SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
For Quarterly Period Ended June 30, 2004
OR
For Transition Period from to .
Commission File Number 1-12658
ALBEMARLE CORPORATION
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code - (804) 788-6000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨
Number of shares of common stock, $.01 par value, outstanding as of July 31, 2004: 41,568,017
I N D E X
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PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
ALBEMARLE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars In Thousands)
June 30,
2004
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, less allowance for doubtful accounts (2004 - $932; 2003 - $2,287)
Inventories:
Finished goods
Raw materials
Stores, supplies and other
Deferred income taxes and prepaid expenses
Total current assets
Property, plant and equipment, at cost
Less accumulated depreciation and amortization
Net property, plant and equipment
Prepaid pension assets
Other assets and deferred charges
Goodwill
Other intangibles, net of amortization
Total assets
See accompanying notes to the consolidated financial statements.
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LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Long-term debt, current portion
Accrued expenses
Dividends payable to shareholders
Income taxes payable
Total current liabilities
Long-term debt
Postretirement benefits
Other noncurrent liabilities
Deferred income taxes
Commitments and contingencies (Note 18)
Shareholders’ equity:
Common stock, $.01 par value, issued and outstanding - 41,553,392 in 2004 and 41,153,008 in 2003
Additional paid-in capital
Accumulated other comprehensive income
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
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CONSOLIDATED STATEMENTS OF INCOME
(In Thousands Except Per-Share Amounts)
(Unaudited)
Six Months Ended
Net sales
Cost of goods sold
Gross profit
Selling, general and administrative expenses
Research and development expenses
Special items
Operating profit
Interest and financing expenses
Other income (expense), net including minority interest
Income before income tax and cumulative effect of a change in accounting principle, net
Income taxes
Income before cumulative effect of a change in accounting principle, net
Cumulative effect of a change in accounting principle, net
Net income
Basic earnings per share:
Diluted earnings per share:
Cash dividends declared per share of common stock
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Other comprehensive (loss) income, net of tax:
Unrealized (loss) gain on securities available for sale
Unrealized (loss) on hedging derivatives
Foreign currency translation
Other comprehensive (loss) income
Comprehensive income
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash and cash equivalents at beginning of year
Cash flows from operating activities:
Cumulative effect of a change in accounting principle, net (a)
Adjustments to reconcile net income before cumulative effect of a change in accounting principle, net to cash flows from operating activities:
Depreciation and amortization
Working capital changes, net of the effects of acquisitions
Increase in prepaid pension assets
Increase in income tax receivable
Other, net
Net cash provided from operating activities
Cash flows from investing activities:
Capital expenditures
Investments in joint ventures and nonmarketable securities
Acquisitions of assets
Proceeds from hedging of anticipated acquisition purchase price
Proceeds from liquidation of nonmarketable security
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from borrowings
Proceeds from exercise of stock options
Repayments of long-term debt
Purchases of common stock
Dividends paid to shareholders
Dividends paid to minority interest
Net cash used in financing activities
Net effect of foreign exchange on cash and cash equivalents
Increase in cash and cash equivalents
Cash and cash equivalents at end of period
(a) Supplemental noncash disclosures due to a cumulative change in accounting principle:
Increase in property, plant and equipment
Increase in accumulated depreciation
Increase in other noncurrent liabilities
Decrease in deferred tax liabilities
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands Except Share and Per-Share Amounts)
Variable-rate bank loans
Industrial revenue bonds
Foreign borrowings
Miscellaneous
Total
Less amounts due within one year
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Basic earnings per share
Numerator:
Income available to shareholders, as reported
Denominator:
Average number of shares of common stock outstanding
Diluted earnings per share
Shares issuable upon exercise of stock options
Total shares
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AdditionalPaid-In
Capital
AccumulatedOtherComprehensive
Income
Retained
Earnings
TotalShare-holders’
Equity
Balance at December 31, 2003
Foreign currency translation, net
Change in unrealized gain on marketable equity securities, net
Change in unrealized (loss) on hedging derivatives, net
Cash dividends declared
Stock option remeasurement adjustments
Shares repurchased and retired
Shares issued upon exercise of stock options
Issuance of incentive award stock
Balance at June 30, 2004
Other intangibles
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Three Months Ended
Federal statutory rate
Revaluation of reserve requirements
State taxes, net of federal tax benefit
Extraterritorial income exclusion
Depletion
Federal income tax settlement
Other items, net
Effective income tax rate
During the quarter ended June 30, 2003, the Company received notification of the finalization of the Internal Revenue Service’s examination of its Federal income tax returns for the years ended December 31, 1998 and 1999. As a result, the Company evaluated its tax reserves and released $6.6 million to earnings.
