1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996 ------------------ 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, 1996, 102,361,084 shares of registrant's common stock were outstanding. 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements. HERCULES INCORPORATED CONSOLIDATED STATEMENT OF INCOME (Dollars in thousands, except per share) (UNAUDITED) Three Months Ended Sept. 30, Nine Months Ended Sept. 30, ------------------------------- ------------------------------ 1996 1995 1996 1995 ------------ ----------- -------------- -------------- NET SALES . . . . . . . . . . . . . . . . . . . . . $518,063 $570,249 $1,565,569 $1,877,611 Cost of sales . . . . . . . . . . . . . . . . . . . 326,489 366,656 1,006,247 1,220,877 Selling, general, and administrative expenses . . . 64,319 80,183 195,908 261,124 Research and development . . . . . . . . . . . . . 13,893 13,513 41,524 43,286 Other operating expenses (income), net . . . . . . (13,502) 4,736 (19,964) 16,157 --------- -------- ----------- ---------- PROFIT FROM OPERATIONS . . . . . . . . . . . . . . 126,864 105,161 341,854 336,167 Equity in income of affiliated companies . . . . . 12,262 11,326 42,106 31,106 Interest and debt expense . . . . . . . . . . . . . 8,804 7,251 25,665 20,945 Other income (expense), net . . . . . . . . . . . . (2,143) 10,966 17,966 30,833 --------- -------- ---------- ---------- INCOME BEFORE TAXES . . . . . . . . . . . . . . . . 128,179 120,202 376,261 377,161 Provision for income taxes . . . . . . . . . . . . 43,306 39,890 127,025 128,355 --------- -------- ----------- ---------- NET INCOME . . . . . . . . . . . . . . . . . . . . $ 84,873 $ 80,312 $ 249,236 $ 248,806 ========= ======== ========== ========== EARNINGS PER SHARE . . . . . . . . . . . . . . . . $ .80 $ 0.72 $ 2.31 $ 2.18 ========= ======== ========== ========== DIVIDENDS PER SHARE . . . . . . . . . . . . . . . . $ 0.23 $ 0.21 $ 0.69 $ 0.63 ========= ======== ========== ========== See accompanying notes to financial statements. 2 3 HERCULES INCORPORATED CONSOLIDATED BALANCE SHEET (Dollars in thousands) (UNAUDITED) SEPTEMBER 30, December 31, ------------- -------------- 1996 1995 ------------- -------------- ASSETS CURRENT ASSETS Cash and cash equivalents . . . . . . . . . . . . . . . . $ 27,430 $ 72,941 Accounts and notes receivable, net . . . . . . . . . . . 413,985 425,865 Inventories Finished products . . . . . . . . . . . . . . . . 157,253 167,793 Materials, supplies, and work in process . . . . . 136,557 140,287 Deferred income taxes . . . . . . . . . . . . . . . . . . 60,194 60,247 ------------ -------------- TOTAL CURRENT ASSETS . . . . . . . . . . . . . 795,419 867,133 Property, plant, and equipment . . . . . . . . . . . . . 2,376,100 2,564,240 Accumulated depreciation and amortization . . . . . . . . 1,507,293 1,564,543 ------------ -------------- Net property, plant, and equipment . . . . . . . . 868,806 999,697 Investments . . . . . . . . . . . . . . . . . . . . . . . 358,950 344,273 Other assets . . . . . . . . . . . . . . . . . . . . . . 331,015 282,376 ------------ -------------- $ 2,354,191 $ 2,493,478 ============ ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable . . . . . . . . . . . . . . . . . . . . $ 125,978 $ 117,030 Accrued expenses . . . . . . . . . . . . . . . . . . . . 255,729 312,565 Short-term debt . . . . . . . . . . . . . . . . . . . . . 337,759 206,799 Income taxes payable . . . . . . . . . . . . . . . . . . 78,428 50,327 ------------ -------------- TOTAL CURRENT LIABILITIES . . . . . . . . . . . . 797,894 686,721 Long-term debt . . . . . . . . . . . . . . . . . . . . . 284,979 297,855 Deferred income taxes . . . . . . . . . . . . . . . . . . 52,344 94,946 Postretirement benefits and other liabilities . . . . . . 313,378 332,080 STOCKHOLDERS' EQUITY Common stock (issued: 1996--152,240,398; 1995--151,663,465 shares) . . . . . . . . . . . . 79,293 78,992 Additional paid-in capital . . . . . . . . . . . . . . . 488,885 471,749 Foreign currency translation adjustment . . . . . . . . . 49,706 74,687 Retained earnings . . . . . . . . . . . . . . . . . . . . 1,888,585 1,712,286 ------------ -------------- 2,506,468 2,337,714 Reacquired stock, at cost (1996--49,325,690; 1995--43,176,841 shares) . . . . . . . . . . . . . . . . 1,600,872 1,255,838 ------------ -------------- TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . 905,596 1,081,876 ------------ -------------- $ 2,354,191 $ 2,493,478 ============ ============== See accompanying notes to financial statements. 