UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 October 31, 2002, 109,201,969 shares of registrant's common stock were
outstanding.
EXPLANATORY NOTE
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 the Form
10-Q filed on November 14, 2002 for the quarterly period ended September 30,
2002. The Company has now completed the preparation of the required condensed
consolidating financial information which is included in this Form 10-Q/A in
Note 15 to the financial statements. The Company has also amended the disclosure
in Note 1 to the financial statements to reflect the inclusion of the required
condensed consolidating financial statements.
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HERCULES INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions, except per share) (Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
------- ------- ------- -------
Net sales $ 443 $ 422 $ 1,282 $ 1,379
Cost of sales (Note 6) 273 264 783 884
Selling, general and administrative expenses 86 94 258 302
Research and development 11 12 32 41
Goodwill and intangible asset amortization (Note 4) 2 6 7 19
Other operating expense (income), net (Note 7) 11 43 35 (19)
------- ------- ------- -------
Profit from operations 60 3 167 152
Interest and debt expense (Note 8) 17 46 78 154
Preferred security distributions of subsidiary trusts 15 15 44 44
Other expense, net (Note 9) 67 6 116 5
------- ------- ------- -------
Loss before income taxes and equity loss (39) (64) (71) (51)
(Benefit) provision for income taxes (4) 12 (11) 26
------- ------- ------- -------
Loss before equity income (loss) (35) (76) (60) (77)
Equity (loss) income of affiliated companies, net of tax -- (6) 1 (10)
------- ------- ------- -------
Net loss from continuing operations before
discontinued operations and cumulative effect of change
in accounting principle (35) (82) (59) (87)
Net income (loss) on discontinued operations,
net of tax (Note 3) -- 11 (199) 29
------- ------- ------- -------
Net loss before cumulative effect of change
in accounting principle (35) (71) (258) (58)
Cumulative effect of change in accounting principle,
net of tax, (Note 4) -- -- (368) --
------- ------- ------- -------
Net loss $ (35) $ (71) $ (626) $ (58)
======= ======= ======= =======
Basic and diluted (loss) income per share (Note 5)
Continuing operations $ (0.32) $ (0.76) $ (0.54) $ (0.81)
Discontinued operations $ -- $ 0.10 $ (1.83) $ 0.27
Cumulative effect of change in accounting principle $ -- $ -- $ (3.37) $ --
Net loss $ (0.32) $ (0.66) $ (5.74) $ (0.54)
Weighted average number of shares - basic and diluted (millions) 109.2 108.4 109.2 108.1
See accompanying notes to financial statements.
2
HERCULES INCORPORATED
CONSOLIDATED BALANCE SHEET
(Dollars in millions) (Unaudited)
September 30, December 31,
2002 2001
------- -------
ASSETS
Current assets
Cash and cash equivalents $ 108 $ 76
Accounts and notes receivable, net 375 506
Inventories
Finished products 86 127
Materials, supplies, and work in process 79 106
Deferred income taxes -- 27
------- -------
Total current assets 648 842
Property, plant, and equipment 1,938 2,234
Accumulated depreciation and amortization (1,277) (1,331)
------- -------
Net property, plant, and equipment 661 903
Goodwill and other intangible assets, net (Note 4) 628 2,476
Other assets 911 828
------- -------
Total assets $ 2,848 $ 5,049
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 152 $ 203
Accrued expenses 363 463
Short-term debt (Note 11) 143 251
------- -------
Total current liabilities 658 917
Long-term debt (Note 11) 541 1,959
Deferred income taxes 214 334
Postretirement benefits and other liabilities 621 503
Commitments and contingencies (Note 13)
Company-obligated preferred securities of subsidiary trusts (Note 12) 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 687 697
Unearned compensation (98) (104)
Other comprehensive losses (125) (218)
Retained earnings 1,473 2,099
------- -------
2,020 2,557
Reacquired stock, at cost (shares: 2002 - 50,781,968;
2001 - 51,196,972) (1,830) (1,845)
------- -------
Total stockholders' equity 190 712
------- -------
Total liabilities and stockholders' equity $ 2,848 $ 5,049
======= =======
See accompanying notes to financial statements.
3
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF CASH FLOW
(Dollars in millions) (Unaudited)
Nine Months Ended
September 30,
--------------------
2002 2001
------- -------
Net cash used in operating activities of continuing operations $ (253) $ (85)
------- -------
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (24) (47)
Proceeds of investment and fixed asset disposals 1,811 347
Other, net 2 (7)
------- -------
Net cash provided by investing activities of continuing operations 1,789 293
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds 250 323
Long-term debt repayments (1,773) (595)
Change in short-term debt (7) (98)
Common stock issued 4 14
------- -------
Net cash used in financing activities of continuing operations (1,526) (356)
Net cash provided by discontinued operations 25 148
Effect of exchange rate changes on cash (3) (2)
------- -------
Net increase (decrease) in cash and cash equivalents 32 (2)
Cash and cash equivalents - beginning of period 76 54
------- -------
Cash and cash equivalents - end of period $ 108 $ 52
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 70 $ 112
Preferred security distributions of subsidiary trusts 43 47
Income taxes 152 26
Non-cash investing and financing activities:
Incentive and other employee benefit stock plan 6 9
See accompanying notes to financial statements.
4
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS
(Dollars in millions) (Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------- ----------------
2002 2001 2002 2001
----- ----- ----- -----
Net loss $ (35) $ (71) $(626) $ (58)
Foreign currency translation 12 20 (10) (46)
Reclassification adjustment for loss included
in net loss -- -- 103 --
----- ----- ----- -----
Comprehensive loss $ (23) $ (51) $(533) $(104)
===== ===== ===== =====
See accompanying notes to financial statements.
5
HERCULES INCORPORATED
NOTES TO FINANCIAL STATEMENTS
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 the Form
10-Q filed on November 14, 2002 for the quarterly period ended September 30,
2002. The Company has now completed the preparation of the required condensed
consolidating financial information which is included in this Form 10-Q/A in
Note 15 to the financial statements.
Pursuant to SEC Regulation S-X, Rule 3-16, the Company was required to
provide separate company stand-alone audited financial statements in its Annual
Report on Form 10-K for the fiscal year ended December 31, 2001 for certain
subsidiaries whose stock was pledged as collateral and constituted a substantial
portion of the collateral for the Company's registered debt (the "Collateral
Audits"). The information necessary to present all of the required Collateral
Audits was not available in time to be included in the Form 10-K filing. The
Company has made substantial progress in the preparation of the required
Collateral Audits and intends to file a Form 10-K/A, which will include this
information, before December 31, 2002. Until these Collateral Audits are filed,
the Company will not have any registration statements or post-effective
amendments to registration statements declared effective, and cannot make
offerings under effective registration statements. The stock pledges were
released on April 29, 2002 (see Note 11). As a result, based on the Company's
current debt structure, separate company stand-alone audited financial
statements will not be required in the Company's Annual Report on Form 10-K for
the fiscal year ending December 31, 2002.
The Company believes that the condensed consolidating financial
information required by Regulation S-X, Rule 3-10, is not necessary to make the
statements in its Quarterly Reports on Forms 10-Q and 10-Q/A for the quarters
ended March 31, 2002, June 30, 2002 and September 30, 2002, in light of the
circumstances under which they were made, not misleading as of the end of the
period covered by each such report. The Company also believes that the
Collateral Audits required by Regulation S-X, Rule 3-16, are not necessary to
make the statements in its Annual Report on Form 10-K for the year ended
December 31, 2001, in light of the circumstances under which they were made,
not misleading as of the end of the period covered by such report.
2. In June 2001, the Financial Accounting Standards Board ("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. The Company does not believe this statement will have a material
effect on its 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 has elected to early
adopt the provisions of SFAS 145 related to the rescission of SFAS 4, "Reporting
Gains and Losses from the Extinguishment of Debt" ("SFAS 4"). Accordingly, the
prepayment penalties and the write-off of debt issuance costs relating to the
April 2002 debt repayment (see Note 11) are reported in net loss from continuing
operations. Under SFAS 4, the majority of these costs would have been reported
as an extraordinary loss in the Consolidated Statement of Operations.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs in a
Restructuring)". SFAS 146 defines the timing of the recognition of costs
associated with exit or disposal activities, the types of costs that may be
recognized and the methodology for calculating the fair value of such costs. The
provisions of SFAS 146 are effective for exit or disposal activities that are
initiated after December 31, 2002. The Company does not believe this statement
will have a material effect on its financial statements.