In March 2003, the Company recorded a receivable for an income tax refund of $11,083. The refund related to the Internal Revenue Service’s examination of the Company’s 1996 and 1997 tax returns. In addition, at June 30, 2003, the Company recorded additional interest income of $195 ($124 after income taxes) for the three months then ended. The net effect of the refund on the Consolidated Statement of Income for the six-month period ended June 30, 2003 amounted to $7,216 or 17 cents per diluted share, including interest of $4,308 ($2,744 after income taxes).
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Current assets
Property, plant and equipment
Other assets
Intangibles
Current liabilities
Noncurrent liabilities
Net cash paid
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On December 2, 2003, the Company, through its wholly-owned subsidiary Albemarle Chemicals SAS, acquired Atofina’s bromine fine chemicals business for $10,130. The transaction included the transfer to Albemarle of Atofina’s production site in Port de Bouc, France, as well as a long-term supply agreement with Atofina for certain fine chemicals. The acquisition provides Albemarle with flexibility in raw material supply and complements the Company’s existing network of bromine-based facilities in Jordan and the United States. The current purchase price allocation as of June 30, 2004, subject to final negotiations with the seller, is summarized below.
Accounts receivable
Inventory
Deferred expenses
Deferred tax assets
Long-term environmental liabilities
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Beginning accrual balance, January 1, 2004
Workforce reduction charges
Payments
Overaccrual reversed to income in first quarter
Ending accrual balance, June 30, 2004
On June 4, 2004, the Company initiated a petition for breach of contract and declaratory judgment against Amerisure Insurance Company and Amerisure Mutual Insurance Company (f/k/a Michigan Mutual Insurance Company) (collectively, the “Defendants”) on the grounds of Defendants’ refusal to honor their respective obligations under certain insurance policies on which the Company was named an additional insured. See “Legal Proceedings” in Part II of this Form 10-Q.
The Company, after initiating the petition for breach of contract against its secondary insurance carrier, also initiated formal discussions regarding existing insurance coverage with its primary general commercial liability carrier, Lexington Insurance Company (“Lexington”). At this time the Company believes that it will collect the full amount of the receivable from the Defendants and/or Lexington.
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Beginning balance at December 31, 2003
Additions
Foreign exchange
Ending balance at June 30, 2004
The amounts recorded represent the Company’s future remediation and other anticipated environmental costs relating to past operations. Although it is difficult to quantify the potential financial impact of compliance with environmental protection laws, management estimates (based on the latest available information) that there is a reasonable possibility that future environmental remediation costs associated with the Company’s past operations, in excess of amounts already recorded, could be up to approximately $11,000 before income taxes.
On another matter, the Company has submitted a request for arbitration against Aventis S.A. (“Aventis”) to confirm that Aventis is obligated to indemnify the Company pursuant to the terms of a stock purchase agreement, for certain present and future claims asserted against the Company arising out of soil and groundwater contamination at the site of the Thann facility. See Note 18.
The Company believes that any sum it may be required to pay in connection with environmental remediation matters in excess of the amounts recorded should occur over a period of time and should not have a material adverse effect upon results of operations, financial condition or cash flows of the Company on a consolidated basis but could have a material adverse impact in a particular quarterly reporting period.
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Summary of Segment Results
Polymer Chemicals
Fine Chemicals
Segment totals
Corporate and other expenses
Other income(expense), net including minority interest
Income before income taxes and cumulative effect of a change in accounting principle, net
Other income, net including minority interest
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17
Stock based compensation expense, net of taxes
as reported
pro forma
Basic earnings per share on net income
Diluted earnings per share on net income
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Basic earnings per share on income before cumulative effect of a change in accounting principle, net
Basic earnings per share on Net income
Diluted earnings per share on income before cumulative effect of a change in accounting principle, net
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for options granted in the three and six-months periods ended June 30, 2004 and 2003.
Fair values of options granted
Dividend Yield
Volatility
Average expected life (in years)
Risk-free interest rate
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The following table summarizes the Company’s contractual obligations for plant construction, purchases of equipment, unused letters of credit and various take or pay and throughput agreements:
3Q
4Q
Take or pay / throughput agreements
Additional investment commitment payments
Capital projects
Letters of credit and guarantees
In addition, the Company has commitments, in the form of guarantees, for 50% of the loan amounts outstanding (which at June 30, 2004, amounted to $31,867) of its 50%-owned joint venture company, Jordan Bromine Company Limited (“JBC”). JBC entered into the loans in 2000 to finance construction of certain bromine and derivatives manufacturing facilities on the Dead Sea. The Company’s total loan guarantee commitment for JBC is 50% of JBC’s total loans, which could amount to up to $44,800 if JBC makes all of its allowable draws.
