<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 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 July 30, 1998, 94,567,009 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 June 30, Six Months Ended June 30,
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net sales ................................... $ 445 $ 502 $ 875 $ 997
Cost of sales ............................... 267 314 529 634
Selling, general, and administrative expenses 68 68 129 134
Research and development .................... 12 14 25 28
Other operating expenses (income), net ...... (3) (1) (3) 162
----- ----- ----- -----
Profit from operations ...................... 101 107 195 39
Equity in income of affiliated companies .... 5 4 10 20
Interest and debt expense ................... 13 9 24 19
Other income (expense), net ................. 16 13 (28) 348
----- ----- ----- -----
Income before income taxes .................. 109 115 153 388
Provision for income taxes .................. 35 40 51 205
----- ----- ----- -----
Net income .................................. $ 74 $ 75 $ 102 $ 183
===== ===== ===== =====
Earnings per share:
Basic .............................. $0.78 $0.75 $1.07 $1.82
===== ===== ===== =====
Diluted ............................ $0.77 $0.73 $1.06 $1.76
===== ===== ===== =====
Dividends per share ......................... $0.27 $0.25 $0.54 $ .50
===== ===== ===== =====
</TABLE>
See accompanying notes to financial statements.
2
<PAGE> 3
HERCULES INCORPORATED
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
1998 1997
------- -------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents ........................... $ 32 $ 17
Accounts and notes receivable, net .................. 420 389
Inventories
Finished products ............................... 139 121
Materials, supplies, and work in process ........ 128 113
Deferred income taxes ............................... 49 49
------- -------
Total current assets ............................ 768 689
Property, plant, and equipment ......................... 2,160 2,088
Accumulated depreciation and amortization .............. 1,435 1,401
------- -------
Net property, plant, and equipment .............. 725 687
Investments ............................................ 602 615
Other assets ........................................... 555 420
------- -------
Total assets .................................... $ 2,650 $ 2,411
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable .................................... $ 128 $ 116
Accrued expenses .................................... 352 317
Short-term debt ..................................... 474 275
Income taxes payable ................................ 80 91
------- -------
Total current liabilities ....................... 1,034 799
Long-term debt ......................................... 461 419
Deferred income taxes .................................. 169 160
Postretirement benefits and other liabilities .......... 338 343
Stockholders' equity
Common stock (shares issued: 1998 -- 154,632,613;
1997 -- 154,357,015) ............................ 81 80
Additional paid-in capital .......................... 508 504
Foreign currency translation adjustment ............. (10) (2)
Retained earnings ................................... 2,214 2,163
------- -------
2,793 2,745
Reacquired stock, at cost (shares: 1998 -- 60,065,557;
1997 -- 58,289,376) ................................. 2,145 2,055
------- -------
Total stockholders' equity ...................... 648 690
------- -------
Total liabilities and stockholders' equity ...... $ 2,650 $ 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)
Six Months Ended June 30,
1998 1997
----- -----
<S> <C> <C>
Net cash provided by operations ............................ $ 38 $ 63
----- -----
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures ....................................... (58) (49)
Proceeds of investment and fixed asset disposals ........... 54 139
Businesses acquired, net of cash received .................. (95) --
Other, net ................................................. (16) (3)
----- -----
Net cash provided by (used in) investing activities . (115) 87
----- -----
CASH FLOW FROM FINANCING ACTIVITIES:
Long-term debt proceeds .................................... 72 114
Long-term debt repayments .................................. (27) (90)
Change in short-term debt .................................. 198 (2)
Common stock reissued ...................................... 8 6
Common stock reacquired .................................... (105) (136)
Dividends paid ............................................. (52) (50)
----- -----
Net cash provided by (used in) financing activities . 94 (158)
----- -----
Effect of exchange rate changes on cash .................... (2) (1)
----- -----
Net decrease in cash and cash equivalents .................. 15 $ (9)
Cash and cash equivalents - beginning of period ............ 17 30
----- -----
Cash and cash equivalents - end of period .................. $ 32 $ 21
===== =====
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) .................... $ 22 $ 13
Income taxes ............................................ 74 76
Noncash investing and financing activities:
Accounts payable for common stock acquisitions .......... 4 3
Incentive plan stock issuances .......................... 4 3
Investment in long-term note ............................ -- 500
Conversion of notes and debentures ...................... 4 1
</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 June 30, Six Months Ended June 30,
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net income ............................. $ 74 $ 75 $ 102 $ 183
Foreign currency translation, net of tax (1) (7) (8) (41)
----- ----- ----- -----
Comprehensive income ................... $ 73 $ 68 $ 94 $ 142
===== ===== ===== =====
</TABLE>
See accompanying notes to financial statements.
5
<PAGE> 6
NOTES TO FINANCIAL STATEMENTS
(Dollars in millions) (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 be read in conjunction with
the accounting policies and the financial statements and notes thereto included
in the Company's annual report for 1997.
