UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended May 28, 2005
or
For the transition period from to
Commission File Number 001-09225
H.B. FULLER COMPANY
(Exact name of Registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(651) 236-5900
(Registrant’s telephone number, including area code)
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 checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨
The number of shares outstanding of the Registrant’s Common Stock, par value $1.00 per share, was 28,909,969 as of June 24, 2005.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
H.B. FULLER COMPANY AND SUBSIDIARIES
Consolidated Statement of Income
(In thousands, except per share amounts)
(Unaudited)
May 29,2004
(Restated)
Cost of sales
Gross profit
Selling, general and administrative expenses
Gains from sales of assets
Other expense, net
Interest expense
Income before income taxes, minority interests, and income from equity investments
Income taxes
Minority interests in consolidated income
Income from equity investments
Basic income per common share
Diluted income per common share
Weighted-average common shares outstanding:
Basic
Diluted
Dividends declared per common share
See accompanying notes to consolidated financial statements.
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Consolidated Balance Sheet
(In thousands, except share and per share amounts)
May 28,
2005
November 27,
2004
Assets
Current assets:
Cash and cash equivalents
Trade receivables
Allowance for doubtful accounts
Inventories
Other current assets
Total current assets
Property, plant and equipment, net
Other assets
Goodwill
Other intangibles, net
Total assets
Liabilities and Stockholders’ Equity
Current liabilities:
Notes payable
Current installments of long-term debt
Trade payables
Accrued payroll and employee benefits
Other accrued expenses
Income taxes payable
Total current liabilities
Long-term debt, excluding current installments
Accrued pensions expense
Other liabilities
Minority interests in consolidated subsidiaries
Total liabilities
Commitments and contingencies
Stockholders’ equity:
Preferred stock (no shares outstanding) Shares authorized – 10,045,900
Common stock, par value $1.00 per share, Shares authorized – 80,000,000, Shares issued and outstanding – 28,904,472 and 28,641,037, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Unearned compensation - restricted stock
Total stockholders’ equity
Total liabilities and stockholders’ equity
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Consolidated Statement of Cash Flows
(In thousands)
May 29, 2004
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization
Deferred income taxes
Change in assets and liabilities:
Accounts receivables, net
Accounts payables
Accrued payroll / employee benefits
Other
Net cash provided by operating activities
Cash flows from investing activities:
Purchased property, plant and equipment
Purchased business, net of cash acquired
Purchased investment
Proceeds from sale of investment
Proceeds from sale of property, plant and equipment
Proceeds from repayment of note receivable with equity method investee
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Repayment of long-term debt
Net proceeds from notes payable
Dividends paid
Net cash used in financing activities
Effect of exchange rate changes
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure of cash flow information:
Cash paid for interest
Cash paid for income taxes
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Notes to Consolidated Financial Statements
(Amounts in thousands, except share and per share amounts)
The company has made certain reclassifications to the fiscal 2004 consolidated financial statements, as previously reported, to conform to current classification. These reclassifications did not change net income or stockholders’ equity as previously reported.
The company has restated its consolidated financial statements for the 13 week and 26 week periods ended May 29, 2004, to correct misstatements found in its Chilean operations at the end of 2004. As previously disclosed in the company’s Annual Report on Form10-K for the year ended November 27, 2004, the company has restated the statements of income for the 13 week and 26 week periods ended May 29, 2004 and the statement of cash flows for the 26 week period ended May 29, 2004 (see Note 2).
The investigation indicated that certain members of the local accounting organization knowingly recorded incorrect entries to certain accounts in the Chilean financial statements, beginning in 1999 and continuing through 2004. Furthermore, the investigation indicated a portion of these accounting irregularities involved the misappropriation of company assets. These actions resulted in a cumulative overstatement of net income totaling $3,067 as follows: cost of sales and other expense, net were understated by $1,684 and $1,622, respectively and income taxes were overstated by $239. Of the cumulative overstatement of net income of $3,067, $1,953 related to overstatements occurring prior to fiscal year 2004, which was determined to be immaterial to the respective prior year periods and 2004 and was recorded in the fourth quarter of 2004. The remaining $1,114 represented misstatements occurring in the second and third quarters in fiscal 2004 of $525 and $589, respectively.
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The statements of income previously reported in the second quarter of 2004 on Form 10-Q were restated as follows:
13 Weeks Ended
26 Weeks Ended
Net revenue
Net income per common share
Net income, as reported
Add back: Stock-based employee compensation expense recorded
Net income excluding stock-based compensation
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
Pro forma net income
Basic income per share:
As reported
Pro forma
Diluted income per share:
Compensation expense for pro forma purposes is reflected on a straight-line basis over the vesting period.
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Weighted-average common shares – basic
Equivalent shares – stock-based compensation plans
Weighted-average common shares – diluted
The computations of diluted income per common share do not include stock options with exercise prices greater than the average market price of the common shares of 2,260 and 5,980 for the 13 week periods ended May 28, 2005 and May 29, 2004 and 12,967 and 4,368 for the 26 week periods ended May 28, 2005 and May 29, 2004, respectively, as the results would have been anti-dilutive.