On April 2, 2004, Albemarle Overseas Development Company (“AODC”), a wholly-owned subsidiary of Albemarle Corporation, initiated a Request for Arbitration against Aventis S.A., through the International Chamber of Commerce, International Court of Arbitration, Paris, France. The dispute arises out of a 1992 Stock Purchase Agreement (“Agreement”) between a predecessor to AODC, and a predecessor to Aventis, pursuant to which 100% of the stock of Potasse et Produits Chimiques, S.A., now known as Albemarle PPC (APPC), was acquired by AODC. The dispute relates to a chemical facility in Thann in eastern France owned by APPC. Under the terms of the Agreement, Aventis is obligated to indemnify AODC and APPC, and hold them harmless from certain claims, losses, damages, costs or any other present or prospective liabilities arising out of soil and/or groundwater contamination at the site in Thann.
Beginning in May 2000, the French Government, with respect to the management of pollution risk on the site of active industrial installations, required APPC to conduct an environmental risk study of the Thann facility. In June 2002, the French Government directed APPC to undertake a more detailed risk study of groundwater contamination. The administrative process of the French Government is still ongoing as of the present date. AODC has demanded indemnification from Aventis for the cost of the studies, but Aventis has refused to pay.
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The Request for Arbitration requests indemnification of AODC by Aventis for certain costs incurred by APPC, in connection with any environmental claims of the French Government for the APPC facility and a declaratory judgment as to the liability of Aventis under the Agreement for costs to be incurred in the future by APPC in connection with such claims.
At this time, it is not possible to predict what the French Government will require with respect to the Thann facility, since this matter is in its initial stages and environmental matters are subject to many uncertainties. The Company believes, however, that it is entitled to be indemnified by Aventis for liabilities arising from this matter.
Net Periodic Pension Benefit Cost:
Service cost
Interest cost
Expected return of assets
Plan pension curtailment *
Amortization of Unrecognized Amounts:
Net transition (asset)
Prior service charge
Net loss
Total income
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Net Periodic Postretirement Benefit Expense:
Net transition (asset)/obligation
Total expense
The Company did not make any contributions to its pension plans in the first six months of 2004; and at this time, none are anticipated for the remainder of the year.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”) was signed into law. The Act introduces a prescription drug benefit under Medicare Part D, as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The Company sponsors medical programs for certain of its U.S. retirees and expects that this legislation will reduce the costs for some of these programs. The Company is continuing to evaluate the impact of the legislation since guidance from various governmental and regulatory agencies concerning the requirements that must be met to obtain these cost reductions is still pending. In April 2004, the FASB issued Staff Position (FSP) No. FAS 106-2 to address the accounting and disclosure requirements related to the Act. The FSP No. FAS 106-2 is effective for interim or annual periods beginning after June 15, 2004. The Company does not expect the adoption of FSP No. FAS 106-2 to have a material impact on the Company’s financial position, results of operations or cash flows.
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2004 (the “364-Day Credit Agreement”). The Company used initial borrowings under the Multi-Year Credit Agreement and the 364-Day Credit Agreement to consummate the acquisition, refinance its existing credit agreement and pay all fees and expenses in connection therewith.
The Company will operate the new business as a third segment (Catalyst), joining it with the Company’s existing Polymer Chemical and Fine Chemical segments, moving its current catalysts products into the new segment and incorporating other polymer additives and its flame retardants into a newly-named Polymer Additives segment.
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ITEM 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition and Additional Information
The following data and discussion provides an analysis of certain significant factors affecting the results of operations of Albemarle Corporation and its subsidiaries (“Albemarle” or the “Company”), during the periods included in the accompanying consolidated statements of income and changes in the Company’s financial condition since December 31, 2003.
Some of the information presented in this Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on the Company’s current expectations, which are in turn based on the Company’s reasonable assumptions within the bounds of its knowledge of its business and operations. There can be no assurance, however, that the Company’s actual results will not differ materially from the results and expectations in the forward-looking statements. Factors that could cause actual results to differ materially include, without limitation, the timing of orders received from customers, the gain or loss of significant customers, competition from other manufacturers, changes in the demand for the Company’s products, increases in the cost of products, increases in the cost of energy and raw materials (notably ethylene, chlorine and natural gas), changes in the Company’s markets in general, fluctuations in foreign currencies, changes in new product introductions resulting in increases in capital project requests and approvals leading to additional capital spending, changes in laws and regulations, unanticipated claims or litigation, the inability to obtain current levels of product or premises liability insurance or the denial of such coverage, political unrest affecting the global economy, changes in accounting standards, and the successful integration of the recently acquired Akzo Nobel refinery catalyst business into the Company’s operations. The Company assumes no obligation to provide revisions to any forward-looking statements should circumstances change, except as otherwise required by securities and other applicable laws.
