<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission file number 1-496
HERCULES INCORPORATED
A Delaware Corporation
I.R.S. Employer Identification No. 51-0023450
Hercules Plaza
1313 North Market Street
Wilmington, Delaware 19894-0001
Telephone: 302-594-5000
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
----- -----
As of October 30, 1998, 100,585,779 shares of registrant's common
stock were outstanding.
<PAGE> 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF INCOME
(Dollars in millions, except per share)
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
------ ------ ------- ------
<S> <C> <C> <C> <C>
Net sales $ 510 $ 448 $1,385 $1,445
Cost of sales 323 270 852 905
Selling, general, and administrative expenses 71 58 200 192
Research and development 17 13 42 41
Other operating expenses (income), net (2) -- (5) 162
----- ----- ------ ------
Profit from operations 101 107 296 145
Equity in income of affiliated companies -- 4 10 25
Interest and debt expense 18 10 42 29
Other income (expense), net 18 22 (10) 370
----- ----- ------ ------
Income before income taxes 101 123 254 511
Provision for income taxes 30 41 81 246
----- ----- ------ ------
Net income $ 71 $ 82 $ 173 $ 265
===== ===== ====== ======
Earnings per share
Basic $0.75 $0.83 $ 1.82 $ 2.65
===== ===== ====== ======
Diluted $0.74 $0.81 $ 1.80 $ 2.57
===== ===== ====== ======
Dividends per share $0.27 $0.25 $ 0.81 $ 0.75
===== ===== ====== ======
</TABLE>
See accompanying notes to financial statements.
2
<PAGE> 3
<TABLE>
<CAPTION>
HERCULES INCORPORATED
CONSOLIDATED BALANCE SHEET
(Dollars in millions) (Unaudited)
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 47 $ 17
Accounts and notes receivable, net 457 389
Inventories
Finished products 151 121
Materials, supplies, and work in process 150 113
Deferred income taxes 46 49
------ ------
Total current assets 851 689
Property, plant, and equipment 2,611 2,088
Accumulated depreciation and amortization 1,667 1,401
------ ------
Net property, plant, and equipment 944 687
Investments 562 615
Goodwill (net of accumulated amortization - 1998, $16; 320 41
1997, $12 - Notes 8 and 9)
Other assets 475 379
------ ------
Total assets $3,152 $2,411
====== ======
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable $ 133 $ 116
Accrued expenses 306 317
Short-term debt 827 275
Income taxes payable 94 91
------ ------
Total current liabilities 1,360 799
Long-term debt 569 419
Deferred income taxes 193 160
Postretirement benefits and other liabilities 339 343
Stockholders' equity
Common stock (shares issued: 1998--154,809,312;
1997--154,357,015) 81 80
Additional paid-in capital 510 504
Foreign currency translation adjustment (10) (2)
Retained earnings 2,259 2,163
------ ------
2,840 2,745
Reacquired stock, at cost (shares: 1998--60,206,448;
1997--58,289,376) 2,149 2,055
------ ------
Total stockholders' equity 691 690
------ ------
Total liabilities and stockholders' equity $3,152 $2,411
====== ======
</TABLE>
See accompanying notes to financial statements.
3
<PAGE> 4
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF CASH FLOW
(Dollars in millions)
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended
September 30,
1998 1997
----- -----
<S> <C> <C>
Net cash provided by operations $ 74 $ 141
----- -----
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (84) (77)
Proceeds of investment and fixed asset disposals 71 144
Businesses acquired, net of cash received (317) --
Other, net (17) (7)
----- -----
Net cash (used in) provided by investing activities (347) 60
----- -----
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds 74 342
Long-term debt repayments (79) (91)
Change in short-term debt 490 (122)
Common stock reissued 9 32
Common stock reacquired (112) (294)
Dividends paid (77) (74)
----- -----
Net cash provided by (used in) financing activities 305 (207)
----- -----
Effect of exchange rate changes on cash (2) (1)
----- -----
Net increase (decrease) in cash and cash equivalents 30 (7)
Cash and cash equivalents - beginning of period 17 30
----- -----
Cash and cash equivalents - end of period $ 47 $ 23
===== =====
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 45 $ 27
Income taxes 81 106
Noncash investing and financing activities:
Accounts payable for common stock acquisitions -- 25
Assumed debt of acquired businesses 190 --
Incentive plan stock issuances 5 2
Investment in long-term note -- 500
Conversion of notes and debentures 7 31
</TABLE>
See accompanying notes to financial statements.
4
<PAGE> 5
HERCULES INCORPORATED
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollars in millions)
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ----- -----
<S> <C> <C> <C> <C>
Net income $71 $ 82 $ 173 $ 265
Foreign currency translation, net of tax -- (6) (8) (47)
--- ---- ----- -----
Comprehensive income $71 $ 76 $ 165 $ 218
=== ==== ===== =====
</TABLE>
See accompanying notes to financial statements.
5
<PAGE> 6
NOTES TO FINANCIAL STATEMENTS
(Dollars in millions, except per share) (Unaudited)
1. These condensed financial statements are unaudited, but in the opinion
of management include all adjustments necessary to present fairly the Company's
financial position and results of operations for interim periods. It is
suggested that these condensed financial statements are read in conjunction with
the accounting policies and the financial statements and notes thereto included
in the Company's Annual Report for 1997. Information for 1997 has been restated
to conform with the 1998 presentation.