Other comprehensive income
Foreign currency translation, net
Total comprehensive income
Components of accumulated other comprehensive income follows:
Accumulated Other Comprehensive Income
Foreign currency translation adjustment
Minimum pension liability
Total accumulated other comprehensive income
Raw materials
Finished goods
LIFO reserve
Total liabilities at November 27, 2004
Currency change effect
Cash payments
Total liabilities at May 28, 2005
Long-term portion of liabilities
Current liabilities at May 28, 2005
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The long-term portion of the restructuring liabilities relate to adverse lease commitments that are expected to be paid beyond one year. The largest cash payment made in 2005 related to $1,884 of lease termination costs for one facility. In the first quarter of 2005, a gain of $1,692 was recognized from the sale of one facility closed as part of the restructuring plan.
As of May 28, 2005, the company had forward foreign currency contracts maturing between May 31, 2005 and December 15, 2005. The fair value effect associated with these contracts was net unrealized gains of $1,761 at May 28, 2005.
Trade
Revenue
Inter-
Segment
Operating
Income
Global Adhesives
Full-Valu/Specialty
Total
Reconciliation of Operating Income to Income before Income Taxes, Minority Interests and Income from Equity Investments:
Operating income
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Environmental: The company is party to various lawsuits and governmental proceedings related to environmental matters. In particular, the company is currently deemed a potentially responsible party (PRP) or defendant, generally in conjunction with numerous other parties, in a number of government enforcement and private actions associated with hazardous waste sites. As a PRP or defendant, the company may be required to pay a share of the costs of investigation and cleanup of these sites. In addition, the company is engaged in environmental remediation and monitoring efforts at a number of current and former company operating facilities, including an investigation of environmental contamination at its Sorocaba, Brazil facility. The company is working with Brazilian regulatory authorities to determine the necessary scope of remediation at the facility. As of May 28, 2005, $1,316 was recorded as a liability for expected investigation and remediation expenses remaining for this site. Once the scope of any necessary remediation is determined, the company may be required to record additional liabilities related to investigation and remediation costs at the Sorocaba facility.
As of May 28, 2005, the company had recorded $2,782 as its best probable estimates of aggregate liabilities for costs of environmental investigation and remediation, inclusive of the accrual related to the Sorocaba facility described above. These estimates are based primarily upon internal or third-party environmental studies, assessments as to the company’s responsibility, the extent of the contamination and the nature of required remedial actions. The company’s current assessment of the probable liabilities and associated expenses related to environmental matters is based on the facts and circumstances known at this time. Recorded liabilities are adjusted as further information develops or circumstances change. Based upon currently available information, management does not believe the effect, in aggregate, of all such lawsuits, proceedings and investigations will have a material adverse effect on the company’s financial condition, results of operations or cash flows. However, adverse developments could negatively impact earnings or cash flows in a particular future period.
Product Liability: As a participant in the chemical and construction products industries, the company faces an inherent risk of exposure to claims in the event that the failure, use or misuse of its products results in or is alleged to result in property damage and/or bodily injury. From time to time and in the ordinary course of business, the company is a party to, or a target of, lawsuits, claims, investigations and proceedings, including product liability, contract, patent and intellectual property, antitrust and employment matters.
A subsidiary of the company is a defendant or co-defendant in numerous exterior insulated finish systems (“EIFS”) related lawsuits. As of May 28, 2005, the company’s subsidiary was a defendant or co-defendant in approximately 70 lawsuits and 6 claims related primarily to single-family homes. The EIFS product was used primarily in the residential construction market in the southeastern United States. Claims and lawsuits related to this product seek monetary relief for water intrusion related property damages. One of the lawsuits is a class action lawsuit purportedly involving 186 members, and some of the lawsuits involve EIFS in commercial or multi-family structures. As of May 28, 2005, the company had recorded $3,629 for the probable liabilities remaining and $1,104 for insurance recoveries for all such matters. The company has insurance coverage for certain years with respect to this product line. The company continually reevaluates these amounts. Management does not believe that the ultimate outcome of any pending legal proceedings and claims related to this product line, individually or in aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows. However, projecting future events, such as the number of new claims to be filed each year, the average cost of disposing of each such claim, as well as the numerous uncertainties surrounding litigation, could cause the actual costs to be higher or lower than the current estimated reserves or insurance recoveries.
The company or its subsidiaries are named in asbestos-related lawsuits in various state courts involving alleged exposure to products manufactured more than 20 years ago. These lawsuits frequently seek both actual and punitive damages, often in very large amounts. In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable loss as a result of such exposure or that injuries incurred in fact resulted from exposure to products manufactured by the company or its subsidiaries. In such cases, the company is generally dismissed without payment. With respect to those cases where compensable disease, exposure and causation are established with
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respect to one of the company’s products, the company generally settles for amounts that reflect the confirmed disease, the seriousness of the case, the particular jurisdiction and the number and solvency of other parties in the case. Prior to 2003, insurance and/or indemnification from solvent third parties paid substantially all of the indemnity and defense costs associated with most of the asbestos litigation involving the company.
During 2003, the company’s insurers replaced the cost sharing agreement that had previously provided for the allocation of settlement payments among the insurers with an interim allocation formula. Under this formula, the company has funded amounts allocable to years in which the responsible insurer is insolvent. As previously reported and accounted for during the third quarter of 2004, the company and a group of other defendants entered into negotiations with a group of plaintiffs to settle a number of asbestos-related lawsuits. Subject to finalization of certain terms and conditions of settlement, the company has agreed to contribute $3,520 towards the settlement amount to be paid to the plaintiffs in exchange for a full release of claims by the plaintiffs. Of this amount, the company’s insurers have agreed to pay approximately $1,211. To the extent the company can reasonably estimate the amount of its probable liability for asbestos-related claims, the company establishes a financial provision and a corresponding receivable amount for insurance coverage if certain criteria are met.
