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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For
the transition period from ___________ to __________
Commission
file number 1-8142
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ENGELHARD CORPORATION |
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(Exact name of registrant as specified in its charter) |
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DELAWARE |
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22-1586002 |
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(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
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101 WOOD AVENUE, ISELIN, NEW JERSEY |
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08830 |
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(Address of principal executive offices) |
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(Zip Code) |
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Registrant’s telephone number, including area code |
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(732) 205-5000 |
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Securities registered pursuant to Section 12(b) of
the Act: |
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Title of each class |
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Name of each exchange on which registered |
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Common Stock, par value $1 per share |
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New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X|. No |_|.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes |X|.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes |X| No |_|.
The aggregate market value of the registrant’s voting common stock held by non-affiliates of the registrant, based on the closing price on the New York Stock Exchange on June 30, 2003 was approximately $3,105,021,007.
As of March 8, 2004, 124,546,751 shares of common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference to the Proxy Statement for the 2004 Annual Meeting of Shareholders, which will be filed by April 30, 2004.
TABLE OF CONTENTS
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1. |
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(a) |
3 |
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(b) |
3 |
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(c) |
3-5, 59-62 |
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(d) |
Description of business |
3-5, 59-62 |
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(e) |
6-7 |
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2. |
7 |
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3. |
7-8 |
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4. |
9 |
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4A. |
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5. |
10 |
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6. |
10-11, 68 |
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7. |
12-26 |
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7A. |
27-28 |
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8. |
29-67 |
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9. |
68 |
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9A. |
68-69 |
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10. |
9, 69 |
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11. |
69 |
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12. |
70-71 |
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13. |
71 |
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14. |
71 |
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15. |
72-94 |
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2
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BUSINESS |
Engelhard Corporation (which together with its subsidiaries, is collectively referred to as the Company) was formed under the laws of Delaware in 1938 and became a public company in 1981. The Company’s principal executive offices are located at 101 Wood Avenue, Iselin, NJ, 08830 (telephone number (732) 205-5000).
The Company maintains a Web site, free of charge, at www.Engelhard.com, which contains information about us, including links to our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and related amendments, which are available as soon as reasonably practicable after such reports are filed or furnished electronically with the SEC. Our Web site and the information contained in it shall not be deemed incorporated by reference in this Form 10-K.
The Company develops, manufactures and markets value-adding technologies based on surface and materials science for a wide spectrum of industrial customers. The Company also provides its technology segments, their customers and others with precious and base metals and related services.
The Company employed approximately 6,480 people as of January 1, 2004 and operates on a worldwide basis with corporate headquarters in the United States, and manufacturing facilities, mineral reserves and other operations in Asia, the European community, North America, the Russian Federation, South Africa and Brazil.
The Company’s businesses are organized into four reportable segments — Environmental Technologies, Process Technologies, Appearance and Performance Technologies and Materials Services.
The following information on the Company is included by segment in Note 19, “Business Segment and Geographic Area Data,” of the Notes to Consolidated Financial Statements: net sales to external customers, operating earnings/(loss), special charges/(credits), net, depreciation, depletion and amortization, equity in earnings of affiliates, total assets, equity investments and capital expenditures. Interest income, interest expense and income taxes are included in total.
Environmental Technologies
The Environmental Technologies segment markets cost-effective compliance with environmental regulations, enabled by sophisticated emission-control technologies and systems. The segment also provides high-value material products made principally from platinum group metals, as well as thermal spray and coating technologies.
Environmental catalysts are used in applications such as the abatement of carbon monoxide, oxides of nitrogen and hydrocarbon emissions from gasoline, diesel and alternate-fueled vehicles. These catalysts also are used to remove odors, fumes and pollutants associated with a variety of process industries, co-generation and gas-turbine power generation, household appliances and lawn and garden power tools.
The products of the Environmental Technologies segment compete in the marketplace on the basis of value, performance and cost. No single competitor is dominant in the markets in which the Company operates.
The manufacturing operations of the Environmental Technologies segment are carried out in the United States, Italy, Germany, India, South Africa, Brazil, China, Thailand, Sweden and the United Kingdom, with equity investments located in South Korea and the United States. The products are sold principally through the Company’s sales organizations or those of its equity investments, supplemented by independent distributors and representatives.
Principal raw materials used by the Environmental Technologies segment include precious metals, procured by the Materials Services segment and/or supplied by customers, and a variety of minerals and chemicals that are generally readily available.
3
As of January 1, 2004, the Environmental Technologies segment had approximately 1,880 employees worldwide. Most hourly employees are not covered by collective bargaining agreements. Employee relations have generally been good.
Process Technologies
The Process Technologies segment enables customers to make their processes more productive, efficient, environmentally sound and safer through the supply of advanced chemical-process catalysts, additives and sorbents.
Process Technologies’ chemical-process catalysts are used in the manufacture of a variety of products and intermediates made by chemical, petrochemical, pharmaceutical and agricultural chemical producers. In addition, they are used in the production of polypropylene, which is used in a wide range of products, including food packaging, carpets, toys and automobile bumpers. Sorbents are used to purify and decolorize naturally occurring fats and oils for the manufacture of shortenings, margarines and cooking oils. Petroleum catalysts and additives are used by refiners to provide economies in petroleum processing and to meet increasingly stringent fuel-quality requirements. The segment’s catalyst products are based on the Company’s proprietary technology and often are application-specific.
The products of the Process Technologies segment compete in the marketplace on the basis of value, performance and cost. No single competitor is dominant in the markets in which the Company operates.
The manufacturing operations of the segment are carried out in the United States, Italy, The Netherlands and Spain. The products are sold principally through the Company’s sales organizations supplemented by independent representatives.
The principal raw materials used by the segment include metals, procured by the Materials Services segment and from third parties; kaolin-based intermediates supplied by the Appearance and Performance Technologies segment; and a variety of other minerals and chemicals that are generally readily available. The segment also uses certain raw materials that are sourced primarily from China.
As of January 1, 2004, the Process Technologies segment had approximately 1,715 employees worldwide. Most hourly employees are covered by collective bargaining agreements. Employee relations have generally been good.
Appearance and Performance Technologies
The Appearance and Performance Technologies segment provides pigments, effect materials and performance additives that enable its customers to market enhanced image and functionality in their products. This segment serves a broad array of end markets, including coatings, plastics, cosmetics, automotive, construction and paper. The segment’s products help customers improve the look, performance and overall cost of their products. In addition, the segment is the internal supply source of precursors for most of the Company’s advanced petroleum-refining catalysts.
The segment’s principal products include special-effect materials and films, color pigments and dispersions, paper pigments and extenders and specialty performance additives. The segment’s special-effect pigments provide a range of aesthetic effects in coatings, personal care and cosmetic products, packaging, plastics, inks, glitter, gift wrap, textiles and other applications. Color pigments include a broad range of organic and inorganic products, dispersions and universal colorants that impart color to automotive finishes, coatings, plastics and inks. Paper pigments are used as coating and extender pigments to improve the opacity, brightness, gloss and printability of coated and uncoated papers. Specialty performance additives are used to improve the functionality, appearance and value of liquid and powder coatings, plastics, rubber, adhesives, inks, concrete and cosmetics. Iridescent and specialty films are used to visually enhance a variety of products in such applications as product packaging, labels, glitter, gift wrap and textiles.
The products of the Appearance and Performance Technologies segment compete in the marketplace on the basis of value, performance and cost. No single competitor is dominant in the markets in which the Company operates.
4
The manufacturing operations of the segment are carried out in the United States, South Korea, China and Finland. Subsidiary sales and distribution centers are located in France, Hong Kong, Japan, Mexico and The Netherlands, in addition to the manufacturing site locations noted above. Products are sold through the Company’s sales organization supplemented by independent distributors and representatives.
The principal raw materials used by the Appearance and Performance Technologies segment include naturally occurring minerals such as kaolin, attapulgite and mica, which are mined from mineral reserves owned or leased by the Company, and a variety of other minerals and chemicals that are readily available.
As of January 1, 2004, the Appearance and Performance Technologies segment had approximately 2,160 employees worldwide. Most hourly employees are covered by collective bargaining agreements. Employee relations have generally been good.
Materials Services
The Materials Services segment serves the Company’s technology segments, their customers and others with precious and base metals and related services. This is a distribution and materials services business that purchases and sells precious metals, base metals and related products and services. It does so under a variety of pricing and delivery arrangements structured to meet the logistical, financial and price-risk management requirements of the Company, its customers and suppliers. Additionally, it offers the related services of precious-metal refining and storage, and produces precious-metal salts and solutions.
The Materials Services segment is responsible for procuring precious and base metals to meet the requirements of the Company’s operations and its customers. Supplies of newly mined platinum group metals are obtained primarily from South Africa and the Russian Federation and, to a lesser extent, from the United States and Canada, the only four regions that are known significant sources. Most of these platinum group metals are obtained pursuant to a number of contractual arrangements with different durations and terms. This segment also refines platinum group metals. Gold, silver and base metals are purchased from various sources. In addition, in the normal course of business, certain customers and suppliers deposit significant quantities of precious metals with the Company under a variety of arrangements. Equivalent quantities of precious metals are returnable as product or in other forms.
Operations are located in the United States, Italy, Japan, the Russian Federation, Switzerland and the United Kingdom. As of January 1, 2004, the Materials Services segment had approximately 84 employees worldwide.
Equity Investments
The Company has equity investments in affiliates that are accounted for under the equity method. These investments are N.E. Chemcat Corporation (N.E. Chemcat), Heesung-Engelhard, Engelhard-CLAL and Prodrive-Engelhard. N.E. Chemcat is a 38.8%-owned, publicly traded Japanese corporation and a leading producer of automotive and chemical catalysts, electronic chemicals and other precious-metal-based products. Heesung-Engelhard, a 49%-owned joint venture in South Korea, manufactures and markets catalyst products for automobiles. Engelhard-CLAL manufactured and marketed certain products containing precious metals and was substantially liquidated as of December 31, 2003. As of December 31, 2003, the Company’s ownership in the remaining Engelhard-CLAL operations has decreased from 50% to 45%. Prodrive-Engelhard, a 50%-owned joint venture in the United States, specializes in the design, development and testing of vehicle emission systems.
Major Customers
No customer accounted for more than 10% of the Company’s net sales for the year ended December 31, 2003. In each of the prior two years, Ford Motor Company, a customer of the Environmental Technologies and Materials Services segments, accounted for more than 10% of the Company’s net sales. Sales of precious metal to this customer were significantly lower in 2003. Fluctuations in precious-metal prices and the type and quantities of metal purchased can result in material variations in sales reported, but do not necessarily have a direct or significant effect on earnings.
5
Research and Patents
At December 31, 2003, the Company employed approximately 532 scientists, technicians and auxiliary personnel engaged in research and development in the fields of surface chemistry and materials science. These activities are conducted in the United States and abroad. Research and development expenses were $93.1 million in 2003, $88.2 million in 2002 and $84.3 million in 2001.
Research facilities include fully staffed instrument analysis laboratories that the Company maintains in order to achieve the high level of precision necessary for its technology businesses and to assist customers in understanding how the Company’s products and services add value to their businesses.
The Company owns, or is licensed under, numerous patents secured over a period of years. It is the policy of the Company to normally apply for patents whenever it develops new products or processes considered to be commercially viable and, in appropriate circumstances, to seek licenses when such products or processes are developed by others. While the Company deems its various patents and licenses to be important to certain aspects of its operations, it does not consider any significant portion or its business as a whole to be materially dependent on patent protection.
With the oversight of environmental agencies, the Company is currently preparing, has under review, or is implementing environmental investigations and cleanup plans at several currently or formerly owned and/or operated sites, including Plainville, Massachusetts. The Company is continuing to investigate contamination at Plainville under a 1993 agreement with the United States Environmental Protection Agency (EPA). The Company is continuing to address decommissioning issues at Plainville under authority delegated by the Nuclear Regulatory Commission to the Commonwealth of Massachusetts.
In addition, as of December 31, 2003, nine sites have been identified at which the Company believes liability as a potentially responsible party is probable under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or similar state laws (collectively referred to as Superfund) for the cleanup of contamination and natural resource damages resulting from the historic disposal of hazardous substances allegedly generated by the Company, among others. Superfund imposes strict, joint and several liability under certain circumstances. In many cases, the dollar amount of the claim is unspecified and claims have been asserted against a number of other entities for the same relief sought from the Company. Based on existing information, the Company believes that it is a de-minimis contributor of hazardous substances at a number of the sites referenced above. Subject to the reopening of existing settlement agreements for extraordinary circumstances, discovery of new information or natural resource damages, the Company has settled a number of other cleanup proceedings. The Company has also responded to information requests from EPA and state regulatory authorities in connection with other Superfund sites.
The accruals for environmental cleanup-related costs reported in the consolidated balance sheets at December 31, 2003 and 2002 were $19.3 million and $18.5 million, respectively, including $0.1 million at December 31, 2003 and 2002 for Superfund sites. These amounts represent those undiscounted costs that the Company believes are probable and reasonably estimable. Based on currently available information and analysis, the Company’s accrual represents approximately 40% of what it believes are the reasonably possible environmental cleanup-related costs of a noncapital nature. The estimate of reasonably possible costs is less certain than the probable estimate upon which the accrual is based.
Cash payments for environmental cleanup-related matters were $1.8 million in each of 2003 and 2002 and $1.7 million in 2001. The amounts accrued in connection with environmental cleanup-related matters were not significant over this time period.
For the past three-year period, environmental-related capital projects have averaged less than 10% of the Company’s total capital expenditure programs, and the expense of environmental compliance (e.g., environmental testing, permits, consultants and in-house staff) was not material.
6
There can be no assurances that environmental laws and regulations will not become more stringent in the future or that the Company will not incur significant costs in the future to comply with such laws and regulations. Based on existing information and currently enacted environmental laws and regulations, cash payments for environmental cleanup-related matters are projected to be $1.5 million for 2004, which has already been accrued. Further, the Company anticipates that the amounts of capitalized environmental projects and the expense of environmental compliance will approximate current levels. While it is not possible to predict with certainty, management believes environmental cleanup-related reserves at December 31, 2003 are reasonable and adequate, and environmental matters are not expected to have a material adverse effect on financial condition. However, if these matters are resolved in a manner different from the estimates, they could have a material adverse effect on the Company’s operating results or cash flows.
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PROPERTIES |
The Company leases a building on approximately seven acres of land with an area of approximately 271,000 square feet in Iselin, NJ. This building serves as the principal executive and administrative office of the Company and its operating segments. The Company owns approximately eight acres of land and three buildings with a combined area of approximately 150,000 square feet in Iselin, NJ. These buildings serve as the major research and development facilities for the Company’s operations. The Company also owns or leases research facilities in Gordon, GA; Union, NJ; Buchanan and Ossining, NY; Beachwood, OH; Pasadena, TX; Hannover, Germany; and De Meern, The Netherlands.
The Environmental Technologies segment operates company-owned plants in Huntsville, AL; East Windsor, CT; Wilmington, MA; Duncan, SC; East Newark and Carteret, NJ; Fremont, CA; Nienburg, Germany; Madras, India; Port Elizabeth, South Africa; Rome, Italy; Indiatuba, Brazil; Shanghai, China; Rayoung, Thailand; Solvesborg, Sweden; and Cinderford in the United Kingdom.
The Process Technologies segment operates company-owned plants in Attapulgus and Savannah, GA; Elyria, OH; Erie, PA; Seneca, SC; Jackson, MS; Pasadena, TX; Rome, Italy; De Meern, The Netherlands; and Tarragona, Spain.
The Appearance and Performance Technologies segment operates company-owned attapulgite processing plants in Quincy, FL near the area containing its attapulgite reserves, plus mica mine and processing facilities in Hartwell, GA. In addition, the segment operates three company-owned kaolin mines and three milling facilities in Middle Georgia, which serve a 70-mile network of pipelines to three processing plants. It also operates on company-owned land containing kaolin and leases on a long-term basis kaolin mineral rights to additional acreage. The segment also operates company-owned sales and manufacturing facilities in Kotka and Rauma, Finland and Shanxi, China in addition to owning and operating color, pearlescent pigment and film manufacturing facilities in Sylmar, CA; Louisville, KY; Eastport, ME; Peekskill, NY; Elyria, OH; Charleston, SC; and Inchon, South Korea. Management believes the Company’s kaolin, attapulgite and mica reserves will be sufficient to meet its needs for the foreseeable future.
The Materials Services segment’s operations are conducted at leased facilities in Iselin, NJ; Lincoln Park, MI; Tokyo, Japan; Moscow, Russia; Zug, Switzerland; and London, the United Kingdom. In addition, the segment’s operations are conducted at company-owned facilities in Seneca, SC; Carteret, NJ; and Rome, Italy.
Management believes that the Company’s processing and refining facilities, plants and mills are suitable and have sufficient capacity to meet its normal operating requirements for the foreseeable future.
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LEGAL PROCEEDINGS
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The Company is one of a number of defendants in numerous proceedings that allege that the plaintiffs were injured from exposure to hazardous substances purportedly supplied by the Company and other defendants or that existed on Company premises. The Company is also subject to a number of environmental contingencies (see Note 21, “Environmental Costs,” for further detail) and is a defendant in a number of lawsuits covering a wide range of other matters. In some of these matters, the remedies sought or damages claimed are substantial. While it is not possible to predict with certainty the ultimate outcome of these lawsuits or the resolution of the environmental contingencies, management believes, after consultation with counsel, that resolution of these matters is not expected
7
to have a material adverse effect on financial condition. However, if these matters are resolved in a manner different from management’s current expectations, they could have a material adverse effect on the Company’s operating results or cash flows.
The Company is involved in a value-added tax dispute in Peru. Management believes the Company was targeted by corrupt officials within a former Peruvian government. On December 2, 1999, Engelhard Peru, S.A., a wholly-owned subsidiary, was denied refund claims of approximately $28 million. The Peruvian tax authority also determined that Engelhard Peru, S.A. is liable for approximately $63 million in refunds previously paid, fines and interest as of December 31, 1999. Interest and fines continue to accrue at rates established by Peruvian law. The Peruvian Tax Court ruled on February 11, 2003 that Engelhard Peru, S.A. was liable for these amounts, overruling precedent to apply a “form over substance” theory without any determination of fraudulent participation by Engelhard Peru, S.A. The Tax Court is part of the Peruvian Ministry of Economics and Finance. Engelhard Peru, S.A. is contesting these determinations vigorously, and management believes, based on consultation with counsel, that Engelhard Peru, S.A. is entitled to all refunds claimed and is not liable for these additional taxes, fines or interest. In late October 2000, a criminal proceeding alleging tax fraud and forgery related to this value-added tax dispute was initiated against two Lima-based officials of Engelhard Peru, S.A. Although Engelhard Peru, S.A. is not a defendant, it may be civilly liable in Peru if its representatives are found responsible for criminal conduct. In its own investigation, and in detailed review of the materials presented in Peru, management has not seen any evidence of tax fraud by these officials. Accordingly, Engelhard Peru, S.A. is assisting in the vigorous defense of this proceeding. Management believes the maximum economic exposure is limited to the aggregate value of all assets of Engelhard Peru, S.A. That amount, which is approximately $30 million including unpaid refunds, has been fully provided for in the accounts of the Company.
8
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SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
Not applicable.