3. Discontinued Operations
On April 29, 2002, the Company completed the sale of the BetzDearborn
Water Treatment Business (the "Water Treatment Business") to GE Specialty
Materials, a unit of General Electric Company. The sale price was $1.8 billion
in cash, resulting in net after tax proceeds of approximately $1.7 billion. The
Company used the net proceeds to prepay debt under its senior credit facility
and ESOP credit facility (see Note 11). Pursuant to 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 and nine
months ended September 30, 2002 and 2001. The loss from discontinued operations
for the nine months ended September 30, 2002 includes an after-tax loss on the
disposal of the business of $230 million.
(Dollars in millions) Three Months Ended Nine Months Ended
September 30, September 30,
--------------- ----------------
2002 2001 2002(1) 2001
----- ----- ----- -----
Net Sales $ -- $ 215 $ 269 $ 630
Profit from operations -- 28 49 70
Income before income taxes -- 28 51 70
Tax provision -- 17 20 41
----- ----- ----- -----
Income from operations -- 11 31 29
Loss from disposal of business, including
a (benefit) provision for income taxes of
$(24) and $51 million for 2002, respectively -- -- (230) --
----- ----- ----- -----
Income (loss) from discontinued operations $ -- $ 11 $(199) $ 29
===== ===== ===== =====
(1) Results of operations for period are through April 28, 2002.
6
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 Pinova (formerly Rosin and Terpenes). In connection with the
Company's transitional review, recorded goodwill was determined to be impaired
in the BetzDearborn and FiberVisions reporting units. In the first quarter of
2002, 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 in
the first quarter of 2002 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
loss and net loss per share as if SFAS 142 had been in effect for the periods
presented.
(Dollars in millions, except per share) Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net loss before cumulative effect of change in
accounting principle:
As reported $ (35) $ (71) $ (258) $ (58)
Goodwill amortization -- 13 -- 38
-------- -------- -------- --------
Adjusted net loss before cumulative effect of change
in accounting principle $ (35) $ (58) $ (258) $ (20)
======== ======== ======== ========
Basic and diluted net (loss) income per share before
cumulative effect of change in accounting principle:
As reported $ (0.32) $ (0.66) $ (2.37) $ (0.54)
Goodwill amortization -- 0.12 -- 0.35
-------- -------- -------- --------
Adjusted basic and diluted (loss) income per share
before cumulative effect of change in accounting principle $ (0.32) $ (0.54) $ (2.37) $ (0.19)
======== ======== ======== ========
Net loss:
As reported $ (35) $ (71) $ (626) $ (58)
Goodwill amortization -- 13 -- 38
-------- -------- -------- --------
Adjusted net loss $ (35) $ (58) $ (626) $ (20)
======== ======== ======== ========
Basic and diluted net (loss) income per share:
As reported $ (0.32) $ (0.66) $ (5.74) $ (0.54)
Goodwill amortization -- 0.12 -- 0.35
-------- -------- -------- --------
Adjusted basic and diluted (loss) income per share $ (0.32) $ (0.54) $ (5.74) $ (0.19)
======== ======== ======== ========
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 nine months ended September 30, 2002, by operating segment.
(Dollars in millions) Engineered
Performance Materials
Products & Additives Total
------- ------- -------
Balance at January 1, 2002 $ 1,724 $ 172 $ 1,896
------- ------- -------
Discontinued operations
BetzDearborn (924) -- (924)
------- ------- -------
Total discontinued operations (924) -- (924)
------- ------- -------
Impairment losses
BetzDearborn, discontinued operations (179) -- (179)
BetzDearborn, cumulative effect (267) -- (267)
FiberVisions, cumulative effect -- (87) (87)
------- ------- -------
Total impairment losses (445) (87) (532)
------- ------- -------
Foreign currency translation 14 -- 14
------- ------- -------
Balance at September 30, 2002 $ 368 $ 85 $ 453
======= ======= =======
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)
----- ----- ----- -----
Balance, September 30, 2002 89 70 70 229
----- ----- ----- -----
ACCUMULATED AMORTIZATION
Balance, January 1, 2002 $ (28) $ (20) $ (57) $(105)
Current year amortization (3) (1) (5) (9)
Discontinued operations - BetzDearborn 21 16 23 60
----- ----- ----- -----
Balance, September 30, 2002 (10) (5) (39) (54)
----- ----- ----- -----
NET CARRYING AMOUNT
Balance, January 1, 2002 $ 302 $ 230 $ 83 $ 615
Current year amortization (3) (1) (5) (9)
Discontinued operations - BetzDearborn (220) (164) (47) (431)
----- ----- ----- -----
Balance, September 30, 2002 $ 79 $ 65 $ 31 $ 175
===== ===== ===== =====
Total amortization expense for each of the three month periods ended
September 30, 2002 and 2001 for other intangible assets was $2 million and $6
million respectively, of which $2 million and $2 million was included in income
from continuing operations for the three months ended September 30, 2002 and
2001, respectively. Total amortization expense for each of the nine month
periods ended September 30, 2002 and 2001 for other intangible assets was $9
million and $19 million, respectively, of which $7 million and $7 million, was
included in income from continuing operations for the nine months ended
September 30, 2002 and 2001, respectively. Total goodwill amortization expense
for the three and nine months ended September 30, 2001 was $13 million and $38
million, respectively, of which $4 million and $12 million respectively, was
included in income from continuing operations. Estimated amortization expense
for 2002 and the five succeeding fiscal years is $9 million per year through
2006 and $8 million during 2007.
8
5. The following table shows the amounts used in computing loss per share and
the effect on loss and the weighted-average number of shares of dilutive
potential common stock:
(In millions, except Three Months Ended September 30, Nine Months Ended September 30,
per share ) 2002 2001 2002 2001
------------------ ------------------ ----------------- ------------------
(Loss) (Loss)
(Loss) (Loss) earnings (Loss) (Loss) earnings
(Loss) per share earnings per share (Loss) per share earnings per share
------- --------- -------- --------- ------ --------- -------- ---------
BASIC AND DILUTED:
Continuing operations $ (35) $ (0.32) $ (82) $ (0.76) $ (59) $ (0.54) $ (87) $ (0.81)
Discontinued operations -- -- 11 0.10 (199) (1.83) 29 0.27
Cumulative effect of change
in accounting principle -- -- -- -- (368) (3.37) -- --
------- ------- ------ ------- ----- ------- ----- -------
Net loss $ (35) $ (0.32) $ (71) $ (0.66) $(626) $ (5.74) $ (58) $ (0.54)
======= ======= ====== ======= ===== ======= ===== =======
Weighted average number
of basic shares (millions) 109.2 108.4 109.2 108.1
The Company has subordinated debentures which are convertible into common stock.
The common stock shares into which these debentures are convertible have not
been included in the dilutive share calculation as the impact of their inclusion
would be anti-dilutive.
6. Cost of sales and expenses include depreciation expense related to continuing
operations of $17 million and $15 million for the three months ended September
30, 2002 and 2001, respectively, and $52 million and $55 million for the nine
months ended September 30, 2002 and 2001, respectively.
7. Other operating expense (income), net, for the three and nine months ended
September 30, 2002 include environmental charges of $4 million and $9 million,
respectively, and additional restructuring charges of $8 million and $18 million
associated with the comprehensive cost reduction and work process redesign
program announced in September 2001 (see Note 10), respectively. Additionally,
the Company recognized a $6 million asset impairment charge in the Performance
Products segment in the nine month period. Miscellaneous (income) expenses were
($1) million and $2 million, respectively, for the three and nine month periods.
Other operating (income) expense for the three and nine months ended
September 30, 2001 includes environmental charges of $2 million and $6 million,
respectively. Both periods also include restructuring charges of $45 million
associated with the comprehensive cost reduction and work process redesign
program (see Note 10), partially offset by $5 million and $7 million in
restructuring reversals pertaining to prior year plans for the quarter and
nine-month periods. The nine months ended September 30, 2001 includes $74
million in net gains from the sale of the Company's hydrocarbon resins business,
select portions of its rosin resins business, its peroxy chemicals business and
its 50% interest in Hercules-Sanyo, Inc. Partially offsetting these gains are $5
million of executive severance charges, $3 million in non-recurring fees related
to the 2001 proxy contest and other matters and $1 million in project
abandonment costs. The quarter also included other charges of $1 million.