In addition to product liability claims discussed above, the company and its subsidiaries are involved in claims or legal proceedings related to its products, which it believes are not out of the ordinary in a business of the type and size in which it is engaged.
With respect to EIFS and asbestos claims, as well as all other litigation, the company cannot always definitively estimate its potential liabilities. While the company is unable to predict the outcome of these matters, it does not believe, based upon currently available facts, that the ultimate resolution of any pending matter, including the EIFS and asbestos litigation described above, will have a material adverse effect on its financial condition, results of operations or cash flows. However, adverse developments could negatively impact earnings or cash flows in a particular future period.
Guarantees: In July 2000, the Board of Directors adopted the Executive Stock Purchase Loan Program, designed to facilitate immediate and significant stock ownership by executives, especially new management employees. During certain designated periods between September 2000 and August 2001, eligible employees were allowed to purchase shares of company common stock in the open market. Under the program, the company arranged for a bank to provide full-recourse, personal loans to eligible employees electing to participate in the program. The loans bear interest at the Applicable Federal Rate and mature in five years, with principal and interest due at that time. The loans are guaranteed by the company only in the event of the participant’s default. The aggregate amount outstanding was $6,921 and $7,388 at May 28, 2005 and November 27, 2004, respectively.
In November 2004 the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and spoilage. This statement requires that those items be recognized as current period charges regardless of whether they meet the criterion of “so abnormal” which was the criterion specified in ARB
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No. 43. In addition, this Statement requires that allocation of fixed production overheads to the cost of production be based on normal capacity of the production facilities. This pronouncement is effective for the company beginning December 4, 2005. The company is in the process of evaluating whether the adoption of SFAS 151 will have a significant impact on the company’s overall results of operations, financial position or cash flows, however, it is unlikely the impact will be material.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” The amendments made by Statement 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. The Statement is effective for the company relative to nonmonetary asset exchanges beginning December 4, 2005. The provisions of this Statement shall be applied prospectively.
In December 2004, the FASB issued SFAS No. 123(R) “Share-Based Payment.” SFAS 123(R) requires the recognition of compensation cost relating to share-based payment transactions in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued as of the grant date, based on the estimated number of awards that are expected to vest. SFAS 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” The original effective date for Statement 123(R) was August 28, 2005. However, in April, 2005, the Securities and Exchange Commission (SEC) adopted a new rule that amended the effective date for SFAS No. 123R. The SEC’s new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005. Therefore, the Company plans to adopt SFAS No. 123R effective December 4, 2005. The company is in the process of evaluating the impact of SFAS 123(R) on its financial condition, results of operations and cash flows. Refer to pro forma disclosure under “Accounting for Stock-Based Compensation” in Note 2 above for indication of ongoing expense that will be included in the income statement beginning in the first quarter of 2006.
In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004”, which provides guidance under SFAS No. 109, “Accounting for Income Taxes,” with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the Jobs Act) on enterprises’ income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004. The Jobs Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. FSP No. 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. As a result of this Act, the company has the opportunity to repatriate approximately $24,000 of cash in 2005 that has been generated over time by its foreign operations, resulting in an estimated increase in the company’s tax provision in 2005 of approximately $1,000. However, the company’s business strategy and intention is to continue to reinvest its undistributed foreign earnings indefinitely and, therefore, no related deferred tax liability has been recorded at this time.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 clarifies that a conditional asset retirement obligation, as used in SFAS 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of the settlement are conditional on a future event that may or may not be within the control of the entity. The Statement is effective for the company no later than December 3, 2006. The company is in the process of evaluating the impact of FIN 47 on its financial condition, results of operations and cash flows.
In May 2005, the FASB issued SFAS No. 154 “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces APB Opinion No. 20 “Accounting Changes”, and SFAS No. 3 “Reporting Accounting Changes in Interim Financial Statements”. This Statement changes the requirements for the accounting
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for and reporting of a change in accounting principle, and applies to all voluntary changes in accounting principles, as well as changes required by an accounting pronouncement in the unusual instance it does not include specific transition provisions. Specifically, this Statement requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the effects of the change, the new accounting principle must be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and a corresponding adjustment must be made to the opening balance of retained earnings for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of the change, the new principle must be applied as if it were adopted prospectively from the earliest date practicable. This Statement is effective for the company for all accounting changes and corrections of errors made beginning December 3, 2006. This Statement does not change the transition provisions of any existing pronouncements. The company does not believe that the adoption of SFAS 154 will have a significant impact on its financial condition, results of operations or cash flows.
The company determined that Autotek met the definition of a variable interest entity under FIN 46R and that the company’s automotive joint venture is the primary beneficiary.
The investment was accounted for under the equity method through the second quarter of fiscal year 2004. Beginning May 30, 2004, the operating results were reflected broadly across the statement of consolidated income with minority interest representing the portion of the operating results applicable to the minority interest holders. Had the company consolidated Autotek results of operations beginning November 30, 2003, the company’s pro forma unaudited net revenue would have been reported as $363,908 and $683,347 for the 13 week and 26 week periods ended May 29, 2004, respectively. As the company had previously accounted for its investment under the equity method, no adjustments were made to the company’s net income or earnings per share for the periods presented.
