our plant in Wigan, United Kingdom. Future yearly capital requirements are not expected to exceed $15,000.
Acquisition of business
In June 2005, we acquired all of the outstanding capital stock of Autotype International Ltd. and associated entities from Norcros (Holdings) Limited of the UK (“Autotype”). Net assets acquired, including goodwill and intangibles, totaled $92,432. The net assets and results of operations are included in our financial statements since the acquisition date. In June 2005, we also acquired a marketing distribution channel for our North American printing blankets business for $995. Of this amount, $245 was accrued in related costs as of December 31, 2005. For more information regarding these acquisitions see Note 17 in our Notes to the Consolidated Financial Statements.
Dividends
Dividends paid on our common stock for the three years ended December 31, 2005, 2004, and 2003, totaled $6,693, $3,635, and $3,754, respectively, or $0.24 , $0.16, and $0.10 per share, respectively. All dividends were paid out of current earnings. We expect to pay quarterly cash dividends in the future, although such payment is dependent upon our financial condition, results of operations, capital requirements, alternative uses of capital and other factors. Our revolving credit facility and bond facilities also have restricted payment covenants which could limit the amount the amount of dividends payable. Dividends for fiscal year 2006 are expected to approximate $7,344.
Common Stock Repurchases
The Board of Directors from time-to-time authorizes the purchase of issued and outstanding shares of MacDermid, Inc.'s common stock. Pursuant to such authorization, in a privately negotiated transaction, MacDermid acquired 1,350,000 common shares on May 7, 2003, for $22.60 per share, and acquired 851,720 common shares on September 22, 2003, for $25.00 per share. Future repurchases of additional shares may be acquired through privately negotiated transactions or on the open market, and will depend on various factors, including the market price of the shares, our business and financial position, borrowing covenants, as well as general economic and market conditions. Additional shares acquired pursuant to such authorizations will be held in our treasury and will be available for us to issue for various corporate purposes without further shareholder action (except as required by applicable law or the rules of any securities exchange on which the shares are then listed). On May 12, 2005, the Board of Directors authorized the repurchase of up to an aggregate of 5,000,000 shares of the Company’s common stock, replacing all previous authorizations, and at December 31, 2005, such a repurchase would cost approximately $139,500.
Adequacy of Liquidity Sources
We believe that cash flows from operations and availability under our revolving credit facility will be sufficient to meet our long-term debt maturities, projected capital expenditures and anticipated working capital requirements for the foreseeable future; however, our cash flows from operations, borrowing availability and overall liquidity are subject to risks and uncertainties, as described in “—Executive Overview”, and in Item 1A, “Risk Factors,” and our statement regarding “Safe Harbor for Forward-Looking Information”, both of which may be found in our Annual Report on Form 10-K for the year ended December 31, 2005.
Off-Balance Sheet Arrangements
We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”) or variable interest entities (“VIEs”). SPEs and VIEs can be established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2005, we are not involved in any unconsolidated SPEs or VIEs.
CUSTOMER CONCENTRATIONS
There is no major portion of our business that is dependent upon a single customer or a few customers.
LEGAL AND ENVIRONMENTAL MATTERS
Environmental Issues:
The nature of our operations, as manufacturers and distributors of specialty chemical products, expose us to the risk of liability or claims with respect to environmental cleanup or other matters, including those in connection with the disposal of hazardous materials. As such, we are subject to extensive U.S. and foreign laws and regulations relating to environmental protection and worker health and safety, including those governing discharges of pollutants into the air and water, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated properties. We have incurred, and will continue to incur, significant costs and capital expenditures in complying with these laws and regulations. We could incur significant additional costs, including cleanup costs, fines, sanctions, and third-party claims, as a result of violations of or liabilities under environmental laws. In order to ensure compliance with applicable environmental, health and safety laws and regulations, we maintain a disciplined environmental and occupational safety and health compliance program, which includes conducting regular internal and external audits at our plants to identify and categorize potential environmental exposure.
Asset Retirement Obligations:
Asset retirement obligations are based principally on legal and regulatory requirements. At December 31, 2005, we have accrued $1,404 for our asset retirement obligation for properties where we can make a reasonable estimate of the future cost. On an ongoing basis, our management evaluates their estimates and assumptions; however, actual amounts could differ from those based on such estimates and assumptions. Changes in the estimate during three years ended December 31, 2005 have not been significant.
Environmental Remediation:
As of December 31, 2005, we reserved $2,715 for various environmental matters. Ultimate costs may vary from current estimates and reserves, and the discovery of additional contaminants at these or other sites, or the imposition of additional cleanup obligations, or third-party claims relating thereto, could result in significant additional costs.