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>
Three Months Ended June 30, Six Months Ended June 30,
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Basic
Net income ........................ $ 74 $ 75 $ 102 $ 183
Weighted-average shares outstanding 94.8 99.8 95.3 100.5
------- ------- ------- -------
EPS ............................... $ 0.78 $ 0.75 $ 1.07 $ 1.82
======= ======= ======= =======
Diluted
Net Income ........................ $ 74 $ 75 $ 102 $ 183
Interest on convertible debentures -- 1 -- 1
------- ------- ------- -------
Net income for EPS calculation .... $ 74 $ 76 $ 102 $ 184
======= ======= ======= =======
Weighted-average shares outstanding 94.8 99.8 95.3 100.5
Options ........................... .7 1.2 .7 1.2
Debentures ........................ .6 2.9 .7 3.0
------- ------- ------- -------
Adjusted weighted-average shares .. 96.1 103.9 96.7 104.7
------- ------- ------- -------
EPS ............................... $ 0.77 $ 0.73 $ 1.06 $ 1.76
======= ======= ======= =======
</TABLE>
3. Cost and expenses include depreciation as follows:
<TABLE>
<CAPTION>
June 30,
1998 1997
------- -------
<S> <C> <C>
Three months ended...................................... $ 16 $ 19
Six months ended ...................................... 32 41
</TABLE>
4. Other operating expenses, net for the six months ended June 30, 1997
include charges of $141 million associated with management organizational
changes and adoption of alternative competitive strategies relative to current
businesses, 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
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 $12 million is the remaining liability at June 30, 1998.
Additionally, other operating
6
<PAGE> 7
expenses include $13 million of net environmental cleanup costs, principally for
nonoperating sites and $8 million of executive retirement benefits.
Other operating expenses, net for the quarter and six months ended June
30, 1998 primarily reflects a favorable settlement of an environmental insurance
claim.
5. Interest and debt costs are summarized as follows:
<TABLE>
<CAPTION>
(Dollars in millions) June 30,
------------------------
1998 1997
------ ------
<S> <C> <C>
Three Months Ended:
Costs incurred ...................... $ 15 $ 11
Amount capitalized .................. 2 2
------ ------
Interest expense .................... $ 13 $ 9
====== ======
Six Months Ended:
Costs incurred ...................... $ 29 $ 22
Amount capitalized .................. 5 3
------ ------
Interest expense .................... $ 24 $ 19
====== ======
</TABLE>
6. Other income (expense), net for the quarter and six months ended June
30, 1998 includes legal settlements and accruals, primarily related to the
settlement of a Qui Tam (Whistle Blower) lawsuit (see Note 9) of $1 million and
$64 million, respectively, interest income of $10 million and $19 million,
respectively, primarily related to the $500 million note obtained upon
completion of transactions that monetized the Tastemaker investment (see below)
and gains on sale of investments of $6 million and $17 million. Additionally,
the six months reflects a $2 million write off of a claim related to a divested
business.
Other income, net for the quarter and six months ended June 30, 1997
includes net foreign currency gains of $3 million and $14 million, respectively,
and interest income, primarily related to the $500 million note of $9 million
and $10 million, respectively. Additionally, the six months reflect a gain of
$357 million on completion of transactions to monetize the investment in
Tastemaker, a 50% owned flavors joint venture, and charges of $32 million
related to legal settlements and accruals.
7
<PAGE> 8
7. A summary of short-term and long-term debt follows:
<TABLE>
<CAPTION>
(Dollars in millions) June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
SHORT-TERM:
Commercial paper ......................... $ 350 $ 195
Banks .................................... 124 80
Current maturities ....................... -- --
------ ------
$ 474 $ 275
====== ======
</TABLE>
At June 30, 1998, Hercules had $174 million of unused lines of credit
that may be drawn as needed. Lines of credit in use or supporting commercial
paper at June 30, 1998, were $103 million.
<TABLE>
<CAPTION>
(Dollars in millions) 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
8% convertible subordinated debentures due 2010 ... 6 10
Commercial paper .................................. 50 50
Variable rate loans ............................... 46 2
Other ............................................. 9 7
------ ------
461 419
Current maturities of long-term debt .............. -- --
------ ------
Net long-term debt ................................ $ 461 $ 419
====== ======
</TABLE>
8. 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 aproximately $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.
In July 1998, Hercules and BetzDearborn Inc. signed a definitive merger
agreement under which Hercules will acquire all BetzDearborn outstanding shares
for approximately $2.4 billion in cash and, in addition, assume $700 million in
debt. The transaction, subject to approvals by BetzDearborn shareholders and
regulatory authorities is expected to close during the fourth quarter of 1998.
Additionally, in July 1998, Hercules completed the acquistion 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. The transaction closed in the third
quarter of 1998.