Net income per share:
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PostretirementBenefits
Net periodic cost (benefit):
Service cost
Interest cost
Expected return on assets
Amortization:
Prior service cost
Actuarial (gain)/ loss
Transition amount
Net periodic benefit cost (benefit)
15. Transactions with Sekisui Chemical Company: In the second quarter of 2005, the company completed its definitive agreements to enter into business-related partnerships in Japan and China with Sekisui Chemical Co., Ltd. In Japan, Sekisui and the company merged their Japanese Adhesives businesses on April 1, 2005 to create Sekisui-Fuller Company, Ltd. H.B. Fuller contributed $15,629 of current assets, $11,463 of long-term assets, $8,665 of current liabilities, $10,639 of long-term liabilities – in aggregate, net assets of $7,788. In exchange, H.B. Fuller received a 40 percent ownership in Sekisui-Fuller Company, Ltd. with an option to purchase an additional 10 percent in 2007 for $12,000. The merger was accounted for as a formation of a corporate joint venture. As a result, the company’s interest in the joint venture was recorded at the carry-over basis of its Japan Adhesives business. Therefore, no gain or loss was recorded on the merger. H.B. Fuller will account for this investment under the equity method.
With respect to China, the company received $8,000 from Sekisui on May 25, 2005 in exchange for a 20 percent investment in H.B. Fuller’s China entities and an option for Sekisui to increase its investment to 30 percent in 2007 for $4,000. As a result of the 20 percent investment sold, the company recorded a pre-tax gain of $4,781. Sekisui’s option to purchase an additional 10 percent in 2007 was recorded as a liability at a fair value of $688. The company will mark-to-market this liability through earnings in subsequent periods. H.B. Fuller will continue to consolidate China with the portion owned by Sekisui represented as a minority interest liability.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Note: Comparisons to 2004 results refer to restated numbers as discussed in Note 2 of the consolidated financial statements.
Overview
The company achieved an increase in net revenue of 6.8 percent as compared to the second quarter of 2004, with 6.6 percentage points of the increase driven by increases in its average selling prices. The pricing increases helped mitigate the continuing effects of rising raw material costs. The gross profit margin in the quarter remained at the first quarter’s level of 25.7 percent.
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There were four transactions/initiatives announced during the second quarter of 2005 that had a significant impact on the company’s financial results. Two of them involved agreements with Sekisui Chemical Co., Ltd., a diversified Japanese corporation.
The other two transactions/initiatives in the quarter related to initiatives to improve efficiencies and reduce cost:
Net income increased 45.1 percent in the second quarter of 2005 as compared to the second quarter of 2004. Earnings per diluted share increased from $0.39 in the second quarter of 2004 to $0.56 in the second quarter of 2005. Through six months of 2005 the earnings per diluted share were $0.78 as compared to $0.55 for the first six months of 2004.
Results of Operations
Net Revenue: Net revenue in the second quarter of 2005 of $387.9 million represented an increase of 6.8 percent from the $363.1 million recorded in the second quarter of 2004. Management reviews variances in net revenue in terms of changes related to product pricing, sales volume, acquisitions/divestitures and changes in foreign currency exchange rates. The following table shows the net revenue variance analysis for the second quarter of 2005 as compared to the second quarter of 2004:
2nd Qtr 2005
vs
2nd Qtr 2004
Product Pricing
Sales Volume
Divestitures
Currency
The 6.6 percent increase in net revenue attributed to increases in average selling prices reflected management’s continuing efforts to address the effects of rising raw material costs. The net revenue decrease due to divestitures of 1.9 percent resulted from the company’s contribution during the second quarter of 2005 of its Japanese adhesives entity to the newly formed joint venture with Sekisui Chemical Co., Ltd. The net revenue increase attributed to currency effects was primarily the result of a stronger euro in the second quarter of 2005 as compared to the second quarter of 2004.
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On an operating segment basis, net revenue increases in the second quarter of 2005 as compared to the second quarter of 2004 were 6.7 percent and 7.2 percent in Global Adhesives and Full-Valu/Specialty, respectively.
Through six months of 2005, net revenue of $740.9 million was 8.7 percent higher than the net revenue of $681.6 million in the first six months of 2004. The following table shows the net revenue variance analysis for the first six months:
Six Months, 2005
Six Months, 2004
Acquisitions/Divestitures
Through six months of 2005 net revenue has increased 9.5 percent in the Global Adhesives segment and 6.8 percent in the Full-Valu/Specialty segment.
Cost of Sales: The cost of sales of $288.4 million in the second quarter of 2005 were 9.7 percent higher than the second quarter of 2004 cost of sales of $262.9 million. Raw material cost increases were the most significant factor in the cost of sales increase in 2005 as compared to 2004. Many of these raw materials are petroleum-based derivatives, minerals and metals. The effects from currency fluctuations increased the 2005 cost of sales by approximately $4 million as compared to last year. Increased transportation costs due to higher fuel prices also contributed to the higher cost of sales in the second quarter of 2005. A decrease in cost of sales of more than $5 million as compared to the second quarter of 2004 resulted from the contribution of the Japan Adhesives business to the Sekisui-Fuller joint venture in Japan. For the first six months of 2005, the cost of sales of $550.6 million was 11.1 percent higher than the $495.7 million in the first six months of 2004. Raw material cost increases and the effects of stronger foreign currencies were the key drivers of the cost of sales increases through the first half of 2005.