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EXECUTIVE OFFICERS OF THE REGISTRANT |
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ARTHUR A. DORNBUSCH, II |
Age 60. Vice President, General Counsel and Secretary of the Company from prior to 1999. |
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MARK DRESNER |
Age 52. Vice President of Corporate Communications from prior to 1999. |
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JOHN C. HESS |
Age 52. Vice President, Human Resources from prior to 1999. |
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MAC C.P. MAK |
Age 55. Treasurer, effective April 7, 2003. Senior Vice President, Strategic Planning and Corporate Development, Coty Inc. (global cosmetics company) from December 2001 to April 2003. Vice President, Strategic Planning and Corporate Development, Coty Inc. from October 1999 to December 2001. Vice President and Deputy Treasurer, RJR Nabisco Inc. (global cigarette and food company) from October 1998 to August 1999. |
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PETER B. MARTIN |
Age 64. Vice President, Investor Relations from prior to 1999. |
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BARRY W. PERRY * |
Age 57. Chairman and Chief Executive Officer of the Company since January 2001. President and Chief Operating Officer from prior to 1999. Mr. Perry is also a director of Arrow Electronics, Inc. and Cookson Group plc. |
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ALAN J. SHAW |
Age 55. Controller of the Company effective January 1, 2003. Vice President-Finance of Materials Services from prior to 1999. |
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MICHAEL A. SPERDUTO |
Age 46. Vice President and Chief Financial Officer of the Company effective August 2, 2001. Controller of the Company from August 1999 to August 2001. Vice President-Finance from prior to 1999. |
* Also a director of the Company.
Officers of the Company are elected at the meeting of the Board of Directors held in May of each year after the annual meeting of shareholders and serve until their successors shall be elected and qualified and shall serve as such at the pleasure of the Board.
9
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MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS |
As of March 1, 2004, there were 4,876 holders of record of the Company’s common stock, which is traded on the New York Stock Exchange (ticker symbol “EC”), as well as on the Swiss stock exchange.
The range of market prices and cash dividends paid for each quarterly period were as follows:
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NYSE |
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Cash |
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Low |
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2003 |
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First quarter |
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$ |
23.11 |
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$ |
19.02 |
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$ |
0.10 |
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Second quarter |
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26.61 |
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21.26 |
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0.10 |
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Third quarter |
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29.15 |
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24.08 |
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0.10 |
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Fourth quarter |
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30.58 |
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27.18 |
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0.11 |
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2002 |
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First quarter |
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$ |
31.16 |
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$ |
25.02 |
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$ |
0.10 |
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Second quarter |
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33.00 |
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26.62 |
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0.10 |
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Third quarter |
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29.00 |
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22.44 |
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0.10 |
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Fourth quarter |
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25.44 |
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21.18 |
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0.10 |
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SELECTED FINANCIAL DATA
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Selected
Financial Data
($ in millions, except per-share amounts)
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2003 |
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2002 |
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2001 |
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2000 |
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1999 |
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Net sales
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$ |
3,714.5 |
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$ |
3,753.6 |
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$ |
5,096.9 |
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$ |
5,542.6 |
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$ |
4,488.0 |
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Net earnings (1) |
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234.2 |
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171.4 |
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225.6 |
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168.3 |
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197.5 |
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Basic earnings per share (1) |
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1.87 |
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1.34 |
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1.73 |
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1.33 |
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1.49 |
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Diluted earnings per share (1) |
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1.84 |
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1.31 |
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1.71 |
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1.31 |
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1.47 |
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Total assets |
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2,933.0 |
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3,020.7 |
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2,995.5 |
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3,166.8 |
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2,920.5 |
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Long-term debt |
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390.6 |
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247.8 |
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237.9 |
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248.6 |
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499.5 |
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Shareholders’ equity |
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1,285.4 |
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1,077.2 |
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1,003.5 |
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874.6 |
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764.4 |
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Cash dividends paid per share |
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0.41 |
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0.40 |
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|
0.40 |
|
|
0.40 |
|
|
0.40 |
|
|
Return on average shareholders’ equity (1) |
|
|
19.8 |
% |
|
16.5 |
% |
|
24.0 |
% |
|
20.5 |
% |
|
23.7 |
% |
(1) Net earnings in 2003 include the following: a royalty settlement gain of $17.6 million, a charge of $4.8 million for the fair value of the remaining lease costs of certain minerals-storage facilities that the Company ceased to use because of productivity initiatives and restructuring charges of $5.6 million (see Note 6, “Special Charges and Credits,” for further detail). In addition, a transition charge of $2.3 million was recorded on January 1, 2003 as the cumulative effect of an accounting change (see Note 4, “Accounting for Asset Retirement Obligations,” for further detail).
Net earnings in 2002 include the following: an impairment charge of $57.7 million associated with the Engelhard-CLAL joint venture (see Note 10, “Investments,” for further detail), an impairment charge of $4.1 million associated with an investment in fuel-cell developer Plug Power Inc. (see Note 10, “Investments,” for further detail), a charge of $1.9 million related to a manufacturing consolidation plan and a $6.8 million insurance settlement gain (see Note 6, “Special Charges and Credits,” for further detail).
10
Net earnings in 2000 include the following: fourth-quarter special and other charges of $75.1 million for a variety of events, a third-quarter impairment charge of $16.9 million related to the write-down of goodwill and fixed assets of the Company’s HexCore business unit and net gains of $12.9 million on sales of investments and land.
Net earnings in 1999 include net gains of $6.0 million on sales of investments and land.
The following tables provide information related to the adoption of Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations” (See Note 4, “Accounting for Asset Retirement Obligations,” for further detail):
Selected
Financial Data
($ in millions, except per-share amounts)
|
|
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
1999 |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Net earnings before cumulative effect of a change in
accounting principle |
|
$ |
236.5 |
|
$ |
171.4 |
|
$ |
225.6 |
|
$ |
168.3 |
|
$ |
197.5 |
|
|
|
Cumulative effect of a change in accounting
principle, net of tax of $1,390 |
|
|
(2.3 |
) |
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
$ |
234.2 |
|
$ |
171.4 |
|
$ |
225.6 |
|
$ |
168.3 |
|
$ |
197.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share – basic: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings before cumulative effect of a change in
accounting principle |
|
$ |
1.89 |
|
$ |
1.34 |
|
$ |
1.73 |
|
$ |
1.33 |
|
$ |
1.49 |
|
|
|
Cumulative effect of a change in accounting
principle, net of tax |
|
|
(0.02 |
) |
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share - basic |
|
$ |
1.87 |
|
$ |
1.34 |
|
$ |
1.73 |
|
$ |
1.33 |
|
$ |
1.49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share – diluted: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings before cumulative effect of a change in
accounting principle |
|
$ |
1.86 |
|
$ |
1.31 |
|
$ |
1.71 |
|
$ |
1.31 |
|
$ |
1.47 |
|
|
|
Cumulative effect of a change in accounting
principle, net of tax |
|
|
(0.02 |
) |
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share – diluted |
|
$ |
1.84 |
|
$ |
1.31 |
|
$ |
1.71 |
|
$ |
1.31 |
|
$ |
1.47 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma amounts assuming the
provisions of SFAS No. 143 were applied retroactively: |
|
2003 |
|
2002 |
|
2001 |
|
2000 |
|
1999 |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Net earnings before cumulative effect of a change in
accounting principle |
|
$ |
236.5 |
|
$ |
170.8 |
|
$ |
225.0 |
|
$ |
167.8 |
|
$ |
197.1 |
|
|
|
Basic earnings per share before cumulative effect |
|
|
1.89 |
|
|
1.33 |
|
|
1.73 |
|
|
1.33 |
|
|
1.49 |
|
|
|
Diluted earnings per share before cumulative effect |
|
|
1.86 |
|
|
1.31 |
|
|
1.70 |
|
|
1.31 |
|
|
1.46 |
|
|
11
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Unless otherwise indicated, all per-share amounts are presented as diluted earnings per share, as calculated under SFAS No. 128, “Earnings per Share.”
For a discussion of the Company’s critical accounting policies, see page 21.
Results of Operations
Net sales were $3.7 billion in 2003, compared with $3.8 billion in 2002 and $5.1 billion in 2001. Net earnings were $234.2 million ($1.84 per share) in 2003, compared with $171.4 million ($1.31 per share) in 2002 and $225.6 million ($1.71 per share) in 2001.
Net earnings in 2003 include a royalty settlement gain of $17.6 million, a charge of $4.8 million for the fair value of the remaining lease costs of certain minerals-storage facilities that the Company ceased to use because of productivity initiatives and restructuring charges of $5.6 million. In addition, a transition charge of $2.3 million was recorded on January 1, 2003 as the cumulative effect of an accounting change. Net earnings in 2002 include an impairment charge of $57.7 million associated with the Engelhard-CLAL joint venture, an impairment charge of $4.1 million associated with an investment in fuel-cell developer Plug Power Inc., a charge of $1.9 million related to a manufacturing consolidation plan and a $6.8 million insurance settlement gain.
The information in the discussion of each segment’s results discussed below is derived directly from the internal financial reporting system used for management purposes. Items allocated to each segment’s results include the majority of corporate operating charges. Unallocated items include interest expense, interest income, royalty income, sale of precious metals accounted for under the last-in, first-out (LIFO) method, certain special charges and credits, income taxes, certain information technology development costs and other miscellaneous corporate items.
Operating earnings in the Company’s “All Other” category increased primarily from the royalty settlement gain of $28.4 million ($17.6 million after tax) reported in 2003 (see Note 6, “Special Charges and Credits,” for further detail).
Environmental Technologies
The Environmental Technologies segment markets cost-effective compliance with environmental regulations, enabled by sophisticated emission-control technologies and systems. The segment also provides high-value material products made principally from platinum group metals, as well as thermal spray and coating technologies.
2003 Performance
Sales increased 22% to $831.4 million and operating earnings increased 9% to $119.3 million.
Discussion
The majority of this segment’s sales and operating earnings are derived from technologies to control pollution from mobile sources, including gasoline- and diesel-powered passenger cars, sport-utility vehicles, trucks, buses and off-road vehicles.
Sales increased primarily from the addition of higher pass-through substrate costs and the favorable impact of foreign exchange, which collectively accounted for approximately two-thirds of the sales increase. Sales were also favorably impacted from increased sales of advanced technology solutions to the automotive markets. In addition, higher volumes and a favorable product mix in both diesel OEM and retrofit markets had a favorable impact on sales. Higher sales were partially offset by $16.3 million on lower volumes of emission-control systems for gas turbines used in power-generation applications and by $12.1 million on lower volumes to surface coating markets primarily due to lower demand from the aerospace industry.
12
Operating earnings were higher from increased sales of advanced technology solutions to the automotive markets. Operating earnings were also favorably impacted due to increased volumes and a favorable product mix in both diesel OEM and retrofit markets; the absence of costs in the year-ago period related to rework for power-generation applications of $11.4 million; the favorable impact of foreign exchange of $6.7 million; and a manufacturing consolidation charge of $3.1 million recorded in the second quarter of 2002. The increase was partially offset by lower volumes of emission-control systems for gas turbines used in power-generation applications and lower volumes to surface-coating markets. This decline resulted from a strong year-ago first quarter in the energy market and lower demand from the aerospace industry. Earnings also decreased due to a management consolidation and productivity initiative that resulted in a charge of $5.3 million recorded in the first quarter of 2003; the reversal of a warranty accrual of $4.9 million in the first quarter of 2002 for a particular stationary-source, emission-control capital equipment project as a result of improved technology; the recognition of expenses of $5.0 million due to customer-related financial issues; higher depreciation costs of $4.3 million and higher energy costs of $2.7 million.
Outlook
This segment expects growth in sales and operating earnings as emission-control regulations become stricter around the world and address a much broader range of emission sources. Demand from the automotive market is expected to remain strong in response to the Company’s development of several new technologies. Although auto builds in our largest market segments are forecasted to be flat in 2004, ongoing productivity improvements and increased demand in Asia are expected to support modest growth in this portion of the segment. A significant decline in auto builds could have an unfavorable effect on this segment, depending on the demand for platforms where the segment provides catalysts.
In stationary-source markets, demand is expected to remain soft for technologies related to peak-power generation due to the current lack of funding for these projects.
Sales of advanced catalysts for medium- and heavy-duty diesel trucks increased in 2003 and are expected to expand in 2004 as new regulations begin to take effect. Significant investment in research for medium- and heavy-duty diesel continues in anticipation of more stringent regulations scheduled to begin phasing in during 2005 and 2007.
This segment continues to work to reduce its reliance on the automotive market by developing an array of applications not only for medium- and heavy-duty diesel markets, but also for non-automotive markets, including technologies for motorcycles; small engines, such as lawn and garden power equipment; charbroilers; mining and construction; and ozone management.
2002 compared with 2001
Sales increased 5% to $680.4 million and operating earnings decreased 23% to $109.2 million.
Discussion
Sales increased primarily from the addition of higher pass-through substrate costs of $32.2 million, an estimated 2% increase in worldwide production of light-duty vehicles and higher volumes in both diesel OEM and retrofit markets. Higher sales were reduced by $15.8 million on lower volumes of emission-control systems for gas turbines used in power-generation applications and by $7.8 million on lower volumes to surface coating markets.
Operating earnings decreased primarily from higher expenses of $11.4 million associated with rework for power-generation applications, higher depreciation, depletion and amortization costs of $5.5 million, a manufacturing consolidation charge of $3.1 million recorded in 2002 and higher research and development costs of $3.0 million.
Process Technologies
The Process Technologies segment enables customers to make their processes more productive, efficient, environmentally sound and safer through the supply of advanced chemical-process catalysts, additives and sorbents.
13
2003 Performance
Sales increased 6% to $569.2 million and operating earnings increased 3% to $95.9 million.
Discussion
Sales grew primarily from increased demand for new technologies offered to the petroleum-refining (DMS platform products and additives), polyolefin (Lynx platform) and gas-to-liquids markets which aggregated $33.0 million and the favorable impact of foreign exchange of $13.0 million. Sales were reduced by $10.3 million due to lower precious-metal prices, which are passed through to chemical-process catalyst customers in Europe and lower sales to chemical-process markets of $7.0 million primarily from the timing of orders and related shipments.
Operating earnings rose primarily due to increased demand for new technologies offered to the petroleum-refining, polyolefin and gas-to-liquids markets; lower raw material costs of $4.5 million (excluding nickel); the favorable impact of foreign exchange of $5.4 million; and benefits from productivity programs. These increases were partially offset by a productivity initiative that resulted in a charge of $2.6 million recorded in the first quarter of 2003, higher energy costs of $5.7 million and higher nickel costs of $3.5 million.
Outlook
Sales and earnings growth in this segment are expected to come from custom-process catalysts, such as those that enable conversion of gas-to-liquids; new catalyst and additive technologies for petroleum refining; and increased market penetration for polypropylene catalysts. Continued cost management, productivity improvements and product technology advances should also contribute to earnings growth. Capacity expansion of a polyolefin catalyst plant in Tarragona, Spain is expected to come online in the first half of 2004. Overall weakness in the chemical-process market and relatively flat demand in the petroleum-refining market are expected to continue for most of 2004.
2002 compared with 2001
Sales decreased 5% to $538.8 million and operating earnings decreased 1% to $93.0 million.
Discussion
Sales and operating earnings were lower in 2002 primarily from lower volumes to the chemical-process and petroleum-refining markets. These decreases were partially offset by increased demand for Lynx 1000™ polypropylene catalysts; NaphthaMax™ refining catalysts and petroleum-refining additives, which aggregated $37.2 million; the full-year inclusion of a fats and oils catalyst business acquired from Sud Chemie in October 2001; and the introduction of a new gas-to-liquids catalyst in 2002. Sales were also reduced by $17.6 million due to lower precious-metal prices, which are passed through to chemical-process catalyst customers in Europe.
Operating earnings were favorably impacted by lower energy and raw material costs of $6.3 million; the elimination of goodwill amortization of $3.6 million related to the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets”; full-year inclusion of $2.5 million of results from the fats and oils catalyst business acquired from Sud Chemie in October 2001; and favorable impact of foreign exchange of $1.6 million.
Appearance and Performance Technologies
The Appearance and Performance Technologies segment provides pigments, effect materials and performance additives that enable its customers to market enhanced image and functionality in their products. This segment serves a broad array of end markets, including coatings, plastics, cosmetics, automotive, construction and paper. The segment’s products help customers improve the look, performance and overall cost of their products. In addition, the segment is the internal supply source of precursors for most of the Company’s advanced petroleum-refining catalysts.
14
2003 Performance
Sales increased 1% to $653.8 million and operating earnings decreased 20% to $69.5 million.
Discussion
Sales increased slightly in 2003 as significant sales volumes to the coatings, cosmetics, personal care and automotive markets, and the net favorable impact of foreign exchange of $5.8 million were partially offset by lower volumes of mineral-based products to the paper and industrial end markets. Lower volumes of mineral-based products were attributed to continued weak demand in the paper market and the loss of some volume to competition due to pricing.
Operating earnings were lower primarily from a charge of $7.8 million recorded in the second quarter of 2003 for the fair value of the remaining lease costs of certain minerals-storage facilities that the Company ceased to use because of productivity initiatives, lower minerals sales volumes to the paper market, higher energy costs of $11.3 million and higher costs related to the start-up of a new manufacturing plant in China. This decrease was partially offset by continued strong growth in the colorant and effect-pigment markets.
Outlook
Earnings growth within this segment is expected to improve from the weak and mixed results reported in 2003. Sales and earnings to several major markets, including coatings, cosmetics, personal care, automotive and agriculture, are expected to continue its pattern of growth. This growth is expected to be driven by expansion of the segment’s technology base through alliances and internal development, which should result in new products, applications and served markets.
Earnings growth from mineral-based markets is expected to improve in spite of a continued weak paper industry outlook through most of the coming year. This growth is expected to come from productivity improvements and sales increases to non-paper markets. However, worldwide coated-paper consumption has been relatively flat over the period 2001 to 2003 and down from the peaks reached in 2000. While modest growth is expected over the next several years, the hydrous kaolin market continues to be particularly difficult. Brazilian producers have brought more than 1.5 million tons of capacity on stream since 1997. This has exacerbated an over-capacity situation and led to severe price competition, particularly as consolidations have given paper producers greater purchasing power. As a consequence of trying to maintain pricing and capture energy surcharges, Engelhard has lost market share, which will reduce 2004 volumes. However, to increase earnings in spite of these conditions, there will be a continued emphasis on productivity and efforts to focus on higher value end markets, including non-paper applications. A series of actions were initiated in the first quarter of 2004 to reduce costs by consolidating plant operations and reducing total headcount. Recent calculations show no impairment of long-lived assets, but continued volume and/or price erosion could change the situation.
2002 compared with 2001
Sales increased 3% to $650.8 million and operating earnings increased 87% to $87.1 million.
Discussion
Sales and operating earnings were up primarily from increased sales volumes to the coatings, automotive, agricultural, cosmetics, personal care and plastics markets. Operating earnings were also favorably impacted by lower costs from productivity improvements of $21.5 million; the elimination of goodwill amortization of $5.7 million related to the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets”; lower energy costs of $4.6 million; the recording of a $7.1 million charge in 2001 relating to asset redeployment actions and productivity initiatives; and selective price increases in the paper market in the range of 3% to 4%.
Materials Services
The Materials Services segment serves the Company’s technology segments, their customers and others with precious and base metals and related services. This is a distribution and materials services business that
15
purchases and sells precious metals, base metals and related products and services. It does so under a variety of pricing and delivery arrangements structured to meet the logistical, financial and price-risk management requirements of the Company, its customers and suppliers. Additionally, it offers the related services of precious-metal refining and storage, and produces precious-metal salts and solutions.
2003 Performance
Sales decreased 12% to $1.6 billion and operating earnings decreased 81% to $10.1 million.
Discussion
Sales for this segment include substantially all of the Company’s sales of metals to industrial customers of all segments. Sales also include fees invoiced for services rendered (e.g., refining and handling charges). Because of the logistical and hedging nature of much of this business and the significant precious metal values included in both sales and cost of sales, gross margins tend to be low in relation to the Company’s other technology businesses as does capital employed. This effect also dampens the gross margin percentages of the Company as a whole, but improves the return on investment.
While many customers for the Company’s platinum-group-metal catalysts purchase the metal from Materials Services, some choose to deliver metal from other sources prior to the manufacture of the catalysts. In such cases, precious metal values are not included in sales. The mix of such arrangements and the extent of market price fluctuations can significantly affect the reported level of sales and cost of sales. Consequently, there is no necessary direct correlation between year-to-year changes in reported sales and operating earnings.