2. Earnings per share (EPS) are calculated under the provisions of
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share," adopted in the fourth quarter of 1997. EPS amounts for 1997 have been
restated to conform with SFAS No. 128. The following table shows the amounts
used in computing EPS and the effect on income and the weighted-average number
of shares of dilutive potential common stock:
<TABLE>
<CAPTION>
(Shares in millions) Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Basic
Net income ............................ $ 71 $ 82 $ 173 $ 265
Weighted-average shares outstanding.... 94.6 99.3 95.1 100.1
----- ----- ----- ------
EPS .................................. $0.75 $0.83 $1.82 $ 2.65
===== ===== ===== ======
Diluted
Net Income .............................. $ 71 $ 82 $ 173 $ 265
Interest on convertible debentures........... -- -- -- 1
----- ----- ----- ------
Net income for EPS calculation............... $ 71 $ 82 $ 173 $ 266
===== ===== ===== ======
Weighted-average shares outstanding.......... 94.6 99.3 95.1 100.1
Options .................................. .5 .8 .6 1.1
Debentures .................................. .4 1.9 .6 2.6
----- ----- ----- ------
Adjusted weighted-average shares............. 95.5 102.0 96.3 103.8
----- ----- ----- ------
EPS .................................. $0.74 $0.81 $1.80 $ 2.57
===== ===== ===== ======
</TABLE>
3. Cost and expenses include depreciation as follows:
<TABLE>
<CAPTION>
September 30,
1998 1997
---- ----
<S> <C> <C>
Three months ended..................................................... $21 $16
Nine months ended ..................................................... 53 57
</TABLE>
4. Other operating expenses (income), net for the nine months ended
September 30, 1997 include charges of $141 million associated with management
organizational changes and adoption of alternative competitive strategies
announced in late February and March of 1997. This charge includes $118 million
related to asset rationalizations and impairment and $23 million related to
severance benefits.
Included in the $118 million is an impairment loss of $91 million ($23
million in Food & Functional Products and $68 million in Chemical Specialties),
where the sum of estimated future cash flows (undiscounted) was less than the
carrying amount of the assets. Additionally, the Company recognized
6
<PAGE> 7
approximately $27 million of rationalization charges primarily associated with
certain assets, which will no longer be utilized, and lease abandonment costs.
Concurrently, management authorized and committed the Company to a plan to
reduce its work force and accrued $23 million of severance related benefits, of
which approximately $11 million is the remaining liability at September 30,
1998. Additionally, other operating expenses include $13 million of net
environmental cleanup costs, principally for nonoperating sites and $8 million
of executive retirement benefits.
5. Interest and debt costs are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in millions) September 30,
-------------
1998 1997
---- ----
<S> <C> <C>
Three Months Ended:
Costs incurred.................................................... $20 $11
Amount capitalized................................................ 2 1
--- ---
Interest expense.................................................. $18 $10
=== ===
Nine Months Ended:
Costs incurred.................................................... $49 $33
Amount capitalized................................................ 7 4
--- ---
Interest expense.................................................. $42 $29
=== ===
</TABLE>
6. Other income (expense), net for the quarter and nine months ended
September 30, 1998 includes interest income of $13 million and $32 million,
respectively, primarily related to the $500 million note remaining upon
completion of the Tastemaker monetization (see below), and gains on sale of
investments of $2 million and $19 million, respectively. Additionally, the nine
months reflects a $64 million legal settlement and accrual, primarily related to
the settlement of a Qui Tam (Whistle Blower) lawsuit (see Note 12) and a $2
million write off of a claim related to a divested business.
Other income (expense), net for the quarter and nine months ended
September 30, 1997 includes net foreign currency gains of $3 million and $17
million, respectively, interest income, primarily related to the $500 million
note of $10 million and $20 million, respectively, and a gain of $7 million and
$364 million, respectively, on completion of transactions to monetize the
investment in Tastemaker, a 50% owned flavors joint venture. Additionally, the
nine months reflects charges of $32 million related to legal settlements and
accruals.
7. A summary of short-term and long-term debt follows:
<TABLE>
<CAPTION>
(Dollars in millions) September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
SHORT-TERM:
Commercial paper.................................................. $650 $195
Banks............................................................. 145 80
Current maturities................................................ 32 --
----- ------
$827 $275
==== ====
</TABLE>
At September 30, 1998, Hercules had $207 million of unused lines of
credit that may be drawn as needed. Lines of credit in use or supporting
commercial paper at September 30, 1998 were $90 million.
7
<PAGE> 8
<TABLE>
<CAPTION>
(Dollars in millions) September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
LONG-TERM:
6.15% notes due 2000................................................... $100 $100
6.60% notes due 2027................................................... 100 100
7.85% notes due 2000................................................... 25 25
6.625% notes due 2003.................................................. 125 125
Term loan due in varying amounts through 2002 with an
average interest rate of 6.27%................................ 84 --
Term notes at various rates from 6.48% to 9.50% and
due in varying amounts through 2006........................... 71 --
8% convertible subordinated debentures due 2010........................ 3 10
Commercial paper ..................................................... 50 50
Variable rate loans.................................................... 27 2
Other .............................................................. 16 7
-- --
601 419
Current maturities of long-term debt................................... 32 --
---- -------
Net long-term debt..................................................... $569 $419
==== ====
</TABLE>
Subsequent to September 30, 1998, substantially all of the Company's debt
has been refinanced upon consummation of the BetzDearbom Inc. acquisition (see
Note 9).
8. Goodwill, representing the excess of cost over net assets of acquired
businesses, is being amortized on a straight-line basis over the estimated
future periods to be benefited (not exceeding forty years). When events and
circumstances indicate, all long-term assets, including goodwill, are assessed
for recoverability based upon cash flow forecasts. An impairment loss would be
recorded in the period expected future net cash flows (undiscounted) become less
than the carrying amount of the asset.