As a percent of net revenue, the second quarter 2005 cost of sales were 74.3 percent as compared to 72.4 percent in the second quarter of 2004. Through the first six months the percentages were 74.3 percent and 72.7 percent for 2005 and 2004, respectively.
Gross Profit Margin: The gross profit margin was 25.7 percent in both the second quarter and first six months of 2005 as compared to 27.6 percent and 27.3 percent in the second quarter and first six months of 2004, respectively. The increases in the company’s average selling prices of 6.6 percent in the second quarter of 2005 and 5.5 percent for the first six months of 2005 were not able to keep pace with the rate of raw material cost increases of approximately 12 percent for both the second quarter and first six months of 2005 as compared to last year.
Selling, General and Administrative (SG&A) Expenses: SG&A expenses of $78.5 million in the second quarter of 2005 increased $0.8 million from $77.7 million of SG&A expenses in the second quarter of 2004. The effects of stronger foreign currencies versus the U.S. dollar added approximately $1.2 million to the SG&A expenses in the second quarter of 2005 as compared to the second quarter of 2004. Severance and other related costs associated with the information technology outsourcing and the Full/Valu Specialty cost reduction initiatives discussed in the Overview resulted in increased SG&A expenses of $2.6 million as compared to last year. Due to improved financial performance in 2005 as compared to 2004, management incentive compensation expenses increased $1.3 million in the second quarter of 2005 as compared to the same period in 2004. This figure was net of a $1.2 million reversal of an accrual related to a long-term incentive compensation plan for which the final performance results and subsequent payouts were not determined until the second quarter of 2005. The Sekisui-Fuller joint venture in Japan resulted in a reduction in SG&A expenses in the second quarter of 2005 of $1.0 million as compared to last year. Additional decreases in expenses were realized through headcount reductions and other cost control measures. Employee census in the SG&A category decreased by 166 employees from May 29, 2004 to May 28, 2005, excluding the effect of transferring the Japan Adhesives business to the Sekisui-Fuller joint venture.
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For the first six months of 2005 SG&A expenses of $158.8 million were $5.7 million or 3.7 percent higher than the first six months of 2004. The increase due to stronger foreign currencies was $2.6 million. In addition to the expense increases from the information technology outsourcing and the Full/Valu Specialty cost reduction initiatives, other significant SG&A expense increases resulted from the company’s Probos acquisition in 2004, increases in expenses associated with the company’s pension and other postretirement benefit plans, severance costs due to the first quarter departure of certain managers and executives and costs incurred in the first quarter related to the investigation of the company’s Chilean operations as discussed in the 2004 annual report filed on Form 10-K on February 25, 2005. SG&A expense decreases resulted from overall cost controls, headcount reductions and cost savings resulting from a variety of Lean Six SigmaSM projects.
As a percent of net revenue, SG&A expenses were 20.2 percent in the second quarter of 2005 and 21.4 percent in the second quarter of 2004. Through six months of 2005 and 2004 the percentages were 21.4 percent and 22.5 percent, respectively.
Gains from Sales of Assets: The second quarter of 2005 included gains from sales of assets of $5.0 million. As mentioned previously in this report, the sale of the company’s 20 percent interest in its China entities to Sekisui Chemical resulted in a gain of $4.8 million. Through six months of 2005 gains from sales of assets were $6.8 million. In addition to the gain on the sale of 20 percent interest in the China entities in the second quarter, the first quarter of 2005 included a $1.7 million gain on the sale of a European facility that had been closed as part of the company’s 2002 restructuring initiative. There were no significant gains or losses on sales of assets in the second quarter or first six months of 2004.
Other Expense, Net: Other expense, net was $0.5 million in the second quarter of 2005 as compared to $2.3 million in the second quarter of 2004. Foreign currency transaction and remeasurement losses were $0.5 million in the second quarter of 2005 and $1.0 million in the second quarter of 2004. Increased interest income, life insurance proceeds in 2005 and other miscellaneous items accounted for the remainder of the reduced expenses in the second quarter of 2005 as compared to the second quarter of 2004. Through the first six months of 2005, other expense, net was $0.8 million versus $3.3 million in the first six months of 2004. The foreign currency related losses were $0.8 million in 2005 and $1.6 million in 2004.
Interest Expense: Interest expense of $2.9 million in the second quarter of 2005 was $0.7 million less than the interest expense in the second quarter of 2004. The repayment in the first quarter of 2005 of $22 million relating to the company’s 1994 private placement was the primary reason for the lower interest expense in the second quarter of 2005 as compared to the second quarter of 2004. For the first half of 2005, interest expense was $6.2 million versus $7.2 million for the same period in 2004.
Income Taxes: The effective income tax rate was 32.7 percent in the second quarter of 2005 as compared to 32.8 percent in the second quarter of 2004. The $4.8 million pretax gain resulting from the sale of investment in China was taxed at a 35.4 percent rate. Pretax income, excluding the China gain was taxed at an effective rate of 32.0 percent. For the first six months of 2005 the effective tax rate was 32.5 percent versus 32.6 in the first six months of 2004.
Minority Interests (Expense)/Income: Minority interests was income of $0.2 million in the second quarter of 2005 and $0.2 million of expense in the second quarter of 2004. Reduced earnings from the company’s North American automotive joint venture, of which it owns 70 percent, was the primary reason for the minority interests income. Through six months of 2005 minority interests income was $0.5 million versus expense of $0.1 million in the first six months of 2004.