3 4 HERCULES INCORPORATED CONSOLIDATED STATEMENT OF CASH FLOW (Dollars in thousands) (UNAUDITED) Nine Months Ended Sept. 30, --------------------------- 1996 1995 --------- -------- NET CASH PROVIDED BY OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . $165,219 $250,554 --------- --------- CASH FLOW FROM INVESTING ACTIVITIES: Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . (77,645) (77,015) Proceeds of investment and fixed asset disposals . . . . . . . . . . . . . . 154,746 266,332 Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,070) 8,896 --------- --------- NET CASH PROVIDED BY INVESTING ACTIVITIES . . . . . . . . . . . . . . . . . . 76,031 198,213 --------- --------- CASH FLOW FROM FINANCING ACTIVITIES: Long-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,026 45,031 Long-term debt repayments . . . . . . . . . . . . . . . . . . . . . . . . . . (25,427) (75,621) Change in short-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . 130,960 85,606 Common stock issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,355 13,606 Common stock reacquired . . . . . . . . . . . . . . . . . . . . . . . . . . . (345,176) (475,246) Dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (72,937) (70,665) --------- --------- NET CASH USED IN FINANCING ACTIVITIES . . . . . . . . . . . . . . . . . . . . (286,199) (477,289) --------- --------- Effect of exchange rate changes on cash . . . . . . . . . . . . . . . . . . . (562) (509) --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS . . . . . . . . . . . . (45,511) (29,031) Cash and cash equivalents - beginning of period . . . . . . . . . . . . . . . 72,941 111,637 --------- --------- Cash and cash equivalents - end of period . . . . . . . . . . . . . . . . . . $ 27,430 $ 82,606 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest (net of amount capitalized) . . . . . . . . . . . . . . . . . . $ 21,542 $ 21,400 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126,834 76,281 Noncash investing and financing activities: Conversion of notes and debentures . . . . . . . . . . . . . . . . . . . 475 27,618 Accounts payable for common stock acquisitions . . . . . . . . . . . . . 11,461 -- Incentive plan stock issuances . . . . . . . . . . . . . . . . . . . . . 15,208 29,545 Investment in unconsolidated affiliates . . . . . . . . . . . . . . . . 600 143,862 Accounts receivable from sale of investments/asset disposals . . . . . . . . . . . . . . . . . 10,757 -- See accompanying notes to financial statements. 4 5 NOTES TO FINANCIAL STATEMENTS (Dollars in thousands) (Unaudited) 1. These condensed financial statements are unaudited, but in the opinion of management include all adjustments (consisting of only normal accruals) necessary to present fairly the company's financial position and results of operations for interim periods. It is suggested that these condensed financial statements be read in conjunction with the accounting policies and the financial statements and notes thereto included in the company's annual report for 1995. 2. Primary earnings per share are calculated on the basis of average number of common and common equivalent shares of 105,886,331 for the quarter ended September 30, 1996; 108,042,269 for the nine months ended September 30, 1996; 111,415,472 for the quarter ended September 30, 1995; and 114,365,786 for the nine months ended September 30, 1995. Net income has been adjusted to reflect the elimination of interest expense, net of taxes, on the 6.5% convertible debentures in the following amounts: SEPTEMBER 30, ----------------------- 1996 1995 ------ ----- Three months ended . . . . . . . . . . . . . . . $ 19 $ 26 Nine months ended . . . . . . . . . . . . . . . 39 93 Fully diluted earnings per share, which additionally assumes conversion of the 8% convertible subordinated debentures, is not materially different from primary earnings per share. In the fully diluted computation, the number of shares is increased by 2,736,959 for the quarter ended September 30, 1996; 2,740,610 for the nine months ended September 30, 1996; 2,899,968 for the quarter ended September 30, 1995; and 3,299,878 for the nine months ended September 30, 1995. Net income is further adjusted in the quarter and nine-month periods for both 1996 and 1995 to reflect the elimination of interest expense on the 8% debentures (net of taxes) in the amount of $533 and $1,655, respectively for 1996, and $551 and $1,662, respectively for the corresponding periods in 1995. 3. Cost and expenses include depreciation as follows: SEPTEMBER 30, ------------------------ 1996 1995 ------- -------- Three months ended . . . . . . . . . . . . . . . $22,391 $ 31,930 Nine months ended . . . . . . . . . . . . . . . 