8. Interest and debt costs are summarized as follows:
(Dollars in millions) Three Months Ended Nine Months Ended
September 30, September 30,
---------------- ----------------
2002 2001 2002 2001
---- ---- ---- ----
Costs incurred $ 17 $ 46 $ 78 $158
Amount capitalized -- -- -- 4
---- ---- ---- ----
Interest expense $ 17 $ 46 $ 78 $154
==== ==== ==== ====
9. Other expense, net for the three and nine-months ended September 30, 2002
includes $65 million and $68 million, respectively, in net charges for estimated
asbestos exposures (see Note 13). The nine months also include a $43 million
charge for debt prepayment penalties and the write-off of debt issuance costs
associated with the repayment of debt with the proceeds from the sale of the
Water Treatment Business (see Notes 3 and 11) and approximately $2 million for
litigation costs of a former operating unit. The three and nine month periods
also include miscellaneous expenses of $2 million and $3 million, respectively.
9
Other expense, net, for the three and nine months ended September 30, 2001
includes approximately $3 million and $6 million, respectively, for litigation
costs; $1 million and $4 million, respectively, of miscellaneous discounts; and
losses from the sale of assets of $2 million and $1 million, respectively.
Interest income of $1 million and $4 million, respectively, is included for the
three and nine month periods and foreign currency gains of approximately $4
million, partially offset by rent expense of $1 million are included in the nine
months ended September 30, 2001. Litigation costs, rent expense and asset sales
primarily relate to former operations of the Company. The quarter and
nine-months included other charges of $1 million each.
10. The consolidated balance sheet reflects liabilities for employee severance
benefits and other exit costs of $28 million and $43 million at September 30,
2002 and December 31, 2001, respectively. During 2001, management authorized and
committed to a plan to reduce the workforce as part of the comprehensive cost
reduction and work process redesign program. Under this plan, 1,279 employees
have left or will leave the Company, of which 1,076 employees were terminated
pursuant to this plan through September 30, 2002. The Company incurred
restructuring charges of $69 million relating to this plan, which includes
charges of $63 million for employee termination benefits and $6 million for exit
costs related to facility closures. For the three and nine months ended
September 30, 2002, as a result of additional employee terminations, the
estimate for severance benefits pertaining to the 2001 plan increased by $8
million and $17 million, respectively. The estimate for exit costs related to
facility closures was increased by an additional $1 million in the nine months
ended September 30, 2002. The plan includes reductions throughout the Company.
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.
Cash payments during the three and nine months ended September 30, 2002
were $8 million and $28 million, respectively, for severance benefits and other
exit costs. Severance benefits paid during the year include 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
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) September 30, December 31,
2002 2001
------------- ------------
Balance at beginning of year $ 43 $ 34
Additional termination benefits and other exit costs 18 51
Cash payments (28) (25)
Reversals against goodwill (3) (10)
Reversals against earnings -- (7)
Transferred with discontinued operations (2) --
---- ----
Balance at end of period $ 28 $ 43
==== ====
The balance at the end of the period represents severance benefits and
other exit costs of which $24 million pertains to the 2001 restructuring plan,
$2 million pertains to the 1998 BetzDearborn plan and $2 million relates to
other restructuring plans initiated in 2000.
11. A summary of short-term and long-term debt follows:
(Dollars in millions) September 30, December 31,
SHORT-TERM: 2002 2001
---- ----
Banks $ 1 $ 9
Current maturities of long-term debt 142 242
---- ----
$143 $251
==== ====
Bank borrowings represent primarily foreign overdraft facilities and
short-term lines of credit, which are generally payable on demand with interest
at various rates. At September 30, 2002, the Company had $47 million of unused
short-term lines of credit that may be drawn as needed. Short-term lines of
credit in use at September 30, 2002 were $14 million.
10
(Dollars in millions) September 30, December 31,
LONG-TERM: 2002 2001
------------- ------------
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 -- 543
Term loan tranche D due 2005 -- 372
Revolving credit agreement due 2003 -- 516
ESOP debt -- 84
Term notes at various rates from 5.23% to 9.60% due in varying amounts through 2006 51 52
Other 4 6
------- -------
683 2,201
Current maturities of long-term debt (142) (242)
------- -------
Net long-term debt $ 541 $ 1,959
======= =======
In 1998, the Company entered into a $3,650 million credit facility
("senior credit facility")with a syndicate of banks which included varying
maturity term loans totaling $2,750 million and a $900 million revolving credit
agreement. 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. In addition, 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. As of September 30, 2002, $200 million of the revolving credit
facility was available for use.
The Company's senior credit facility requires 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
senior credit facility was 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 senior 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 included 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.
A portion of the net proceeds ($73 million) from the sale of the Water
Treatment Business was used to collateralize the Company's outstanding letters
of credit.
12. Company-obligated Preferred Securities of Subsidiary Trusts consists of:
(Dollars in millions) September 30, December 31,
2002 2001
------------- ------------
9.42% Trust Originated Preferred Securities $362 $362
6 1/2% CRESTS Units 262 262
---- ----
$624 $624
==== ====
13. 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 $85 million and $251
11
million. The Company believes that the actual cost will more likely approximate
$85 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 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
from the prior judgment.
Hercules Incorporated v. Aetna Casualty & Surety Company, et al., Del.
Super., C.A. No. 92C-10-105 and 90C-FE-195-1-CV (consolidated)
In 1992, Hercules brought suit against its insurance carriers for past and
future costs for cleanup of certain environmental sites. In April 1998, the
trial regarding insurance recovery for the Jacksonville, Arkansas site (see
discussion above) was completed. The jury returned a "Special Verdict Form" with
findings that, in conjunction with the Court's other opinions, were used by the
Court to enter a judgment in August 1999. The judgment determined the amount of
Hercules' recovery for past cleanup expenditures and stated that Hercules is
entitled to similar coverage for costs incurred since September 30, 1997 and in
the future. Hercules has not included any insurance recovery in the estimated
range of costs above. Since entry of the Court's August 1999 order, Hercules has
entered into settlement agreements with several of its insurance carriers and
has recovered certain settlement monies. The terms of those settlements and the
amounts recovered are confidential. On August 15, 2001, the Delaware Supreme
Court issued a decision in Hercules Incorporated v. Aetna
12
Casualty & Surety Company, et al., Del. Super., C.A. No. 92C-10-105 and
90C-FE-195-1-CV (consolidated). In its decision, the Delaware Supreme Court
affirmed the trial court in part, reversed the trial court in part and remanded
the case for further proceedings. The specific basis upon which the Delaware
Supreme Court reversed the trial court was the trial court's application of pro
rata allocation to determine the extent of the insurers' liability. Over the
past few months, Hercules has reached an agreement or agreement in principle to
settle with two additional insurers, the terms of which are confidential. As a
result, Hercules has decided not to pursue this litigation against the remaining
defendants, and has taken steps to conclude this litigation.
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 September 30, 2002, the accrued liability of $85 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 an
on-going basis. In late December 1999, the Company entered into a settlement
agreement to resolve the majority of the claims then pending. In connection with
that settlement, the Company also entered into an agreement with several of the
insurance carriers which sold that former subsidiary primary and first level
excess insurance policies. Under the terms of that agreement, the majority of
the amounts paid to resolve those products claims 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 an on-going basis, with the number of
new claims averaging approximately 2,200 per year during 2000 and 2001. Between
January 1, 2002 and October 31, 2002, the Company received approximately 7,145
claims. During that same time period, the Company also received approximately
10,501 claims all of which have either been dismissed without payment or are in
the process of being dismissed without payment, as described below. We are
continuing to evaluate whether this increase in claims throughout 2002 is an
anomaly or a new trend.
As of October 31, 2002, the Company had pending approximately 11,518
unresolved claims, of which approximately 756 are premises claims. Further, as
of October 31, 2002, the Company had pending approximately 10,642 claims, all of
which have been dismissed without payment or are in the process of being
dismissed without payment, but with plaintiffs' retaining the right to re-file
should they be able to establish exposure to an asbestos-containing product for
which the Company bears liability. A significant portion of the current increase
in products claims both pending and which are in the process of being dismissed
are the result of the filing of a small number of "consolidated" complaints each
of which names hundreds to thousands of plaintiffs and a large number of
defendants, but which provides little information connecting any specific
plaintiff's alleged injuries to any specific defendant's products or premises.