9. 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
June 30, 1998, a total of 66,247,388 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 $37.36 per share.
8
<PAGE> 9
10. 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.
11. 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 remediation is between $64
million and $210 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
sites in which it may be, but has not yet been named, a PRP principally through
its knowledge of investigation of sites by the U.S. Environmental Protection
Agency (EPA) or other government agency or through correspondence with
previously named PRPs requesting information on Hercules' activities at sites
under investigation. Hercules brought suit in 1992 against its insurance
carriers for past and future costs for remediation of certain environmental
sites. In April 1998, the trial of the Jacksonville, Arkansas, site was
completed. The jury has returned a "Special Verdict Form" with findings that
will 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.
9
<PAGE> 10
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 of liability and damages among Hercules, Uniroyal, and the United
States will begin in October 1998. Hercules expects to appeal the Court's
determination with respect to its liability, the divisibility of harm issue, and
Standard Chlorine's liability when final judgment is entered.
Hercules' potential costs for remediation of the Jacksonville site are
presently estimated between $18 million and $92 million. These costs are based
on Hercules' assessment of potential liability, the level of participation by
other PRPs, and current estimates of remediation costs.
At June 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.
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.
10
<PAGE> 11
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. The settlement was recognized in
the first quarter of 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 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, remain unresolved. The government has indicated it
does not intend to intervene in these matters.
While it is not feasible to predict the outcome of all pending suits
and claims, other then the settlement described above, 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.
11
<PAGE> 12
OTHER FINANCIAL INFORMATION
Operational Highlights
<TABLE>
<CAPTION>
(Dollars in millions) Three Months Ended June 30, Six Months Ended June 30,
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
NET SALES BY INDUSTRY SEGMENT
Chemical Specialties ....................... $ 227 $ 267 $ 441 $ 539
Food & Functional Products ................. 218 235 433 458
Corporate and Other ........................ -- -- 1 --
----- ----- ----- -----
Total ................................ $ 445 $ 502 $ 875 $ 997
===== ===== ===== =====
PROFIT (LOSS) FROM OPERATIONS BY INDUSTRY SEGMENT
Chemical Specialties ....................... $ 43 $ 49 $ 81 $ 3
Food & Functional Products ................. 58 60 113 57
Corporate and Other ........................ -- (2) 1 (21)
----- ----- ----- -----
Total ................................ $ 101 $ 107 $ 195 $ 39
===== ===== ===== =====
</TABLE>
12
<PAGE> 13
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. The 1997 results exclude the effects of asset rationalization
and impairment, severance, benefits, and other adjustments aggregating $161
million (see Notes 4 and 6). 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 June 30, Six Months Ended June 30,
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net sales ....................................... $ 445 $ 462 $ 875 $ 913
Cost of sales ................................... 267 282 529 566
Selling, general, and administrative expenses ... 68 64 129 126
Research and development ........................ 12 13 25 27
Other operating expenses (income), net .......... (3) 1 (3) 2
----- ----- ----- -----
Profit from operations .......................... $ 101 $ 102 $ 195 $ 192
===== ===== ===== =====
Net Sales by Industry Segment
Chemical Specialties ....................... $ 227 $ 227 $ 441 $ 455
Food & Functional Products ................. 218 235 433 458
Corporate and other ........................ -- -- 1 --
----- ----- ----- -----
Total ................................. $ 445 $ 462 $ 875 $ 913
===== ===== ===== =====
Profit (Loss) From Operations by Industry Segment
Chemical Specialties ....................... $ 43 $ 44 $ 81 $ 92
Food & Functional Products ................. 58 60 113 105
Corporate and other ........................ -- (2) 1 (5)
----- ----- ----- -----
Total ................................. $ 101 $ 102 $ 195 $ 192
===== ===== ===== =====
</TABLE>
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<PAGE> 14
RESULTS OF OPERATIONS
Within the following discussion, unless otherwise stated, "quarter" and
"six-month period" refer to the second quarter of 1998 and the six months ended
June 30, 1998. All comparisons are with the corresponding periods in the
previous year unless otherwise stated.
Consolidated net sales decreased $17 million and $38 million for the
quarter and six-month period, or 4% respectively. Chemical Specialties sales
were flat for the quarter and declined 3%, or $14 million, for the six-month
period. Food & Functional Products sales decreased 7%, or $17 million, for the
quarter, and 5%, or $25 million, for the six-month period. The primary reason
for the decline in sales revenues is the economic crisis in Asia. This has not
only negatively affected sales volumes and prices in Asia, but has also
resulted in increased competitive pressure and lower prices in other parts of
the world. The overall effects of Asian economic crisis for the quarter and
six-month period are estimated to be approximately $27 million and $44 million
on a consolidated basis; $14 million and $22 million in each segment.