The following summary provides some details regarding the Company’s environmental liabilities:
| · | We are named as a potentially responsible party (“PRP”) at two Superfund sites (Fike-Artel in Nitro, West Virginia, and Solvents Recovery in Southington, Connecticut), in which many other PRPs are also involved. With respect to both of these sites, we have entered into cost sharing agreements that result in costs of less than $10 per year for funding the Company’s share of the ongoing cleanup costs at each site. No reserve has been established, given the deminimus nature of the costs. Our cost sharing percentage at each site is 0.2%. On October 31, 2005, the Environmental Protection Agency (“EPA”) notified the Company of alleged deminimus responsibility for certain contamination at the Mercury Refining Site in New York. MacDermid entered into a settlement agreement with the EPA to resolve this deminimus liability for a payment of $1. |
| · | Some of our facilities have an extended history of chemical and industrial activity. We are directly involved in the remediation of sites that have environmental contamination arising from its operations. These sites include certain sites such as the Kearny, New Jersey and Waukegan, Illinois sites, which were acquired in the December 1998 acquisition of W. Canning plc. With respect to the Kearny, New Jersey site, our Canning subsidiary withheld, under the Acquisition Agreement (“the Acquisition Agreement”), a deferred purchase price payment of approximately $1,600. We estimate the range of clean-up costs at these sites to be between $2,000 and $5,000. The owners of the Kearny, New Jersey site have primary responsibility for clean-up costs that exceed the deferred purchase price. Investigations into the extent of contamination at these sites are, however, ongoing. |
| · | We are in the process of characterizing contamination at our Huntingdon Avenue, Waterbury, Connecticut site, which was closed in the quarter ended September 30, 2003. The extent of required remediation activities at the Huntingdon Avenue site has not yet been determined; however, we do not anticipate that we will be materially affected by the environmental remediation costs. |
Legal Proceedings:
From time to time, there are various legal proceedings pending against us. We consider all such proceedings to be ordinary litigation incident to the nature of our business. Certain claims are covered by liability insurance. We believe that the resolution of these claims, to the extent not covered by insurance, will not individually or in the aggregate, have a material adverse effect on our financial position or results of operations. To the extent reasonably estimable, reserves are established regarding pending legal proceedings. On July 25, 2005, the Company settled a litigation which had been brought against the Company by a supplier in exchange for a payment of $5,000. The litigation had arisen as a result of a contractual dispute. The underlying contract and the dispute had been inherited by a Company subsidiary as a result of the acquisition of PTI, Inc. in December 1999. The Company had previously reserved $2,500 as a contingency in this litigation. As a result of the July 2005 settlement, we charged an additional $2,500 against our second quarter results. We paid the full settlement amount during the third quarter of 2005.
CRITICAL ACCOUNTING ESTIMATES
General: In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management must make estimates and assumptions that effect reported amounts in our consolidated financial statements. Management uses their best judgment based on their understanding and analysis of the relevant circumstances to reach these decisions. These judgments, by nature, are subject to an inherent degree of uncertainty. Accordingly, actual results could differ significantly from the estimates applied. Management has reviewed our critical accounting estimates with our Audit Committee and our Board of Directors.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes the following critical accounting policies reflect the significant estimates and assumptions used in the preparation of the Consolidated Financial Statements.
Allowance for doubtful receivables: We maintain an allowance for estimated credit losses based upon our historical collections experience and any specific customer collection issues that we have identified through continuous monitoring of customer collections and payments. Historically, our provisions for such bad debts based on historical experience have adequately matched actual experience, however, there is no guarantee that we will continue to experience the same credit loss rates as in the past. Further, we are not able to predict future changes in the financial condition of our customers. If circumstances related to our customers deteriorate or if credit loss rates change considerably from past experience, our estimates of the recoverability of our trade receivables could be materially affected, we may be required to record additional allowances. As of December 31, 2005, 2004, and 2003, our allowance for doubtful receivables was $10,966, $11,822, and $11,908, respectively.
Reserve for obsolete inventories: We value inventory at lower of average cost or market and maintain a reserve for estimated inventory obsolescence, which is regularly reviewed by management. Our calculation of the reserve for obsolete inventories considers historical write-offs, customer demand, product evolution, usage rates and quantities of stock on hand. Based on this information, we reserve against obsolete and slow-moving inventory up to the inventory's net realizable value. Significant changes in any of the factors used to estimate this allowance could materially affect our allowance and may require us to record additional reserves, which are expensed through the cost of sales line in our consolidated statement of earnings. Historically, our reserve has been adequate to cover actual expense. As of December 31, 2005, 2004, and 2003, we held reserves of $16,254, $15,274, and $16,179, respectively, related to our inventories.
Goodwill and intangible assets: We evaluate the carrying value of our goodwill and indefinite-lived intangible assets annually, or more often if circumstances warrant, in accordance with Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). Our evaluations require us to estimate future cash flows to be generated by our goodwill and indefinite-lived intangible assets in order to assess the recoverability of these assets. This process requires us to make significant judgments and assumptions about future business conditions, including
future revenues and discount rates, based upon the best information available to us at the time of the assessment. Changes in any of the assumptions we use to perform our impairment testing could have a material effect on our assessment of the recoverability of these assets, and could thereby require us to write down these assets to our estimated net realizable value. If an asset is found to be impaired, the impairment would be recorded in the operating expense line on our consolidated statement of earnings. We performed goodwill and intangible asset impairment testing during our fourth fiscal quarter of 2005 and determined that no balance was impaired. Based on our annual assessment, we do not expect any impairment is forthcoming.