Results of Operations
Second Quarter 2004 Compared with Second Quarter 2003
Net Sales
Net sales by operating segment for the second-quarter periods ended June 30, 2004 and 2003 are as follows:
(In Thousands)
Net sales for second quarter 2004 of $326.7 million were up $54.9 million (20.2%) from second-quarter 2003 net sales of $271.8 million. Polymer Chemicals’ net sales increased $54.2 million (36.1%) primarily due to higher volumes in flame retardants ($22.3 million) and catalysts and additives ($10.8 million), the contributions made by the Company’s 2003 acquisitions ($18.3 million) and the favorable impact of foreign exchange ($5.5 million) offset, in
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part, by lower prices ($2.6 million), primarily in flame retardants. Fine Chemicals’ net sales increased $0.8 million (0.6%) primarily due to the contributions made by the Company’s 2003 bromine fine chemicals acquisition ($5.2 million), the favorable impact of foreign exchange ($3.6 million) and higher volumes in bulk active pharmaceuticals and agricultural chemicals ($1.9 million). The increase was mostly offset by an unfavorable sales mix in performance chemicals ($6.6 million) and lower prices in bulk active pharmaceuticals ($2.9 million) and fine chemistry services and intermediates ($0.6 million).
Operating Costs and Expenses
Cost of goods sold in the second quarter of 2004 increased $48.7 million (23.0%) from the corresponding 2003 period. The increase was primarily due to the impact of the Company’s 2003 acquisitions and higher sales volumes in the 2004 period as well as higher raw material and energy costs and the idling of the zeolite business assets. The gross profit margin decreased approximately 183 basis points to 20.3% in second-quarter 2004 from 22.2% for the corresponding period in 2003.
Selling, general and administrative expenses (“SG&A”) and research and development expenses (“R&D”) increased $3.9 million (11.5%) in the second quarter of 2004 versus second-quarter 2003 primarily due to higher employee incentive costs ($1.8 million), higher outside service costs ($0.8 million), higher research and development costs ($0.7 million), and the unfavorable impact of foreign exchange ($0.6 million) as well as higher SG&A costs related to acquisitions ($0.4 million) offset, in part, by the benefits of cost reduction efforts and a voluntary separation program implemented in the third quarter of 2003. As a percentage of net sales, SG&A and R&D were 11.5% in 2004 versus 12.5% in the 2003 quarter.
Operating Profit
Operating profit by reportable operating segment for the three-month periods ended June 30, 2004, and 2003 is as follows:
Corporate and Other Expenses
Polymer Chemicals’ second-quarter 2004 segment operating profit increased $6.2 million (32.9%) from second-quarter 2003. The increase was primarily due to higher shipments in flame retardants ($10.2 million) and catalysts and additives ($3.1 million), and the overall favorable net effects of foreign exchange ($2.0 million), offset, in part, by unfavorable raw material and energy costs ($6.3 million) and lower prices ($2.6 million), primarily in flame retardants.
Fine Chemicals’ second-quarter 2004 segment operating profit, including a special item charge of $0.6 million related to the cleanup of the Pasadena plant zeolite facility, decreased
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$2.5 million (18.3%) from second-quarter 2003. Excluding the special item, second-quarter 2004 segment operating profit decreased $1.9 million (14.2%) from second-quarter 2003 primarily due to lower prices ($3.6 million), primarily in bulk active pharmaceuticals, unfavorable sales mix in performance chemicals ($0.6 million), the unfavorable net effects of foreign exchange ($0.4 million) and higher energy costs ($0.5 million). The decrease was partially offset by product mix in fine chemistry services and intermediates ($3.2 million).
Corporate and other expenses for the second-quarter of 2004 increased $1.9 million (32.3%) from second-quarter 2003 primarily due to higher employee incentive costs offset, in part, by the Company’s overall cost reduction efforts.
Interest and Financing Expenses
Interest and financing expenses for second-quarter 2004 amounted to $1.4 million, up slightly from $1.3 million in second-quarter 2003 due to higher average outstanding debt in the 2004 period.
Other Income (Expense), Net Including Minority Interest
Other income (expense), net for the second-quarter 2004 amounted to $2.7 million, up $3.0 million from the 2003 corresponding period. Second-quarter 2004 includes foreign exchange hedging gains of $2.9 million related to the Company’s hedging of euros for its acquisition of the refinery catalyst business of Akzo Nobel.