9. In July 1998, Hercules completed the acquisition of the 49%
share of FiberVisions L.L.C. owned by its joint venture partner Jacob Holm &
Sons A/S for approximately $230 million in cash, plus assumed debt of $188
million. FiberVisions has annual revenues of approximately $250 million and is
included in the Chemical Specialties segment. The acquisition has been
accounted for as a purchase and, accordingly, the operating results of
FiberVisions have been included in the Company's consolidated financial
statements since the date of acquisition. The purchase price exceeded the
book value of the net assets acquired by approximately $210 million. Appraisals
and other analyses are in progress to allocate the purchase price based on fair
values. The final purchase price allocation is expected to be completed by
year-end and intangible assets will be amortized over a period not to exceed
forty years.
The following unaudited pro forma consolidated results of operations
for the nine months ended September 30, 1998 and 1997 assume the FiberVisions
acquisition occurred as of the beginning of each nine-month period.
<TABLE>
<CAPTION>
(Dollars in millions, except per share) September 30,
1998 1997
-------- --------
<S> <C> <C>
Net Sales.............................................................. $1,517 $1,579
Net Income ..................................................... 170 255
Earnings per share
Basic ..................................................... 1.79 2.55
Diluted ..................................................... 1.77 2.47
</TABLE>
The unaudited pro forma amounts are not necessarily indicative of what the
actual results of operations might have been if the acquisition had occurred at
the beginning of each period.
8
<PAGE> 9
In April 1998, Hercules completed the acquisition of the worldwide
paper chemicals group of Houghton International, Inc. and the international
pectin business of Citrus Colloids Ltd. for approximately $95 million.
Houghton's paper chemicals group has annual sales of approximately $30 million
and Citrus Colloids has annual revenues in excess of $30 million.
On October 15, 1998, Hercules completed the acquisition of BetzDearborn
Inc. for $72 per share in cash, or approximately $2.4 billion. Hercules has also
assumed approximately $700 million in BetzDearborn debt. The acquisition was
financed with borrowings under a $3.65 billion credit facility syndicated by
NationsBank, N.A., and was consummated on October 15, 1998. The acquisition will
be accounted for using the purchase method of accounting and, accordingly, the
purchase price will be allocated to the assets acquired and liabilities assumed
based on the estimated fair value of such assets and liabilities at the date of
acquisition. BetzDearborn's worldwide sales of specialty chemicals and other
products during 1997 were $1.3 billion, and consolidated net earnings were $86
million.
10. Since 1991, the Board of Directors has authorized the repurchase of up
to 74,650,000 shares of Company common stock, 6,150,000 shares of which is
intended to satisfy requirements of various employee benefit programs. Through
September 30, 1998, a total of 66,457,875 shares of common stock (including
6,150,000 shares for employee benefit programs) had been purchased in the open
market at an average price of $37.34 per share.
11. In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133). SFAS 133 is effective for fiscal
years beginning after June 15, 1999. SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction. For fair-value hedge transactions in which the Company is
hedging changes in an asset's, liability's, or firm commitment's fair value,
changes in the fair value of the derivative instrument will generally be offset
in the income statement by changes in the hedged item's fair value. For
cash-flow hedge transactions, in which the Company is hedging the variability of
cash flows related to a variable-rate asset, liability, or a forecasted
transaction, changes in the fair value of the derivative instrument will be
reported in other comprehensive income. The gains and losses on the derivative
instrument that are reported in other comprehensive income will be reclassified
as earnings in the periods in which earnings are impacted by the variability of
the cash flows of the hedged item. The ineffective portion of all hedges will be
recognized in current-period earnings.
The Company has not yet determined the impact that the adoption of SFAS
133 will have on its earnings or statement of financial position.
12. COMMITMENTS AND CONTINGENCIES
Environmental:
Hercules has been identified as a potentially responsible party (PRP) by U.S.
federal and state authorities for environmental cleanup at numerous sites. The
estimated range of the reasonably possible costs of cleanup is between $60
million and $206 million. The actual costs will depend upon numerous factors,
including the number of parties found liable at each environmental site and
their ability to pay, the actual method of remediation, outcome of negotiations
with regulatory authorities, outcome of litigation, changes in environmental
laws and regulations, technological developments, and the years of remedial
activity required, which could range up to 30 years. Hercules becomes aware of
9
<PAGE> 10
sites in which it may be, but has not yet been named, a PRP principally through
its knowledge of investigation of sites by the U.S. Environmental Protection
Agency (EPA) or other government agency or through correspondence with
previously named PRPs requesting information on Hercules' activities at sites
under investigation. Hercules brought suit in 1992 against its insurance
carriers for past and future costs for cleanup of certain environmental sites.
In April 1998, the trial of the Jacksonville, Arkansas, site was completed. The
jury returned a "Special Verdict Form" with findings that will, in conjunction
with the Court's other opinions, be used by the Court to enter a judgment. The
judgment will determine the amount of Hercules recovery for past clean-up
expenditures and will state that Hercules is entitled to similar coverage for
costs incurred since September 30, 1997 and in the future. Hercules has not
included any insurance recovery in the estimates above.
Hercules has established procedures for identifying environmental
issues at Hercules plant sites. Environmental coordinators, a designated
position at all operating facilities, are familiar with environmental laws and
regulations and are resources for identification of environmental issues.
Hercules also has an environmental audit program, which is designed to identify
environmental issues at operating plant sites. Through these programs, Hercules
identifies potential environmental, regulatory, and remedial issues.
Litigation over liability at Jacksonville, Arkansas, the most
significant site, has been pending since 1980. As a result of a pretrial court
ruling in October 1993, Hercules has been held jointly and severally liable for
costs incurred, and for future remediation costs, at the Jacksonville site by
the District Court, Eastern District of Arkansas (the Court).