Finally, as of October 31, 2002, there were pending approximately 2,938 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 unpaid settled claims will be insured.
The Company anticipates that the primary and first level excess insurance
policies referenced above will exhaust over the next 6 to 12 months, assuming
that the rate of settlements and payments remains relatively consistent with the
Company's past experience. Nonetheless, based on the current number of claims
pending, the amounts the Company anticipates paying to resolve those claims
which are not dismissed or otherwise resolved without payment, and anticipated
future claims, the Company believes that it and its former subsidiary together
have sufficient additional insurance to cover the majority of its current and
estimated future asbestos-related liabilities. (The foregoing is based on the
Company's
13
assumption that the number of future claims filed per year and claim resolution
payments will vary considerably from year-to-year and by plaintiff, disease,
venue, and other circumstances, but will, when taken as a whole, remain
relatively consistent with the Company's past experience. It is also based on
the Company's assumption that these matters cease to be an on-going liability
after ten years, the Company's evaluation of potentially available insurance
coverage, and its review of the relevant case law. However, the Company
recognizes that the number of future claims filed per year and claim resolution
payments could greatly exceed those reflected by its past experience, that these
matters may continue to be an on-going liability for a period extending well
beyond ten years, that its evaluation of potentially available insurance
coverage may change depending upon numerous variables including risks inherent
in litigation and the risk that one or more insurance carriers may refuse or be
unable to meet its obligations to the Company, and that conclusions resulting
from its review of relevant case law may be impacted by future court decisions
or changes in the law.) The Company is seeking defense and indemnity payments or
an agreement to pay from those carriers responsible for excess coverage whose
levels of coverage have been or will soon be reached. Although those excess
carriers have not yet agreed to defend or indemnify it, the Company believes
that it is likely that they will ultimately agree to do so, and that the
majority of its estimated future asbestos related costs will ultimately be paid
or reimbursed by those carriers. However, if the Company is not able to reach
satisfactory agreements with those carriers prior to exhaustion of the primary
and first level excess insurance policies now covering the majority of its
current asbestos related claims, then beginning as early as sometime in 2003,
the Company might be required to completely fund these matters while it seeks
reimbursement from its carriers.
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 $350 million. Based on extrapolating data from a recently published
study on asbestos litigation in the United States, the reasonably possible
minimum financial exposure to the Company for these matters is estimated to be
$160 million. However, there can be no assurance that such extrapolated data
will apply to the Company since the Company's actual financial exposure will
depend on its particular circumstances. As stated above, the Company presently
believes that the majority of this range of financial exposures 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 present estimates and may require a
material change in the accrued liability for these matters within the next
twelve months. If the Company's liability does exceed amounts recorded in the
balance sheet, the Company presently believes that the majority of any
additional liability it may reasonably anticipate will be paid or reimbursed by
its insurance carriers.
The Company has estimated and, therefore, has a recorded gross liability
for asbestos-related matters in its September 30, 2002 balance sheet of $225
million. The Company believes that it is probable that $145 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 September 30, 2002 balance
sheet. The Company, in conjunction with outside advisors, intends to study its
asbestos-related exposures, insurance recovery expectations, and reserves on an
on-going quarterly basis, and make adjustments as appropriate.
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, and
has denied liability and will vigorously defend this action.
14
Since September 2001, Hercules, along with the other defendants in
the Thomas & Thomas Rodmakers action referred to above, has been sued in nine
California state court purported class actions brought on behalf of indirect
purchasers of carbon fiber. In January 2002, these were consolidated into a case
captioned Carbon Fiber Cases I, II, and III, Judicial Council Coordination
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.
In June 2002, a purported class action was filed in Massachusetts under
the caption Saul M. Ostroff, et al. v. Newport Adhesives, et al., Civil Action
No. 02-2385, Superior Court of Middlesex County. This matter is a purported
class action brought on behalf of consumers who purchased merchandise
manufactured by carbon fiber, and alleges the same types of price fixing
activities alleged in the actions described in the previous two paragraphs. In
October 2002, the Company was notified that Horizon Sports Technologies had
"opted out" of the federal antitrust class action described above (Thomas &
Thomas Rodmakers) and filed its own suit against Hercules and the other
defendants in that action (Horizon Sports Technologies, Inc. v. Newport
Adhesives and Composites, Inc., et al., Case No. CV02-8126FMC (RNEX), U.S.
District Court, Central District of California, Western Division).
Further, in April 2002, a related "Qui Tam" action was unsealed by the
U.S. District Court for the Southern District of California. That action is
captioned Randall M. Beck, et al. v. Boeing Defense and Space Group, Inc., et
al. (Civil Action No. 99 CV 1557 JM JAH), was filed under seal in 1999, and is a
"False Claims" action brought pursuant to the False Claims Act (31 U.S.C.
Section 729 et seq.). In that action, the Relators, in the name of the United
States Government, allege the same price fixing activities which are the subject
of the above-described actions. The Relators then allege that those alleged
price fixing activities resulted in inflated prices being charged by the
defendant carbon fiber manufacturers to the defendant defense contractors, who,
in turn, submitted claims for payment to the United States Government under
various government contracts. It is alleged that those claims for payment were
"False Claims" because the prices charged for the carbon fiber and carbon
prepreg were "fixed" contrary to the laws of the United States. The Company
denies liability and will vigorously defend each of these actions.
In connection with the grand jury investigation noted above, in January
2000, the United States Department of Justice (DOJ), Antitrust Division, served
a grand jury subpoena duces tecum upon Hercules. The Company has been advised
that it is one of several manufacturers of carbon fiber and carbon prepreg that
have been served with such a subpoena.
On September 28, 2000, the Company sold its Food Gums Division to CP Kelco
ApS, a joint venture that the Company entered into with Lehman Brothers Merchant
Banking Partners II, L.P. CP Kelco also acquired the biogums business of
Pharmacia Corporation (formerly Monsanto Company). In April 2001, CP Kelco U.S.,
Inc., a wholly owned subsidiary of CP Kelco ApS, sued Pharmacia (CP Kelco U.S.,
Inc. v. Pharmacia Corporation, U.S. District Court for the District of Delaware,
Case No. 01-240-RRM) alleging federal securities fraud, common law fraud, breach
of warranties and representations, and equitable fraud. In essence, the lawsuit
alleges that Pharmacia misrepresented the value of the biogums business,
resulting in damages to CP Kelco U.S., including the devaluation of CP Kelco
U.S.'s 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 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 and filed a Motion for Judgment on the Pleadings,
which was granted on September 19, 2002. Pharmacia has indicated that it will
appeal. The Company continues to deny any liability to Pharmacia and will
vigorously defend any appeal.
At September 30, 2002, the consolidated balance sheet reflects a current
liability of approximately $30 million and a long-term liability of
approximately $200 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.
14. Segment Information
Subsequent to the sale of 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 the FiberVisions
Division and the Pinova (formerly Rosin and Terpenes) Division.
15
(Dollars in millions) Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2002 2001 (a) 2002 2001 (a)
------- ------- ------- -------
Net Sales:
Performance Products $ 359 $ 341 $ 1,042 $ 1,024
Engineered Materials & Additives (b) 84 81 240 355
------- ------- ------- -------
Consolidated $ 443 $ 422 $ 1,282 $ 1,379
======= ======= ======= =======
Profit from Operations:
Performance Products $ 63 $ 44 $ 183 $ 117
Engineered Materials & Additives (b) 8 1 14 15
Reconciling Items (c) (11) (42) (30) 20
------- ------- ------- -------
Consolidated $ 60 $ 3 $ 167 $ 152
======= ======= ======= =======
(a) 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.
(b) Net sales and profit from operations in 2001 include the results of the
hydrocarbon resins, select rosin resins and the peroxy chemicals businesses
which were divested in May 2001. Net sales and Profit from operations in 2001
have been reclassified to conform to the current year presentation.