82,823 100,744 During the third quarter, the Company revised its estimates of useful lives of certain machinery and equipment. The change was made to better reflect the estimated periods during which assets will remain in service and had the effect of reducing depreciation expense by $5,467 for the quarter and nine months ended September 30, 1996. 5 6 4. Other operating expenses (income) for the quarter and nine months ended September 30, 1996, include probable recoveries related to environmental remediation of $12,750. Additionally, the nine-month period includes reduction in the estimated loss on the divestiture of the Composite Products Division of $5,000. The quarter and nine months ended September 30, 1995, included environmental cleanup costs for nonoperating sites of $3,521 and $12,461, respectively. 5. Interest and debt costs are summarized as follows: SEPTEMBER 30, ------------------------- 1996 1995 --------- -------- Three Months Ended: Costs incurred . . . . . . . . . . . . . . . . $ 9,905 $ 8,575 Amount capitalized . . . . . . . . . . . . . . 1,101 1,324 -------- -------- Interest expense . . . . . . . . . . . . . . . $ 8,804 $ 7,251 ======== ======== Nine Months Ended: Costs incurred . . . . . . . . . . . . . . . . $ 29,482 $ 24,235 Amount capitalized . . . . . . . . . . . . . . 3,818 3,290 -------- -------- Interest expense . . . . . . . . . . . . . . . $ 25,665 $ 20,945 ======== ======== 6. Other income (expense) for the nine months ended September 30, 1996 reflects net foreign currency gains of $8,421, and gains on the sale of real estate of $10,979. Other income (expense) for the quarter ended September 30, 1995, included $7,000 of additional gain related to the final settlement of the sale of the Aerospace segment and additional recoveries of costs under a contract related to the former Aerospace business. The nine months ended September 30, 1995, primarily reflect the net gain on the divestiture of the Aerospace segment of $38,700, the aforementioned cost recoveries and foreign exchange contracts and translation losses of $12,073. 7. Dividends received from affiliated companies accounted for on the equity method were as follows: SEPTEMBER 30, ------------------------ 1996 1995 ------- -------- Three months ended . . . . . . . . . . . . . . . $2,301 $ 5,771 Nine months ended . . . . . . . . . . . . . . . 8,290 12,317 6 7 8. A summary of short-term and long-term debt follows: SEPTEMBER 30, December 31, ------------- ------------ 1996 1995 ------------- ---------- SHORT-TERM: Commercial paper . . . . . . . . . . . . . . . . . . . . . . $300,000 $160,000 Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37,519 46,577 Current maturities . . . . . . . . . . . . . . . . . . . . . 240 222 -------- -------- $337,759 $206,799 ======== ======== At September 30, 1996, Hercules had $51,190 of unused lines of credit that may be drawn as needed. Lines of credit in use or supporting commercial paper at September 30, 1996, were $36,090. LONG-TERM: Term loans due 1997-2000 . . . . . . . . . . . . . . . . . . . . $ 95 $ 804 6.5% convertible subordinated debentures due 1999 . . . . . . . . 1,666 1,981 7.85% notes due 2000 . . . . . . . . . . . . . . . . . . . . . . 25,000 25,000 6.625% notes due 2003 . . . . . . . . . . . . . . . . . . . . . . 124,875 124,861 8% convertible subordinated debentures due 2010 . . . . . . . . . 40,969 41,130 Commercial paper . . . . . . . . . . . . . . . . . . . . . . . . 50,000 50,000 Variable rate loans . . . . . . . . . . . . . . . . . . . . . . . 35,200 46,600 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,414 7,701 ------------- ----------- 285,219 298,077 Current maturities of long-term debt . . . . . . . . . . . . . . (240) (222) ------------- ----------- Net long-term debt . . . . . . . . . . . . . . . . . . . . . . . $ 284,979 $ 297,855 ============ =========== 9. Since 1991, the Board of Directors has authorized the repurchase of up to 64,650,000 shares of company common stock, 6,150,000 shares of which is intended to satisfy requirements of various employee benefit programs. Through September 30, 1996, a total of 53,155,120 shares of common stock (including 6,150,000 shares for employee benefit programs) had been purchased in the open market at an average price of $34.81 per share. 10. In June 1996, the company completed the divestiture of its Composite Products Division for $135 million in cash, subject to post-closing adjustments. Net sales and operating profit of this division, which are reported as part of the Corporate and Other segment for the six months ended June 30, 1996, were $48,597 and $8,033, respectively. For the three months and nine months ended September 30, 1995 net sales and operating profit were $24,055 and $1,690 and $72,308 and $4,921, respectively. 