Operating earnings were lower primarily from the timing of certain items discussed below, changes in pricing formulas that reduce margins and lower results from the recycling (refining) of platinum group metals of $9.3 million. Recycling earnings were down primarily from higher costs associated with performance issues at a domestic refinery and a less favorable mix of metals. The performance issues, which are apart from the current level of operations, are being actively addressed by management.
Operating earnings in both years were favorably affected by several items that triggered recognition of events reflecting operations from prior periods. Operating earnings in 2003 benefited from a contract settlement of $9.3 million and the reversal of an accrual that is no longer necessary of $2.8 million. In 2002, operating earnings were favorably affected by $22.0 million of income related to platinum-group-metal transactions realized previously but deferred pending the resolution of certain contractual provisions, an insurance settlement gain of $11.0 million, $5.5 million of income related to a previously unrecognized contractual benefit and $3.0 million of income related to cash received from the settlement of litigation for a customer receivable recorded in 1997 that was previously written off. The prior-year benefits were partially offset by higher operating expenses from multiple causes, including legal and compensation expenses. Sales decreased from lower platinum-group-metal prices and lower volumes.
Outlook
The results of this segment are likely to approximate recent levels rather than the higher levels of 2001. Overall weakness projected in the chemical markets should continue to adversely impact the recycling and refining of platinum group metals. In addition, the segment is continuing to experience the change that has been going on in these markets, which involves different pricing formulas that have reduced historical margins.
2002 compared with 2001
Sales decreased 43% to $1.8 billion and operating earnings decreased 6% to $52.7 million.
Discussion
Operating earnings were down as a result of lower volumes and lower results from the recycling (refining) of platinum group metals of $11.0 million. Operating earnings in both years were favorably affected by several items that triggered recognition of events reflecting operations from prior periods. In 2002, operating earnings were
16
favorably affected by $22.0 million of income related to platinum-group-metal transactions realized previously but deferred pending the resolution of certain contractual provisions; an insurance settlement gain of $11.0 million; $5.5 million of income related to a previously unrecognized contractual benefit; and $3.0 million of income related to cash received from the settlement of litigation for a customer receivable recorded in 1997 that was previously written off. In 2001, operating earnings were favorably impacted by the recovery of metal from an unexpected industrial customer bankruptcy ($6.2 million) and the restructuring of a professional services contract ($3.3 million). Sales decreased from lower platinum-group-metal prices and lower volumes.
Acquisitions
|
Other Party |
|
Business |
|
Transaction Date |
|
Business Opportunity |
|
|
|
|
|
|
|
|
|
Shuozhou Anpeak |
|
Acquired certain operating assets of a China-based producer of calcined kaolin products for $12.1 million |
|
November 2002 |
|
Enhances the Company’s ability to provide specialty mineral technologies to the Asian market |
|
|
|
|
|
|
|
|
|
Sud-Chemie AG |
|
Acquired the fats and oils catalyst business of Sud Chemie for $13.6 million |
|
October 2001 |
|
Broadens the Company’s catalyst technology offering to oleochemical markets |
Consolidated Gross Profit
Gross profit as a percentage of sales was 17.1% in 2003, compared with 17.4% in 2002 and 13.0% in 2001. The following table represents gross margin percentages of the Materials Services segment and the Company’s technology segments (Environmental, Process and Appearance and Performance Technologies) and “All Other” for the years ended December 31, 2003, 2002 and 2001:
|
|
|
2003 |
|
2002 |
|
2001 |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Materials Services |
|
|
2.3% |
|
|
3.8% |
|
|
2.9% |
|
|
Technology Segments and “All
Other” |
|
|
28.3% |
|
|
30.4% |
|
|
30.3% |
|
|
Total Company |
|
|
17.1% |
|
|
17.4% |
|
|
13.0% |
|
The overall decrease in 2003 was primarily due to lower margins earned in the Materials Services segment and in the Environmental Technologies segment primarily due to higher pass-through substrate costs. Sales from the Materials Services segment decreased 12% in 2003 to $1.6 billion and provided a gross profit of 2%, while 2003 sales from all other reportable segments increased 10% to $2.1 billion and provided a gross profit of 29%. As described earlier, the lower margins on Materials Services sales are driven by the inclusion of the value of precious metals in both sales and cost of sales. The overall increase in 2002 was primarily related to a $1.3 billion decrease in sales from lower precious-metal prices.
Selling, Administrative and Other Expenses
Selling, administrative and other expenses were $364.5 million in 2003 compared with $350.1 million in 2002 and $336.0 million in 2001. The increase in 2003 was primarily due to increased professional and legal fees of $6.9 million, increased research and development expenses of $4.9 million and increased information technology expenses of $3.9 million. The increase in 2002 was primarily due to increased information technology expenses of $5.7 million, increased research and development expenses of $3.9 million, increased administrative rent expenses of $2.6 million and increased professional fees of $2.4 million.
Equity Earnings
Equity in earnings of affiliates was $39.4 million in 2003, compared with equity earnings of $16.2 million in 2002 (excluding the impairment charge discussed below) and $29.1 million in 2001. The increase was primarily
17
due to higher earnings from Engelhard-CLAL recognized in liquidation resulting from the sale of platinum inventories at favorable prices, realized gains on the sale of an inactive facility and the strengthening of the Euro versus the U.S. dollar, all in relation to projections made at the time of the impairment. The decrease in 2002 was from gains reported in 2001 related to a change in the mix of platinum group metals used in its operations and lower volumes due to the absence of divested business units.
In the third quarter of 2002, the Company recorded an impairment charge of $57.7 million associated with its Engelhard-CLAL joint venture (see Note 10, “Investments,” for further detail).
Loss on Investment
In the second quarter of 2002, the Company recorded an impairment charge of $6.7 million ($4.1 million after tax) associated with its Plug Power Inc. investment (see Note 10, “Investments,” for further detail).
Interest
Interest expense was $24.3 million in 2003, compared with $27.4 million in 2002 and $47.3 million in 2001. Interest expense in 2003 decreased due to decreased borrowings, partially offset by higher foreign short-term interest rates. Interest expense in 2002 decreased from decreased borrowings and lower short-term interest rates.
Interest income was $4.0 million in 2003, $2.0 million in 2002 and $3.3 million in 2001. The Company capitalized interest of $3.0 million in each of 2003, 2002 and 2001.
Taxes
The worldwide income tax expense was $64.2 million in 2003, compared with $66.5 million in 2002 and $79.7 million in 2001. The effective income tax rate was 21.3% in 2003, 22.5% in 2002 (excluding the equity investment impairment charge of $57.7 million) and 26.1% in 2001.
The decrease in the worldwide effective tax rate in 2003 was primarily the result of the recognition of favorable tax variances from foreign tax credits, partially offset by a shift in the geographical mix of earnings. The decrease in the worldwide effective tax rate in 2002 was primarily the result of higher percentage depletion deductions and research and development tax credits in excess of previous estimates (see Note 14, “Income Taxes,” for further detail of variances).
The World Trade Organization has ruled that the extraterritorial income (ETI) exclusion, which provides the Company with a tax benefit based on export sales, is a prohibited export subsidy. As a result, ETI rules are presently under reconsideration by Congress and the repeal of this benefit is likely. In fiscal year 2003, export benefits reduced the Company’s effective tax rate by approximately three percentage points. It is not possible to predict at this time the eventual outcome of this matter and the impact to the Company. However, if ETI is repealed and legislation that would result in comparable benefits is not enacted, the loss of the tax benefit to the Company will adversely impact the Company’s effective tax rate and net income.
Liquidity and Capital Resources
Working capital was $445.5 million at December 31, 2003, compared with $179.8 million at December 31, 2002. The current ratio was 1.5 and 1.1 at December 31, 2003 and 2002, respectively. The year-end market value of the Company’s precious metals, accounted for under the LIFO method, exceeded carrying cost by $52.8 million at December 31, 2003, compared with $58.3 million at December 31, 2002. The decrease in excess value reflects lower market values and the impact of slightly reduced inventory levels (see Note 8, “Inventories,” for further detail).
The Company’s total debt decreased to $458.8 million at December 31, 2003 from $596.6 million at December 31, 2002. The percentage of total debt to total capitalization decreased to 26% at December 31, 2003 from 36% at December 31, 2002, primarily due to decreased borrowings and increased retained earnings.
18
The Company currently has a $400 million, five-year committed credit facility that expires in May 2006 and a $400 million, 364-day committed credit facility that expires in May 2004, with a group of major U.S. and overseas banks. The Company intends to renew, and possibly increase, the $400 million committed line of credit that expires in May 2004. In addition, the Company has a $12 million, seven-year committed credit facility with two major foreign banks that expires in October 2010 relating to a plant expansion in China. Unused, uncommitted lines of credit were $428 million at December 31, 2003.
Through a public debt offering in May 2003, the Company issued $150 million of 10-year notes. These notes mature on May 15, 2013 and bear an interest rate of 4.25%. The proceeds were used to repay short-term borrowings. As discussed in Note 2, “Derivative Instruments and Hedging,” these notes were effectively changed from a fixed rate debt obligation to a floating rate debt obligation through the use of interest rate swap agreements. The notes were issued under the Company’s existing $300 million shelf registration, effectively reducing the available shelf registration to $150 million. Plans to increase the shelf registration up to $450 million are under consideration by management. Plans to issue $50 million to $150 million in Japanese yen denominated Notes are also under consideration by management.
Operating activities provided net cash of $631.0 million in 2003, compared with $302.3 million in 2002 and $345.8 million in 2001. The variance in cash flows from operating activities primarily occurred in the Materials Services segment and reflects changes in metal positions used to facilitate requirements of the Company, its metal customers and suppliers (see Note 24, “Supplemental Information,” for Materials Services variances). Due to changing customer/supplier relationships with respect to platinum group metals, the levels of committed metal positions and hedged metal obligations have been reduced by approximately half from those of the last several years. Current levels are expected to prevail for at least the next year. Materials Services routinely enters into a variety of arrangements for the sourcing of metals. Generally, transactions are hedged on a daily basis (see Note 1, “Summary of Significant Accounting Policies,” for further detail). Hedging is accomplished primarily through forward, future and option contracts. However, in closely monitored situations for which exposure levels have been set by senior management, the Company, from time to time, holds large unhedged industrial commodity positions that are subject to future market price fluctuations. These positions are included in committed metal positions, along with hedged metal holdings. The bulk of hedged metal obligations represent spot short positions. As these positions generate cash, their cash effect is included in the financing activities section of the Company’s “Consolidated Statements of Cash Flows.” Other than in closely monitored situations, these positions are hedged with forward purchases. In addition, the aggregate fair value of derivatives in a loss position are reported in hedged metal obligations (derivatives in a gain position are included in committed metal positions). Materials Services works to ensure that the Company and its customers have an uninterrupted source of metals, primarily platinum group metals, utilizing supply contracts and commodities markets around the world. Committed metal positions may include significant advances made for the purchase of precious metals that have been delivered to the Company but for which the final purchase price has not yet been determined. As of December 31, 2003, the aggregate market value of the metals purchased under a contract for which a provisional price had been paid was in excess of the amounts advanced by a total of $92.9 million. As a result, this amount was recorded in committed metal positions and accounts payable at December 31, 2003.
The variance in cash flows from investing activities is primarily related to liquidating distributions received in connection with the 2002 plan to unwind the Company’s Engelhard-CLAL joint venture, the acquisition of certain operating assets of Shuozhou Anpeak Kaolin Co., Ltd. in November 2002, an additional non-equity investment in fuel-cell developer Plug Power Inc. in 2002 and the acquisition of the fats and oils catalyst business of Sud Chemie in October 2001.
The variance in cash flows from financing activities was impacted by a change in hedged metal obligations (as discussed above), proceeds received from the issuance of long-term debt in May 2003, a decrease in short-term borrowings, the repayment of long-term debt in 2001 and cash received from the exercise of stock options, particularly in 2001.
19
The following table is a representation of the Company’s contractual obligations as of December 31, 2003 (the notes below provide further detail with regard to the Company’s purchase obligations):
PAYMENTS DUE BY PERIOD
|
CONTRACTUAL
OBLIGATIONS
|
|
Total |
|
Less than |
|
2-3 years |
|
4-5 years |
|
More than |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
(in
millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
borrowings
|
|
$ |
68.3 |
|
$ |
68.3 |
|
$ |
— |
|
$ |
— |
|
$ |
— |
|
|
|
Accounts
payable
|
|
|
297.0 |
|
|
297.0 |
|
|
— |
|
|
— |
|
|
— |
|
|
|
Other
current liabilities
|
|
|
286.9 |
|
|
286.9 |
|
|
— |
|
|
— |
|
|
— |
|
|
|
Hedged
metal obligations
|
|
|
295.8 |
|
|
295.8 |
|
|
— |
|
|
— |
|
|
— |
|
|
|
Long-term
debt
|
|
|
390.6 |
|
|
— |
|
|
126.8 |
|
|
0.1 |
|
|
263.7 |
|
|
|
Operating
leases
|
|
|
169.9 |
|
|
33.8 |
|
|
38.4 |
|
|
28.4 |
|
|
69.3 |
|
|
|
Purchase
obligations – metal supply contracts (a)
|
|
|
1,919.6 |
|
|
594.0 |
|
|
460.6 |
|
|
432.5 |
|
|
432.5 |
|
|
|
Other
purchase obligations (b)
|
|
|
62.9 |
|
|
41.9 |
|
|
11.4 |
|
|
9.4 |
|
|
0.2 |
|
|
|
Other
long-term liabilities reflected on the balance sheet under GAAP (c)
|
|
|
183.6 |
|
|
— |
|
|
68.6 |
|
|
40.8 |
|
|
74.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
contractual obligations
|
|
$ |
3,674.6 |
|
$ |
1,617.7 |
|
$ |
705.8 |
|
$ |
511.2 |
|
$ |
839.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) – These amounts reflect minimum purchase obligations for the purchase of platinum group metals assuming the December 31, 2003 prices for the various metals continue into the specified future periods. However, these are not fixed price arrangements; the prices are based on future market prices. As a result, the Company will be able to hedge the purchases with sales at those future prices.
(b) – Amounts primarily relate to purchase orders for raw material purchases and warehousing- and transportation-related costs.
(c) – Amounts primarily relate to postretirement/postemployment obligations (see Note 16, “Benefits,” for further detail), with the remainder consisting of executive deferred compensation, SFAS No. 143 asset retirement obligations (see Note 4, “Accounting for Asset Retirement Obligations,” for further detail) and the long-term portion of the environmental reserve (see Note 21, “Environmental Costs,” for further detail).
In the normal course of business, the Company incurs obligations with regard to contract completion and product performance. Under certain circumstances, these obligations are supported through the issuance of letters of credit. At December 31, 2003, the aggregate outstanding amount of letters of credit supporting such obligations amounted to $122.6 million, of which $114.0 million will expire in less than one year, $8.5 million will expire in two to three years and $0.1 million will expire after five years. In the opinion of management, such obligations will not significantly affect the Company’s financial position or results of operations as the Company anticipates fulfilling its performance obligations.
At December 31, 2003, the Company did not have any guarantees of any unconsolidated subsidiary or third party obligations.
The Company has consistently derived considerable cash flow from operations, which has been used, along with both short- and long-term debt, to pay for capital expenditures, acquisitions, dividends and other corporate requirements. The continuation of these levels of cash flow is expected, but is subject to the risk factors listed elsewhere in this report (particularly in the Forward-Looking Statements section on page 25). In addition, the Company has always maintained investment-grade credit ratings that it considers important for cost-effective and ready access to the credit markets. Management fully expects to be able to obtain future funding from both short- and long-term debt for cash requirements in excess of cash flow from operations. In the event that any of these sources prove to be below expectations, the Company has access to committed lines of credit aggregating $810 million as of December 31, 2003. Management intends to renew, and possibly increase, the $400 million committed line of credit that expires in May 2004.
20
Credit Risk
The Company believes that its financial instruments do not represent a concentration of credit risk because the Company deals with a variety of major banks worldwide and its accounts receivable are spread among a number of major industries, customers and geographic areas. A centralized credit committee reviews significant credit transactions and risk-management issues before granting of credit, and an appropriate level of reserves is maintained. In addition, the Company monitors the status of accounts receivable and the financial condition of its customers to help ensure collections and to minimize losses.
The Company may enter into transactions in which it advances funds after receipt of metal as provisional payment for the metal which is to be finally priced under market-based pricing formulae that will result in a determination of that price. If the final price is less than the provisional price paid, the supplier will be obligated to return the difference to the Company. Therefore, if the market price (and the anticipated final price) falls below the provisional price, the Company is exposed to the potential credit risk associated with the possibility of non-payment by the supplier, although no payment is due until after the final price is determined. As of December 31, 2003, the aggregate market value of metals purchased under a contract for which a provisional price had been paid was in excess of the amounts advanced by a total of $92.9 million. As a result, this amount was recorded in committed metal positions and accounts payable at December 31, 2003 and no current credit risk exists.
Capital Expenditures, Commitments and Contingencies
Capital projects are designed to maintain capacity, expand operations, improve efficiency or protect the environment. Capital expenditures amounted to $113.6 million in 2003, $113.3 million in 2002 and $168.9 million in 2001. Capital expenditures in 2004 are expected to be approximately $135.0 million. For information about commitments and contingencies, see Note 21, “Environmental Costs” and Note 22, “Litigation and Contingencies.”
Dividends and Capital Stock
Common stock dividends paid were $0.41 per share in 2003 and $0.40 per share in each of 2002 and 2001.
Peru Update
See Note 22, “Litigation and Contingencies,” for a discussion of Peru.
Special Charges and Credits
See Note 6, “Special Charges and Credits,” for a discussion of the Company’s special charges and credits.
Other Matters
See Note 1, “Summary of Significant Accounting Policies,” for a discussion of new accounting pronouncements.
Related Party Transactions
See Note 15, “Related Party Transactions,” for a discussion of related party transactions.
Critical Accounting Policies
Certain key policies are explained below to assist in understanding the Company’s consolidated financial statements. More detailed explanations may be found elsewhere in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section and in Note 1, “Summary of Significant Accounting Policies.”
21
Sales
A significant portion of consolidated net sales represent the sale of platinum group metals to industrial customers who buy the metals from Materials Services in connection with products manufactured by the Environmental and Process Technologies segments. Accordingly, almost all of these sales are reported in the Materials Services segment, with a limited amount included in Environmental and Process Technologies’ reported sales. Because metal price levels may vary widely, there is no consistent relationship between consolidated sales and gross profit.
Because the timing of the purchase of spot metals often does not coincide with the timing of the subsequent sales to industrial users, Materials Services needs to hedge price risk, usually by selling forward (i.e., for future delivery) to investment-grade trading entities, industrial companies or on futures exchanges. If a surplus of physical metal develops, Materials Services may also sell spot and buy forward to balance the risk position. Other than hedges entered into with industrial customers, sales related to these hedging transactions are not included in reported sales, as they are not meaningful in an industrial context.
Customers of the Environmental and Process Technologies segments who purchase products that improve efficiency and yields are often unable to precisely predict the dates that catalysts will be required. Accordingly, they may request that product that has already been ordered, manufactured and prepared for shipment at the agreed upon date be temporarily held by the Company until that customer’s manufacturing facility is prepared to accept the new charge of catalyst. In cases where the customer requests the Company to hold the goods, agrees to be invoiced and to pay the invoices on normal terms, as well as to accept title to the goods, the Company will recognize the sale prior to shipment. Great care is exercised to make sure that these sales are only recognized in accordance with the applicable revenue recognition guidance.