(c) Reconciling Items for the three and nine months ended September 30, 2002
include restructuring charges, environmental costs and other corporate costs not
allocated to the businesses. Reconciling items for the three and nine months
ended September 30, 2001 include restructuring charges, environmental costs,
other corporate costs not allocated to the businesses and the net gains from the
sale of the hydrocarbon resins, select rosin resins and peroxy chemicals
businesses.
15. Financial Information of Guarantor Subsidiaries
The following condensed consolidating financial information for the Company
presents the financial information of Hercules, the Guarantor Subsidiaries and
the Non-Guarantor Subsidiaries based on the Company's understanding of the
Securities and Exchange Commission interpretation and application of Rule 3-10
under the Securities and Exchange Commission's Regulation S-X. The financial
information may not necessarily be indicative of results of operations or
financial position had the Guarantor Subsidiaries or Non-Guarantor Subsidiaries
operated as independent entities.
In this presentation, Hercules consists of parent company operations.
Guarantor Subsidiaries and Non-Guarantor Subsidiaries of Hercules are reported
on an equity basis.
16
Condensed Consolidating Statement of Operations
Three Months Ended September 30, 2002
(Unaudited)
(Millions of Dollars)
---------------------
Unconsolidated
--------------
Guarantor Non-Guarantor Eliminations
Parent Subsidiaries Subsidiaries & Adjustments Consolidated
------ ------------ ------------- ------------- ------------
Net sales $ 137 $ 101 $ 238 $ (33) $ 443
Cost of sales 88 70 148 (33) 273
Selling, general, and administrative expenses 25 14 47 -- 86
Research and development 5 4 2 -- 11
Goodwill and intangible asset amortization 2 -- -- -- 2
Other operating expenses (income), net 4 2 5 -- 11
--------- --------- --------- --------- ---------
Profit from operations 13 11 36 -- 60
Interest and debt expense (income), net 43 (17) (9) -- 17
Preferred security distributions of subsidiary trusts -- -- 15 -- 15
Other (expense) income, net (66) 2 (3) -- (67)
--------- --------- --------- --------- ---------
(Loss) income before income taxes and equity income (loss) (96) 30 27 -- (39)
Provision (benefit) for income taxes (26) 11 11 -- (4)
Equity loss of affiliated companies -- -- -- -- --
Equity income (loss) from consolidated subsidiaries 35 14 1 (50) --
--------- --------- --------- --------- ---------
Net (loss) income from continuing operations (35) 33 17 (50) (35)
Net (loss) income from discontinued operations,
net of tax -- -- -- -- --
Net (loss) income before cumulative effect of
change in accounting principle (35) 33 17 (50) (35)
Cumulative effect of change in accounting principle,
net of tax -- -- -- -- --
--------- --------- --------- --------- ---------
Net (loss) income $ (35) $ 33 $ 17 $ (50) $ (35)
========= ========= ========= ========= =========
17
Condensed Consolidating Statement of Operations
Three Months Ended September 30, 2001
(Unaudited)
(Millions of Dollars)
---------------------
Unconsolidated
--------------
Guarantor Non-Guarantor Eliminations
Parent Subsidiaries Subsidiaries & Adjustments Consolidated
------ ------------ ------------ ------------- ------------
Net sales $ 134 $ 130 $ 211 $ (53) $ 422
Cost of sales 84 100 133 (53) 264
Selling, general, and administrative expenses 27 19 48 -- 94
Research and development 5 5 2 -- 12
Goodwill and intangible asset amortization 1 3 2 -- 6
Other operating expenses (income), net 13 11 19 -- 43
------ ----------- ----------- ----------- -----------
Profit (loss) from operations 4 (8) 7 -- 3
Interest and debt expense (income), net 76 (47) 17 -- 46
Preferred security distributions of
subsidiary trusts -- -- 15 -- 15
Other (expense) income, net (1) (1) (6) 2 (6)
------ ----------- ----------- ----------- -----------
(Loss) income before income taxes and
equity income (loss) (73) 38 (31) 2 (64)
(Benefit) provision for income taxes (8) 23 (5) 2 12
Equity of affiliated companies -- -- (6) -- (6)
Equity income (loss) from consolidated subsidiaries (17) (119) -- 136 --
------ ----------- ----------- ----------- -----------
Net (loss) income from continuing operations (82) (104) (32) 136 (82)
Net income from discontinued operations, net of tax 11 8 3 (11) 11
Net (loss) income before cumulative effect of
change in accounting principle (71) (96) (29) 125 (71)
Cumulative effect of change in accounting
principle, net of tax -- -- -- -- --
------ ----------- ----------- ----------- -----------
Net (loss) income $ (71) $ (96) $ (29) $ 125 $ (71)
====== =========== =========== =========== ===========
18
Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2002
(Unaudited)
(Millions of Dollars)
---------------------
Unconsolidated
------------------------------------------
Guarantor Non-Guarantor Eliminations
Parent Subsidiaries Subsidiaries & Adjustments Consolidated
------ ------------ ------------ ------------- ------------
Net sales $ 408 $ 326 $ 664 $ (116) $ 1,282
Cost of sales 259 226 414 (116) 783
Selling, general, and administrative expenses 69 53 136 -- 258
Research and development 15 12 5 -- 32
Goodwill and intangible asset amortization 5 2 -- -- 7
Other operating expenses (income), net 11 9 15 -- 35
------ ----------- ----------- ----------- -----------
Profit from operations 49 24 94 -- 167
Interest and debt expense (income), net 163 (57) (28) -- 78
Preferred security distributions of subsidiary trusts -- -- 44 -- 44
Other (expense) income, net (113) 1 (5) 1 (116)
------ ----------- ----------- ----------- -----------
(Loss) income before income taxes and
equity income (loss) (227) 82 73 1 (71)
(Benefit) provision for income taxes (58) 30 17 -- (11)
Equity of affiliated companies -- 1 -- -- 1
Equity (loss) income from consolidated subsidiaries 110 52 4 (166) --
------ ----------- ----------- ----------- -----------
Net (loss) income from continuing operations (59) 105 60 (165) (59)
Net (loss) income from discontinued operations,
net of tax (199) 18 13 (31) (199)
Net (loss) income before cumulative effect of
change in accounting principle (258) 123 73 (196) (258)
Cumulative effect of change in accounting
principle, net of tax (368) -- -- -- (368)
------ ----------- ----------- ----------- -----------
Net (loss) income $ (626) $ 123 $ 73 $ (196) $ (626)
====== =========== =========== =========== ===========
19
Condensed Consolidating Statement of Operations
Nine Months Ended September 30, 2001
(Unaudited)
(Millions of Dollars)
---------------------
Unconsolidated
----------------------------------------
Guarantor Non-Guarantor Eliminations
Parent Subsidiaries Subsidiaries & Adjustments Consolidated
------ ------------ ------------ ------------- ------------
Net sales $ 464 $ 451 $ 685 $ (221) $ 1,379
Cost of sales 303 360 442 (221) 884
Selling, general, and administrative expenses 67 83 152 -- 302
Research and development 23 12 6 -- 41
Goodwill and intangible asset amortization 2 10 7 -- 19
Other operating expenses (income), net (62) 28 15 -- (19)
------ ----------- ----------- ----------- -----------
Profit (loss) from operations 131 (42) 63 -- 152
Interest and debt expense (income), net 248 (150) 56 -- 154
Preferred security distributions of
subsidiary trusts -- -- 44 -- 44
Other (expense) income, net -- 7 (13) 1 (5)
------ ----------- ----------- ----------- -----------
(Loss) income before income taxes and
equity income (loss) (117) 115 (50) 1 (51)
(Benefit) provision for income taxes (17) 51 (9) 1 26
Equity of affiliated companies -- -- (10) -- (10)
Equity income (loss) from consolidated subsidiaries 13 (52) 1 38 --
------ ----------- ----------- ----------- -----------
Net (loss) income from continuing operations (87) 12 (50) 38 (87)
Net income (loss) from discontinued operations,
net of tax 29 14 15 (29) 29
Net (loss) income before cumulative effect of
change in accounting principle (58) 26 (35) 9 (58)
Cumulative effect of change in accounting
principle, net of tax -- -- -- -- --
------ ----------- ----------- ----------- -----------
Net (loss) income $ (58) $ 26 $ (35) $ 9 $ (58)
====== =========== =========== =========== ===========
20
Condensed Consolidating Balance Sheet
September 30, 2002
(Unaudited)
(Millions of Dollars)
---------------------
Unconsolidated
--------------
Guarantor Non-Guarantor Eliminations
Parent Subsidiaries Subsidiaries & Adjustments Consolidated
------ ------------ ------------ ------------- ------------
ASSETS
Current assets
Cash and cash equivalents $ 39 $ 6 $ 63 $ -- $ 108
Accounts and notes receivable, net 101 60 215 (1) 375
Intercompany receivables 82 43 52 (177) --
Inventories 42 56 79 (12) 165