Income from Equity Investments: Income from equity investments was $0.7 million in the second quarter of 2005 and $0.4 million in the second quarter of 2004. Income from the company’s 30 percent ownership interest in an automotive joint venture with a European company accounted for $0.6 million in 2005 and the company’s 40 percent ownership in the new Japanese joint venture mentioned previously accounted for $0.1 million in the second quarter of 2005. Through six months of 2005 the income from equity investments was $1.2 million versus $0.9 million for the same period of 2004.
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Net Income: Net income of $16.2 million in the second quarter of 2005 was 45.1 percent more than the net income of $11.2 million in the second quarter of 2004. The income per diluted share was $0.56 in the second quarter of 2005 and $0.39 in the second quarter of 2004. The gain realized from the sale of the 20 percent ownership interest in China accounted for $3.1 million of net income and $0.11 per diluted share in the second quarter of 2005. The net income of $22.7 million through the first six months of 2005 increased 43.9 percent from the $15.8 million recorded in the first half of 2004. Income per diluted share was $0.78 and $0.55 in the first six months of 2005 and 2004, respectively.
Operating Segment Results
Note: Management evaluates the performance of its operating segments based on operating income which is defined as gross profit less SG&A expenses and excluding the gains/(losses) on sales of assets. Corporate expenses are fully allocated to the operating segments.
Global Adhesives: Net revenue in the Global Adhesives operating segment of $273.3 million in the second quarter of 2005 was 6.7 percent higher than the net revenue of $256.2 million in the second quarter of 2004. Through six months of 2005 net revenue in Global Adhesives of $523.8 million was 9.5 percent above last year. The following table shows the net revenue variance analysis for both the second quarter and the first six months:
Six Months
2005 vs
The focus on increasing selling prices in response to the escalating pace of raw material cost increases gained momentum in the second quarter as evidenced by the 7.5 percent increase in net revenue attributed to pricing. The selling price increases still were not enough to prevent a reduction in the gross profit margin from the second quarter of 2004 as raw material costs continued their upward movement. The margin did increase slightly from the first quarter of 2005. Efficiency improvements in the manufacturing areas resulting from Lean Six SigmaSM projects helped to mitigate the raw material cost increases. There was some slippage in Global Adhesives sales volume in the quarter as certain competitors maintained their lower selling prices in spite of the higher raw material costs. The net revenue decrease due to acquisitions/divestitures resulted from the contribution of the Japanese adhesives entity to the new joint venture formed with Sekisui Chemical. SG&A expenses in the second quarter of 2005 were 3.7 percent less than the second quarter of 2004. Severance and other costs related to the outsourcing of certain I.T. functions, as discussed earlier in this report, added $1.4 million to the 2005 SG&A expenses. The effects from currency fluctuations added approximately $1.0 million to the Global Adhesives expenses in the second quarter of 2005. Focused cost control resulted in the overall decline in expenses from the second quarter of 2004. The resulting operating income of $15.0 million was 13.1 percent higher than the $13.2 million achieved in the second quarter of 2004. As a percent of net revenue, operating income in the Global Adhesives segment was 5.5 percent as compared to 5.2 percent in the second quarter of 2004.
For the first six months of 2005 the gross profit margin in Global Adhesives decreased 1.5 percentage points from the first half of 2004. The rate of raw material cost increases exceeded the rate at which the company was able to raise its selling prices. SG&A expenses increased 2.9 percent in the first half of 2005 as compared to last year. Increases due to currency fluctuations, severance and other related costs, increased pension and other benefit plan expenses were partially mitigated by cost control measures and benefits from completed Lean Six SigmaSM projects. The operating income through the first six months of 2005 of $20.6 million was 2.1 percent above the $20.2 million recorded in the first six months of 2004.
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Full-Valu/Specialty: Net revenue in the second quarter of 2005 for the Full-Valu/Specialty segment of $114.6 million was 7.2 percent above the net revenue recorded in the second quarter of 2004 of $106.9 million. Through six months of 2005 net revenue in Full-Valu/Specialty of $217.1 million was 6.8 percent above last year.
The net revenue variance analysis is shown in the following table:
As with Global Adhesives, selling price increases continue to be a key area of focus in response to the continuation of increased raw material costs. The insulating glass sealants and ceramic tile installation product lines had strong sales growth in the quarter as compared to last year. Both of these product lines also had strong first quarter sales growth. The gross profit margin in this segment decreased 2.8 percentage points in the second quarter of 2005 versus the second quarter of 2004. In addition to the higher raw material costs, the second quarter gross profit margin was negatively impacted by increases in transportation costs and higher LIFO inventory reserves. SG&A expenses in the second quarter of 2005 increased 9.6 percent from the second quarter of 2004. The 2005 expenses included $1.2 million of severance and other related expenses associated with the previously discussed initiatives. Operating income of $6.1 million in the second quarter of 2005 was 33.7 percent less than last year’s second quarter operating income of $9.2 million. As a percent of net revenue, operating income was 5.3 percent in the second quarter of 2005 and 8.6 percent in the second quarter of 2004.