Income Taxes
Second-quarter 2004 effective income tax rate was 29.6%, up from 4.3% for the corresponding period in 2003. The 2003 period benefited from a favorable income tax adjustment of $6.6 million due to the revaluation of reserve requirements resulting from IRS settlements. The significant differences between the U.S. Federal statutory income tax rate on pretax income and the effective income tax rate for the three-month periods ended June 30, 2004 and 2003, respectively, are as follows:
Six Months 2004 Compared with Six Months 2003
Net sales by operating segment for the six-month periods ended June 30, 2004 and 2003 are as follows:
Net sales for first six months of 2004 of $648.8 million were up $110.2 million (20.5%) from the first six months of 2003 net sales of $538.6 million. Polymer Chemicals’ net sales increased $102.3 million (34.4%) primarily due to higher volumes in flame retardants ($37.7 million) and catalysts and additives ($19.4 million), the contributions made by the Company’s 2003 acquisitions ($35.4 million) and the favorable impact of foreign exchange ($15.0 million) offset, in part, by lower prices ($5.1 million), primarily in flame retardants. Fine Chemicals’ net sales increased $7.9 million (3.3%) primarily due to the favorable impact of foreign exchange
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($10.5 million), the contributions made by the Company’s 2003 bromine fine chemicals acquisition ($9.2 million), higher volumes in bulk active pharmaceuticals ($8.6 million) and higher volumes, offset in part, by lower prices, in fine chemistry services and intermediates ($0.8 million). The increase in Fine Chemicals’ net sales was partially offset by an unfavorable sales mix in performance chemicals ($15.2 million) and lower prices in bulk active pharmaceuticals ($5.7 million).
Cost of goods sold in the first six months of 2004 increased $101.7 million (24.2%) from the corresponding 2003 period. The increase was primarily due to the impact of the Company’s 2003 acquisitions and higher sales volumes in the 2004 period as well as the idling of the zeolite business assets and higher raw material costs. The gross profit margin decreased approximately 240 basis points to 19.6% in the 2004 period from 22.1% for the corresponding period in 2003.
SG&A and R&D increased $6.2 million (9.4%) in the first six months of 2004 versus first six months of 2003 primarily due to higher employee related costs ($5.2 million), the unfavorable impact of foreign exchange ($1.7 million), higher SG&A costs related to acquisitions ($0.9 million), higher outside legal costs ($0.4 million) as well as higher R&D costs ($0.3 million) offset, in part, by the benefits of cost reduction efforts and a voluntary separation program implemented in the third quarter of 2003. As a percentage of net sales, SG&A and R&D were 11.2% in 2004 versus 12.3% in the 2003 period.
Operating profit by reportable operating segment for the six-month periods ended June 30, 2004, and 2003 is as follows:
Six-months 2004 operating profit, including special item charges in the Fine Chemicals’ segment of $4.5 million that resulted from the layoff of 53 employees at the Pasadena plant zeolite facility and their related SFAS No. 88 pension curtailment charge ($0.9 million) and $0.6 million for cleanup of the facility, was down $2.9 million (5.5%) from six-months 2003 operating profit. Excluding the effects of the special items, six-months 2004 operating profit increased $2.2 million (4.2%) from the corresponding 2003 period.
Polymer Chemicals’ first six months of 2004 segment operating profit increased $11.2 million (31.8%) from the first six months of 2003. The increase was primarily due to higher shipments in flame retardants ($14.0 million) and catalysts and additives ($6.7 million), the overall favorable net effects of foreign exchange ($5.5 million), offset, in part, by unfavorable
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raw material costs ($8.5 million), lower prices ($5.1 million), primarily in flame retardants, higher SG&A costs related to acquisitions ($0.9 million) and higher manufacturing and production costs ($0.6 million).
Fine Chemicals’ first six months of 2004 segment operating profit, including special item charges of $4.5 million that resulted from the layoff of 53 employees at the Pasadena plant zeolite facility and their related SFAS No. 88 pension curtailment charge ($0.9 million) and $0.6 million for cleanup of the facility, decreased $11.5 million (41.2%) from the first six months of 2003. Excluding the special items, first six-months 2004 segment operating profit decreased $6.4 million (23.1%) from the 2003 period primarily due to unfavorable plant utilization and manufacturing costs primarily due to the idling of the zeolite business assets ($5.8 million), lower prices, offset in part, by higher shipments in bulk active pharmaceuticals ($4.2 million), and unfavorable sales mix in performance chemicals ($1.7 million). The decrease was partially offset by higher shipments, offset in part, by lower prices in fine chemistry services and intermediates ($2.3 million) and higher shipments ($1.7 million) and prices ($1.4 million) in agricultural chemicals.
Corporate and other expenses for the first six months of 2004 increased $2.6 million (24.0%) from first six months of 2003 primarily due to higher estimated employee incentive costs.
Interest and financing expenses for the first six months of 2004 amounted to $2.9 million, up slightly from $2.6 million in the first six months of 2003 due to higher average outstanding debt in the 2004 period.