Deferred income taxes -- -- -- -- --
------ ----------- ----------- ----------- -----------
Total current assets 264 165 409 (190) 648
Property, plant, and equipment, net 188 166 307 -- 661
Investments in subsidiaries 2,142 63 55 (2,260) --
Goodwill and other intangible assets, net 213 120 295 -- 628
Other assets 840 6 52 13 911
------ ----------- ----------- ----------- -----------
Total assets $3,647 $ 520 $ 1,118 $ (2,437) $ 2,848
====== =========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 47 $ 20 $ 85 $ -- $ 152
Accrued expenses 125 111 127 -- 363
Intercompany payables 57 62 (43) (76) --
Short-term debt 125 -- 18 -- 143
------ ----------- ----------- ----------- -----------
Total current liabilities 354 193 187 (76) 658
Long-term debt 503 -- 38 -- 541
Deferred income taxes 74 82 58 -- 214
Postretirement benefits and
other liabilities 506 80 35 -- 621
Company-obligated preferred securities
of subsidiary trusts -- -- 624 -- 624
Intercompany notes payable/(receivable) 2,020 (976) (1,057) 13 --
Stockholders' equity 190 1,141 1,233 (2,374) 190
------ ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity $3,647 $ 520 $ 1,118 $ (2,437) $ 2,848
====== =========== =========== =========== ===========
21
Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2002
(Unaudited)
(Millions of Dollars)
---------------------
Unconsolidated
--------------
Guarantor Non-Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
------ ------------ ------------- ------------ ------------
NET CASH (USED IN) PROVIDED BY OPERATIONS $ (300) $ (52) $ (33) $ 132 $ (253)
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (10) (5) (9) -- (24)
Proceeds of investment and
fixed asset disposals 1,810 -- 1 -- 1,811
Other, net -- -- 2 -- 2
------- ----------- ----------- ----------- -----------
Net cash provided by (used in)
investing activities 1,800 (5) (6) -- 1,789
------- ----------- ----------- ----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds 250 -- -- -- 250
Long-term debt repayments (1,693) (5) (75) -- (1,773)
Change in short-term debt -- -- (7) -- (7)
Change in intercompany, noncurrent (30) 51 111 (132) --
Common stock issued (10) -- -- -- (10)
Common stock reacquired 14 -- -- -- 14
Dividends paid -- -- -- -- --
------- ----------- ----------- ----------- -----------
Net cash (used in) provided by
financing activities (1,469) 46 29 (132) (1,526)
------- ----------- ----------- ----------- -----------
Net cash flow provided by (used in)
discontinued operations -- 5 20 -- 25
Effect of exchange rate changes on cash -- -- (3) -- (3)
------- ----------- ----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents 31 (6) 7 -- 32
Cash and cash equivalents at
beginning of period 8 12 56 -- 76
------- ----------- ----------- ----------- -----------
Cash and cash equivalents at
end of period $ 39 $ 6 $ 63 $ -- $ 108
======= =========== =========== =========== ===========
22
Condensed Consolidating Statement of Cash Flows
Nine Months Ended September 30, 2001
(Unaudited)
(Millions of Dollars)
---------------------
Unconsolidated
--------------
Guarantor Non-Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
------ ------------ ------------- ------------ ------------
NET CASH (USED IN) PROVIDED BY OPERATIONS $ (252) $ 220 $ (44) $ (9) $ (85)
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (10) (10) (27) -- (47)
Proceeds of investment and
fixed asset disposals 223 2 122 -- 347
Other, net -- 1 (8) -- (7)
------- ----------- ----------- ----------- -----------
Net cash provided by (used in)
investing activities 213 (7) 87 -- 293
------- ----------- ----------- ----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds 322 -- 1 -- 323
Long-term debt repayments (559) (16) (20) -- (595)
Change in short-term debt -- -- (98) -- (98)
Change in intercompany, noncurrent 264 (303) 39 -- --
Common stock issued 15 -- -- -- 15
Common stock reacquired (1) -- -- -- (1)
Dividends paid -- -- (9) 9 --
------- ----------- ----------- ----------- -----------
Net cash provided by (used in)
financing activities 41 (319) (87) 9 (356)
------- ----------- ----------- ----------- -----------
Net cash flow provided by
discontinued operations -- 105 43 -- 148
Effect of exchange rate changes on cash -- -- (2) -- (2)
------- ----------- ----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents 2 (1) (3) -- (2)
Cash and cash equivalents at
beginning of period 1 7 46 -- 54
------- ----------- ----------- ----------- -----------
Cash and cash equivalents at
end of period $ 3 $ 6 $ 43 $ -- $ 52
======= =========== =========== =========== ===========
23
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
"nine-month period" refer to the third quarter of 2002 and the nine-months ended
September 30, 2002. All comparisons are with the corresponding periods in the
previous year, unless otherwise stated.
On April 29, 2002, the Company completed the sale of its BetzDearborn
Water Treatment Business (the "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 the Pulp and Paper
and Aqualon Divisions, and Engineered Materials and Additives, consisting of the
FiberVisions and Pinova (formerly Rosin and Terpenes) Divisions. In addition,
substantially all reconciling items have been allocated to the segments. The
reconciling items primarily include corporate expenses. 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 $13 million and $38 million in the three
and nine-months ended September 30, 2001, of which approximately $4 million and
$12 million was related to continuing operations for the corresponding periods,
and $9 million and $26 million was related to discontinued operations in the
three and nine-months ended September 30, 2001.
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").
The following tables reconcile reported net sales and profit from
operations for the three and nine-month periods ended September 30, 2002 and
2001 to net sales and profit from operations for the respective periods
excluding unusual items, divested businesses and goodwill amortization.
(Dollars in millions) (Unaudited)
------------------------------------------------------------
Unusual Divested Goodwill
Reported Items Businesses Amortization Adjusted
-------- ------------- ---------- ------------ --------
THREE MONTHS ENDED SEPTEMBER 30, 2002:
Net Sales by Industry Segment
Performance Products $ 359 $ -- $-- $-- $ 359
Engineered Materials & Additives 84 -- -- -- 84
----- ----- --- --- -----
Total $ 443 $ -- $-- $-- $ 443
===== ===== === === =====
Profit from Operations by Industry Segment
Performance Products $ 63 $ -- $-- $-- $ 63
Engineered Materials & Additives 8 -- -- -- 8
Reconciling Items (11) 9(1) -- -- (2)
----- ----- --- --- -----
Total $ 60 $ 9 $-- $-- $ 69
===== ===== === === =====
THREE MONTHS ENDED SEPTEMBER 30, 2001:
Net Sales by Industry Segment
Performance Products $ 341 $ -- $-- $-- $ 341
Engineered Materials and Additives 81 -- -- -- 81
----- ----- --- --- -----
Total $ 422 $ -- $-- $-- $ 422
===== ===== === === =====
Profit from Operations by Industry Segment
Performance Products $ 44 $ -- $-- $ 2 $ 46
Engineered Materials and Additives 1 -- -- 2 3
Reconciling Items (42) 40(1) -- -- (2)
----- ----- --- --- -----
Total $ 3 $ 40 $-- $ 4 $ 47
===== ===== === === =====
24
(Dollars in millions) (Unaudited)
-----------------------------------------------------------------------
Unusual Divested Goodwill
Reported Items Businesses Amortization Adjusted
-------- ------------- ----------- ------------ --------
NINE MONTHS ENDED SEPTEMBER 30, 2002:
Net Sales by Industry Segment
Performance Products $ 1,042 $ -- $ -- $ -- $ 1,042
Engineered Materials & Additives 240 -- -- -- 240
------- ------- ------- ---- -------
Total $ 1,282 $ -- $ -- $ -- $ 1,282
======= ======= ======= ==== =======
Profit from Operations by Industry Segment
Performance Products $ 183 $ 6(2) $ -- $ -- $ 189
Engineered Materials & Additives 14 -- -- -- 14
Reconciling Items (30) 20(1) -- -- (10)
------- ------- ------- ---- -------
Total $ 167 $ 26 $ -- $ -- $ 193
======= ======= ======= ==== =======
NINE MONTHS ENDED SEPTEMBER 30, 2001:
Net Sales by Industry Segment
Performance Products $ 1,024 $ -- $ -- $ -- $ 1,024
Engineered Materials and Additives 355 -- (113)(4) -- 242
------- ------- ------- ---- -------
Total $ 1,379 $ -- $ (113) $ -- $ 1,266
======= ======= ======= ==== =======
Profit from Operations by Industry Segment
Performance Products $ 117 $ -- $ -- $ 8 $ 125
Engineered Materials and Additives 15 -- (8)(4) 4 11
Reconciling Items 20 (27)(3) -- -- (7)
------- ------- ------- ---- -------
Total $ 152 $ (27) $ (8) $ 12 $ 129
======= ======= ======= ==== =======
(1) Primarily restructuring charges.