7 8 11. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The provisions of SFAS No. 121 require the Company to review its long-lived assets for impairment on an exception basis whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through future cash flows. If it is determined that an impairment loss has occurred based on expected future cash flows, then the loss is recognized in the income statement and certain disclosures regarding the impairment are made in the financial statements. The adoption of SFAS No. 121 did not have an effect on the Company's consolidated financial statements. 12. Commitments and Contingencies (a) Environmental Hercules has been identified as a potentially responsible party (PRP) by U.S. Federal and state authorities for environmental cleanup at numerous sites. The estimated range of the reasonably possible costs of remediation is between $80,000 and $245,000. The actual costs will depend upon numerous factors, including the number of parties found liable at each environmental site and their ability to pay, the actual method of remediation, outcome of negotiations with regulatory authorities, outcome of litigation, changes in environmental laws and regulations, technological developments, and the years of remedial activity required, which could range up to 30 years. Hercules becomes aware of sites in which it may be, but has not yet been named, a PRP principally through its knowledge of investigation of sites by the U.S. Environmental Protection Agency (EPA) or other government agency or through correspondence with previously named PRPs requesting information on Hercules' activities at sites under investigation. Hercules brought suit in 1992 against its insurance carriers for past and future costs for remediation of certain environmental sites. Hercules has not included any insurance recovery in the estimates set forth above. Hercules has established procedures for identifying environmental issues at Hercules plant sites. Environmental coordinators, a designated position at all operating facilities, are familiar with environmental laws and regulations and are resources for identification of environmental issues. Hercules also has an environmental audit program, which is designed to identify environmental issues at operating plant sites. Through these programs, Hercules identifies potential environmental, regulatory, and remedial issues. Litigation over liability at Jacksonville, Arkansas, the most significant site, has been pending since 1980. As a result of a pretrial court ruling in October 1993, Hercules has been held jointly and severally liable for costs incurred, and for future remediation costs, at the Jacksonville site by the District Court, Eastern District of Arkansas (the Court). Appeal of the Court's ruling will be filed promptly after issuance of a final court order. In November 1993, an advisory jury found Uniroyal Chemical, Ltd., liable for the Jacksonville site, but also found that Uniroyal had proven a reasonable basis for allocation of responsibility. That same advisory jury found Standard Chlorine of Delaware is not a liable party for the Jacksonville site. The Court may take the jury's findings into consideration when reaching its decision regarding these parties. The Court has not entered its ruling on the liability of Uniroyal and Standard Chlorine. Appeals of the Court's expected rulings with respect to Uniroyal and Standard Chlorine are probable. 8 9 Other defendants in this litigation have either settled with the government or, in the case of the Department of Defense, have not been held liable. Hercules appealed the Court's order finding the Department of Defense not liable. On January 31, 1995, the 8th Circuit Court of Appeals upheld the Court's order. Hercules filed a petition to the U.S. Supreme Court requesting review and reversal of the 8th Circuit Court ruling. This petition was denied on June 26, 1995, and the case has been remanded to the District Court for further proceedings. Hercules' potential costs for remediation of the Jacksonville site are presently estimated between $33,000 and $109,000. These costs are based on Hercules' assessment of potential liability, the level of participation by other PRPs, and current estimates of remediation costs. Remediation costs will vary as Records of Decision are issued on each operable unit of the site and as remediation methods are approved by the EPA. At September 30, 1996, the accrued liability 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 investigation at each site and the current status of negotiations with regulatory authorities regarding the method and extent of apportionment of costs among other PRPs. 