Other defendants in this litigation have either settled with the
government or, in the case of the Department of Defense (DoD), have not been
held liable. Hercules appealed the Court's order finding the DoD not liable. On
January 31, 1995, the 8th Circuit Court of Appeals upheld the Court's order.
Hercules filed a petition to the U.S. Supreme Court requesting review and
reversal of the 8th Circuit Court ruling. This petition was denied on June 26,
1995, and the case was remanded to the District Court for further proceedings.
On May 21, 1997, the Court issued a ruling that Uniroyal is liable and
that Standard Chlorine is not liable to Hercules for contribution. A trial on
allocation and damages among Hercules, Uniroyal, and the United States was
scheduled to begin in October, 1998. Through the filing of separate summary
judgment motions, Hercules and Uniroyal raised a number of defenses to the
United States' costs. On October 23, 1998, the Court denied those motions and
granted the United States' summary judgment motion, ordering Hercules and
Uniroyal to pay the United States approximately $103 million plus any additional
response costs incurred or to be incurred after July 31, 1997. Hercules expects
that this amount will be reduced by approximately $7 million, the amount
received by the United States in previous settlements with other parties. Trial
testimony on the issue of allocation between Hercules and Uniroyal was completed
on November 6, 1998. When a final judgment has been entered, Hercules expects to
appeal the Court's determination with respect to its liability, the United
States' costs, the divisibility of harm issue, and Standard Chlorine's
liability.
At September 30, 1998, the accrued liability for environmental
remediation represents management's best estimate of the probable and reasonably
estimable costs related to environmental remediation. The extent of liability is
evaluated quarterly. The measurement of the liability is evaluated based on
currently available information, including the progress of remedial
investigation at each site and the current status of negotiations with
regulatory authorities regarding the method and extent of apportionment of costs
among other PRPs. The Company does not anticipate that its financial condition
will be materially affected by environmental remediation costs in excess of
amounts accrued, although quarterly or annual operating results could be
materially affected.
10
<PAGE> 11
Litigation:
Hercules is a defendant in numerous lawsuits that arise out of, and are
incidental to, the conduct of its business. In these legal proceedings, no
director, officer, or affiliate is a party or a named defendant. These suits
concern issues such as product liability, contract disputes, labor-related
matters, patent infringement, environmental proceedings, property damage, and
personal injury matters.
Hercules also has been a defendant in two Qui Tam (Whistle Blower)
lawsuits in the U.S. District Court for the Central District of Utah, brought by
former employees of the Aerospace business sold to Alliant Techsystems. The
first suit (United States of America ex. rel. Katherine A. Colunga v. Hercules
Incorporated, et al., Civil No. 89-C-954B), involved allegations relating to
submission of false claims and records under various government contracts,
delivery of defective products, a deficient quality control program, and
wrongful termination claims. The second suit (United States of America ex. rel.
Benny D. Hullinger, et al., Civil No. 92-CV-085) involves allegations relating
to submission of false claims and records, mischarging of work performed under
government contracts, misuse of government equipment, other acts of financial
mismanagement, and wrongful termination claims. The government, after
investigation of the allegations, declined to intervene in either lawsuit. (A
third Qui Tam lawsuit is described in the third paragraph below.) The first
lawsuit was previously scheduled for trial in June 1998. The Court denied
various motions filed by Hercules, including motions for summary judgment and
other motions designed to limit the scope of the trial and the extent of damages
claimed. If any damages had been awarded by the jury under the False Claims Act,
such damages would have been automatically tripled by the Court, and attorneys'
fees and costs would also have been added. As a result of the Court's denial of
the Company's motions, and the Court's position as to how the relevant contracts
should be interpreted, which position was adverse to the Company, damage claims
could have been presented to the jury in amounts which, if awarded, would have
had a material adverse effect on the Company. The damages in the second suit
were not defined.
In May 1998, Hercules announced that it had agreed to settle the first
lawsuit. Under the terms of the settlement, which was subject to the approval of
the Court, Hercules was obligated to pay $36 million to settle the case, plus
another $19 million to cover the plaintiff's attorneys fees, expenses, and
costs. The Company believed no damages were incurred by the government, no false
claims were made to the government, and alleged damages were speculative and
unsupportable. However, because of the mounting legal costs, the prospect of
treble damages, uncertainty present in any litigation, and to avoid the major
costs of a lengthy trial and subsequent appeal by the losing party management
determined that the settlement was in the best interest of Hercules'
shareholders. The settlement was approved by the Court, and the case was
dismissed in July 1998.
In August 1998, the parties to the second lawsuit reached a tentative
settlement, subject to approval of the Court. Although it has not intervened in
the case, the U. S. Department of Justice (DOJ) has objected to approval of the
tentative settlement, arguing that the Company should only be released from
claims actually investigated by the government and that the proposed allocation
of settlement proceeds between False Claims Act claims and wrongful Termination
Claims should be revised to attribute a higher percentage of recovery to claims
arising under the False Claims Act. The parties are awaiting a ruling from the
Court. The settlement was recognized in the first quarter 1998.