Income taxes: As of December 31, 2005, 2004, and 2003, we recorded deferred tax assets related to income tax loss carry forwards, investment credits and other items of $89,385, $84,476, and $101,782, respectively. These assets were offset by valuation allowances of $12,883, $11,952, and $17,246, respectively, thereby resulting in net deferred tax asset of $76,505, $72,524, and $84,536, for each year. We determine our income tax valuation by considering multiple factors, including the tax jurisdiction, the carry forward period, and our income tax planning strategies. We record a valuation allowance when, based on available evidence, we conclude that it is more likely than not that a portion or all of a deferred tax asset will not be realized. This valuation allowance could change significantly if tax laws change in any of the jurisdictions where we do business or if any of our assumptions used in the calculation of the allowance change significantly. We cannot reasonably foresee any of these changes and base our valuations on best evidence at the time of the assessment. We are also subject to examination of our income tax returns for multiple years by the Internal Revenue Service (“IRS”) and other tax authorities. We periodically assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision and related accruals for income taxes.
Environmental and Other Legal Matters: The nature of our business exposes us to the risk of liability of claims with respect to environmental cleanup or other matters, including those in connection with the disposal of hazardous materials. As such, from time to time, we are subject to costs associated with the cleanup of various contaminated sites (see Note 14 in our Notes to the Consolidated Financial Statements). Because there are often many parties that are held responsible for paying for cleanup, we must estimate our reserve based on the best information we have at the time of assessment. It is our policy to review environmental issues in light of both historical experience and current information and reserve accordingly. We are unable to predict what our actual costs will be for environmental cleanup with complete accuracy. Significant changes in third party cleanup estimates or departures from past experience could have a material impact on our reserves for environmental issues.
We are also subject to litigation in the ordinary course of business (see Note 14 in our Notes to the Consolidated Financial Statements).
We reserve for legal and environmental contingencies when a liability for those contingencies has become probable and the cost is reasonably estimable, in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (“SFAS 5”). Any significant litigation or significant change in our estimates of cleanup costs could materially affect our financial results and cause us to increase our provision for related costs. Any provision made for these costs are expensed to selling, technical and administrative expenses. Historically, our legal and environmental provisions have adequately matched actual expense.
Asset Retirement Obligations: Effective January 1, 2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations”, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and normal use of the asset. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made.
Restructuring Charges: We have recognized restructuring charges related to reductions in workforce, facility closures and facility consolidations. These charges were recorded pursuant to formal plans developed and approved by management. The recognition of restructuring charges in accordance with Statement of Financial Accounting Standard No. 146 Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”) requires that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with these plans. The estimates of future liabilities may change, requiring additional restructuring and impairment charges or the reduction of liabilities already recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with the restructuring programs. For further discussion of our restructuring programs, refer to Note 18 in the Notes to the Consolidated Financial Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations.”
Employee Benefit Plans: We sponsor a defined benefit pension plan and a retirement medical benefit plan for our domestic employees providing retirement benefits based upon years of service and compensation levels. We also sponsored a defined benefit pension plan for our United Kingdom-based employees employed at our Canning subsidiary that was frozen as of April 6, 1997, when the plan was converted from a defined benefit plan to a defined contribution plan. The projected benefit obligations and pension expenses from both of these plans is dependent upon various factors such as the discount rate, actual return on plan assets and the funding of the plan. Management can neither predict the future interest rate environment, which directly impacts the selection of future discount rates, nor predict future asset returns that the pension plan will experience. Changes in these assumptions will affect current year and future year pension expense and the projected benefit obligation. For the domestic defined benefit plan, the Company chose a discount rate which is used to state expected future cash flows at a present value on the measurement date. This rate represents the market rate for high-quality fixed income investments as depicted in a study that the company commissioned during 2005. A lower discount rate increases the present value of benefit obligations and increases pension expense. The discount rate was decreased to 5.5% for the 2005 pension cost determination from 6% in 2004. The Company believes this decrease better reflects the interest rate environment as of the September 30, 2005 measurement date. The 0.5% decrease in the discount rate will cause annual pension expense to increase by approximately $800 in fiscal year 2006. The rate of compensation increase assumption remained constant when compared to the prior fiscal year, at 4.5%. For the foreign defined benefit plan in the United Kingdom, the Company chose a discount rate which is comparable to the fifteen-year UK AA Bond Indices. A lower discount rate increases the present value of benefit obligations and increases pension expense. The discount rate for the foreign plan was decreased to 5.0% for the 2005 pension cost determination from 5.6% in 2004. The foreign defined benefit plan was frozen in 1997; therefore, there is no service-cost component recognized in conjunction with this plan going forward.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 in our Notes to the Consolidated Financial Statements for information on new accounting standards adopted in 2005 or pending adoption.