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. (b) Litigation: Hercules is a defendant in numerous lawsuits that arise out of, and are incidental to, the conduct of its business. In these legal proceedings, no director, officer, or affiliate is a party or a named defendant. These suits concern issues such as product liability, contract disputes, labor-related matters, patent infringement, environmental proceedings, property damage, and personal injury matters. Hercules also is a defendant in two Qui Tam ("Whistle Blower") lawsuits brought by former employees of the Aerospace segment sold to Alliant Techsystems. One suit involves allegations relating to submission of false claims and records, delivery of defective products, and a deficient quality control program. The other suit involves allegations of mischarging of work performed under government contracts, misuse of government equipment, other acts of financial mismanagement, and wrongful termination claims. The government, after investigation of the allegations, declined to intervene in either lawsuit. The first of these lawsuits is presently scheduled for trial in 1997. While damages claimed in the first suit are material, the Company believes no damages were incurred by the government, no false claims were made to the government, and alleged damages are speculative and insupportable. The damages in the second suit were not defined. The Company intends to vigorously defend these lawsuits. 9 10 Hercules is also a defendant in a class action (approximately 140 members) of property owners adjacent to its Brunswick, Georgia, plant. The class members seek property impairment related damages including damages for alleged decrease in property values caused by the presence of toxaphene (a pesticide manufactured at the plant from 1948 to 1980) on their properties. The class members claim that the toxaphene resulted from manufacturing operations. The Company intends to vigorously defend this lawsuit. While it is not feasible to predict the outcome of all pending suits and claims, management does not anticipate that the ultimate resolution of these matters will have a material effect upon the consolidated financial position of Hercules, although 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. 10 11 OTHER FINANCIAL INFORMATION OPERATIONAL HIGHLIGHTS (Dollars in millions) Three Months Ended Sept. 30, Nine Months Ended Sept. 30, ---------------------------- --------------------------- 1996 1995 1996 1995 -------- ------- ------- -------- NET SALES BY INDUSTRY SEGMENT Chemical Specialties . . . . . . . . . . . . . . . . $ 280 $ 286 $ 807 $ 874 Food & Functional Products . . . . . . . . . . . . . 237 260 707 804 Aerospace . . . . . . . . . . . . . . . . . . . . . . 0 0 0 123 * Corporate and Other . . . . . . . . . . . . . . . . . 1 25 52 77 -------- ------- ------ -------- Total . . . . . . . . . . . . . . . . . . $ 518 $ 571 $1,566 $ 1,878 ======== ======= ====== ======== PROFIT (LOSS) FROM OPERATIONS BY INDUSTRY SEGMENT Chemical Specialties . . . . . . . . . . . . . . . . $ 55 $ 55 $ 153 $ 175 Food & Functional Products . . . . . . . . . . . . . 60 56 169 162 Aerospace . . . . . . . . . . . . . . . . . . . . . . 0 0 0 13 * Corporate and Other . . . . . . . . . . . . . . . . . 12 (6) 20 (14) -------- ------- ------- -------- Total . . . . . . . . . . . . . . . . . . $ 127 $ 105 $ 342 $ 336 ======== ======= ======= ======== * Reflects results of operations through March 14, 1995. 11 12 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 1996 and the nine months ended September 30, 1996. All comparisons are with the corresponding periods in the previous year. The table below reflects the results of operations on both a consolidated and segment basis, exclusive of divested businesses. The pro forma amounts exclude the results of operations of the Aerospace segment, divested in March 1995, the Electronics & Printing Division of the Food & Functional Products segment, divested in December 1995, and the Composite Products Division reported in Corporate and Other, divested in June 1996. The table is presented to facilitate the comparison of operating results for purposes of the Management's Discussion and Analysis. Accordingly, the discussion that follows speaks to the comparisons in the table. (Dollars in millions) (Unaudited) Three Months Ended September 30, Nine Months ended September 30, -------------------------------- ------------------------------- Pro Forma Pro Forma Pro Forma 1996 1995 1996 1995 ----- --------- --------- --------- Net Sales ................................... $ 518 $ 528 $ 1,517 $ 1,628 Cost of sales ............................... 