Mark-to-market
Materials Services procures physical metal from third parties for resale and enters into forward contracts and other relatively straight-forward hedging derivatives that are recorded as either assets or liabilities at their fair value. By acting in its capacity as a distributor and materials service provider to the Company’s technology businesses and their customers and by taking closely monitored unhedged positions as described below, Materials Services takes on the attributes of a dealer in metals. Both spot metal and derivative instruments used in hedging (i.e., forwards, futures, swaps and options) are stated at fair value. The Company values platinum, palladium, gold and silver based on the daily closing New York Mercantile Exchange (NYMEX) settlement prices. There are no so-called “terminal” markets for rhodium, ruthenium and iridium, so the Company’s own published Industrial Bullion (EIB) prices are used. However, these are compared to other reference prices published in “Metals Week,” an independent trade journal. Values for base metals come from the closing prices of the London Metals Exchange (LME).
In closely monitored situations, for which exposure levels and transaction size limits have been set by senior management, the Company holds unhedged metal positions that are subject to future market fluctuations. Such positions may include varying levels of derivative instruments. At times, these positions can be significant. All unhedged metal transactions are monitored and marked to market daily. The portion of this metal that has not been hedged is therefore subject to price risk and is disclosed in Note 11, “Committed Metal Positions and Hedged Metal Obligations.”
The fair values of Materials Services’ various spot and derivative positions are included in committed metal positions on the asset side of the consolidated balance sheet and hedged metal obligations on the liability side. The credit (performance) risk associated with the fair value of derivatives in a gain position is greatly mitigated through the selection of investment-grade counterparties.
Precious metals
Most of the platinum group metals used by Environmental and Process Technologies to manufacture products are provided in advance by the customers. The customers often purchase these metals from Materials Services, but they may also be shipped in from other sources.
22
Certain quantities of precious metals are carried at historical cost using the LIFO method, which provides a better matching of current costs with current revenues. Because most of the metal was acquired some time ago, the market value of this metal, while fluctuating from year to year, has generally been substantially above cost. While this excess of market over cost is useful in evaluating the consolidated balance sheet from a credit perspective, the annual changes are not reflected in the income statement except to the extent that periodic liquidations of LIFO layers produce book profits. LIFO liquidation profits are separately disclosed and not included in the operating earnings of the technology segments.
Provision for Environmental Remediation
As addressed in Note 21, “Environmental Costs,” the Company is currently preparing, has under review, or is implementing environmental investigations and cleanup plans at several currently or formerly owned and/or operated sites. In addition, nine sites have been identified at which the Company believes liability as a potentially responsible party is probable for the cleanup of contamination and natural resource damages resulting from historic disposal of hazardous substances allegedly generated by the Company, among others.
The Company conducts studies, as well as site surveys, to determine the extent of environmental damage and determine the necessary requirements to remediate this damage. These studies incorporate the analysis of our internal environmental staff and consultation with legal counsel. From these studies and surveys, a range of estimates of the costs involved is derived and a liability and related expenses for environmental remediation is recorded within this range. The Company’s recorded liabilities for these issues represent its best estimates of remediation and restoration costs that may be required to comply with present laws and regulations. These estimates are based on forecasts of future direct costs related to environmental remediation. These estimates change periodically as additional or better information becomes available as to the extent of site remediation required, if any. Certain changes could occur that would materially affect the Company’s estimates and environmental remediation costs at known sites. If the Company discovers additional contamination, discovers previously unknown sites, or becomes subject to related personal or property damage, the Company could incur material additional costs in connection with its environmental remediation.
The accrual for environmental cleanup-related costs reported in the consolidated balance sheet at December 31, 2003 was $19.3 million, including $0.1 million for Superfund sites. These amounts represent those undiscounted costs that the Company believes are probable and reasonably estimable. For the year ended December 31, 2003, cash payments for environmental cleanup-related matters were $1.8 million. For environmental remediation sites known as of December 31, 2003, if the highest estimate from the range (based upon information presently available) were recorded, the total estimated liability would have increased by $29.5 million at December 31, 2003. Based on existing information and currently enacted environmental laws and regulations, cash payments for environmental cleanup-related matters are projected to be $1.5 million for 2004, which has already been accrued. Further, the Company anticipates that the amounts of capitalized environmental projects and the expense of environmental compliance will approximate current levels.
Goodwill
As of December 31, 2003, the Company had $275.1 million of goodwill that, based on impairment testing completed in 2003, is not impaired. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” we complete an impairment test of goodwill annually, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting units below their carrying value. The impairment test requires us to estimate the fair values of our reporting units, which is done by using a discounted cash flow model. Significant estimates used in our discounted cash flow model include future cash flows and long-term rates of growth of our reporting units and a discount rate based on our weighted average cost of capital. Assumptions used in determining future cash flows include current and expected market conditions and future sales forecasts.
Approximately 94% of the Company’s goodwill is attributable to reporting units with fair values that exceed the carrying values of the reporting units by a substantial margin. The use of different estimates and assumptions, within the range of predictable possibilities, employed in the discounted cash flow model that measures the fair value of these reporting units, would not be expected to result in an impairment of goodwill. The remaining 6% of the goodwill resides in reporting units with fair values that modestly exceed the carrying values of
23
the reporting units. The use of different estimates and assumptions employed in the discounted cash flow model that measures the fair value of these reporting units could result in an impairment of goodwill. However, the maximum value exposed to changes in estimates and assumptions, based upon the current range of predictable possibilities, is $15.9 million. Included in this amount is $10.6 million of goodwill acquired with the thermal spray and coating business within the Environmental Technologies segment and $4.0 million of goodwill related to two acquisitions that provide minerals-based products within the Appearance and Performance Technologies segment.
Certain Long-Lived Assets
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we review our property, plant and equipment for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. Impairment reviews require a comparison of the estimated future undiscounted cash flows to the carrying value of the asset. If the total of the undiscounted cash flows is less than the carrying value, an impairment charge is recorded for the difference between the estimated fair value and the carrying value of the asset. Significant assumptions used in our undiscounted cash flow model include future cash flows attributed to the group of assets, the group of assets subject to the impairment and the time period for which the assets will be held and used. Assumptions used in determining future cash flows include current and expected market conditions and future sales forecasts. The use of different estimates or assumptions within our undiscounted cash flow model could result in undiscounted cash flows lower than the current value of our assets, thereby requiring the need to compare the carrying values to their fair values. The use of different estimates or assumptions when determining the fair value of our property, plant and equipment may result in different values for our property, plant and equipment, and any related impairment charges (also, see Appearance and Performance Technologies MD&A outlook section on page 15).
In order to provide kaolin-based products to the Company’s customers and the Process Technologies segment, the Company engages in kaolin mining operations that are integrated into the manufacturing processes. The Company owns and leases land containing kaolin deposits on a long-term basis. The Company does not own any mining reserves or conduct any mining operations with respect to platinum, palladium or other metals. The kaolin mining process includes exploration, topsoil and overburden removal, extraction of kaolin and the subsequent reclamation of mined areas. In order to match the costs of the mining process with revenues associated with kaolin-based products, certain mining process costs are expensed by the Company over the life of the related estimated mineable reserves. The quality and quantity of these mineable reserves are estimated by use of mapping, drilling, sampling and assaying that are standard evaluation methods generally accepted by the minerals industry. Other estimates considered in the evaluation of the estimated mineable reserves include long-term demand forecasts and the impact of future regulatory changes. A reduction in the estimated quantity of kaolin deposits of 10% would result in an increase of annual amortization expense of less than $1 million.
Provision for Income Taxes
As of December 31, 2003, net deferred tax assets are approximately $110.2 million. The Company determines its current and deferred taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” The tax effect of the reversal of tax differences are recorded at rates currently enacted for each jurisdiction in which it operates. To the extent that temporary differences will result in future tax benefit, the Company must estimate the timing of their reversal, and whether taxable operating income in future periods will be sufficient to fully recognize any deferred tax assets of the Company. The future impact on earnings from using different assumptions and/or estimates cannot be reasonably quantified due to the number of scenarios and variables that are present.
As of December 31, 2003, the Company had approximately $281.6 million of state net operating loss carryforwards that expire at various intervals between 2006 and 2023. The probability of not being able to utilize these operating loss carryforwards is low under a wide range of scenarios.
It is the Company’s policy to establish reserves for taxes that may become payable in future years as a result of tax examinations. The Company establishes reserves for taxes based upon management’s assessment of tax exposures under applicable accounting principles and pronouncements. The tax reserves are analyzed on a quarterly basis and adjustments are recorded as events occur that warrant changes to individual exposure items and to the overall tax reserve balance. The Company is regularly audited by the Internal Revenue Service (IRS) and the
24
various foreign and state tax authorities in the jurisdictions in which the Company does business. The IRS is currently examining the Company’s tax returns for 1998, 1999 and 2000. As of December 31, 2003, the Company has recorded an appropriate reserve for exposures it has determined are probable.
Pensions and other postretirement/postemployment costs
The Company’s employee pension and other postretirement/postemployment benefit costs and obligations are dependent on its assumptions used by actuaries in calculating such amounts. These assumptions include discount rates, salary growth, expected returns on plan assets, retirement rates, mortality rates and other factors. The discount rate assumption is based on investment yields available at the Company’s measurement date of September 30 on AA-rated corporate long-term bond yields. The salary growth assumptions reflect our long-term actual experience, the near-term outlook and assumed inflation. The health care cost trend assumptions are developed based on historical cost data, the near-term outlook and an assessment of likely long-term trends. Retirement rates are based primarily on actual plan experience. Mortality rates are based on published data. Actual results that differ from our assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and recorded obligations in such future periods. While we believe that the assumptions used are appropriate, significant differences in actual experience or significant changes in assumptions would affect our pension and other postretirement/postemployment benefit costs and obligations.
The Company has determined that its net pension cost is projected to be approximately $26 million in 2004, compared to $21 million in 2003 and $12 million in 2002. Based on a review of the current environment, we have lowered our domestic and foreign long-term rate of return assumptions used in determining net periodic pension expense from 10% and 8.43%, respectively, in 2002 to 9% and 7%, respectively, in 2003. No changes are expected for 2004. A 1% change in the long-term rate of return assumption would increase or decrease net periodic pension expense by approximately $5 million in 2004. The Company lowered its domestic and foreign discount rates for determining net periodic pension expense from 7.50% and 6.02%, respectively, in 2002 to 6.75% and 5.77%, respectively, in 2003. Further adjustments are being made in 2004 to lower the domestic rate to 6.25% and the foreign rate to 5.50%. This adjustment reflects industry trends and the current interest rate environment. A 25 basis point increase in the discount rate would decrease pension expense by approximately $2 million in 2004 and decrease the 2003 projected benefit obligation (PBO) by approximately $25 million. A 25 basis point decrease in the discount rate would increase pension expense by approximately $2 million in 2004 and increase the 2003 PBO by approximately $25 million. The Company used September 30, 2003 as the measurement date for its assets and liabilities. Assets on this date were $513 million. The value of the assets increased to $549 million at December 31, 2003. Had December 31, 2003 assets been used to determine 2004 net periodic pension expense, our 2004 pension expense would have decreased by approximately $1 million. The Company expects its postretirement/postemployment benefit costs to increase from $8 million to $13 million in 2004. This increase primarily reflects the elimination of a gain that was being amortized from plan amendments made after the initial adoption of SFAS No. 106 (see Note 16, “Benefits,” for further detail regarding costs and assumptions).
Forward-Looking Statements
This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information that are based on forecasts of future results and estimates of amounts not yet determinable. These statements also relate to the future prospects, developments and business strategies. These forward-looking statements are identified by their use of terms and phrases such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will” and similar terms and phrases, including references to assumptions. These forward-looking statements involve risks and uncertainties that may cause the Company’s actual future activities and results of operations to be materially different from those suggested or described in this document.
Among the risks and uncertainties that could cause actual results to differ materially are the following:
|
|
• |
competitive pricing or product development activities that could affect the demand for our products, particularly competing catalyst and kaolin producers |
|
|
|
|
|
|
• |
the Company’s ability to achieve and execute internal business plans |
|
|
|
|
25
|
|
• |
worldwide political instability as the Company operates primarily in the United States, the European community, Asia, the Russian Federation, South Africa and Brazil |
|
|
• |
alliances and geographic expansions developing differently than anticipated |
|
|
|
|
|
|
• |
fluctuations in the supply and prices of precious and base metals and fluctuations in the relationships between forward prices to spot prices |
|
|
|
|
|
|
• |
government legislation and/or regulation (particularly on environmental issues), including tax obligations |
|
|
|
|
|
|
• |
the impact of the anticipated repeal of the current U.S. export sales tax incentive |
|
|
|
|
|
|
• |
technology, manufacturing and legal issues |
|
|
|
|
|
|
• |
the impact of any economic downturns and inflation |
|
|
|
|
|
|
• |
interest rate risk, foreign currency exchange rate risk, commodity price risk and credit risk (these are discussed further in the Company’s MD&A section) |
|
|
|
|
|
|
• |
the impact of higher energy and raw material costs, and the availability of natural gas and rare earth elements |
|
|
|
|
|
|
• |
the success of research and development activities and the speed with which regulatory authorizations and product launches may be achieved |
|
|
|
|
|
|
• |
the impact of increased employee benefit costs and/or the resultant impact on employee relations |
|
|
|
|
|
|
• |
contingencies related to actual or alleged environmental contamination to which the Company may be a party |
|
|
|
|
|
|
• |
the impact of acquisitions, divestitures and restructurings |
|
|
|
|
|
|
• |
overall demand for the Company’s products, including demand from the worldwide automotive and chemical-process markets |
|
|
|
|
|
|
• |
product quality/performance issues |
|
|
|
|
|
|
• |
exposure to product liability and other types of lawsuits |
|
|
|
|
|
|
• |
the impact of physical inventory losses, particularly with regard to precious and base metals |
|
|
|
|
|
|
• |
the loss of business from property and casualty exposure |
Investors are cautioned not to place undue reliance upon these forward-looking statements, which speak only as of their dates. The Company disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
26
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market Risk Sensitive Transactions
The Company is exposed to market risks arising from adverse changes in interest rates, foreign currency exchange rates and commodity prices. In the normal course of business, the Company uses a variety of techniques and instruments, including derivatives, as part of its overall risk-management strategy. The Company enters into derivative agreements with a diverse group of major financial and other institutions with individually determined credit limits to reduce exposure to the risk of nonperformance by counterparties.
Interest rate risk
The Company uses a sensitivity analysis to assess the market risk of its debt-related financial instruments and derivatives. Market risk is defined here as the potential change in the fair value of debt resulting from an adverse movement in interest rates. The fair value of the Company’s total debt was $477.5 million at December 31, 2003 and $616.6 million at December 31, 2002, based on average market quotations of price and yields provided by investment banks. A 100 basis-point increase in interest rates could result in a reduction in the fair value of total debt of $27.8 million at December 31, 2003, compared with $18.8 million at December 31, 2002.
The Company also uses interest rate derivatives to help achieve its fixed and floating rate debt objectives. The Company currently has two interest rate swap agreements with a total notional value of $100 million maturing in August 2006 and three interest rate swap agreements with a total notional value of $150 million maturing in May 2013. These agreements effectively change fixed rate debt obligations into floating rate obligations. The total notional values and maturity dates of these agreements are equal to the face values and the maturity dates of the related debt instruments.
Approximately 69% and 76% of the Company’s borrowings had variable interest rates as of December 31, 2003 and 2002, respectively.
Foreign currency exchange rate risk
The Company uses a variety of strategies, including foreign currency forward contracts, to minimize or eliminate foreign currency exchange rate risk associated with its foreign currency transactions, including metal-related transactions denominated in other than U.S. dollars.
The Company uses a sensitivity analysis to assess the market risk associated with its foreign currency transactions. Market risk is defined here as the potential change in fair value resulting from an adverse movement in foreign currency exchange rates. A 10% adverse movement in foreign currency rates could result in a net loss of $14.7 million at December 31, 2003, compared with $13.3 million at December 31, 2002, on the Company’s foreign currency forward contracts. However, since the Company limits the use of foreign currency derivatives to the hedging of contractual and anticipated foreign currency payables and receivables, this loss in fair value for those instruments generally would be offset by a gain in the value of the underlying payable or receivable.
A 10% adverse movement in foreign currency rates could result in an unrealized loss of $63.3 million at December 31, 2003, compared with $40.9 million at December 31, 2002, on the Company’s net investment in foreign subsidiaries and affiliates. However, since the Company views these investments as long term, the Company would not expect such a loss to be realized in the near term.
Commodity price risk
In closely monitored situations, for which exposure levels and transaction size limits have been set by senior management, the Company, from time to time, holds large, unhedged industrial commodity positions that are subject to market price fluctuations. Such positions may include varying levels of derivative commodity instruments. All unhedged industrial commodity transactions are monitored and marked to market daily. All other
27
industrial commodity transactions are hedged on a daily basis, using forward, future, option or swap contracts to substantially eliminate the exposure to price risk. These positions are also marked to market daily.
The Company performed a “value-at-risk” analysis on all of its metal-related commodity assets and liabilities. The “value-at-risk” calculation is a statistical model that uses historical price and volatility data to predict market risk on a one-day interval with a 95% confidence level. While the “value-at-risk” models are relatively sophisticated, the quantitative information generated is limited by the historical information used in the calculation. For example, the volatility in the platinum and palladium markets in 2001 and 2000 was much greater than historical norms. Therefore, the Company uses this model only as a supplement to other risk management tools and not as a substitute for the experience and judgment of senior management and dealers who have extensive knowledge of the markets and adjust positions and revise strategies as the markets change. Based on the “value-at-risk” analysis in the context of a 95% confidence level, the maximum potential one-day loss in fair value was approximately $3.3 million at December 31, 2003, compared with $6.0 million as of December 31, 2002. The actual one-day changes in fair value of the Company’s metal-related commodity assets and liabilities never exceeded the average of the “value-at-risk” amounts as of the yearly open and close for each of the Company’s 2003 and 2002 fiscal years.
The Company is also exposed to commodity price risk on the unhedged portion of its natural gas purchases related to its purchase of natural gas that is used in the manufacture of its products. As of December 31, 2003, the Company has hedged approximately 48% of its expected natural gas purchases for 2004. At December 31, 2003, a uniform one-dollar increase in the price of natural gas would result in a decrease in operating earnings of approximately $5.1 million for the year ending December 31, 2004 based upon the Company’s unhedged portion of its expected natural gas purchases for 2004.
28
|
FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA |
ENGELHARD
CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
|
Year ended December 31 (in thousands, except per-share
amounts)
|
|
2003 |
|
2002 |
|
2001 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||
|
Net sales
|
|
$ |
3,714,493 |
|
$ |
3,753,571 |
|
$ |
5,096,926 |
|
||||||||||
|
Cost of sales |
|
|
3,080,408 |
|
|
3,099,806 |
|
|
4,433,709 |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Gross profit |
|
|
634,085 |
|
|
653,765 |
|
|
663,217 |
|
|||||||||
|
Selling, administrative and other expenses |
|
|
364,490 |
|
|
350,137 |
|
|
335,994 |
|
||||||||||
|
Special (credits)/charges, net |
|
|
(11,978 |
) |
|
(7,862 |
) |
|
7,100 |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Operating earnings |
|
|
281,573 |
|
|
311,490 |
|
|
320,123 |
|
|||||||||
|
Equity in earnings of affiliates |
|
|
39,368 |
|
|
16,207 |
|
|
29,095 |
|
||||||||||
|
Equity investment impairment |
|
|
— |
|
|
(57,704 |
) |
|
— |
|
||||||||||
|
Loss on investment |
|
|
— |
|
|
(6,659 |
) |
|
— |
|
||||||||||
|
Interest income |
|
|
4,035 |
|
|
1,968 |
|
|
3,297 |
|
||||||||||
|
Interest expense |
|
|
(24,330 |
) |
|
(27,378 |
) |
|
(47,291 |
) |
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Earnings before income taxes |
|
|
300,646 |
|
|
237,924 |
|
|
305,224 |
|
|||||||||
|
Income tax expense |
|
|
64,154 |
|
|
66,516 |
|
|
79,663 |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Net earnings before cumulative effect of a change in
accounting principle |
|
$ |
236,492 |
|
$ |
171,408 |
|
$ |
225,561 |
|
|||||||||
|
|
Cumulative effect of a change in accounting
principle, net of tax of $1,390 |
|
|
(2,269 |
) |
|
— |
|
|
— |
|
|||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Net earnings |
|
$ |
234,223 |
|
$ |
171,408 |
|
$ |
225,561 |
|
|||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Earnings per share – basic: |
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Earnings before cumulative effect of a change in
accounting principle |
|
$ |
1.89 |
|
$ |
1.34 |
|
$ |
1.73 |
|
|||||||||
|
|
Cumulative effect of a change in accounting
principle, net of tax |
|
|
(0.02 |
) |
|
— |
|
|
— |
|
|||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Earnings per share – basic |
|
$ |
1.87 |
|
$ |
1.34 |
|
$ |
1.73 |
|
|||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Earnings per share – diluted: |
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Earnings before cumulative effect of a change in
accounting principle |
|
$ |
1.86 |
|
$ |
1.31 |
|
$ |
1.71 |
|
|||||||||
|
|
Cumulative effect of a change in accounting
principle, net of tax |
|
|
(0.02 |
) |
|
— |
|
|
— |
|
|||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Earnings per share – diluted |
|
$ |
1.84 |
|
$ |
1.31 |
|
$ |
1.71 |
|
|||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Average number of shares outstanding – basic |
|
|
125,359 |
|
|
128,089 |
|
|
130,018 |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
Average number of shares outstanding – diluted |
|
|
127,267 |
|
|
130,450 |
|
|
132,155 |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
See accompanying Notes to Consolidated Financial Statements.