In March 1995, Hercules sold its Aerospace business to Alliant
Techsystems, Inc., pursuant to a Purchase and Sale Agreement between Alliant and
Hercules (the Purchase Agreement). As part of such sale, Hercules received an
ownership interest in Alliant. In March 1997, Alliant and Hercules received a
partially unsealed complaint that named both as defendants, initiated on an
unknown date, and filed in an undisclosed federal court, in a Qui Tam action by
a former employee alleging violations
11
<PAGE> 12
of the False Claims Act. The action has subsequently been identified as United
States of America ex.rel. P. Robert Pratt v. Alliant Techsystems, Inc. and
Hercules Incorporated, Civil No. 95-4812 SVW(JGx) pending in the U.S. District
Court for the Central District of California. The action alleges labor
mischarging at Alliant's Bacchus Works facility in Magna, Utah, and contains a
claim for wrongful termination. Damages are not specified; and Alliant and
Hercules have agreed to share equally the cost of defense until such time as a
determination is made as to the applicability of the indemnification provisions
of the Purchase Agreement. In February 1998, the parties reached a tentative
settlement, which has now been finalized, under which all claims alleging
mischarging to the Intermediate Nuclear Forces Contract have been settled. The
settlement was recognized in the fourth quarter of 1997. Other portions of the
complaint, which include allegations of mischarging to other government
contracts and claims for wrongful termination of employment were not resolved by
the settlement. The government has indicated it does not intend to intervene in
these matters. In August 1998, the parties reached a tentative settlement of the
remaining portions of the complaint, subject to approval of the Court.
While it is not feasible to predict the outcome of all pending suits
and claims, management does not anticipate that the ultimate resolution of these
matters will have a material effect upon the consolidated financial position of
Hercules, although the resolution of any of the matters during a specific period
could have a material effect on the quarterly or annual operating results for
that period.
12
<PAGE> 13
OTHER FINANCIAL INFORMATION
Operational Highlights
<TABLE>
<CAPTION>
(Dollars in millions) Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ------ ------
<S> <C> <C> <C> <C>
NET SALES BY INDUSTRY SEGMENT
Chemical Specialties.............................. $287 $217 $ 728 $ 755
Food & Functional Products........................ 223 231 656 689
Corporate and Other............................... -- -- 1 1
---- ---- ------ ------
Total....................................... $510 $448 $1,385 $1,445
==== ==== ====== ======
PROFIT (LOSS) FROM OPERATIONS BY INDUSTRY SEGMENT
Chemical Specialties.............................. $ 49 $ 41 $ 130 $ 44
Food & Functional Products........................ 54 67 167 124
Corporate and Other............................... (2) (1) (1) (23)
---- ---- ------ -----
Total....................................... $101 $107 $ 296 $ 145
==== ==== ====== =====
</TABLE>
13
<PAGE> 14
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
The table below reflects results through profit from operations on an
adjusted basis. Third quarter 1998 includes sales from acquired businesses of
$81 million (Chemical Specialties $72 million and Food & Functional Products $9
million), and profit from operations of $12 million in Chemical Specialties (see
Note 9). The 1997 results exclude the effects of asset rationalization and
impairment, severance, benefits, and other adjustments aggregating $161 million
(see Note 4). Additionally, 1997 has been further adjusted to exclude the
operations of the Fibers Division of the Chemical Specialties segment, which was
joint ventured in June 1997. The table should make it easier to compare
year-over-year operating results. Accordingly, the discussion that follows
speaks to the comparisons in the table through profit from operations.
<TABLE>
<CAPTION>
(Dollars in millions) Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
----- ----- ------- -------
<S> <C> <C> <C> <C>
Net sales ....................................... $ 510 $ 448 $ 1,385 $ 1,361
Cost of sales ................................... 323 270 852 837
Selling, general, and administrative expenses ... 71 58 200 184
Research and development ........................ 17 13 42 39
Other operating expenses (income), net .......... (2) -- (5) 2
----- ----- ------- -------
Profit from operations .......................... $ 101 $ 107 $ 296 $ 299
===== ===== ======= =======
Net Sales by Industry Segment
Chemical Specialties ....................... $ 287 $ 217 $ 728 $ 671
Food & Functional Products ................. 223 231 656 689
Corporate and other ........................ -- -- 1 1
----- ----- ------- -------
Total ...................................... $ 510 $ 448 $ 1,385 $ 1,361
===== ===== ======= =======
Profit (Loss) From Operations by Industry Segment
Chemical Specialties ....................... $ 49 $ 41 $ 130 $ 133
Food & Functional Products ................. 54 67 167 172
Corporate and other ........................ (2) (1) (1) (6)
----- ----- ------- -------
Total ...................................... $ 101 $ 107 $ 296 $ 299
===== ===== ======= =======
</TABLE>
14
<PAGE> 15
'
RESULTS OF OPERATIONS
Within the following discussion, unless otherwise stated, "quarter" and
"nine-month period" refer to the third quarter of 1998 and the nine months ended
September 30, 1998. All comparisons are with the corresponding periods in the
previous year.
Consolidated net sales increased $62 million, or 14%, for the quarter,
and $24 million, or 2%, for the nine-month period.
The economic crisis in the Asia Pacific region has negatively affected
sales volumes and prices in both industry segments, as well as increasing
competitive pressures in other parts of the world. For the quarter, sales in
Asia were lower by approximately $16 million (Chemical Specialties $10 million
and Food & Functional Products $6 million) and for the nine-month period they
were down approximately $58 million ($29 million in each segment).
Chemical Specialties sales increased by $70 million, or 32%, during the
quarter and increased $57 million, or 8%, for the nine-month period.
Businesses acquired in 1998 (see Note 9) added $72 million to third quarter
segment sales. Excluding the effect of acquisitions, sales were relatively
flat despite the Asian crisis, from higher volumes and favorable product mix in
other regions of the world. Additionally, the strength of the U.S. dollar
relative to foreign currencies lowered reported sales approximately $16 million
for the nine-month period.
Food & Functional Products sales decreased $8 million, or 3%, during the
quarter and $33 million, or 5%, for the nine-month period. Businesses acquired
in 1998 (see Note 9) added $9 million to third quarter segment sales.
Excluding the effect of acquistions, sales declined $17 million, or 7%, during
the quarter and $42 million, or 6%, for the nine-month period primarily due to
the Asian crisis and relatively lower demand from the paint and construction
markets and the oilfield drilling industry. Additionally, the stronger U.S.
dollar reduced reported sales for the nine-month period by approximately $13
million.