Additionally, weaker foreign currencies relative to the dollar
negatively impacted consolidated and segment sales by 2% for the quarter and 3%
for the six-month period, or $10 million and $26 million on a consolidated
basis; $5 million and $13 million in each segment. Improved volume (excluding
Asia) and favorable sales mix in both segments, particularly in Chemical
Specialties, coupled with improved pricing in Food & Functional Products,
partially offset the decreases noted above as well as lower prices in Chemical
Specialties.
Consolidated profit from operations was virtually flat for the quarter
and six-month period. Manufacturing cost improvement initiatives, improved
plant operations and lower raw material costs, in Chemical Specialties
(excluding Asia), offset the reduced sales revenues. As a result, overall
gross margin improved to 40% for the quarter and six-month period from 39% and
38%, respectively, for the comparable year ago periods.
For the six-month period, Chemical Specialties' operating profit
declined $11 million, or 12%, as volume improvements (excluding Asia) and
manufacturing cost initiatives partially offset the negative impact of Asia and
weaker foreign currencies. In Food & Functional Products, operating profit
increased $8 million, or 8%, as improved pricing and manufacturing cost
initiatives more than offset the declines associated with lower demand from the
Asian crisis and the effect of weaker foreign currencies relative to the dollar.
Equity in income of affiliated companies decreased $10 million for the
six-month period and primarily reflects the monetization of investments in
Tastemaker in March 1997 (see Note 6) and Alliant Techsystems in December 1997,
partially offset by equity income from FiberVisions, the 51% owned fibers joint
venture.
Interest and debt expense increased for the quarter and six-month
period, principally due to higher average debt outstanding.
Other income, net increased $3 million for the quarter and decreased
$376 million for the six-month period (see Note 6).
The provision for income taxes for the six-month period ended June 30,
1998 reflects an estimated annual effective tax rate of 34.5%. 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
14
<PAGE> 15
required increases to tax reserves related to anticipated tax assessments by
federal, state, and foreign tax authorities.
FINANCIAL CONDITION
Cash provided by operations was $38 million compared to $63 million in
1997. Higher working capital requirements and higher interest payments primarily
account for the decrease.
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.
In July 1998, Hercules and BetzDearborn Inc. signed a definitive
merger agreement under which Hercules will acquire all BetzDearborn outstanding
shares for approximately $2.4 billion in cash and, in addition, assume $700
million in debt. The transaction, subject to approvals by BetzDearborn
shareholders and regulatory authorities is expected to close during the fourth
quarter of 1998. Additionally, 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. The transaction
closed in the third quarter of 1998.
Short-term liquidity has remained relatively stable since year-end
1997, with current and quick ratios at .7 and .4, respectively. At June 30,
1998, $174 million was available under short-term lines of credit and $300
million was available under revolving credit. During the six-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. Transaction gains and loses related to the notes are deferred and
recognized as an adjustment to the revenue supporting the note repayment.
Additionally, during the quarter, the Company entered into a $480 million cross
currency swap agreement to effectively hedge its investment in foreign
subsidiaries. The interest rate effects of the cross currency swap agreement
are recorded as an adjustment to interest expense.
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 received as a result
of the Tastemaker transaction. At June 30, 1998, net market value of these
combined instruments was a liability of $462 million. The sensitivity analysis
assumes an instantaneous 100-basis point move in interest rates from their
levels at June 30, 1998, with all other variables held constant. A 100-basis
point increase in interest rates would result in a $21 million decrease in the
net liability. A 100-basis point decrease in interest rates would result in a
$28 million increase in the net liability.
The market value of the company's portfolio of financial instruments
subject to equity price risk at June 30, 1998, was an asset of $42 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.
15
<PAGE> 16
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 asset position of $1 million at June 30, 1998. The
sensitivity analysis assumes an instantaneous 10% change in foreign currency
exchange rates from the June 30, 1998 levels, with all other variables held
constant. A 10% strengthening of the U.S. dollar versus other currencies would
result in an increase of $51 million in the net asset position, while a 10%
weakening of the dollar versus all other currencies would result in a decrease
of $62 million in the net asset position.
16
<PAGE> 17
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 entered into settlement discussions with EPD in an
attempt to resolve this matter.
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 was not required to file any reports on Form 8-K
during the quarter; however, optional (Item 5 event) Form 8Ks
were filed during the third quarter related to the acquisition
of the 49% share of the FiberVisions joint venture and the
announcement of the signing of a definitive merger agreement
between Hercules and BetzDearborn.
17
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Hercules Incorporated
by George MacKenzie
--------------------------------
George MacKenzie
Senior Vice President
and Chief Financial Officer
(Principal Financial Officer
and duly authorized signatory)
August 14, 1998
by Vikram Jog
--------------------------------
Vikram Jog
Vice President and Controller
(Principal Accounting Officer)
August 14, 1998
18
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