Other income (expense), net for the first six months of 2004 amounted to $1.6 million, down $1.6 million from the 2003 corresponding period. The decrease is primarily attributable to the absence of $4.3 million of interest income from an Internal Revenue Service (“IRS”) income tax settlement in the 2003 period, partially offset by foreign exchange hedging gains of $2.9 million related to the Company’s hedging of euros for its acquisition of the refinery catalyst business of Akzo Nobel in the 2004 period.
The first six months of 2004 effective income tax rate was 28.7%, up from 10.4% for the corresponding period in 2003. The significant differences between the U.S. Federal statutory income tax rate on pretax income and the effective income tax rate for the six-month periods ended June 30, 2004 and 2003, respectively, are as follows:
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Financial Condition and Liquidity
Cash and cash equivalents at June 30, 2004, were $38.7 million, representing an increase of $3.5 million from $35.2 million at year-end 2003.
Cash flows provided from operating activities of $85.4 million, together with approximately $14.8 million of proceeds from borrowings and $3 million of realized hedging gains associated with the acquisition of Akzo Nobel’s refinery catalyst business, were used to cover operating activities, repay debt of $66.5 million, fund capital expenditures totaling $19.6 million, pay quarterly dividends to shareholders of $11.9 million, fund investments in joint ventures and nonmarketable securities of $5 million, purchase 27,569 shares of the Company’s common stock, purchase the assets and intellectual property of Taerim, and increase cash and cash equivalents by $3.5 million. The Company anticipates that cash provided from operations in the future will be sufficient to pay its operating expenses, satisfy debt-service obligations and make dividend payments.
The change in the Company’s accumulated other comprehensive loss from December 31, 2003, was due primarily to net foreign currency translation adjustments (strengthening of the U.S. Dollar versus the euro), net of related deferred taxes.
The noncurrent portion of the Company’s long-term debt amounted to $176.5 million at June 30, 2004, compared to $228.4 million at the end of 2003. The Company’s long-term debt, including the current portion, as a percentage of total capitalization amounted to 21.2% at June 30, 2004. The Company is guarantor of $44.8 million of long-term debt, in the form of commitments (of which $31.7 million was outstanding at June 30, 2004), on behalf of its 50-percent owned joint venture company, Jordan Bromine Company Limited. The Company’s long-term debt, including the guarantee, as a percent of total capitalization amounted to 24.1% at June 30, 2004.
On July 31, 2004, the Company completed the acquisition of the catalyst refinery business of Akzo Nobel N.V. (“Akzo Nobel”) for EUR 615.7 million (approximately $763 million) in cash in accordance with an International Share and Business Sale Agreement, dated as of July 16, 2004 (the “Purchase Agreement”), by and between the Company, Albemarle Catalysts International, L.L.C., a wholly-owned subsidiary of the Company (“Albemarle Catalysts”), and Akzo Nobel.
In connection with the acquisition, the Company entered into (i) a new senior credit agreement, dated as of July 29, 2004 (the “Multi-Year Credit Agreement”), among the Company, Albemarle Catalysts, certain subsidiaries of the Company, as guarantors, the banks named therein, Bank of America, N.A., as Administrative Agent, UBS Securities LLC, as Syndication Agent, and The Bank of New York, Fortis (USA) Finance LLC and SunTrust Bank, as Co-Documentation Agents, consisting of a $300 million revolving credit facility and a $450 million term loan facility and (ii) a 364-day loan agreement, dated as of July 29, 2004 (the “364-Day Credit Agreement”), among the Company, Albemarle Catalysts, certain subsidiaries of the Company, as guarantors, the banks named therein, Banc of America Bridge LLC, as Administrative Agent, and UBS Securities LLC, as Syndication Agent, consisting of a $450 million term loan facility. The Company used the initial borrowings under the Multi-Year Credit Agreement and the 364-Day Credit Agreement to consummate the acquisition, refinance its existing Credit Agreement dated September 10, 2002 and pay all fees and expenses in connection therewith.
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The Company intends to operate the new business as a third segment, to be known as Catalyst, joining it with the Company’s existing Polymer Chemical and Fine Chemical segments, moving its current catalysts products into the new segment and incorporating other polymer additives and its flame retardants into a newly-named Polymer Additives segment.
Borrowings under the Company’s new Multi-Year Credit Agreement and 364-Day Credit Agreement are conditioned upon compliance with the following financial covenants: (a) consolidated fixed charge coverage ratio, as defined, must be greater than or equal to 1.25:1.00 as of the end of any fiscal quarter, (b) consolidated debt to capitalization ratio, as defined, at the end of any fiscal quarter of the Company must be less than or equal to 65% (i) prior to the earlier of (A) the first anniversary of the closing date and (B) the first equity issuance of the Company subsequent to the closing date, and (ii) thereafter, 60%, (c) consolidated tangible domestic assets, as defined, must be or greater than or equal to $750 million for the Company to make investments in entities and enterprises that are organized outside the United States, (d) with the exception of liens specified in the new Multi-Year Credit Agreement and the 364-Day Credit Agreement, liens may not attach to assets with a value of more than 10% of consolidated net worth, as defined in the agreements.