Consolidated profit from operations decreased $6 million for the
quarter, or 6%. Acquired businesses contributed $12 million to third quarter
profit from operations in Chemical Specialties. Excluding acquisitions,
operating profit in the Chemical Specialty segment declined $4 million, or 10%,
as the benefits from manufacturing cost improvement and lower raw material
prices were offset by higher selling, general and administrative expenses. In
Food & Functional Products, operating profit declined $13 million, or 19%, due
to the impact of the decline in sales described above and higher expenditures
for research and development.
For the nine-month period, profit from operations decreased $3 million.
Acquired businesses contributed $12 million to Chemical Specialties operating
profit. Excluding acquired businesses, Chemical Specialties operating profit
declined $15 million, or 11%. Improved manufacturing costs were offset by
competitive pressure on selling price, lower demand from the Asian crisis,
higher selling, general and administrative expenses and the effect of weaker
foreign currencies relative to the U.S. dollar. Food & Functional Products
operating profit decreased $5 million, or 3%. Cost saving initiatives largely
offset the unfavorable operating profit impact from the lower sales demand
(described above), higher research and development expenditures, and weaker
foreign currencies relative to the U.S. dollar.
Equity in income of affiliated companies decreased $4 million and $15
million for the quarter and nine-month period, respectively. The decrease for
the quarter reflects the change in ownership of FiberVisions. In the third
quarter of 1998, Hercules acquired 100% interest in FiberVisions, and
accordingly consolidated their operating results. Beginning in the third quarter
of 1997, FiberVisions' results were in equity income (see Note 9). The decline
for the nine-month period is primarily from the monetization of Tastemaker in
March 1997 (see Note 6) and Alliant Techsystems in December 1997, partially
offset by equity income from FiberVisions.
15
<PAGE> 16
Interest and debt expense increased for the quarter and nine-month
period, principally from higher average debt outstanding relating to
acquisitions (see Note 9).
Other income, net decreased $4 million and $380 million for the quarter
and nine-month period, respectively (see Note 6).
The provision for income taxes for the quarter and nine-months ended
September 30, 1998 reflects an estimated annual underlying effective tax rate of
34.5%. During the periods, favorable state tax settlements relating to a prior
year's sale of an investment and adjustments to taxes payable related to tax
assessments reduced the rate. The 1997 full-year rate of 45% was unfavorably
affected by a higher rate on the monetization of the Tastemaker and Alliant
investments, along with required increases to tax accruals related to
anticipated tax assessments by federal, state, and foreign tax authorities.
Subsequent to the BetzDearborn acquisition in the fourth quarter of 1998, the
underlying effective tax rate for the Company may be higher than the current
rate primarily from the non-deductibility of amortized goodwill.
FINANCIAL CONDITION
Cash provided by operations was $74 million compared to $141 million in
1997. A decrease of approximately $50 million resulted from payment of legal
settlements (see Notes 8 and 12). Additionally, higher working capital
requirements and higher interest payments, partially offset by lower tax
payments, contributed to the decrease.
In July 1998, Hercules completed the acquisition of the 49% share of
FiberVisions owned by its joint venture partner Jacob Holm & Sons A/S for
approximately $230 million in cash, plus assumed debt. FiberVisions has annual
revenues of approximately $250 million. Additionally, in April 1998, Hercules
completed the acquisition of the worldwide paper chemicals group of Houghton
International, Inc. and the international pectin business of Citrus Colloids
Ltd. for approximately $95 million. Houghton's paper chemicals group has annual
sales of approximately $30 million and Citrus Colloids has annual revenues in
excess of $30 million.
Acquisitions and the related financing have impacted Hercules'
liquidity since year-end 1997. At September 30, 1998, current and quick ratios
were .6 and .4, respectively, compared with .9 and .5, respectively, at December
31, 1997. The weaker liquidity ratios reflect higher short-term debt, primarily
from recent acquisitions. At September 30, 1998, $207 million was available
under short-term lines of credit; the $700 million revolving credit agreement
was fully utilized. Hercules filed a $3.0 billion shelf registration during the
third quarter of 1998. The amount currently available is $2.8 billion (see below
for further discussion of the BetzDearborn acquisition and related financing).
During the nine-month period, the Company entered into a financing
agreement with a bank, which provides for the sale of promissory notes in the
principal amount of up to $22 million at any one time. The agreement, which
expires in December 1998, provides for commitments by the bank and the Company
under which the bank purchases promissory notes denominated in a number of
foreign currencies in exchange for U.S. dollars. The notes are repayable only to
the extent of future revenue of certain foreign subsidiaries. Obligations under
the agreement are not cancelable by the Company or the bank. Additionally, the
Company is party to a $480
16
<PAGE> 17
million cross currency swap agreement to effectively hedge its investment in
foreign subsidiaries.
The Company's derivative and other financial instruments subject to
interest rate risk consist of debt instruments, interest rate swaps, cross
currency swaps, and the five-year $500 million note remaining after the
Tastemaker monetization. At September 30, 1998, net market value of these
combined instruments was a liability of $963 million. The sensitivity analysis
assumes an instantaneous 100-basis point move in interest rates from their
levels at September 30, 1998, with all other variables held constant. A
100-basis point increase in interest rates would result in a $25 million
decrease in the net liability. A 100-basis point decrease in interest rates
would result in a $31 million increase in the net liability.
The market value of the Company's portfolio of financial instruments
subject to equity price risk at September 30, 1998, was an asset of $36 million.
The sensitivity analysis assumes an instantaneous 10% change in valuation with
all other variables held constant. A 10% increase or decrease would increase or
decrease the asset position by $4 million.