(2) Asset impairment charge.
(3) Primarily net gains on Resins Divestitures of $74 million offset by
restructuring charges relating to the 2001 restructuring program.
(4) Sales and operating profit pertaining to the Resins Divestitures.
Consolidated net sales increased $21 million, or 5%, for the quarter.
Compared with the third quarter 2001, prices declined 3% while volume/mix had a
5% positive impact and rate of exchange had a 3% positive impact. For the
nine-month period, consolidated net sales declined $97 million, or 7%. The
decline primarily reflects the effects of the Resins Divestitures. Profit from
operations improved $57 million for the quarter and $15 million for the
nine-month period. Excluding non-recurring items, divested businesses and
goodwill amortization, profit from operations improved $22 million for the
quarter, or 47%, and $64 million, or 50%, for the nine-month period. The
improvement in profit from operations for both periods was driven by cost
reductions and higher volumes, partially offset by lower prices. The second and
third quarters are historically the strongest quarters. As the Company enters
the fourth quarter, historically the weakest quarter, we see little evidence
that aggregate demand is improving. The Company expects that earnings
improvements in the fourth quarter and 2003 will be generated primarily by
continued cost savings realized from the implementation of work process
improvements.
In the Performance Products segment, net sales grew $18 million, or 5%,
for the quarter and $18 million, or 2% for the nine-month period versus the
corresponding periods in 2001. Profit from operations improved $19 million, or
43%, for the quarter and $66 million, or 56%, for the nine-month period. In the
Pulp and Paper Division, net sales grew 7% and 3% for the quarter and nine-month
period, respectively, versus the prior year periods. Sales to GE Betz pursuant
to a two-year supply agreement accounted for 3% and 2% of the net sales growth
for the quarter and nine-month period, respectively. Excluding non-recurring
items from all comparative periods and goodwill amortization from 2001 results,
profit from operations in Pulp and Paper improved 23% for the quarter and 52%
for the nine-month period versus the same periods last year. The net sales
growth and improvement in profit from operations resulted from lower costs and
slightly higher volumes, partially offset by lower pricing. Profit from
operations in the nine-month period 2002 was negatively impacted by an asset
impairment charge. Net sales in the Aqualon Division, compared to 2001,
increased 3% for the quarter and were flat for the nine-month period and profit
from operations, excluding goodwill amortization from 2001 results, improved 50%
and 49%, respectively, for the quarter and nine-month period. The increase in
profit from operations was driven by lower raw material costs, operating cost
reductions and favorable product mix, partially offset by lower selling prices.
In the Engineered Materials and Additives segment, excluding divested
businesses and goodwill amortization from 2001 operating profit results, net
sales increased $3 million, or 4%, for the quarter and decreased $2 million, or
1%, for the nine-month period. On the same basis, profit from operations
improved $5 million, or 167%, in the quarter and $3 million, or 27%, for the
nine-month period versus the prior year period. FiberVisions net sales increased
9% for the quarter and declined
25
2% for the nine-month period. Improved sales in the quarter were largely driven
by a positive rate of exchange effect and higher volumes partially offset by
competitive pricing issues while lower sales in the nine-month period were
driven by contractual customer pass through of lower polypropylene costs and
competitive pricing issues partially offset by a positive rate of exchange
effect and higher volumes. Profit from operations improved for the quarter on
lower fixed costs and was flat for the nine-month period, after adjusting 2001
for a revision to an estimate for accrued benefits. Excluding divested
businesses, Pinova (formerly Rosin and Terpenes) net sales decreased 7% for the
quarter and increased 1% for the nine-month period and profit from operations
improved substantially versus both the prior year quarter and nine-month period.
The improvement in profit from operations was driven by lower fixed costs.
Interest and debt expense, and preferred security distributions of
subsidiary trusts decreased $29 million for the quarter and $76 million for the
nine-month period, primarily due to lower outstanding debt balances, reflecting
the application of proceeds from the sale of the Water Treatment Business on
April 29, 2002 and 2001 asset sales, as well as lower interest rates. The
Company used the proceeds from 2001 asset sales to reduce debt balances by
approximately $336 million in 2001. Following the sale of the Water Treatment
Business, the Company applied the proceeds to permanently reduce long-term debt
by approximately $1.6 billion and collateralize $73 million of the Company's
outstanding letters of credit (see Note 11).
Other expense, net increased $61 million in the quarter and $111 million
in the nine-month period. Both the quarter and nine-month period include a $65
million charge to increase the reserve for future potential asbestos claims. The
nine-month period also includes the write-off of debt issuance costs associated
with the repayment of debt from the proceeds of the Water Treatment Business
sale (see Notes 3, 9 and 11).
The effective tax rate for the quarter for continuing operations was 11%.
The tax expense in 2001 reflects the effects of non-deductible goodwill
amortization, repatriation of foreign earnings and other provisions. The
anticipated full year 2002 tax rate for continuing operations is approximately
8%.
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 11).
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
nine-months ended September 30, 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 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 by continuing operations
was $253 million for the nine-month period 2002 compared to cash used by
continuing operations of $85 million in the nine-month period 2001. The increase
primarily reflects higher tax payments and a $65 million pension contribution.
Net cash provided by operations was $50 million for the quarter compared to cash
used by operations of $69 million for the third quarter 2001. The current ratio
has increased to .98 at September 30, 2002, compared with .92 at December 31,
2001. The quick ratio has improved to .73 at September 30, 2002 from .66 at
December 31, 2001. As of September 30, 2002, the Company had $200 million
available under its revolving credit agreement and $47 million of unused
short-term lines of credit. The Company expects to meet short-term cash
requirements from operating cash flow and availability under lines of credit.
Future compliance with debt covenants is dependent upon generating sufficient
earnings, 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
26
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 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 recognized a $43 million charge (included in other
expense (income), net) for debt prepayment penalties and the write-off of debt
issuance costs relating to the debt that was repaid from the proceeds of the
sale of the Water Treatment Business (see Notes 3 and 9).
The $200 million revolving credit facility expires in October 2003. The
Company is currently negotiating with a consortium of financial institutions for
a new multi-year revolving credit facility, term loan and asset backed finance
facility. The proceeds from these facilities, expected to close at the end of
2002, will be used to retire maturing short-term debt, replace expiring credit
facilities and for general corporate purposes.
Capital Structure and Commitments. Total capitalization (stockholders'
equity, Company obligated preferred securities of subsidiary trusts and debt)
decreased to $1.5 billion at September 30, 2002, from $3.5 billion at year-end
2001. The ratio of debt-to-total capitalization decreased to 46% at September
30, 2002 from 62% at December 31, 2001.
RISK FACTORS
Market Risk - Fluctuations in interest and foreign currency exchange rates
affect the Company's financial position and results of operations. The Company
uses several strategies from time to time to actively hedge interest rate and
foreign currency exchange rate exposure and minimize the effect of such
fluctuations on reported earnings and cash flow. Sensitivity of the Company's
financial instruments to selected changes in market rates and prices which are
reasonably possible are described below. Market values are the present value of
projected future cash flows based on the market rates and prices chosen. The
market values for interest rate risk are calculated by utilizing a third-party
software model that utilizes standard pricing models to determine the present
value of the instruments based on the market conditions as of the valuation
date.