Through the first six months of 2005 the gross profit margin decreased by 1.6 percentage points from the first six months of 2004. The 4.4 percent net revenue increase from pricing was not enough to offset the increased raw material costs. SG&A expenses increased 5.3 percent in the first six months of 2005 as compared to the first six months of 2004. Operating income for the first half of 2005 was $10.8 million versus $12.6 million for the same period in 2004. As a percent of net revenue the operating income was 5.0 percent and 6.2 percent in 2005 and 2004, respectively.
Restructuring and Other Related Costs
The remaining liabilities accrued as part of the 2002 restructuring plan were $1.1 million and $3.1 million as of May 28, 2005 and November 27, 2004, respectively. Details of the activity for fiscal 2005 are as follows:
(in thousands)
Employee
Severance
and Benefits
The long-term portion of the restructuring liabilities relate to adverse lease commitments that are expected to be paid beyond one year. The largest cash payment made in 2005 related to $1.8 million of lease termination costs for one facility. In the first quarter of 2005, a gain of $1.7 million was recognized from the sale of one facility closed as part of the restructuring plan.
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Liquidity and Capital Resources
The company’s financial condition remains strong. Cash and cash equivalents totaled $81.7 million as of May 28, 2005 versus $67.0 million at November 27, 2004 and $10.5 million at May 29, 2004. The capitalization ratio, defined as total debt divided by total debt plus total equity, was 21.1 percent at May 28, 2005, 24.0 percent at November 27, 2004 and 25.6 percent as of May 29, 2004.
Cash Flows from Operating Activities: Cash provided from operating activities was $27.6 million in the first six months of 2005 as compared to $42.7 million in the first six months of 2004. The 2005 figure includes a first quarter payment of $9.5 million, recorded in other accrued expenses, related to the establishment of a defined contribution pension plan in Austria in 2004. Changes in inventory accounted for a reduction in cash provided from operating activities of $13.1 million in the first half of 2005 as compared to a reduction of $3.7 million in the first half of 2004. Accounts payable increases accounted for increased cash flow of $5.6 million in the first half of 2004 and a reduction in cash flow of $7.0 million in the first half of 2005. A key metric monitored by management is net working capital as a percentage of annualized net revenue (current quarter multiplied by four). Net working capital is defined as trade receivables, net of allowance for doubtful accounts plus inventory minus trade payables. That percentage was 16.7 percent at the end of the second quarter of 2005 versus 17.0 percent at the end of the fourth quarter of 2004 and 18.7 percent for the second quarter of 2004. Additional key metrics are trade accounts receivable days sales outstanding (DSO) and inventory days on hand as shown in the following table:
Accounts Receivable DSO
Inventory Days on Hand
These metrics may not be calculated the same at all companies. The calculations used by the company are as follows:
Cash Flows from Investing Activities: Investing activities contributed $15.5 million of positive cash flow in the first half of 2005 as compared to cash outflows from investing activities of $33.1 million in the first six months of 2004. The major components of the 2005 activities were as follows:
Last year’s investing activities included the $22 million acquisition of the Probos businesses in Portugal. Purchases of property, plant and equipment were $12.2 million in the first six months of 2005 and $13.9 million in the first six months of 2004. For the full year of 2005 purchases of property, plant and equipment are expected to approximate $35 to $40 million.
Cash Flows from Financing Activities: Financing activities resulted in a use of cash of $26.2 million in the first six months of 2005 as compared to cash used by financing activities in the first six months of 2004 of $2.4 million. Financing activity in 2005 included the first quarter repayment of $22 million related to the company’s 1994 private placement debt. Cash dividends paid were $6.9 million in the first two quarters of 2005 and $6.5 million in the first two quarters of 2004.
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Management believes the company’s ongoing operating cash flows provide sufficient amounts of cash to fund expected investments and capital expenditures. In addition, the company has sufficient access to capital markets to meet currently anticipated growth and acquisition funding requirements.
Forward-Looking Statements and Risk Factors
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In this Quarterly Report on Form 10-Q, the company discusses expectations regarding future performance of the company which include anticipated financial performance, savings from restructuring and process initiatives, global economic conditions, liquidity requirements, the effect of new accounting pronouncements and one-time accounting charges and credits, and similar matters. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of words like “plan,” “expect,” “aim,” “believe,” “project,” “anticipate,” “intend,” “estimate,” “will,” “should,” “could” (including the negative or variations thereof) and other expressions that indicate future events and trends. These plans and expectations are based upon certain underlying assumptions, including those mentioned with the specific statements. Such assumptions are in turn based upon internal estimates and analyses of current market conditions and trends, management plans and strategies, economic conditions and other factors. These plans and expectations and the assumptions underlying them are necessarily subject to risks and uncertainties inherent in projecting future conditions and results. Actual results could differ materially from expectations expressed in the forward-looking statements if one or more of the underlying assumptions and expectations proves to be inaccurate or is unrealized. In addition to the factors described in this report, the following are some of the important factors that could cause the company’s actual results to differ materially from those in any such forward-looking statements. In order to comply with the terms of the safe harbor, the company hereby identifies important factors which could affect the company’s financial performance and could cause the company’s actual results for future periods to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Additionally, the variety of products sold by the company and the regions where the company does business makes it difficult to determine with certainty the increases or decreases in revenues resulting from changes in the volume of products sold, currency impact, changes in product mix and selling prices. However, management’s best estimates of these changes as well as changes in other factors have been included. These factors should be considered, together with any similar risk factors or other cautionary language which may be made elsewhere in this Quarterly Report on Form 10-Q.