The Company's financial instruments subject to foreign currency
exchange risk consist of foreign currency forwards, options, and cross currency
swaps and represent a net liability position of $34 million at September 30,
1998. The sensitivity analysis assumes an instantaneous 10% change in foreign
currency exchange rates from the September 30, 1998 levels, with all other
variables held constant. A 10% strengthening of the U.S. dollar versus other
currencies would result in a decrease of $49 million in the net liability
position, while a 10% weakening of the dollar versus all other currencies would
result in an increase of $60 million in the net liability position.
Total capitalization (stockholders' equity plus debt) has increased to
$2.1 billion at September 30, 1998 from $1.4 billion at December 31, 1997. The
increase is primarily from higher levels of debt, both short and long-term. As a
result, total debt as a percentage of capitalization increased to 67% from 50%
at the corresponding periods before consideration of the $500 million
Tastemaker Note.
On October 15, 1998, Hercules consummated the previously announced
Agreement and Plan of Merger, dated July 30, 1998, with BetzDearborn Inc.
becoming a wholly owned subsidiary of Hercules. Hercules completed the
acquisition for $72 per share in cash, or approximately $2.4 billion.
Additionally, Hercules assumed approximately $700 million in BetzDearborn debt.
The acquisition will be accounted for as a purchase. The difference in the
purchase price over net assets will result in significant goodwill and goodwill
amortization. BetzDearborn's 1997 worldwide revenues were $1.3 billion, and
consolidated net earnings were $86 million.
The acquisition is financed with borrowings under a $3.65 billion
credit facility syndicated by NationsBank, N.A. Under this credit facility,
Hercules can borrow up to $900 million under revolving credit loans and up to
$2.75 billion in term loans, due at various times ending December 31, 2003. The
term loans bear interest at LIBOR plus 200 basis points. Depending on certain
events and circumstances, the interest rate may be adjusted downward after a
six-month period. Substantially all of Hercules and BetzDearborn debt has been
refinanced with the new obligation. The incremental increase in annual interest
costs is expected to be approximately $180 million. The BetzDearborn ESOP was
funded with 5,890,873 shares of Hercules common stock which reduced the cash
purchase price by $186 million.
17
<PAGE> 18
In October, 1998, Hercules Finance Company (wholly-owned by Hercules)
sold its $500 million note remaining from the Tastemaker monetization. Over the
next several years, management plans to reduce the Company's leverage to
pre-acquisition debt levels. The Company has maintained an investment grade
rating on outstanding debt.
YEAR 2000
Readiness
The Company has recognized the need to ensure that its operations and
relationships with its business partners will not be adversely affected by the
Year 2000 problem, and thus has developed and implemented a comprehensive
project that addresses those areas of vulnerability. A cross-functional Year
2000 program office has been created by the Company at the corporate level to
coordinate and provide policies, guidance and support on its Year 2000
initiatives. Site compliance teams have been formed at all sites worldwide.
The areas addressed by the Program Office include:
o Corporate and plant computer systems
o Desktop and telecommunications systems
o Safety, environmental and quality systems
o Process control systems and plant floor equipment and devices with
embedded chips
o Equipment manufactured by or for the BetzDearborn Division and sold to
customers
o Business partner risk management
A risk management plan has been developed for our business partners
(suppliers, shippers, financial institutions, service providers, etc.) involving
direct communications to them and feedback analysis to assess their Year 2000
readiness as it relates to their potential impact on Hercules' business.
Contingency plans will be developed in those cases where the Company appears to
be at risk.
The Company is engaged in a major project to implement SAP R/3
software. The resulting systems comprise the Company's core business systems,
including sales and distribution, inventory and purchasing, finance and
control, product costing, human resources and payroll, and fixed assets. All
are Year 2000 capable. The system is in the process of being rolled out in
North America and Europe. The most critical applications are either already
operational or will be in early 1999. Overall, the project is approximately 75%
complete, and is on schedule to be completed by third quarter 1999.
In other regions of the world, only minor changes are required to make
the core business systems Year 2000 capable. Projects to accomplish these
changes have been initiated and are on schedule to complete in the first
quarter of 1999 or earlier. The recently acquired BetzDearborn Division, is
also in the process of implementing SAP, and is on schedule to complete its
program in the second quarter of 1999 in North America. BetzDearborn's
Information Technology (IT) systems in other regions are already Year 2000
capable.
For all plants and departments, inventories have been taken of
equipment that may have an embedded chip. Assessments of the compliance status
and potential impact on company operations,
18
<PAGE> 19
and remediation plans will be completed by year-end 1998. Additionally,
suppliers of raw materials and other critical services have been identified.
Questionnaires requesting Year 2000 status have been sent to all of the
identified suppliers. Identification of the most critical suppliers is in
progress and, where necessary, additional research is being conducted.
Contingency plans will be developed or alternate suppliers identified in those
cases where the Company appears at risk.
The BetzDearborn Division sells chemical feed equipment installed at
customer sites. Earlier versions of this equipment were not Year 2000 capable. A
kit to make this equipment Year 2000 capable has been designed and tested. A
plan is in place to update affected equipment by the second quarter of 1999
(well in advance of potential failure) through regular service visits of the
field technicians.
It is also possible that some customers may be unable to place orders
or conduct business due to their potential inability to cope with the Year 2000.
Due to the broad dispersion of sales among our customer base, there are
currently no plans to conduct any customer readiness assessments.
Costs
The primary strategy for achieving Year 2000 capability is the
replacement of the core business systems through information
technology transformation activities. The total 1998-1999 costs for the
preparation of the contingency plan, the assessment of third party IT
infrastructure components, and remediation is estimated at $8.4 million.