326 339 966 1,042 Selling, general, and administrative expenses 64 73 191 228 Research and development .................... 14 13 41 40 Other operating expenses, net ............... (13) 5 (15) 13 ----- ----- ------- ------- Profit From Operations ...................... 127 98 334 305 Net Sales by Industry Segment Chemical Specialties ................... $ 280 $ 286 $ 807 $ 874 Food & Functional Products ............. 237 242 707 750 Corporate and Other .................... 1 0 3 4 ----- ----- ------- ------- Total ............................. $ 518 $ 528 $ 1,517 $ 1,628 ===== ===== ======= ======= Profit From Operations by Industry Segment Chemical Specialties ................... $ 55 $ 55 $ 153 $ 175 Food & Functional Products ............. 60 51 169 149 Corporate and Other .................... 12 (8) 12 (19) ----- ----- ------- ------- Total ............................. $ 127 $ 98 $ 334 $ 305 ===== ===== ======= ======= Net Sales declined $10 million and $111 million, or 2% and 7%, for the quarter and nine-month period, respectively, primarily due to lower volumes and weaker foreign currencies relative to the dollar. 12 13 Profit from operations increased $29 million for both the quarter and nine-month period. For the quarter, the increase represents lower selling, general, and administrative expenses, particularly those associated with the revisions to employee incentive compensation programs in 1995, lower depreciation (see Note 3), and favorable variations in other operating expenses. For the nine-month period, the increase principally represents favorable variations in other operating expenses. Lower selling, general, and administrative expenses were offset by lower gross profits resulting from lower sales revenues. Other operating expenses are discussed in Note 4 to the financial statements. Chemical Specialties: Net sales decreased $6 million, or 2%, for the quarter and $67 million, or 8%, for the nine-month period. Lower volume and pricing for polypropylene nonwoven fibers, due to increased competition and lower export sales, primarily account for the unfavorable change in the quarter and nine-month period. Partially offsetting these effects in the quarter were favorable volume and pricing in paper chemicals, while resins volume improvements were partially offset by unfavorable rates of exchange. Additionally, the nine-month revenues were impacted by unfavorable resins volume, related to softness in the adhesives market, and weaker foreign currencies relative to the dollar. Profit from operations remained flat for the quarter while declining $22 million, or 13%, for the nine-month period. For the quarter and nine-month period, the effects of lower revenue and higher raw material costs were offset by manufacturing cost improvements and lower employee incentive compensation costs. Food & Functional Products: Net sales decreased $5 million, or 2%, for the quarter and $43 million, or 6%, for the nine-month period. For the quarter, unfavorable exchange rates and lower volume in the food gums markets are partially offset by improved pricing, particularly in Aqualon water-soluble polymers. Additionally, the nine months reflect lower overall volume in the construction, oilfield, and food markets, and unfavorable exchange rates, partially offset by improved pricing in Aqualon. Profit from operations increased $9 million, or 18%, and $20 million, or 13%, for the quarter and nine months, respectively. Improved pricing, manufacturing cost improvements, lower employee incentive compensation costs, along with the aforementioned change in depreciation expense, offset the revenue decline. Softness in demand experienced during the nine-month period is continuing into the fourth quarter. As a result, the trends in overall operating results are expected to continue at about the year-to-date pace.* * This paragraph contains forward looking statements and is included here to provide safe harbor under the Private Securities Litigation Reform Act of 1995. 