29
ENGELHARD
CORPORATION
CONSOLIDATED BALANCE SHEETS
|
December
31 (in thousands)
|
|
2003 |
|
2002 |
|
||||||||||||||||
|
|
|
|
|
|
|
||||||||||||||||
|
Assets
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Cash
|
|
$ |
87,889 |
|
$ |
48,246 |
|
|||||||||||||
|
|
Receivables,
net of allowances of $11,566 and $9,739, respectively
|
|
|
400,043 |
|
|
380,270 |
|
|||||||||||||
|
|
Committed
metal positions
|
|
|
350,163 |
|
|
615,441 |
|
|||||||||||||
|
|
Inventories
|
|
|
442,787 |
|
|
427,162 |
|
|||||||||||||
|
|
Other
current assets
|
|
|
112,678 |
|
|
94,922 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Total
current assets
|
|
|
1,393,560 |
|
|
1,566,041 |
|
|||||||||||||
|
|
Investments
|
|
|
158,664 |
|
|
136,804 |
|
|||||||||||||
|
|
Property,
plant and equipment, net
|
|
|
880,822 |
|
|
860,475 |
|
|||||||||||||
|
|
Goodwill
|
|
|
275,121 |
|
|
272,353 |
|
|||||||||||||
|
|
Other
intangible and noncurrent assets
|
|
|
224,836 |
|
|
185,041 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Total
assets
|
|
$ |
2,933,003 |
|
$ |
3,020,714 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||||
|
Liabilities
and Shareholders’ Equity
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Short-term
borrowings
|
|
$ |
68,275 |
|
$ |
348,749 |
|
|||||||||||||
|
|
Accounts
payable
|
|
|
296,979 |
|
|
225,045 |
|
|||||||||||||
|
|
Hedged
metal obligations
|
|
|
295,821 |
|
|
537,243 |
|
|||||||||||||
|
|
Other
current liabilities
|
|
|
286,940 |
|
|
275,250 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Total
current liabilities
|
|
|
948,015 |
|
|
1,386,287 |
|
|||||||||||||
|
|
Long-term
debt
|
|
|
390,565 |
|
|
247,805 |
|
|||||||||||||
|
|
Other
noncurrent liabilities
|
|
|
309,024 |
|
|
309,455 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Total
liabilities
|
|
|
1,647,604 |
|
|
1,943,547 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||||
|
Shareholders’
equity
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Preferred
stock, no par value, 5,000 shares authorized but unissued
|
|
|
— |
|
|
— |
|
|||||||||||||
|
|
Common
stock, $1 par value, 350,000 shares authorized and 147,295 shares issued
|
|
|
147,295 |
|
|
147,295 |
|
|||||||||||||
|
|
Additional
paid-in capital
|
|
|
26,756 |
|
|
20,876 |
|
|||||||||||||
|
|
Retained
earnings
|
|
|
1,619,284 |
|
|
1,436,637 |
|
|||||||||||||
|
|
Treasury
stock, at cost, 22,885 and 19,937 shares, respectively
|
|
|
(492,057 |
) |
|
(412,451 |
) |
|||||||||||||
|
|
Accumulated
other comprehensive loss
|
|
|
(15,879 |
) |
|
(115,190 |
) |
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Total
shareholders’ equity
|
|
|
1,285,399 |
|
|
1,077,167 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
|
|
Total
liabilities and shareholders’ equity
|
|
$ |
2,933,003 |
|
$ |
3,020,714 |
|
|||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||
See accompanying Notes to Consolidated Financial Statements.
30
ENGELHARD
CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
Year
ended December 31 (in thousands)
|
|
2003 |
|
2002 |
|
2001 |
|
|||||||
|
|
|
|
|
|
|
|
|
|||||||
|
Cash
flows from operating activities
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Net
earnings
|
|
$ |
234,223 |
|
$ |
171,408 |
|
$ |
225,561 |
|
|||
|
|
Adjustments
to reconcile net earnings to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
Depreciation
and depletion
|
|
|
124,315 |
|
|
110,676 |
|
|
94,996 |
|
|||
|
|
Amortization
of intangible assets
|
|
|
3,357 |
|
|
2,886 |
|
|
13,521 |
|
|||
|
|
Loss
on investment
|
|
|
— |
|
|
6,659 |
|
|
— |
|
|||
|
|
Equity
results, net of dividends
|
|
|
(14,805 |
) |
|
(12,279 |
) |
|
(24,937 |
) |
|||
|
|
Equity
investment impairment
|
|
|
— |
|
|
57,704 |
|
|
— |
|
|||
|
|
Net
change in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|||
|
|
Materials
Services related
|
|
|
332,590 |
|
|
(30,053 |
) |
|
59,734 |
|
|||
|
|
All
other
|
|
|
(48,696 |
) |
|
(4,732 |
) |
|
(23,082 |
) |
|||
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Net
cash provided by operating activities
|
|
|
630,984 |
|
|
302,269 |
|
|
345,793 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Capital
expenditures
|
|
|
(113,557 |
) |
|
(113,309 |
) |
|
(168,882 |
) |
|||
|
|
Proceeds
from sale of investments
|
|
|
6,651 |
|
|
— |
|
|
3,400 |
|
|||
|
|
Acquisitions
and other investments
|
|
|
(1,000 |
) |
|
(7,606 |
) |
|
(16,559 |
) |
|||
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Net
cash used in investing activities
|
|
|
(107,906 |
) |
|
(120,915 |
) |
|
(182,041 |
) |
|||
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Proceeds
from short-term borrowings
|
|
|
— |
|
|
264,155 |
|
|
285,000 |
|
|||
|
|
Repayment
of short-term borrowings
|
|
|
(284,283 |
) |
|
(304,457 |
) |
|
(248,064 |
) |
|||
|
|
(Decrease)/increase
in hedged metal obligations
|
|
|
(225,000 |
) |
|
3,784 |
|
|
11,333 |
|
|||
|
|
Repayment
of long-term debt
|
|
|
(184 |
) |
|
(148 |
) |
|
(159,308 |
) |
|||
|
|
Proceeds
from issuance of long-term debt
|
|
|
150,224 |
|
|
— |
|
|
— |
|
|||
|
|
Purchase
of treasury stock
|
|
|
(119,568 |
) |
|
(133,543 |
) |
|
(101,154 |
) |
|||
|
|
Cash
from exercise of stock options
|
|
|
32,880 |
|
|
48,781 |
|
|
101,175 |
|
|||
|
|
Dividends
paid
|
|
|
(51,576 |
) |
|
(51,492 |
) |
|
(52,267 |
) |
|||
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Net
cash used in financing activities
|
|
|
(497,507 |
) |
|
(172,920 |
) |
|
(163,285 |
) |
|||
|
Effect
of exchange rate changes on cash
|
|
|
14,072 |
|
|
6,778 |
|
|
(967 |
) |
||||
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Net
increase/(decrease) in cash
|
|
|
39,643 |
|
|
15,212 |
|
|
(500 |
) |
|||
|
Cash
at beginning of year
|
|
|
48,246 |
|
|
33,034 |
|
|
33,534 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
Cash
at end of year
|
|
$ |
87,889 |
|
$ |
48,246 |
|
$ |
33,034 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
||||
See accompanying Notes to Consolidated Financial Statements.
31
ENGELHARD
CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
|
(in
thousands, except per-share amounts)
|
|
Common |
|
Additional paid- |
|
Retained |
|
Treasury stock |
|
Comprehensive |
|
Accumulated |
|
Total |
|
|||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||
|
Balance
at December 31, 2000
|
|
$ |
147,295 |
|
$ |
(21,050 |
) |
$ |
1,143,427 |
|
$ |
(344,036 |
) |
|
|
|
$ |
(51,069 |
) |
$ |
874,567 |
|
||||||||
|
Comprehensive
income/(loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Net
earnings
|
|
|
|
|
|
|
|
|
225,561 |
|
|
|
|
$ |
225,561 |
|
|
|
|
|
225,561 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Other
comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
|
|
Cash
flow derivative adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,550 |
) |
|
|
|
|
|
|
|||||||
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(51,035 |
) |
|
|
|
|
|
|
|||||||
|
|
Minimum
pension liability adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,355 |
) |
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Other
comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(80,940 |
) |
|
(80,940 |
) |
|
(80,940 |
) |
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
144,621 |
|
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
Dividends
($0.40 per share)
|
|
|
|
|
|
|
|
|
(52,267 |
) |
|
|
|
|
|
|
|
|
|
|
(52,267 |
) |
||||||||
|
Treasury
stock acquired
|
|
|
|
|
|
|
|
|
|
|
|
(101,154 |
) |
|
|
|
|
|
|
|
(101,154 |
) |
||||||||
|
Stock
bonus and option plan transactions
|
|
|
|
|
|
28,428 |
|
|
|
|
|
109,311 |
|
|
|
|
|
|
|
|
137,739 |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Balance
at December 31, 2001
|
|
|
147,295 |
|
|
7,378 |
|
|
1,316,721 |
|
|
(335,879 |
) |
|
|
|
|
(132,009 |
) |
|
1,003,506 |
|
|||||||
|
Comprehensive
income/(loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Net
earnings
|
|
|
|
|
|
|
|
|
171,408 |
|
|
|
|
$ |
171,408 |
|
|
|
|
|
171,408 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Other
comprehensive income/(loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
|
|
Cash
flow derivative adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,424 |
|
|
|
|
|
|
|
|||||||
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
70,284 |
|
|
|
|
|
|
|
|||||||
|
|
Minimum
pension liability adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(57,689 |
) |
|
|
|
|
|
|
|||||||
|
|
Investment
adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(200 |
) |
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Other
comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,819 |
|
|
16,819 |
|
|
16,819 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
188,227 |
|
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
Dividends
($0.40 per share)
|
|
|
|
|
|
|
|
|
(51,492 |
) |
|
|
|
|
|
|
|
|
|
|
(51,492 |
) |
||||||||
|
Treasury
stock acquired
|
|
|
|
|
|
|
|
|
|
|
|
(133,543 |
) |
|
|
|
|
|
|
|
(133,543 |
) |
||||||||
|
Stock
bonus and option plan transactions
|
|
|
|
|
|
13,498 |
|
|
|
|
|
56,971 |
|
|
|
|
|
|
|
|
70,469 |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||
|
|
Balance
at December 31, 2002
|
|
|
147,295 |
|
|
20,876 |
|
|
1,436,637 |
|
|
(412,451 |
) |
|
|
|
|
(115,190 |
) |
|
1,077,167 |
|
|||||||
|
Comprehensive
income/(loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Net
earnings
|
|
|
|
|
|
|
|
|
234,223 |
|
|
|
|
$ |
234,223 |
|
|
|
|
|
234,223 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Other
comprehensive income/(loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
|
|
Cash
flow derivative adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(123 |
) |
|
|
|
|
|
|
|||||||
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
77,787 |
|
|
|
|
|
|
|
|||||||
|
|
Minimum
pension liability adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21,120 |
|
|
|
|
|
|
|
|||||||
|
|
Investment
adjustment, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
527 |
|
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Other
comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
99,311 |
|
|
99,311 |
|
|
99,311 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
333,534 |
|
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
Dividends
($0.41 per share)
|
|
|
|
|
|
|
|
|
(51,576 |
) |
|
|
|
|
|
|
|
|
|
|
(51,576 |
) |
||||||||
|
Treasury
stock acquired
|
|
|
|
|
|
|
|
|
|
|
|
(119,568 |
) |
|
|
|
|
|
|
|
(119,568 |
) |
||||||||
|
Stock
bonus and option plan transactions
|
|
|
|
|
|
5,880 |
|
|
|
|
|
39,962 |
|
|
|
|
|
|
|
|
45,842 |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
|
Balance
at December 31, 2003
|
|
$ |
147,295 |
|
$ |
26,756 |
|
$ |
1,619,284 |
|
$ |
(492,057 |
) |
|
|
|
$ |
(15,879 |
) |
$ |
1,285,399 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
See accompanying Notes to Consolidated Financial Statements.
32
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Engelhard Corporation and its majority-owned subsidiaries (collectively referred to as Engelhard or the Company). All significant intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents include all investments purchased with an original maturity of three months or less.
Inventories
Inventories are stated at the lower of cost or market. The elements of inventory cost include direct labor and materials, variable overhead and fixed manufacturing overhead. The majority of the Company’s physical metal is carried in committed metal positions at fair value with the remainder carried in inventory at historical cost. The cost of owned precious metals included in inventory is determined using the last-in, first-out (LIFO) method of inventory valuation. The cost of other inventories is principally determined using the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation of buildings and equipment is provided primarily on a straight-line basis over the estimated useful lives of the assets. Buildings and building improvements are depreciated over 20 years, while machinery and equipment is depreciated based on lives varying from 3 to 10 years. Depletion of mineral deposits and deferred mine development costs is provided under the units-of-production method. When assets are sold or retired, the cost and related accumulated depreciation is removed from the accounts, and any gain or loss is included in earnings. The Company continually evaluates the reasonableness of the carrying value of its fixed assets. If the expected future undiscounted cash flows associated with these assets are less than their carrying value, the assets are written down to their fair value.
Intangible Assets
Identifiable intangible assets, such as patents and trademarks, are amortized using the straight-line method over their estimated useful lives. Goodwill was amortized by the straight-line method over periods up to 40 years for all acquisitions completed prior to June 30, 2001. Effective January 1, 2002, with the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill and other intangible assets that have indefinite useful lives will not be amortized, but will be tested for impairment based on the specific guidance of SFAS No. 142 (see the Company’s Goodwill critical accounting policy on page 23 and Note 3, “Goodwill and Other Intangible Assets,” for further detail).
The Company continually evaluates the reasonableness of the carrying value of its intangible assets. For its identifiable intangible assets, an impairment would be recognized if it became probable that expected future undiscounted cash flows would be less than their carrying amounts. For goodwill and other intangible assets that have indefinite useful lives, an impairment would be recognized if the carrying amount of a respective reporting unit exceeded the fair value of that reporting unit.
33
Committed Metal Positions and Hedged Metal Obligations
Committed metal positions reflect the fair value of the long spot metal positions (other than LIFO inventory) held by the Company plus the fair value of contracts that are in a gain position undertaken to economically hedge price exposures. Because most of the spot metal has been hedged through forward/future sales or other derivative arrangements (e.g., swaps), it is referred to as being “committed,” although the physical metal can be used by the Company until such time as the sales are settled. The portion of this metal that has not been hedged and, therefore, is subject to price risk is discussed below and disclosed in Note 11, “Committed Metal Positions and Hedged Metal Obligations.”
The bulk of hedged metal obligations represents spot short positions. As these positions generate cash, their cash effect is included in the financing activities section of the Company’s “Consolidated Statements of Cash Flows.” Other than in the closely monitored situations noted below, these positions are hedged with forward purchases. In addition, the aggregate fair value of derivatives in a loss position are reported in hedged metal obligations (derivatives in a gain position are included in committed metal positions).
For the purpose of determining whether the Company is in a net spot long or short position with respect to a metal, purchased quantities received for which the Company is not exposed to market price risk (because of provisional rather than final pricing) are considered a component of its spot positions.
To the extent metal prices increase subsequent to a spot purchase that has been hedged, the Company will recognize a gain as a result of marking the spot metal to market while at the same time recognizing a loss related to the fair value of the derivative instrument. As noted above, the aggregate fair value of derivatives in a loss position is classified as part of hedged metal obligations at the balance sheet date because the Company has incurred a liability to the counterparty. Should the reverse occur and metal prices decrease, the resultant gain on the derivative will be offset against the spot loss within committed metal positions.
Both spot metal and derivative instruments used in hedging (i.e., forwards, futures, swaps and options) are stated at fair value. If relevant listed market prices are not available, fair value is determined based on other relevant factors, including dealer price quotations and price quotations in different markets, including markets located in different geographic areas. Any change in value, whether realized or unrealized, is recognized as an adjustment to cost of sales in the period of the change.
In closely monitored situations, for which exposure levels and transaction size limits have been set by senior management, the Company holds unhedged metal positions that are subject to future market fluctuations. Such positions may include varying levels of derivative instruments. At times, these positions can be significant. All unhedged metal transactions are monitored and marked to market daily. The metal that has not been hedged is therefore subject to price risk and is disclosed in Note 11, “Committed Metal Positions and Hedged Metal Obligations.”
Environmental Costs
In the ordinary course of business, like most other industrial companies, the Company is subject to extensive and changing federal, state, local and foreign environmental laws and regulations and has made provisions for the estimated financial impact of environmental cleanup-related costs. The Company’s policy is to accrue for environmental cleanup-related costs of a noncapital nature when those costs are believed to be probable and can be reasonably estimated. Environmental cleanup costs are deemed probable when litigation has commenced or a claim or an assessment has been asserted, or, based on available information, commencement of litigation or assertion of a claim or an assessment is probable, and, based on available information, it is probable that the outcome of such litigation, claim or assessment will be unfavorable. The quantification of environmental exposures requires an assessment of many factors, including changing laws and regulations, advancements in environmental technologies, the quality of information available related to specific sites, the assessment stage of each site investigation, preliminary findings and the length of time involved in remediation or settlement. For certain matters, the Company expects to share costs with other parties. The Company does not include anticipated recoveries from insurance carriers or other third parties in its accruals for environmental liabilities.
34
Revenue Recognition
Revenues are recognized on sales of product at the time the goods are shipped or when risks of ownership have passed to the customer. Sales of product include sales of catalysts, pigments, performance additives, sorbents and precious metal sold to industrial customers. Revenues for refining services are recognized on the contractually agreed settlement date. In limited situations, revenue is recognized on a bill-and-hold basis as title passes to the customer before shipment of goods. These bill-and-hold sales meet the criteria of Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” for revenue recognition. Sales recognized on a bill-and-hold basis were approximately $19.4 million as of December 31, 2003, $31.0 million as of December 31, 2002 and $28.9 million as of December 31, 2001. With regard to the balance classified as bill-and-hold sales, the Company has collected $13.7 million of the outstanding balance as of December 31, 2003.
In accordance with Emerging Issues Task Force EITF 00-10, “Accounting for Shipping and Handling Fees and Costs,” the Company reports amounts billed to customers for shipping and handling fees as sales in the Company’s “Consolidated Statements of Earnings.” Costs incurred by the Company for shipping and handling fees are reported as cost of sales.