The Company's derivative and other financial instruments subject to
interest rate risk at September 30, 2002 consist of debt instruments, pension
benefit obligations and pension plan assets invested in fixed rate securities.
The debt instruments have a net market value at September 30, 2002 of $1.2
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 September 30, 2002
would result in a $57 million decrease in the net market value of the liability.
A 100-basis point decrease in interest rates at September 30, 2002 would result
in a $69 million increase in the net market value of the liability. The change
in the net market value of derivative and other financial instruments from
year-end 2001 is primarily due to the repayment of both syndicated and revolving
debt as a result of the sale of the Water Treatment Business on April 29, 2002
(see Notes 3 and 11).
The Company's financial instruments subject to foreign currency exchange
risk consist of foreign currency forward contracts and represent a net asset
position of $0.1 million at September 30, 2002. The following sensitivity
analysis assumes an instantaneous 10% change in foreign currency exchange rates,
with all other variables held constant. A 10% strengthening of the U.S. dollar
versus other currencies at September 30, 2002 would result in a net liability of
$1.2 million while a 10% weakening of the dollar versus all currencies would
result in a net asset of $1.4 million.
Foreign exchange forward and option contracts have been used to hedge the
Company's firm and anticipated foreign currency cash flows. Thus, there is
either an asset or cash flow exposure related to all the financial instruments
in the above sensitivity analysis for which the impact of a movement in foreign
exchange rates would be in the opposite direction and substantially equal to the
impact on the instruments in the analysis. There are presently no significant
restrictions on the remittance of funds generated by the Company's operations
outside the United States.
The Company has not designated any derivative as a hedge instrument under
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended, and accordingly, changes in the
fair value of derivatives are recorded each period in earnings.
27
Pension and other post-retirement benefit obligations - The Company
provides defined benefit pension and post-retirement welfare benefit plans to
employees in the United States who meet eligibility requirements. Similar plans
are provided outside the United States in accordance with local practice.
Pension and other post-retirement benefit obligations in the United States and
the related expense (income) are determined based upon actuarial assumptions
regarding mortality, medical inflation rates, discount rates, long-term return
on assets, salary increases, Medicare availability and other factors. The actual
return on plan assets currently being earned in 2002 is, and the historical
return on plan assets earned in 2000 and 2001 was, less than the corresponding
assumption for long-term return on plan assets of 9.25% disclosed in previous
financial statements. Because of the unfavorable performance of the pension
investment portfolio over the past three years, pension expense is currently
projected to increase $25 to $35 million each year over the next three years.
Based on existing assumptions, pension and post-retirement benefit plan expenses
for the years 2003, 2004 and 2005 are projected to be approximately $45 million,
$70 million and $95 million, respectively. Of these amounts, approximately 35%,
60% and 65% are expected to be non-cash charges for the years 2003, 2004 and
2005, respectively. The actuarial assumptions are currently under review and a
change in these assumptions, including an expected reduction in the return on
plan assets, could adversely affect the level of projected expenses. In
addition, interest rates have continued to decrease throughout 2002. At
September 30, 2002, the Moody's Aa corporate bond yield, which is a key
determinant for the discount rate, was 6.51%. A 100 basis point decrease or
increase in the discount rate has approximately a plus or minus $130 million
impact on the Company's accumulated pension benefit obligation ("ABO"). Based on
current economic conditions and anticipated benefit payments, the Company
anticipates that the ABO will exceed the fair value of plan assets at December
31, 2002 and, consequently, the Company will be required to recognize an
additional liability equal to the sum of such excess plus the prepaid pension
asset balance, with a corresponding after-tax charge to other comprehensive
income in stockholders' equity. The prepaid pension asset balance for the U.S.
plan is approximately $325 million at September 30, 2002. The Company presently
expects to record a non-cash, after-tax charge to other comprehensive income of
approximately $375 million at December 31, 2002. This charge is expected to
result in a negative equity position for the Company. The Company does not
believe this will have any substantial adverse effect on its operations or
liquidity. If the plan performs in accordance with the actuarial assumptions, we
anticipate making a cash contribution of about $40 million per year over the
next six to seven years to our U.S. qualified pension plan to bring funding to
required levels. We will also contribute $15 to $20 million to our non-U.S.
pension plans in the fourth quarter 2002 to bring funding to required levels.
The Company does not anticipate making any unusual contributions to its non-U.S.
plans in 2003.
Environmental Litigation - Hercules has been identified by U.S. federal
and state authorities as a "potentially responsible party" for environmental
cleanup at numerous sites. The estimated range of reasonably possible costs for
remediation is between $85 million and $251 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 13 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.
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. The Company is a defendant in numerous asbestos-related personal
injury lawsuits and claims which typically arise from alleged exposure to
asbestos fibers from resin-encapsulated pipe and tank products which were sold
by one of the Company's former subsidiaries to a limited industrial market
("products claims"). The Company is also a defendant in lawsuits alleging
exposure to asbestos at facilities formerly or presently owned or operated by
the Company ("premises claims"). The Company's estimated liability and insurance
recoveries are based on numerous assumptions regarding the number of future
claims, the cost of settlements, potential insurance recoveries and other
variables. While the Company believes its estimates are reasonable, there can be
no assurance that these assumptions will prove to be correct and the Company's
actual experience may differ materially over time. Since it is not feasible to
predict the outcome of all pending suits and claims, the ultimate resolution of
these matters could have a material effect upon the financial position of
Hercules, and the resolution of any of the matters during a specific period
could have a material effect on the quarterly or annual operating results for
that period (see Note 13 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 what management
believes to be reasonable assumptions. Forward-looking statements may involve
known and unknown risks, uncertainties and other factors, which may cause the
actual results to differ materially from those projected, stated or implied,
depending on such factors as: ability to generate cash, ability to raise
capital, ability to refinance, the result of the pursuit of strategic
alternatives, ability to execute work process redesign and reduce costs,
business climate, business performance, economic and competitive uncertainties,
higher manufacturing costs, reduced level of customer orders, changes in
strategies, risks in developing new products and technologies, environmental and
safety regulations and clean-up costs, foreign exchange rates, the impact of
changes in the value of pension fund assets and liabilities, 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
28
exposures by collecting indemnity payments from insurers, the impact of
increased accruals and reserves for such exposures, and adverse changes in
economic and political climates around the world, including terrorist activities
and international hostilities. Accordingly, there can be no assurance that the
Company will meet future results, performance or achievements expressed or
implied by such forward-looking statements. As appropriate, additional factors
are contained in other reports filed by the Company with the Securities and
Exchange Commission. This paragraph is included to provide safe harbor for
forward-looking statements, which are not generally required to be publicly
revised as circumstances change, and which the Company does not intend to
update.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
For discussion of quantitative and qualitative disclosure about market
risk, see "Risk Factors" under Item 2, Management's Discussion and Analysis of
Results of Operations and Financial Condition.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's Chief
Executive Officer and Vice President and Controller, of the effectiveness of
the design and operation of our disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15 as of September 30, 2002. Based upon that evaluation,
the Company's Chief Executive Officer and Vice President and Controller
concluded that the Company's disclosure controls and procedures are effective.
Disclosure controls and procedures are controls and procedures that are
designed to ensure that information required to be disclosed in Company reports
filed or submitted under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms.
There have been no significant changes in our internal controls or in
other factors that could significantly affect internal controls subsequent to
the date we carried out this evaluation.
29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For information related to Legal Proceedings, see Notes to Financial
Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
99.1 Certification of Chairman and Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of Vice President and Controller Pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
Date of Report Item No. Financial Statements Included
-------------- -------- -----------------------------
July 19, 2002 2, 7 Yes
August 19, 2002 9 No
August 21, 2002 9 No
30
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)
December 11, 2002
By: /s/ Fred G. Aanonsen
---------------------------------------
Fred G. Aanonsen
Vice President and Controller
(Principal Accounting Officer and duly
authorized signatory)
December 11, 2002
31
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, William H. Joyce, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of Hercules
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ William H. Joyce
___________________________________
William H. Joyce
Chairman & Chief Executive Officer
December 11, 2002
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Fred G. Aanonsen, Vice President and Controller, certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of Hercules
Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Fred G. Aanonsen
- -----------------------------
Fred G. Aanonsen
Vice President and Controller
December 11, 2002