13 14 Corporate and Other: Operating profit increased for the quarter and nine-month period (see Note 4), primarily due to probable recoveries related to environmental remediation and lower environmental remediation expenses. Equity in income of affiliated companies improved $1 million and $11 million for the quarter and nine-month period, respectively, reflecting higher earnings in Tastemaker, the 50% owned flavors joint venture, along with equity earnings from Hercules' investment in Alliant Techsystems acquired in March 1995 in conjunction with the divestiture of the Aerospace segment. Interest and debt expense increased for the quarter and nine-month period principally due to higher average debt outstanding. Other income (expense), net (see Note 6). The provision for income taxes for the nine-month period reflects an estimated annual effective tax rate of 34.4%. The 1995 full-year rate of 34% was favorably affected by increased utilization of foreign tax credits and a state income tax settlement related to a prior year sale of an investment. FINANCIAL CONDITION Cash flow from operations was $165 million for the nine-month period compared to $251 million for the corresponding 1995 period, primarily resulting from higher income tax payments and lower profit from operations. Income tax payments in the nine-month period were $51 million higher than the corresponding period in 1995. 1996 payments include $36 million associated with the divestiture of EPD and $25 million related to the settlement of prior years' federal income tax audits. Overall, cash flow benefited by the divestiture of the Composite Products Division in June 1996 for $135 million in cash, subject to post-closing adjustments (see Note 10). Short-term liquidity has remained stable since year-end 1995. Both the current and quick ratios are relatively flat at 1.0 and 0.5, respectively. At September 30, 1996, $51 million was available under short-term lines of credit. 14 15 During the nine-month period, an additional 6,533,321 shares of common stock were reacquired in the open market. Total debt increased by $118 million during the nine-month period. As a result, total debt as a percentage of total capitalization increased from 32% to 41% during the nine-month period and it is probable that this ratio will increase over time. Funds available under revolving credit agreements at September 30, 1996 are $30 million; in addition, $50 million is accessible, depending on market conditions, under a shelf registration. 15 16 PART II - OTHER INFORMATION Item 1. Legal Proceedings. In September 1993, Hercules and the U.S. Environmental Protection Agency Region 1 reached an agreement in principle in settlement of EPA's claims that Hercules violated its wastewater permit with the City of Chicopee and the Federal pretreatment standard for industrial users of publicly owned treatment works at its Chicopee, Massachusetts, facility. Hercules signed a Consent Decree, which was entered by the court on December 15, 1994, based on this agreement, requiring supplemental environmental projects (at a cost of approximately $375,000), compliance with permit limits in the future, and $250,000 in fines. Hercules has paid the $250,000 fine and is currently in the process of performing the supplemental environmental projects, which are expected to be completed in 1997. Hercules received a letter from the New Jersey Department of Environmental Protection (the "Department") dated March 9, 1995, which stated that the Department was considering an enforcement action against Hercules for alleged noncompliance with the terms of a 1993 Administrative Consent Order ("ACO") at its Kenvil, New Jersey, facility. The ACO covered alleged violations of the Air Pollution Control Act. The letter also identified potential violations under the Spill Compensation and Control Act, the New Jersey Water Pollution Control Act, and the New Jersey Safe Drinking Water Act. Hercules has met with the Department and has submitted a schedule addressing all matters identified in the Department's letter. Although no formal legal proceeding has been commenced, a civil enforcement action, including a penalty assessment in excess of $100,000 is expected. Item 4. Submission of Matters to a Vote of Security-Holders. The Company's Annual Meeting was held on April 25, 1996. Required information has been supplied in registrant's Form 10-Q for the quarter ended March 31, 1996. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K. Hercules was not required to file any reports on Form 8-K for the quarter ended September 30, 1996. 16 17 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 George MacKenzie ------------------------------ George MacKenzie Senior Vice President and Chief Financial Officer (Principal Financial Officer and duly authorized signatory) November 14, 1996 by Vikram Jog ------------------------------ Vikram Jog Vice President and Controller (Principal Accounting Officer) November 14, 1996 17