Sales and Cost of Sales
Some of the Company’s businesses use precious metals in their manufacturing processes. Precious metals are included in sales and cost of sales if the metal has been supplied by the Company. Often, customers supply the precious metals for the manufactured product. In those cases, precious-metals values are not included in sales or cost of sales. The mix of such arrangements, the extent of market-price fluctuations and the general price level of platinum group and other metals can significantly affect the reported level of sales and cost of sales. Consequently, there is no direct correlation between year-to-year changes in reported sales and operating earnings.
In addition to the cost of precious metals recognized as revenues, cost of sales includes all manufacturing costs (raw materials, direct labor and overhead). Cost of sales also includes shipping and handling fees and warranties.
For all Materials Services activities, a gain or loss is recorded as an element of cost of sales based on changes in the market value of the Company’s positions.
Selling, Administrative and Other Expenses
The selling, administrative and other expenses line item in the “Consolidated Statements of Earnings” includes management and administrative compensation, research and development, professional fees, information technology expenses, travel expenses, administrative rent expenses, sales commissions and insurance expenses.
Income Taxes
Deferred income taxes reflect the differences between the assets and liabilities recognized for financial reporting purposes and amounts recognized for tax purposes. Deferred taxes are based on tax laws as currently enacted.
Equity Method of Accounting
The Company’s investments in companies in which it has the ability to exercise significant influence over operating and financial policies, generally 20% to 50% owned, are accounted for using the equity method. Accordingly, the Company’s share of the earnings of these companies is included in consolidated net income. Investments in nonsubsidiary companies in which the Company does not have significant influence are carried at cost.
Foreign Currency Translation
The functional currency for the majority of the Company’s foreign operations is the applicable local currency. The translation from the applicable foreign currencies to U.S. dollars is performed for balance sheet
35
accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using an appropriate average exchange rate during the period. The resulting translation adjustments are recorded as a component of shareholders’ equity. Gains or losses resulting from foreign currency transactions are included in the Company’s “Consolidated Statements of Earnings.”
Stock Option Plans
The Company adopted the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” in 1995 and adopted SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of Financial Accounting Standards Board (FASB) Statement No. 123,” in December 2002. The Company will continue to apply the intrinsic-value-based method of accounting prescribed by Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” with pro forma disclosure of net income and earnings per share as if the fair-value-based method prescribed by SFAS No. 123 had been applied. In general, no compensation cost related to the Company’s stock option plans is recognized in the Company’s “Consolidated Statements of Earnings” as options are issued at market price on the date of grant.
Had compensation cost for the Company’s stock option plans been determined based on the fair value at grant date consistent with the provisions of SFAS No.123, “Accounting for Stock Based Compensation,” the Company’s net earnings and earnings per share would have been as follows:
PRO
FORMA INFORMATION
(in millions, except per-share data)
|
|
|
2003 |
|
2002 |
|
2001 |
|
||||
|
|
|
|
|
|
|
|
|
||||
|
Net earnings — as reported |
|
$ |
234.2 |
|
$ |
171.4 |
|
$ |
225.6 |
|
|
|
Deduct:
Total stock-based employee compensation expense determined under
fair-value-based method for all awards, net of tax |
|
|
(5.8 |
) |
|
(6.3 |
) |
|
(5.9 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings — pro forma |
|
$ |
228.4 |
|
$ |
165.1 |
|
$ |
219.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings Per Share: |
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share — as reported |
|
$ |
1.87 |
|
$ |
1.34 |
|
$ |
1.73 |
|
|
|
Basic earnings per share — pro forma |
|
|
1.82 |
|
|
1.29 |
|
|
1.69 |
|
|
|
Diluted earnings per share — as reported |
|
|
1.84 |
|
|
1.31 |
|
|
1.71 |
|
|
|
Diluted earnings per share — pro forma |
|
|
1.79 |
|
|
1.27 |
|
|
1.66 |
|
|
Research and Development Costs
Research and development costs are charged to expense as incurred and were $93.1 million in 2003, $88.2 million in 2002 and $84.3 million in 2001. These costs are included within selling, administrative and other expenses in the Company’s “Consolidated Statements of Earnings.”
New Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement is effective for financial Statements issued for fiscal years beginning after June 15, 2002. The Company adopted this statement on January 1, 2003 and has incorporated the requirements of this Statement into these consolidated financial statements (see Note 4, “Accounting for Asset Retirement Obligations” for further detail of this standard).
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The primary difference between this Statement and Issue 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. This Statement requires that a
36
liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company adopted this Statement on January 1, 2003 and has incorporated the requirements of this Statement into these consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 addresses consolidation by business enterprises of variable interest entities with certain defined characteristics. This interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company does not have any significant interests in any variable interest entities. This interpretation did not have any impact on the accompanying financial statements.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. This Statement did not have any impact on the accompanying financial Statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability or an asset in some circumstances. Generally, this Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. This Statement did not have any impact on the accompanying financial statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” an amendment of FASB statements No. 87, 88 and 106. This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement and recognition of those plans required by FASB Statements 87, 88 and 106. This Statement retains the disclosure requirements contained in the original Statement 132. It requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit plans and other defined benefit postretirement plans. This Statement is effective for financial statements with fiscal years ending after December 15, 2003, except for the disclosure of estimated future benefit payments and information about foreign plans which is effective for fiscal years ending after June 15, 2004. The Company adopted this Statement in December 2003 and has incorporated all required disclosure provisions that are effective as of December 31, 2003 into these consolidated financial statements, except for information about estimated future benefit payments.
On December 8, 2003, the President of the United States signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). This Act introduces a prescription drug benefit under Medicare (Medicare Part D), as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In December 2003, the FASB issued FASB Staff Position (FSP) No. 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” In accordance with FSP No. 106-1, the Company has decided to make a one-time election to defer accounting for the effects of the Act until specific authoritative guidance is issued on how to account for the federal subsidy. Accordingly, the Company’s benefit obligation and net periodic benefit cost do not reflect the effects of this Act.
2. DERIVATIVE INSTRUMENTS AND HEDGING
The Company reports all derivative instruments on the balance sheet at their fair value. Changes in the fair value of derivatives designated as cash flow hedges are initially recorded in comprehensive income and are reclassified to earnings in the period the hedged item is reflected in earnings. Changes in the fair value of derivatives that are not designated as cash flow hedges are reported immediately in earnings.
37
In order to manage in a manner consistent with historical processes, procedures and systems and to achieve operating economies, certain economic hedge transactions are not designated as hedges for accounting purposes. In those cases, which primarily relate to precious and base metals, the Company will continue to mark-to-market both the hedge instrument and the related position constituting the risk hedged, recognizing the net effect in current earnings.
The Company documents all relationships between derivative hedging instruments and items impacted by cash flow hedges at the time the hedges are initiated, as well as its risk-management strategies for entering into various hedge transactions. For the years ended December 31, 2003, 2002 and 2001, there was no gain or loss recognized in earnings resulting from hedge ineffectiveness.
Foreign Exchange Contracts
The Company designates as cash flow hedges certain foreign currency forward contracts entered into as hedges against anticipated receivables or payables which will arise from forecasted transactions that are denominated in currencies other than the functional currency of the entity which holds those assets or liabilities. The ultimate maturities of the contracts are timed to coincide with the expected occurrence of the underlying sale or purchase transaction.
For the twelve-month periods ended December 31, 2003 and 2002, the Company reported after-tax losses of $1.7 million and $0.3 million, respectively, in accumulated other comprehensive income relating to the change in the fair value of derivatives designated as foreign exchange cash flow hedges. For the twelve-month period ended December 31, 2001, the Company reported after-tax gains of $0.2 million in accumulated other comprehensive income. It is expected that cumulative losses of $1.8 million as of December 31, 2003 will be reclassified into earnings within the next twelve months. There was no gain or loss reclassified from accumulated other comprehensive income into earnings as a result of the discontinuance of cash flow hedges due to the probability of the original forecasted transactions not occurring. As of December 31, 2003, the maximum length of time over which the Company has hedged its exposure to movements in foreign exchange rates for forecasted transactions is twelve months.
A second group of forward contracts entered into to hedge the exposure to foreign currency fluctuations associated with certain monetary assets and liabilities is not designated as hedging instruments for accounting purposes. Changes in the fair value of these items are recorded in earnings to offset the foreign exchange gains and losses arising from the effect of changes in exchange rates used to measure related monetary assets and liabilities.
Commodity Contracts
The Company enters into contracts that are designated as cash flow hedges to protect a portion of its exposure to movements in certain commodity prices. The ultimate maturities of the contracts are timed to coincide with the expected usage of these commodities.
For the twelve-month periods ended December 31, 2003 and 2002, the Company reported after-tax gains of $1.6 million and $4.7 million, respectively, in accumulated other comprehensive income relating to the change in the fair value of derivatives designated as cash flow commodity hedges. For the twelve-month period ended December 31, 2001, the Company reported after-tax losses of $4.8 million in accumulated other comprehensive income. These amounts primarily relate to derivatives designated as natural gas cash flow hedges. It is expected that cumulative gains of $1.6 million as of December 31, 2003 will be reclassified into earnings within the next twelve months. There was no gain or loss reclassified from accumulated other comprehensive income into earnings as a result of the discontinuance of cash flow commodity hedges due to the probability of the original forecasted transactions not occurring. As of December 31, 2003, the maximum length of time over which the Company has hedged its exposure to movements in commodity prices for forecasted transactions is twelve months.
The use of derivative metal instruments is discussed in Note 1, “Summary of Significant Accounting Policies,” under Committed Metal Positions and Hedged Metal Obligations. To the extent that the maturities of these instruments are mismatched, the Company may be exposed to market risk. This exposure is mitigated through the use of Eurodollar futures that are marked to market daily along with the underlying commodity instruments.
38
Interest Rate Derivatives
The Company uses interest rate derivatives that are designated as fair value hedges to help achieve its fixed and floating rate debt objectives. The Company currently has two interest rate swap agreements with a total notional value of $100 million maturing in August 2006 and three interest rate swap agreements with a total notional value of $150 million maturing in May 2013. These agreements effectively change fixed rate debt obligations into floating rate debt obligations. The total notional values and maturity dates of these agreements are equal to the face values and the maturity dates of the related debt instruments. For these fair value hedges, there was no gain or loss recognized from hedged firm commitments no longer qualifying as fair value hedges for the twelve-month periods ending December 31, 2003, 2002 and 2001.
3. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted SFAS No. 141, “Business Combinations,” for all acquisitions made after June 30, 2001. This statement requires that all business combinations be accounted for by the purchase method and that intangible assets be recognized apart from goodwill if they meet certain criteria.
The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002. SFAS No. 142 addresses post-acquisition financial accounting and reporting for acquired goodwill and other intangible assets. Under this statement, goodwill and other intangible assets that have indefinite useful lives will not be amortized, but rather will be tested for impairment based on the specific guidance of SFAS No. 142. The Company did not recognize an impairment loss as a result of the impairment testing that was completed in 2003 and 2002.
The following table sets forth the pro forma impact of applying the new non-amortization provisions of SFAS No. 142 on net income and earnings per share (in millions, except per-share amounts):
|
|
|
Twelve
Months Ended |
|
||||||||||||||||||||||||
|
|
|
|
|
||||||||||||||||||||||||
|
|
|
2003 |
|
2002 |
|
2001 |
|
||||||||||||||||||||
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
|
Net
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
|
Reported
net income
|
|
|
$ |
234.2 |
|
|
|
$ |
171.4 |
|
|
|
$ |
225.6 |
|
|
||||||||||
|
|
Add
back: Goodwill amortization, net of tax
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
8.4 |
|
|
||||||||||
|
|
Tradename
amortization, net of tax
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
0.6 |
|
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
|
Adjusted
net income
|
|
|
$ |
234.2 |
|
|
|
$ |
171.4 |
|
|
|
$ |
234.6 |
|
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
Basic
Earnings Per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
|
Reported
basic earnings per share
|
|
|
$ |
1.87 |
|
|
|
$ |
1.34 |
|
|
|
$ |
1.73 |
|
|
||||||||||
|
|
Add
back: Goodwill amortization, net of tax
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
0.06 |
|
|
||||||||||
|
|
Tradename
amortization, net of tax
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
|
Adjusted
basic earnings per share
|
|
|
$ |
1.87 |
|
|
|
$ |
1.34 |
|
|
|
$ |
1.79 |
|
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
Diluted
Earnings Per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
|
Reported
diluted earnings per share
|
|
|
$ |
1.84 |
|
|
|
$ |
1.31 |
|
|
|
$ |
1.71 |
|
|
||||||||||
|
|
Add
back: Goodwill amortization, net of tax
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
0.06 |
|
|
||||||||||
|
|
Tradename
amortization, net of tax
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
|
Adjusted
diluted earnings per share
|
|
|
$ |
1.84 |
|
|
|
$ |
1.31 |
|
|
|
$ |
1.77 |
|
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
39
The following information relates to acquired amortizable intangible assets (in millions):
|
|
|
As of December 31, 2003 |
|
As of December 31, 2002 |
|
||||||||||||||||||
|
|
|
|
|
|
|
||||||||||||||||||
|
|
|
Gross
Carrying |
|
Accumulated |
|
Gross
Carrying |
|
Accumulated |
|
||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
||||||||||||||
|
Acquired Amortizable Intangible Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
Usage right |
|
|
$ |
20.7 |
|
|
|
$ |
4.5 |
|
|
|
$ |
17.2 |
|
|
|
$ |
2.6 |
|
|
|
|
|
Supply agreements |
|
|
|
17.9 |
|
|
|
|
4.7 |
|
|
|
|
15.4 |
|
|
|
|
3.1 |
|
|
|
|
|
Technology licenses |
|
|
|
8.6 |
|
|
|
|
2.6 |
|
|
|
|
7.4 |
|
|
|
|
1.9 |
|
|
|
|
|
Other |
|
|
|
3.7 |
|
|
|
|
2.1 |
|
|
|
|
3.7 |
|
|
|
|
1.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
Total |
|
|
$ |
50.9 |
|
|
|
$ |
13.9 |
|
|
|
$ |
43.7 |
|
|
|
$ |
9.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
Total accumulated amortization for goodwill and other intangible assets amounted to $80.2 million and $76.8 million at December 31, 2003 and 2002, respectively. As of December 31, 2003, the estimated aggregate amortization expense for each of the five succeeding years is as follows (in millions):
|
Estimated Annual Amortization Expense: |
|
|||
|
|
|
|||
|
2004 |
|
$ |
3.5 |
|
|
2005 |
|
|
3.5 |
|
|
2006 |
|
|
3.3 |
|
|
2007 |
|
|
3.3 |
|
|
2008 |
|
|
3.3 |
|
The following table represents the changes in the carrying amount of goodwill for the years ended December 31, 2003 and 2002 (in millions):
|
|
|
Environmental |
|
Process |
|
Appearance |
|
All Other |
|
Total |
|
||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||||||||
|
Balance as of January 1, 2002 |
|
|
$ |
12.3 |
|
|
|
$ |
108.2 |
|
|
|
$ |
132.3 |
|
|
|
$ |
0.8 |
|
|
|
$ |
253.6 |
|
|
|
|
Goodwill additions |
|
|
|
0.8 |
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
|
|
0.8 |
|
|
|
|
Reclassification of other intangible asset (a) |
|
|
|
— |
|
|
|
|
— |
|
|
|
|
18.6 |
|
|
|
|
— |
|
|
|
|
18.6 |
|
|
|
|
Foreign currency translation adjustment |
|
|
|
0.1 |
|
|
|
|
0.6 |
|
|
|
|
1.1 |
|
|
|
|
— |
|
|
|
|
1.8 |
|
|
|
|
Purchase accounting adjustment |
|
|
|
— |
|
|
|
|
(1.9 |
) |
|
|
|
— |
|
|
|
|
— |
|
|
|
|
(1.9 |
) |
|
|
|
Other |
|
|
|
(0.2 |
) |
|
|
|
— |
|
|
|
|
— |
|
|
|
|
(0.3 |
) |
|
|
|
(0.5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2002 |
|
|
|
13.0 |
|
|
|
|
106.9 |
|
|
|
|
152.0 |
|
|
|
|
0.5 |
|
|
|
|
272.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill additions |
|
|
|
— |
|
|
|
|
— |
|
|
|
|
1.5 |
|
|
|
|
— |
|
|
|
|
1.5 |
|
|
|
|
Foreign currency translation adjustment |
|
|
|
0.2 |
|
|
|
|
0.7 |
|
|
|
|
(0.1 |
) |
|
|
|
— |
|
|
|
|
0.8 |
|
|
|
|
Other |
|
|
|
0.5 |
|
|
|
|
(0.1 |
) |
|
|
|
— |
|
|
|
|
— |
|
|
|
|
0.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2003 |
|
|
$ |
13.7 |
|
|
|
$ |
107.5 |
|
|
|
$ |
153.4 |
|
|
|
$ |
0.5 |
|
|
|
$ |
275.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
SFAS No. 141 provides that an intangible asset shall be recognized apart from goodwill if it arises from contractual or other legal rights or if it is separable from the acquired entity. In accordance with the transition provisions of the statement, the Company reviewed its intangible assets to determine if they met the new criteria. As a result, it was determined that an other intangible asset of $18.6 million did not meet the new criteria and should thus be recognized as goodwill upon adoption of SFAS No. 142. |
40
4. ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS
The Company adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,” on January 1, 2003. This statement, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs, requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is incurred. The liability is measured at fair value and is adjusted in subsequent periods as accretion expense is recorded. The corresponding asset retirement costs are capitalized as part of the carrying amount of the related long-lived asset and depreciated over the asset’s useful life.
The Company’s asset retirement obligations primarily relate to kaolin mining operations of its Appearance and Performance Technologies segment. In order to provide kaolin-based products to the Company’s customers and the Process Technologies segment, the Company engages in kaolin mining operations. The kaolin mining process includes exploration, topsoil and overburden removal, extraction of kaolin and the subsequent reclamation of mined areas. The Company has a legal obligation to reclaim mined areas under state regulations. Prior to adoption of SFAS No. 143, the Company expensed reclamation costs as the mined areas were reclaimed.
At January 1, 2003, the Company recognized transition amounts for existing asset retirement obligation liabilities, associated capitalizable costs and accumulated depreciation. A transition charge of $3.7 million ($2.3 million after tax or $0.02 per share on a diluted basis) was recorded on January 1, 2003 as the cumulative effect of an accounting change. Pro forma net income and diluted earnings per share as if the provisions of SFAS No. 143 had been adopted on January 1, 2002, excluding the cumulative effect of an accounting change, for the twelve-month period ended December 31, 2002 are $170.8 million and $1.31 per share.
The following table represents the change in the Company’s asset retirement obligation liability for the year ended December 31, 2003 (in millions):
|
|
|
2003 |
|
||
|
|
|
|
|
||
|
Asset retirement obligation at January 1, 2003 |
|
$ |
— |
|
|
|
Liability recognized in transition |
|
|
7.1 |
|
|
|
Liability recognized during the twelve months ended
December 31, 2003 |
|
|
2.0 |
|
|
|
Accretion expense |
|
|
1.9 |
|
|
|
Payments |
|
|
(0.5 |
) |
|
|
|
|
|
|
|
|
|
|
Asset retirement obligation at December 31, 2003 |
|
$ |
10.5 |
|
|
|
|
|
|
|
|
The pro forma amount of liability for asset retirement obligation as if the provisions of SFAS No. 143 had been applied at January 1, 2002 is $6.7 million. This amount would not have been materially different if the provisions of SFAS No. 143 been applied at January 1, 2001.
5. ACQUISITIONS
In November 2002, the Company acquired certain operating assets of Shuozhou Anpeak Kaolin Co., Ltd., a China-based producer of calcined kaolin products for approximately $12.1 million. This acquisition enhances the Company’s ability to provide specialty mineral technologies to the Asian market and was recorded under the purchase method of accounting. The results of operations of this acquisition, integrated into the Appearance and Performance Technologies segment, are included in the accompanying consolidated financial statements from the date of acquisition. A portion of the purchase price has been allocated to assets acquired based on their fair values, while the remaining balance was recorded as goodwill. Pro forma information is not provided because the impact of the acquisition does not have a material effect on the Company’s results of operations, cash flows or financial position.