The Company’s capital expenditures in the first six months of 2004 were up slightly from the six-month period of 2003. For the year, however, capital expenditures are forecasted to be about 20% greater than the 2003 level. Capital spending will be financed primarily with cash flow provided from operations with additional cash needed, if any, provided from debt. The amount and timing of any additional borrowings will depend on the Company’s specific cash requirements.
The Company is subject to federal, state, local and foreign requirements regulating the handling, manufacture and use of materials (some of which may be classified as hazardous or toxic by one or more regulatory agencies), the discharge of materials into the environment and the protection of the environment. To the Company’s knowledge, it is currently complying, and expecting to continue to comply, in all material respects with existing environmental laws, regulations, statutes and ordinances applicable to its operations. Such compliance with federal, state, local and foreign environmental protection laws is not expected to have in the future a material effect on earnings or the competitive position of Albemarle.
Among other environmental requirements, the Company is subject to the federal Superfund law, and similar state laws, under which the Company may be designated as a potentially responsible party and may be liable for a share of the costs associated with cleaning up various hazardous waste sites.
Additional Information
Outlook
Overview
Albemarle’s second quarter results continued to reflect the strong sales growth trend that we have experienced for the past six quarters. Based on market indicators in our key segments, we expect continued growth in net sales in the third quarter, especially in our Polymer Additives and the newly formed Catalyst segments.
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As noted elsewhere, we completed the acquisition of Akzo Nobel’s refinery catalysts business on July 31, for EUR 615.7 million (approximately $763 million). With this acquisition, we will add a number of foundation technologies to our portfolio including catalysts for hydro-processing and fluidized catalytic cracking, as well as new products targeting the fast growing clean fuels catalyst market. Based on first-half 2004 unaudited results to date, the new Catalyst business is performing well and is poised to further participate in the three-to-five percent per year overall growth in the $10 billion catalyst industry.
We have begun to execute on our integration plans to combine our current polyolefin catalyst business with the newly acquired refinery catalysts business. Overall, the Catalyst segment is forecasted to generate about 30 percent of Albemarle’s total sales on an annual basis (excluding JVs). However, the acquisition is not expected to be accretive to earnings for the balance of the year due to significant integration activities and financing expenses.
We continue to experience significant increases in raw material and energy costs, particularly in benzene, bisphenol-A and phenol, which impact primarily in the Polymer Additives segment. By year end, raw material costs are expected to add nearly $16 million with energy adding another $3 to 4 million to our overall cost structure. In order to offset these increases, we are seeking price increases in most product areas, and these initiatives are taking effect with various levels of success. Our manufacturing cost reduction program, which began in 2003 to capture $50 million in savings over three years, is on track and contributing to partially offset the impact of raw material cost inflation.
Acquisitions continue to play a key role in sales growth for the Company. Over 40% of the net sales growth experienced in the second quarter was related to acquisitions made in the past 12 months. With the acquisition of the refinery catalysts business, the Company will have an annual sales rate of approximately $1.75 billion. We continue to forecast an effective tax rate of about 30% looking forward.
Second quarter sales were flat with last year’s levels and were down slightly from the first quarter of 2004. Looking forward, we expect to see increasingly tight supply, high asset utilizations and price improvement in the bromine products area. Underlying trends in Fine Chemistry Services continue to improve, based on a strong new product development pipeline. This year alone, revenue from new products is expected to increase by 7 percent versus 2003. These new activities will help to offset the loss of revenue from the zeolites business and may provide opportunities to use these idle assets for more value-adding activities.
Overall profitability is expected to be down in agricultural chemicals due to the normal seasonal downturn in the third quarter. During this timeframe we will also experience the impact of unabsorbed factory costs resulting from a plant turnaround in our ibuprofen facility designed to provide further cost reductions through automation.
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We also expect competitive pricing pressure in ibuprofen. Profitability improvement plans are in place and we should begin to see better results in 2005.
Polymer Chemicals sales have increased to record levels for the past four quarters with a growth rate of close to eight percent per quarter. Segment revenues and income grew 36 percent and 33 percent year over year. General indicators of market recovery continue to show strength, driving shipments throughout our polymer additives product line. Flame retardants will continue to be the primary growth driver as we move into the second half of the year. The third quarter is typically the strongest for electronic equipment sales in advance of the holiday season, and we are seeing signs that recovery in this sector will continue.
Pricing in flame retardants improved sequentially 4-5 percent in the second quarter and we expect continued price improvement in third quarter, helping to offset anticipated raw material cost escalation.