To-date, approximately 40% has been spent.
For non-IT systems, operational staff conducted departmental
inventories under the direction of an outside consulting firm. The costs
associated with these inventories were not material and have not been separately
identified. The Company is in the process of identifying the costs associated
with any necessary equipment upgrades or replacements. Estimates of these costs
are not currently available.
Risks and Contingency Plans
Failure to complete implementation of the SAP system by the end of 1999
would clearly represent the worst case Year 2000 scenario for Hercules. At the
present time, the Company believes that the implementation efforts will be
completed as scheduled so that the risks of material adverse consequences to
the Company's results of operation, liquidity, or financial condition to its
Year 2000 readiness should be reduced.
Some of Hercules' production facilities are similar in nature and
products could be manufactured and shipped from alternate locations. At these
locations, there are feasible manual procedures that can be implemented in the
case of a Year 2000 related failure. For cases where product cannot be made in
multiple locations or where manual procedures are not feasible, appropriate
contingency plans are being developed and are targeted for completion in the
first quarter of 1999.
The Company believes that it is unlikely to experience a material
adverse effect to its business, results of operations, liquidity, or financial
condition as a result of Year 2000 related failures.
Forward Looking Statements
The foregoing Year 2000 discussion includes forward-looking statements
of the Company's efforts and management's expectations relating to Year 2000
readiness. The Company's ability to achieve Year 2000 readiness and the level
of incremental costs associated therewith, could be adversely affected by,
among other things, the availability and cost of remediation and testing
resources, vendors' abilities to install or modify IT and Non-IT Systems and
unanticipated problems identified in the ongoing Year 2000 readiness review.
The costs of the Year 2000 project and the dates by which the Company
plans to complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third parties'
remediation plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially.
Specific factors that might cause such material differences include, but are
not limited to: the availability and cost of personnel trained to perform Year
2000 modifications; the ability of the Company to locate and correct all
non-compliant computer codes and embedded controls; the ability of material
customers, suppliers and trading partners to successfully complete their own
Year 2000 remediation projects; the accuracy of information received from third
parties concerning the Year 2000 compliance of their information systems or
automated equipment or concerning their Year 2000 business risk assessments;
and similar uncertainties.
19
<PAGE> 20
PART II - OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS.
In September 1993, Hercules and the U.S. Environmental Protection
Agency (EPA) Region 1 reached an agreement in principle in settlement of the
EPA's claims that Hercules violated its wastewater permit with the City of
Chicopee and the Federal pretreatment standard for industrial users of publicly
owned treatment works at its Chicopee, Massachusetts, facility. Hercules signed
a Consent Decree, which was entered by the court on December 15, 1994, based on
this agreement, requiring supplemental environmental projects (at a cost of
approximately $375,000), compliance with permit limits in the future, and
$250,000 in fines. Hercules has paid the $250,000 fine and has completed
performance of the supplemental environmental projects. On March 26, 1998 the
Court granted its approval for the termination of the Consent Decree.
In December 1997, Hercules received notice of an enforcement action by
the State of Georgia, Environmental Protection Department (EPD). EPD has
requested that Hercules enter into a proposed Consent Order, alleging violations
of the Resource Conservation and Recovery Act (RCRA) and seeking a civil penalty
of $250,000. Hercules has negotiated a Consent Order with the EPD which, when
finalized, will resolve all issues that were the subject of this enforcement
action. The Consent Order has been made available to the public for comment
prior to being finalized by the EPD. Under the proposed Consent Order, among
other things, Hercules would pay a fine of $80,000 and place saltwater aquaria
in local schools and other locations within the community.
Item 4. Submission of Matters to a Vote of Security-Holders.
The Company's Annual Meeting was held on April 30, 1998. Required
information has been supplied in registrant's Form 10-Q for the quarter ended
March 31, 1998.
Item 5. Other Information.
In accordance with recent amendments to the shareholder proposal rules
set forth in Rules 14a-4 and 14a-8 under the Securities Exchange Act of 1934, as
amended, written notice of shareholder proposals submitted outside the processes
of Rule 14a-8 for consideration at the 1999 Annual Shareholders' Meeting must be
received by the Company on or before February 3, 1999, in order to be considered
timely for purposes of Rule 14a-4. The persons designated in the Company's proxy
statement shall be granted discretionary authority with respect to any
shareholder proposal of which the Company does not receive timely notice.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K.
Hercules filed a Form 8-K on October 29, 1998, announcing the
consummation of the Agreement and Plan of Merger, dated July 30, 1998, between
Hercules and BetzDearborn Inc. An optional (Item 5) event was reported when the
District Court for the Eastern District of Arkansas denied the Company's summary
judgment motions at the Jacksonville, Arkansas environmental site. Financial
statements (Item 7) of BetzDearborn Inc. and pro forma condensed combined
financial statements of Hercules and BetzDearborn were filed. In addition, the
Credit Agreement to finance the acquisition, dated October 15, 1998, between
Hercules and NationsBank, N.A., was filed as an exhibit.
20
<PAGE> 21
On July 30, 1998, an optional (Item 5) Form 8-K was filed announcing
the signing of a definitive merger agreement between Hercules and BetzDearborn.
On July 24, 1998, an optional (Item 5) Form 8-K was filed related to
the acquisition of the 49% share of the FiberVisions joint venture.
21
<PAGE> 22
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Hercules Incorporated
by /s/ George MacKenzie
------------------------------
George MacKenzie
Senior Vice President
and Chief Financial Officer
(Principal Financial Officer
and duly authorized signatory)
November 17, 1998
by /s/ Vikram Jog
------------------------------
Vikram Jog
Vice President and Controller
(Principal Accounting Officer)
November 17, 1998
22