In October 2001, the Company acquired the fats and oils catalyst business of Sud Chemie for approximately $13.6 million. This acquisition broadened the Company’s catalyst technology offering to oleochemical markets and was recorded under the purchase method of accounting. The results of operations of this acquisition, integrated into the Process Technologies segment, are included in the accompanying consolidated
41
financial statements from the date of acquisition. A portion of the purchase price has been allocated to assets acquired based on their fair values, while the remaining balance was recorded as goodwill. Pro forma information is not provided since the impact of the acquisition does not have a material effect on the Company’s results of operations, cash flows or financial position.
6. SPECIAL CHARGES AND CREDITS
In the first quarter of 2003, the Company entered into a settlement agreement, releasing a claim the Company had brought against Research Corporation and Research Corporation Technologies in exchange for payment of $38.0 million. Accordingly, the Company recorded a gain of $28.4 million ($17.6 million after tax) in the first quarter of 2003, net of legal fees and the portion of the settlement related to future royalties. This gain was included in the Company’s “All Other” category and in the “Special (credits)/charges, net” line in the “Consolidated Statements of Earnings.” By way of background, on October 29, 2002, a jury in the New York County Supreme Court had awarded the Company $29.8 million in damages in a breach of contract action the Company had brought against Research Corporation and Research Corporation Technologies in 1998. The jury found that the defendants did not share with the Company all of the royalties to which the Company was entitled under a royalty-sharing agreement it entered into with Research Corporation in 1979. Statutory interest to the date of the verdict would have increased the amount awarded to approximately $42.2 million.
Also in the first quarter of 2003, the Company recorded charges totaling $8.7 million ($5.6 million after tax) primarily related to a management consolidation and productivity initiative in the Environmental and Process Technologies segments and within the “All Other” category. The amounts of $5.3 million ($3.5 million after tax), $2.6 million ($1.6 million after tax) and $0.8 million ($0.5 million after tax) were reported in the Environmental Technologies segment, the Process Technologies segment and the “All Other” category, respectively. These charges are included in the “Special (credits)/charges, net” line in the “Consolidated Statements of Earnings.”
In the Environmental Technologies segment, the charge of $5.3 million primarily relates to the closure of the segment’s Coleford, United Kingdom plant ($2.8 million) and employee severance costs related to productivity initiatives ($2.5 million). The employee severance charges include an actual reduction of 96 salaried and 8 hourly employees. As a result of closing this plant, the segment will outsource the canning operations associated with this business. The closure resulted in an impairment charge of $1.5 million to write down fixed assets and other exit-related costs of $1.3 million. As of December 31, 2003, the remaining liability associated with this charge was $0.3 million.
In the Process Technologies segment, the charge of $2.6 million primarily relates to employee severance and the termination of an agency agreement associated with sales to the chemical-process market. The employee severance charges relate to the reduction of 13 salaried employees. Selling activities associated with the termination of this agency agreement will be covered by the segment’s internal sales force. As of December 31, 2003, the remaining liability associated with this charge was $0.1 million.
In the “All Other” category, the charge of $0.8 million was for employee severance costs related to the actual reduction of six salaried employees. As of December 31, 2003, the remaining liability associated with this charge was $0.1 million.
The actions undertaken by the Company in relation to the aforementioned 2003 special charges are expected to be substantially complete by the end of 2004.
In the second quarter of 2003, the Company recorded a charge of $7.8 million ($4.8 million after tax) for the fair value of the remaining lease costs of certain minerals-storage facilities no longer needed because of productivity initiatives. As of June 30, 2003, the Company’s Appearance and Performance Technologies segment had ceased using these facilities and, accordingly, a provision for the fair value of remaining lease costs was reported in the “Special (credits)/charges, net” line in the “Consolidated Statements of Earnings.”
In the second quarter of 2002, the Company recorded a charge of $3.1 million ($1.9 million after tax) primarily related to a manufacturing consolidation plan within a business that serves the aerospace turbine-engine overhaul and repair market in the Company’s Environmental Technologies segment. This charge includes asset write-offs of $1.7 million, employee severance costs of $0.6 million and other exit costs of $0.8 million related to
42
the plant closure. The employee severance charges included the actual reduction of 43 salaried employees. These actions were substantially complete by the end of 2003.
Also in the second quarter of 2002, the Company recorded a gain of $11.0 million ($6.8 million after tax) related to insurance settlements stemming from events in 1997 and 1998 in which Engelhard and other companies were victimized in an elaborate scheme involving base-metal inventories held in third-party warehouses in Japan. A special charge recorded by the Company in 1997 included an inventory loss of approximately $40 million associated with the Japan matter. An additional $20 million inventory loss was recorded in 1998. In the first quarter of 1998, the Company recorded a receivable from insurance carriers and third parties involved for approximately $20 million. As of June 30, 2002, the Company had recovered $11.2 million. In July 2002, the Company received an additional $19.8 million, net of legal fees, from insurance settlements reached in June. Accordingly, the Company recorded a gain of $11.0 million ($6.8 million after tax) in the second quarter of 2002 in its Materials Services segment.
The Company recorded a charge of $7.1 million ($4.3 million after tax) in the second quarter of 2001 related to the redeployment of assets between the Company’s kaolin-based operations in Middle Georgia and its petroleum refining catalyst facility in Savannah, Georgia. Some assets previously dedicated to providing kaolin-based products to the paper industry are being redirected to enable the Company to produce more value-added catalyst technologies for petroleum refining. This charge includes employee severance costs of $3.2 million, asset write-offs of $2.6 million and other costs of $1.3 million related to the asset redeployment actions and productivity initiatives. The actual number of employees terminated as a result of this action was 213 and these employees were primarily located at the Middle Georgia facility. This charge was recorded in the Appearance and Performance Technologies segment. These actions were completed by the end of 2003.
The following table sets forth the components of the Company’s reserves for restructuring costs:
RESTRUCTURING
RESERVES
(in millions)
|
|
|
Separations |
|
Other |
|
||||||||||||||||||
|
|
|
|
|
|
|
||||||||||||||||||
|
|
|
Pre-2002 |
|
2002 |
|
2003 |
|
Pre-2002 |
|
2002 |
|
2003 |
|
Total |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
Balance at December 31, 2000
|
|
$ |
2.0 |
|
$ |
— |
|
$ |
— |
|
$ |
18.0 |
|
|
— |
|
$ |
— |
|
$ |
20.0 |
|
|
|
Cash spending |
|
|
(2.6 |
) |
|
— |
|
|
— |
|
|
(13.2 |
) |
|
— |
|
|
— |
|
|
(15.8 |
) |
|
|
Provision |
|
|
3.2 |
|
|
— |
|
|
— |
|
|
1.3 |
|
|
— |
|
|
— |
|
|
4.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2001 |
|
|
2.6 |
|
|
— |
|
|
— |
|
|
6.1 |
|
|
— |
|
|
— |
|
|
8.7 |
|
|
Cash spending |
|
|
(2.4 |
) |
|
(0.3 |
) |
|
— |
|
|
(2.4 |
) |
|
(0.2 |
) |
|
— |
|
|
(5.3 |
) |
|
|
Provision |
|
|
— |
|
|
0.6 |
|
|
— |
|
|
— |
|
|
0.8 |
|
|
— |
|
|
1.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2002 |
|
|
0.2 |
|
|
0.3 |
|
|
— |
|
|
3.7 |
|
|
0.6 |
|
|
— |
|
|
4.8 |
|
|
Cash spending |
|
|
— |
|
|
(0.2 |
) |
|
(5.0 |
) |
|
(1.3 |
) |
|
(0.1 |
) |
|
(3.1 |
) |
|
(9.7 |
) |
|
|
Provision |
|
|
(0.2 |
) |
|
(0.1 |
) |
|
5.3 |
|
|
(1.0 |
) |
|
(0.1 |
) |
|
3.3 |
|
|
7.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003 |
|
$ |
— |
|
$ |
— |
|
$ |
0.3 |
|
$ |
1.4 |
|
$ |
0.4 |
|
$ |
0.2 |
|
$ |
2.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7. GUARANTEES AND WARRANTIES
In the normal course of business, the Company incurs obligations with regard to contract completion and product performance. Under certain circumstances, these obligations are supported through the issuance of letters of credit. At December 31, 2003, the aggregate outstanding amount of letters of credit supporting such obligations amounted to $122.6 million, of which $114.0 million will expire in less than one year, $8.5 million will expire in two to three years and $0.1 million will expire after five years. In the opinion of management, such obligations will not significantly affect the Company’s financial position or results of operations as the Company anticipates fulfilling its performance obligations.
The Company accrues for anticipated product warranty expenses on certain products. Accruals for anticipated warranty liabilities are recorded based upon a review of historical warranty claims experience. Adjustments are made to accruals as claim data and historical experience warrant. The Company’s accrual is
43
primarily comprised of warranty liabilities within the non-automotive business of the Environmental Technologies segment.
The changes in the Company’s product warranty reserves for the years ended December 31, 2003, 2002 and 2001 are as follows (in millions):
|
|
|
2003 |
|
2002 |
|
2001 |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Balance
at beginning of year
|
|
$ |
11.1 |
|
$ |
14.7 |
|
$ |
15.9 |
|
|
Payments
|
|
|
(4.0 |
) |
|
(10.1 |
) |
|
(1.6 |
) |
|
Provision
(a)
|
|
|
2.9 |
|
|
11.4 |
|
|
0.4 |
|
|
Reversal
of reserve (b)
|
|
|
— |
|
|
(4.9 |
) |
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at end of year
|
|
$ |
10.0 |
|
$ |
11.1 |
|
$ |
14.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
In 2002, the Company experienced product difficulties in the non-automotive business of the Environmental Technologies segment resulting in higher warranty expenses. |
|
(b) |
In 2002, the Company reduced its warranty accrual for a particular stationary-source, emission-control capital equipment project by $4.9 million as a result of improved catalyst technology that reduced estimated costs. |
8. INVENTORIES
Inventories at December 31, 2003 and 2002 consist of the following:
INVENTORIES
(in millions)
|
|
|
2003 |
|
2002 |
|
|||
|
|
|
|
|
|
|
|||
|
Raw materials |
|
$ |
121.3 |
|
$ |
95.4 |
|
|
|
Work in process |
|
|
48.1 |
|
|
77.0 |
|
|
|
Finished goods |
|
|
256.2 |
|
|
237.4 |
|
|
|
Precious metals |
|
|
17.2 |
|
|
17.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total inventories |
|
$ |
442.8 |
|
$ |
427.2 |
|
|
|
|
|
|
|
|
|
|
|
The majority of the Company’s physical metal is carried in the committed metal positions line on the balance sheet at fair value with the remainder carried in the inventory line at historical cost. The inventory portion of precious metals are stated at LIFO cost. The market value of the precious-metals recorded at LIFO exceeded cost by $52.8 million and $58.3 million at December 31, 2003 and 2002, respectively. Net earnings include after-tax gains of $3.1 million in 2003 and 2002, and $3.4 million in 2001 from the sale of precious metals accounted for under the LIFO method.
In the normal course of business, certain customers and suppliers deposit significant quantities of precious metals with the Company under a variety of arrangements. Equivalent quantities of precious metals are returnable as product or in other forms. Metals held for the accounts of customers and suppliers are not reflected in the Company’s financial statements.
44
9. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31, 2003 and 2002 consist of the following (in millions):
|
|
|
2003 |
|
2002 |
|
|||
|
|
|
|
|
|
|
|||
|
Land |
|
$ |
30.5 |
|
$ |
27.8 |
|
|
|
Buildings and building improvements |
|
|
264.5 |
|
|
244.4 |
|
|
|
Machinery and equipment |
|
|
1,654.8 |
|
|
1,508.6 |
|
|
|
Construction in progress |
|
|
81.3 |
|
|
94.6 |
|
|
|
Mineral deposits and mine development costs |
|
|
82.7 |
|
|
73.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,113.8 |
|
|
1,949.2 |
|
|
|
Accumulated depreciation and depletion |
|
|
1,233.0 |
|
|
1,088.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment, net |
|
$ |
880.8 |
|
$ |
860.5 |
|
|
|
|
|
|
|
|
|
|
|
Mineral deposits and mine development costs consist of industrial mineral reserves including kaolin, attapulgite and mica. The Company does not own any mining reserves or conduct any mining operations with respect to platinum, palladium or other metals. The Company capitalized interest of $3.0 million in each of 2003, 2002 and 2001.
10. INVESTMENTS
The Company has investments in affiliates that are accounted for under the equity method. These investments are N.E. Chemcat Corporation (N.E. Chemcat), Heesung-Engelhard, Engelhard-CLAL and Prodrive-Engelhard. N.E. Chemcat is a 38.8%-owned, publicly traded Japanese corporation and a leading producer of automotive and chemical catalysts, electronic chemicals and other precious-metals-based products. Heesung-Engelhard, a 49%-owned joint venture in South Korea, manufactures and markets catalyst products for automobiles. Engelhard-CLAL manufactured and marketed certain products containing precious metals and was substantially liquidated as of December 31, 2003. As of December 31, 2003, the Company’s ownership in the remaining Engelhard-CLAL operations has decreased from 50% to 45%. Prodrive-Engelhard, a 50%-owned joint venture in the United States, specializes in the design, development and testing of vehicle emission systems.
The unaudited financial information below represents a summary of the Company’s Engelhard-CLAL investment on a 100% basis, unless otherwise noted:
FINANCIAL
INFORMATION
(unaudited) (in millions)
|
|
|
2003 |
|
2002 |
|
2001 |
|
||||
|
|
|
|
|
|
|
|
|
||||
|
Earnings
data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
127.4 |
|
$ |
366.9 |
|
$ |
892.1 |
|
|
|
Gross
profit
|
|
|
19.0 |
|
|
32.7 |
|
|
51.6 |
|
|
|
Net
earnings
|
|
|
10.1 |
|
|
(18.6 |
) |
|
28.4 |
|
|
|
Engelhard’s
equity investment impairment
|
|
|
— |
|
|
(57.7 |
) |
|
— |
|
|
|
Engelhard’s
equity in net earnings
|
|
|
19.6 |
|
|
1.6 |
|
|
14.2 |
|
|
Balance
sheet data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
assets
|
|
$ |
28.3 |
|
$ |
148.8 |
|
$ |
264.9 |
|
|
|
Noncurrent
assets
|
|
|
3.6 |
|
|
23.2 |
|
|
42.3 |
|
|
|
Current
liabilities
|
|
|
10.6 |
|
|
63.2 |
|
|
100.4 |
|
|
|
Noncurrent
liabilities
|
|
|
— |
|
|
3.6 |
|
|
27.1 |
|
|
|
Net
assets
|
|
|
21.3 |
|
|
105.2 |
|
|
179.7 |
|
|
|
Engelhard’s
equity investment
|
|
|
— |
|
|
6.0 |
|
|
88.6 |
|
In the third quarter of 2002, the Company recorded an impairment charge of $57.7 million associated with its Engelhard-CLAL joint venture. On September 19, 2002, the Company and its partner, Fimalac, formally agreed to adopt a plan to unwind their Paris-based joint venture, Engelhard-CLAL. The Company received a distribution in
45
the form of cash and operating assets of approximately $16.0 million in the fourth quarter of 2002 net of the working capital requirements of the distributed operating assets and a cash distribution of approximately $26.0 million net of costs in 2003. As of December 31, 2003, the Engelhard-CLAL joint venture has been substantially liquidated.
The unaudited financial information below represents an aggregation of the Company’s nonsubsidiary affiliates, excluding Engelhard-CLAL, on a 100% basis, unless otherwise noted:
FINANCIAL
INFORMATION
(unaudited) (in millions)
|
|
|
2003 |
|
2002 |
|
2001 |
|
|||||||
|
|
|
|
|
|
|
|
|
|||||||
|
Earnings data: |
|
|
|
|
|
|
|
|
|
|
||||
|
|
Revenue |
|
$ |
483.3 |
|
$ |
644.6 |
|
$ |
748.2 |
|
|||
|
|
Gross profit |
|
|
138.1 |
|
|
109.7 |
|
|
106.4 |
|
|||
|
|
Net earnings |
|
|
43.4 |
|
|
33.2 |
|
|
34.4 |
|
|||
|
|
Engelhard’s equity in net earnings |
|
|
19.8 |
|
|
14.6 |
|
|
14.9 |
|
|||
|
Balance sheet data: |
|
|
|
|
|
|
|
|
|
|
||||
|
|
Current assets |
|
$ |
345.1 |
|
$ |
306.0 |
|
$ |
286.6 |
|
|||
|
|
Noncurrent assets |
|
|
198.3 |
|
|
182.6 |
|
|
165.5 |
|
|||
|
|
Current liabilities |
|
|
125.6 |
|
|
155.8 |
|
|
148.5 |
|
|||
|
|
Noncurrent liabilities |
|
|
51.5 |
|
|
24.7 |
|
|
20.8 |
|
|||
|
|
Net assets |
|
|
366.3 |
|
|
308.1 |
|
|
282.8 |
|
|||
|
|
Engelhard’s equity investment |
|
|
152.5 |
|
|
126.8 |
|
|
116.3 |
|
|||
The Company’s share of undistributed earnings of affiliated companies included in consolidated retained earnings were earnings of $75.8 million, $41.4 million and $87.1 million in 2003, 2002 and 2001, respectively. Dividends from affiliated companies were $5.0 million in 2003, $3.9 million in 2002 and $4.2 million in 2001.
In the second quarter of 2002, the Company recorded an impairment charge of $6.7 million ($4.1 million after tax) associated with a non-equity investment. The write down was taken to reflect the lower current value of an investment in fuel-cell developer Plug Power Inc. This investment was made as part of agreements between the two companies for development of advanced materials for fuel cells. The carrying amount of this investment has been reduced to its estimated fair value based on quoted market prices. The Company considered this market decline to be other than temporary. Plug Power Inc. designs and develops on-site electric power generation systems utilizing proton exchange membrane fuel cells for stationary applications. This impairment charge was reported in the Company’s “All Other” category and was recorded in “Loss on investment” in the Company’s “Consolidated Statements of Earnings.”
11. COMMITTED METAL POSITIONS AND HEDGED METAL OBLIGATIONS
Both spot metal positions and derivative instruments are stated at fair value. Fair value is based on published market prices. The following table sets forth the Company’s unhedged metal positions included in committed metal positions at December 31, 2003 and 2002 on the Company’s “Consolidated Balance Sheets”:
METAL
POSITIONS INFORMATION
(in millions)
|
|
|
2003 |
|
2002 |
|
|||||||
|
|
|
|
|
|
|
|||||||
|
|
|
Net Position |
|
Value |
|
Net Position |
|
Value |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|||
|
Platinum group metals |
|
Long |
|
$ |
10.1 |
|
Long |
|
$ |
16.6 |
|
|
|
Gold |
|
Long |
|
|
0.7 |
|
Long |
|
|
1.1 |
|
|
|
Silver |
|
Short |
|
|
0.6 |
|
Long |
|
|
0.4 |
|
|
|
Base metals |
|
Long |
|
|
2.0 |
|
Short |
|
|
2.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total unhedged metal positions |
|
|
|
$ |
13.4 |
|
|
|
$ |
20.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
46
Committed metal positions may include significant advances made for the purchase of precious metals that have been delivered to the Company but for which the final purchase price has not yet been determined. As of December 31, 2003, the aggregate market value of the metals purchased under a contract for which a provisional price had been paid was in excess of the amounts advanced by a total of $92.9 million. As a result, this amount was recorded in committed metal positions and accounts payable at December 31, 2003.