With the majority of flame retardant assets running at full capacity, we expect to continue to increase production of tetrabrom at our Jordan facility in response to market demand and are expanding Martinal ATH capacity of 10%.
Overall, strength in Polymer Chemicals sales is expected to continue in 2004. Success of the price increases underway will become even more critical, however, as we face escalating raw material and energy costs in the second half of the year.
Additional information regarding the Company, its products, markets and financial performance is provided at the Company’s Internet web site, www.albemarle.com. The Company’s Internet website is not a part of this document nor is it incorporated herein by reference.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no significant changes in the Company’s interest rate risk, marketable security price risk or raw material price risk from the information provided in the Annual Report on Form 10-K for the year ended December 31, 2003, except as noted below.
The operations of the Company are exposed to market risk from changes in natural gas prices. The Company purchases natural gas to meet its production requirements. In the second quarter of 2003, the Company began hedging a portion of its 12 month rolling forecast for North American natural gas requirements, by entering into natural gas futures contracts, to help mitigate uncertainty and volatility.
Hedge transactions are executed with a major financial institution by the Company’s purchasing personnel. Such derivatives are held to secure natural gas at fixed prices and not for trading.
The natural gas contracts qualify as cash flow hedges under SFAS No. 133 and are marked to market. The unrealized gains and/or losses are deferred and reported in Other Comprehensive Income to the extent that the unrealized gains and losses are offset by the forecasted transaction. Any unrealized gains and/or losses on the derivative instrument that are not offset by the forecasted transaction are recorded in earnings. There were no hedges of natural gas contracts at June 30, 2004.
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For the six-months ended June 30, 2004, the Company had unrealized losses of approximately $80 thousand ($51 thousand, net of tax) in Other Comprehensive Income.
ITEM 4. Controls and Procedures
The Company carried out an evaluation, with the participation of the Company’s management, including the Company’s President and Chief Executive Officer, and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Company’s President and Chief Executive Officer, and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings. There has been no change in the Company’s internal control over financial reporting during the quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II - OTHER INFORMATION
ITEM 1. Legal Proceedings
On April 2, 2004, Albemarle Overseas Development Company (“AODC”), a wholly-owned subsidiary of Albemarle Corporation, initiated a Request for Arbitration against Aventis S.A. (“Aventis”), through the International Chamber of Commerce, International Court of Arbitration, Paris, France. The dispute arises out of a 1992 Stock Purchase Agreement (“Agreement”) between a predecessor to AODC, and a predecessor to Aventis pursuant to which 100% of the stock of Potasse et Produits Chimiques, S.A., now known as Albemarle PPC (APPC), was acquired by AODC. The dispute relates to a chemical facility in Thann in eastern France owned by APPC. Under the terms of the Agreement, Aventis is obligated to indemnify AODC and APPC, and hold them harmless from certain claims, losses, damages, costs or any other present or prospective liabilities arising out of soil and/or groundwater contamination at the site in Thann.
The Request for Arbitration requests indemnification of AODC by Aventis for all costs incurred by APPC in connection with any environmental claims of the French Government for the APPC facility and a declaratory judgment as to the liability of Aventis under the Agreement for costs to be incurred in the future by APPC in connection with such claims.
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At this time, it is not possible to predict what the French Government will require with respect to the Thann facility, since this matter is in its initial stages and environmental matters are subject to many uncertainties. The Company believes, however, that it is entitled be fully indemnified by Aventis for all liabilities arising from this matter.
On June 4, 2004, the Company initiated a petition for breach of contract and declaratory judgment against Amerisure Insurance Company and Amerisure Mutual Insurance Company (f/k/a Michigan Mutual Insurance Company) (collectively, the “Defendants”) in the Nineteenth Judicial District Court, Parish of Baton Rouge, Louisiana on the grounds of Defendants’ refusal to honor their respective obligations under certain insurance policies on which the Company was named an additional insured to reimburse the Company for certain damages incurred by Albemarle in the discontinuance of product support for and the withdrawal from a water treatment venture. The Company has also initiated formal discussions related to such damages with its primary general commercial liability carrier. At this time the Company believes that it will collect the full amount of the receivable from the Defendants and/or its primary general insurance carrier.
In addition, the Company is involved from time to time in legal proceedings of types regarded as common in the Company’s businesses, particularly administrative or judicial proceedings seeking remediation under environmental laws, such as Superfund, products liability and premises liability litigation.
The Company maintains a financial accrual for these proceedings which includes defense costs and potential damages, as estimated by its General Counsel. The Company also maintains insurance to mitigate such risks. The Company is not party to any pending litigation proceedings that are expected to have a material adverse effect on the Company’s results of operations, financial position or cash flows.
ITEM 6. Exhibits and Reports on Form 8-K
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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.
/s/ PAUL F. ROCHELEAU
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EXHIBIT INDEX