Derivative metal and foreign currency instruments are used to hedge metal positions and obligations. As of December 31, 2003, approximately 99% of these instruments have settlement terms of less than one year, with the remaining instruments expected to settle within 36 months. These derivative metal and foreign currency instruments consist of the following at December 31, 2003 and 2002:
METAL
HEDGING INSTRUMENTS
(in millions)
|
|
|
2003 |
|
2002 |
|
||||||||
|
|
|
|
|
|
|
||||||||
|
|
|
Buy |
|
Sell |
|
Buy |
|
Sell |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Metal
forwards/futures
|
|
$ |
848.4 |
|
$ |
719.4 |
|
$ |
1,234.5 |
|
$ |
494.4 |
|
|
Eurodollar
futures
|
|
|
43.1 |
|
|
127.4 |
|
|
113.0 |
|
|
86.0 |
|
|
Swaps
|
|
|
19.7 |
|
|
5.4 |
|
|
4.7 |
|
|
7.7 |
|
|
Options
|
|
|
33.6 |
|
|
14.6 |
|
|
101.7 |
|
|
98.7 |
|
|
Foreign
exchange forwards/futures – Japanese yen
|
|
|
|
|
|
97.3 |
|
|
|
|
|
49.9 |
|
|
Foreign
exchange forwards/futures – Euro
|
|
|
— |
|
|
37.9 |
|
|
— |
|
|
43.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12. FINANCIAL INSTRUMENTS
The Company’s nonderivative financial instruments consist primarily of cash in banks, temporary investments, accounts receivable and debt. The fair value of financial instruments in working capital approximates book value. The fair value of long-term debt was $409.3 million as of December 31, 2003 and $267.0 million as of December 31, 2002 based on prevailing interest rates at those dates, compared with a book value of $390.6 million as of December 31, 2003 and $247.8 million as of December 31, 2002.
The Company believes that its financial instruments do not represent a concentration of credit risk because the Company deals with a variety of major banks worldwide, and its accounts receivable are spread among a number of major industries, customers and geographic areas. A centralized credit committee reviews significant credit transactions and risk-management issues before the granting of credit, and an appropriate level of reserves is maintained. In addition, the Company monitors the financial condition of its customers to help ensure collections and to minimize losses.
Foreign Currency Instruments
Aggregate foreign exchange transaction gains and losses were not significant for any year presented. The following table sets forth, in U.S. dollars, the Company’s open foreign exchange contracts used for hedging other than metal-related transactions as of the respective year-ends (see Note 11, “Committed Metal Positions and Hedged Metal Obligations,” for further detail):
47
FOREIGN
EXCHANGE CONTRACTS INFORMATION
(in millions)
|
|
|
2003 |
|
2002 |
|
|||||||||
|
|
|
|
|
|
|
|||||||||
|
|
|
Buy |
|
Sell |
|
Buy |
|
Sell |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|||||
|
Japanese yen |
|
$ |
2.8 |
|
$ |
8.0 |
|
$ |
14.7 |
|
$ |
0.3 |
|
|
|
Australian dollar |
|
|
— |
|
|
— |
|
|
— |
|
|
0.1 |
|
|
|
Euro |
|
|
45.4 |
|
|
101.9 |
|
|
34.0 |
|
|
60.0 |
|
|
|
Thai baht |
|
|
— |
|
|
2.4 |
|
|
— |
|
|
— |
|
|
|
South African rand |
|
|
— |
|
|
23.2 |
|
|
— |
|
|
7.2 |
|
|
|
Brazilian real |
|
|
— |
|
|
2.3 |
|
|
— |
|
|
0.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total open foreign exchange contracts |
|
$ |
48.2 |
|
$ |
137.8 |
|
$ |
48.7 |
|
$ |
68.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
None of these contracts exceeds a year in duration. These contracts were marked to market at December 31, 2003 and 2002.
13. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
At December 31, 2003, the Company had two unsecured committed revolving credit agreements for $400 million each with a group of major North American banks and foreign banks. The $400 million, five-year agreement expires in May 2006, and the $400 million, 364-day agreement expires in May 2004. Management intends to renew, and possibly increase, the $400 million committed credit facility that expires in May 2004. In connection with these credit facilities, the Company has agreed to certain covenants, including maintaining a debt-to-EBITDA ratio of less than 3:1 (as defined in the credit agreements). Throughout 2003, the Company was fully compliant with all of its debt covenants.
In October 2003, the Company entered into a new seven-year committed revolving credit facility with two major foreign banks for $12 million relating to a plant expansion in China. This new credit facility expires in October 2010. Facility fees are paid to both banks for this new credit line. As of December 31, 2003, the Company borrowed $2.4 million under this credit facility.
At December 31, 2003 and 2002, short-term bank borrowings were $16.8 million and $136.7 million, respectively. Weighted-average interest rates were 12.4%, 2.0% and 4.1% during 2003, 2002 and 2001, respectively. Long-term debt due within one year was $0.1 million and $0.2 million at December 31, 2003 and 2002, respectively.
At December 31, 2003 and 2002, commercial paper borrowings were $51.5 million and $212.0 million, respectively. Weighted-average interest rates were 1.3%, 1.9% and 4.1% during 2003, 2002 and 2001, respectively.
Unused, uncommitted lines of credit available were $428 million at December 31, 2003. The Company’s lines of credit with its banks are available in accordance with normal terms for prime commercial borrowers and are not subject to commitment fees or other restrictions.
Through a public debt offering in May 2003, the Company issued $150 million of 10 year notes. These notes mature on May 15, 2013 and bear an interest rate of 4.25%. The proceeds were used to repay short-term borrowings. As discussed in Note 2, “Derivative Instruments and Hedging,” these notes were effectively changed from a fixed rate debt obligation to a floating rate debt obligation through the use of interest rate swap agreements. The notes were issued under the Company’s existing $300 million shelf registration, effectively reducing the available shelf registration to $150 million. Plans to increase the shelf registration up to $450 million are under consideration by management. Plans to issue $50 million to $150 million in Japanese yen denominated Notes are also under consideration by management.
48
The following table sets forth the components of long-term debt at December 31, 2003 and 2002:
DEBT
INFORMATION
(in millions)
|
|
|
2003 |
|
2002 |
|
|||
|
|
|
|
|
|
|
|||
|
Notes,
with a weighted-average interest rate of 12.1%, due 2006
|
|
$ |
14.0 |
|
$ |
14.1 |
|
|
|
7.375%
Notes, due 2006, net of discount
|
|
|
106.1 |
|
|
107.0 |
|
|
|
4.25%
Notes, due 2013, net of discount
|
|
|
142.6 |
|
|
— |
|
|
|
6.95%
Notes, due 2028, net of discount
|
|
|
118.7 |
|
|
118.6 |
|
|
|
Industrial
revenue bonds, 5.375%, due 2006
|
|
|
6.5 |
|
|
6.5 |
|
|
|
Foreign
bank loans with a weighted-average interest rate of 5.0%, due 2010
|
|
|
2.4 |
|
|
1.2 |
|
|
|
Other,
with weighted-average rates of 6.3% and 10.0%, due 2004-2008
|
|
|
0.4 |
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
390.7 |
|
|
248.0 |
|
|
|
Amounts
due within one year
|
|
|
0.1 |
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
long-term debt
|
|
$ |
390.6 |
|
$ |
247.8 |
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2003, the aggregate maturities of long-term debt for the succeeding five years are as follows: $0.1 million in 2004, $0.1 million in 2005, $126.7 million in 2006, $0.1 million in 2007 and $263.7 million thereafter.
Interest expense was $24.3 million in 2003, compared with $27.4 million in 2002 and $47.3 million in 2001. Interest expense in 2003 decreased due to decreased borrowings, partially offset by higher foreign short-term interest rates. Interest expense in 2002 decreased due to decreased borrowings and lower short-term interest rates. Interest income was $4.0 million in 2003, $2.0 million in 2002 and $3.3 million in 2001.
14. INCOME TAXES
The components of income tax expense are shown in the following table:
INCOME
TAX EXPENSE
(in millions)
|
|
|
2003 |
|
2002 |
|
2001 |
|
|||||
|
|
|
|
|
|
|
|
|
|||||
|
Current income tax expense |
|
|
|
|
|
|
|
|
|
|
||
|
|
Federal |
|
$ |
15.1 |
|
$ |
24.8 |
|
$ |
8.8 |
|
|
|
|
State and local |
|
|
4.5 |
|
|
13.3 |
|
|
3.3 |
|
|
|
|
Foreign |
|
|
47.8 |
|
|
15.6 |
|
|
27.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
67.4 |
|
|
53.7 |
|
|
39.6 |
|
||
|
|
|
|
|
|
|
|
|
|
|
|
||
|
Deferred income tax expense/(benefit) |
|
|
|
|
|
|
|
|
|
|
||
|
|
Federal |
|
|
21.5 |
|
|
12.3 |
|
|
38.1 |
|
|
|
|
State and local |
|
|
(5.2 |
) |
|
(1.1 |
) |
|
6.5 |
|
|
|
|
Foreign |
|
|
(19.5 |
) |
|
1.6 |
|
|
(4.5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
|
|
(3.2 |
) |
|
12.8 |
|
|
40.1 |
|
||
|
|
|
|
|
|
|
|
|
|
|
|
||
|
|
Income tax expense |
|
$ |
64.2 |
|
$ |
66.5 |
|
$ |
79.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
The foreign portion of earnings before income tax expense was $120.1 million in 2003, $10.1 million in 2002 and $112.6 million in 2001. The decrease in 2002 was primarily due to the Engelhard-CLAL equity investment impairment charge of $57.7 million recorded in the third quarter of 2002. Taxes on income of foreign consolidated subsidiaries and affiliates are provided at the tax rates applicable to their respective foreign tax jurisdictions.
49
The following table sets forth the components of the net deferred tax asset that result from temporary differences between the amounts of assets and liabilities recognized for financial reporting and tax purposes:
NET
DEFERRED INCOME TAX ASSET
(in millions)
|
|
|
2003 |
|
2002 |
|
|||||
|
|
|
|
|
|
|
|||||
|
Deferred tax assets |
|
|
|
|
|
|
|
|||
|
|
Accrued liabilities |
|
$ |
187.8 |
|
$ |
167.0 |
|
||
|
|
Noncurrent liabilities |
|
|
59.4 |
|
|
60.4 |
|
||
|
|
Unrealized net loss – pension liability |
|
|
42.7 |
|
|
51.0 |
|
||
|
|
Tax credits/attribute carryforward amounts |
|
|
89.2 |
|
|
65.1 |
|
||
|
|
|
|
|
|
|
|
|
|||
|
|
Total deferred tax assets |
|
|
379.1 |
|
|
343.5 |
|
||
|
|
|
|
|
|
|
|
|
|||
|
Valuation allowance |
|
|
(22.6 |
) |
|
(11.7 |
) |
|||
|
|
|
|
|
|
|
|
|
|||
|
|
Total deferred tax assets, net of valuation
allowance |
|
|
356.5 |
|
|
331.8 |
|
||
|
|
|
|
|
|
|
|
|
|||
|
Deferred tax liabilities |
|
|
|
|
|
|
|
|||
|
|
Prepaid pension expense |
|
|
(54.2 |
) |
|
(45.6 |
) |
||
|
|
Property, plant and equipment |
|
|
(68.0 |
) |
|
(38.8 |
) |
||
|
|
Timing of dealing results |
|
|
(47.4 |
) |
|
(71.3 |
) |
||
|
|
Other assets |
|
|
(76.7 |
) |
|
(64.4 |
) |
||
|
|
|
|
|
|
|
|
|
|||
|
|
Total deferred tax liabilities |
|
|
(246.3 |
) |
|
(220.1 |
) |
||
|
|
|
|
|
|
|
|
|
|||
|
|
Net deferred tax asset |
|
$ |
110.2 |
|
$ |
111.7 |
|
||
|
|
|
|
|
|
|
|
|
|||
Deferred income taxes reflect the tax effect of temporary differences between the amounts of assets and liabilities for financial reporting purposes and amounts as measured for tax purposes. The Company will establish a valuation allowance if it is more likely than not these items will either expire before the Company is able to realize their benefits, or that future deductibility is uncertain. Periodically, the valuation allowance is reviewed and adjusted based on management’s assessment of realizable deferred tax assets.
Net current deferred tax assets of $83.3 million (net of a $1.2 million valuation allowance) and $60.2 million (net of a $1.2 million valuation allowance) at December 31, 2003 and December 31, 2002, respectively, are included in other current assets and net noncurrent deferred tax assets of $26.9 million (net of a $21.4 million valuation allowance) and $51.5 million (net of a $10.5 million valuation allowance) at December 31, 2003 and December 31, 2002, respectively, are included in other intangible and noncurrent assets in the Company’s “Consolidated Balance Sheets.”
At December 31, 2003, the Company had approximately $24.9 million of foreign tax credit carryforwards of which $9.2 million will expire in 2006 and $15.7 million will expire in 2008. The Company had a $15.7 million valuation allowance against these foreign tax credits. The Company also had approximately $5.0 million of research and development credits, of which $3.5 million will expire in 2022 and $1.5 million will expire in 2023 and approximately $9.1 million of foreign net operating losses of which $5.0 million will expire in 2005, $0.5 million will expire in 2007, $1.9 million will expire in 2008 and $1.7 million will carry forward indefinitely. Minimum tax credit carryforwards at December 31, 2003 totaled approximately $38.5 million and will carry forward indefinitely. At December 31, 2003, the Company also had approximately $281.6 million of state net operating loss carryforwards expiring at various intervals between 2006 and 2023.
50
A reconciliation of the difference between the Company’s consolidated income tax expense and the expense computed at the federal statutory rate is shown in the following table:
CONSOLIDATED
INCOME TAX EXPENSE RECONCILIATION
(in millions)
|
|
|
2003 |
|
2002 |
|
2001 |
|
||||
|
|
|
|
|
|
|
|
|
||||
|
Income
tax expense at federal statutory rate
|
|
$ |
105.2 |
|
$ |
83.3 |
|
$ |
106.8 |
|
|
|
State
income taxes, net of federal effect
|
|
|
2.9 |
|
|
7.9 |
|
|
5.4 |
|
|
|
Percentage
depletion
|
|
|
(14.6 |
) |
|
(19.5 |
) |
|
(7.8 |
) |
|
|
Equity
earnings
|
|
|
(0.9 |
) |
|
(3.6 |
) |
|
(3.5 |
) |
|
|
Equity
investment impairment with no tax benefit
|
|
|
— |
|
|
20.2 |
|
|
— |
|
|
|
Taxes
on foreign income which differ from U.S. statutory rate
|
|
|
19.9 |
|
|
3.0 |
|
|
1.5 |
|
|
|
Tax
credits
|
|
|
(51.7 |
) |
|
(18.7 |
) |
|
(20.3 |
) |
|
|
Export
sales exclusion
|
|
|
(9.7 |
) |
|
(10.5 |
) |
|
(6.8 |
) |
|
|
Non-deductible
goodwill
|
|
|
— |
|
|
— |
|
|
2.0 |
|
|
|
Valuation
allowance
|
|
|
10.9 |
|
|
5.6 |
|
|
(2.5 |
) |
|
|
Other
items, net
|
|
|
2.2 |
|
|
(1.2 |
) |
|
4.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
$ |
64.2 |
|
$ |
66.5 |
|
$ |
79.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No provision has been made for U.S. or additional foreign taxes on the undistributed earnings of foreign subsidiaries because such earnings are expected to be reinvested indefinitely in the subsidiaries’ operations. At December 31, 2003, the Company’s share of the cumulative undistributed earnings of foreign subsidiaries upon which potential additional U.S. taxes have not been provided was approximately $493.6 million. It is not practical to estimate the amount of additional tax, net of applicable foreign tax credits, that might be payable on these foreign earnings in the event of distribution or sale. However, under existing law, foreign tax credits would be available to substantially reduce U.S. taxes payable.
15. RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has related party transactions with its equity affiliates, including N.E. Chemcat, Engelhard-CLAL and Heesung-Engelhard. The Company’s transactions with such entities amounted to: purchases-from of $21.6 million in 2003, $26.0 million in 2002 and $4.0 million in 2001; sales-to of $37.2 million in 2003, $36.4 million in 2002 and $17.1 million in 2001; and metal leasing-to of $0.6 million in 2003, $1.1 million in 2002 and $2.6 million in 2001. At December 31, 2003 and 2002, net amounts due from such entities totaled $0.6 million and $1.9 million, respectively.
Citibank, N.A., a subsidiary of Citigroup Inc., which reports beneficial ownership of more than 5% of our Common Stock, participated with other lenders in lines of credit available to Engelhard under revolving credit facilities. Citibank’s total commitment is $39,000,000, none of which was drawn in 2003. In 2003, Citibank received an initial fee of $10,000 and annual facility fees of $34,000 for these facilities. Citigroup received $85,000 in underwriting fees in our May 13, 2003 note offering. We use subsidiaries of Citigroup, as well as other firms, to provide cash management services to Engelhard. Fees to subsidiaries of Citigroup for these services aggregated less than $30,000 in 2003. In addition, Barclays Global Investors, N.A., which reported beneficial ownership of more than 5% of our Common Stock prior to July 2003, provides certain investment management services to Engelhard’s pension plans. Fees for such services aggregated approximately $135,000 in 2003.
Barclays Bank, plc, an affiliate of Barclays Global Investors, subsidiaries of Citigroup and other firms, engage in foreign exchange and commodities transactions with Engelhard in the ordinary course of business. All of these transactions are negotiated at arms length as principals in competitive markets. During 2003, foreign exchange transactions with subsidiaries of Citigroup aggregated approximately $126,600,000 and metals transactions with Barclays Bank, plc aggregated approximately $330,000,000. In addition, during 2003, Engelhard provided services in precious metals financing transactions in which subsidiaries of Citigroup and Barclays Bank, plc received funds from third parties. Engelhard received approximately $157,372 in fees from subsidiaries of
51
Citigroup and approximately $8,000 in net revenues from these transactions in which Barclays Bank, plc participated.
Vanguard Group, an affiliate of Vanguard Windsor Funds, which reports beneficial ownership of more than 5% of our Common Stock, received $100,293 for administering 401(k) plans for our employees during 2003.
16. BENEFITS
The Company has domestic and foreign pension plans covering substantially all employees. Plans covering most salaried employees generally provide benefits based on years of service and the employee’s final average compensation. Plans covering most hourly bargaining unit members generally provide benefits of stated amounts for each year of service. The Company makes contributions to the plans as required and to such extent contributions are currently deductible for tax purposes. Plan assets primarily consist of listed stocks, fixed income securities and cash.
The following table sets forth the plans’ funded status:
|
FUNDED
STATUS (in millions)
|
|
2003 |
|
2002 |
|
||||||||||||||||
|
|
|
|
|
|
|
||||||||||||||||
|
|
|
Domestic |
|
Foreign |
|
Total |
|
Domestic |
|
Foreign |
|
Total |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
CHANGE
IN PROJECTED BENEFIT OBLIGATION
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
Projected
benefit obligation at beginning of year
|
|
$ |
441.6 |
|
$ |
99.5 |
|
$ |
541.1 |
|
$ |
374.6 |
|
$ |
78.1 |
|
$ |
452.7 |
|
||
|
Service
cost
|
|
|
15.6 |
|
|
2.9 |
|
|
18.5 |
|
|
13.3 |
|
|
2.3 |
|
|
15.6 |
|
||
|
Interest
cost
|
|
|
28.6 |
|
|
5.9 |
|
|
34.5 |
|
|
27.2 |
|
|
5.1 |
|
|
32.3 |
|
||
|
Plan
amendments
|
|
|
3.4 |
|
|
1.2 |
|
|
4.6 |
|
|
0.4 |
|
|
3.5 |
|
|
3.9 |
|
||
|
Engelhard-CLAL
asset distribution
|
|
|
— |
|
|
21.1 |
|
|
21.1 |
|
|
21.9 |
|
|
0.4 |
|
|
22.3 |
|
||
|
Actuarial
losses
|
|
|
34.2 |
|
|
0.6 |
|
|
34.8 |
|
|
34.9 |
|
|
4.1 |
|
|
39.0 |
|
||
|
Benefits
paid
|
|
|
(27.2 |
) |
|
(4.0 |
) |
|
(31.2 |
) |
|
||||||||||