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The company may refer to this section of the Form 10-Q to identify risk factors related to other forward looking statements made in oral presentations, including investor conferences and/or webcasts open to the public.
The foregoing list of important factors does not include all such factors nor necessarily present them in order of importance. This disclosure, including that under “Forward-Looking Statements and Risk Factors,” and other forward-looking statements and related disclosures made by the company in this report and elsewhere from time to time, represents management’s best judgment as of the date the information is given. The company does not undertake responsibility for updating any of such information, whether as a result of new information, future events, or otherwise, except as required by law. Investors are advised, however, to consult any further public company disclosures (such as in filings with the Securities and Exchange Commission or in company press releases) on related subjects.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market Risk: The company is exposed to various market risks, including changes in interest rates, foreign currency rates and prices of raw materials. Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates.
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Interest Rate Risk: Exposure to changes in interest rates result primarily from borrowing activities used to fund operations. Committed floating rate credit facilities are used to fund a portion of operations.
Management believes that probable near-term changes in interest rates would not materially affect financial condition, results of operations or cash flows. The annual impact on net income of a one-percentage point interest rate change on the outstanding balance of its variable rate debt as of May 28, 2005 would be approximately $0.1 million.
Foreign Exchange Risk: As a result of being a global enterprise, there is exposure to market risks from changes in foreign currency exchange rates, which may adversely affect operating results and financial condition. Approximately 51 percent of net revenue was generated outside of the United States in the first six months of 2005. Principal foreign currency exposures relate to the euro, British pound sterling, Japanese yen, Australian dollar, Canadian dollar, Argentine peso and Brazilian real.
Management’s objective is to balance, where possible, local currency denominated assets to local currency denominated liabilities to have a natural hedge and minimize foreign exchange impacts. The company enters into cross border transactions through importing and exporting goods to and from different countries and locations. These transactions generate foreign exchange risk as they create assets, liabilities and cash flows in currencies other than the local currency. This also applies to services provided and other cross border agreements among subsidiaries.
Management takes steps to minimize risks from foreign currency exchange rate fluctuations through normal operating and financing activities and, when deemed appropriate, through the use of derivative instruments. Management does not enter into any speculative positions with regard to derivative instruments.
From a sensitivity analysis viewpoint, based on the financial results of the first six months of 2005, a hypothetical overall 10 percent change in the U.S. dollar would have resulted in a change in net income of approximately $1.6 million.
Raw Materials: The principal raw materials used to manufacture products include resins, polymers, synthetic rubbers, vinyl acetate monomer and plasticizers. The company generally avoids sole source supplier arrangements for raw materials. While alternate sources for most key raw materials are available, if worldwide supplies were disrupted due to unforeseen events, or if unusual demand causes products to be subject to allocation, shortages could occur.
Management’s objective is to purchase raw materials that meet both its quality standards and production needs at the lowest total cost. Most raw materials are purchased on the open market or under contracts that limit the frequency but rarely limit the magnitude of price increases. In some cases, however, the risk of raw material price changes is managed by strategic sourcing agreements which limit price increases to increases in supplier feedstock costs, while requiring decreases as feedstock costs decline. The leverage of having substitute raw materials approved for use wherever possible is used to minimize the impact of possible price increases.
Item 4. Controls and Procedures
(a) Disclosure controls and procedures
As of the end of the period covered by this report, the company conducted an evaluation, under the supervision and with the participation of the company’s chief executive officer and chief financial officer, of the company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on this evaluation, and due to the material weakness in the company’s internal control over financial reporting in the company’s Chilean accounting operations as discussed below and as reported in the company’s Annual Report on Form 10-K for the year ended November 27, 2004, the chief executive officer and chief financial officer concluded that, as of May 28, 2005, the company’s disclosure controls and procedures were not effective to ensure that information
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required to be disclosed by the company in reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
(b) Change in internal control over financial reporting
The company is responsible for establishing and maintaining adequate internal control over financial reporting. The company’s internal control system was designed to provide reasonable assurance to the company’s management and the board of directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
As of November 27, 2004 the company’s assessment of the effectiveness of its internal control over financial reporting identified a material weakness in the company’s internal control over financial reporting in the company’s Chilean accounting operations due to insufficient supervision and oversight of certain local accounting personnel. Specifically, there was no review of the local books and records of the smaller locations within the Latin America region, which includes the Chilean operations, by regional financial management or internal audit. As a result of the material weakness in internal control, the company’s financial statements were misstated from 1999 through the third quarter of 2004, due to the intentional recording of incorrect accounting entries by local accounting personnel under the supervision of the Chilean financial controller. This material weakness is discussed in greater detail in the company’s Annual Report on Form 10-K for the year ended November 27, 2004.
During the first six months of 2005 the company has implemented, or is in the process of implementing, the following remediation steps to address the material weakness discussed above:
The company believes that, once fully implemented, these remediation steps will correct the material weakness discussed above.
Except as discussed above, there were no changes in the company’s internal control over financial reporting during its most recently completed fiscal quarter that have materially affected or are reasonably likely to materially affect its internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Environmental Matters. From time to time, the company is identified as a “potentially responsible party” under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) and similar state laws that impose liability for costs relating to the cleanup of contamination resulting from past spills, disposal or other release of hazardous substances. The company is also subject to similar laws in some of the countries where current and former plants are located. The company’s environmental, health and safety department monitors compliance with all applicable laws on a global basis.
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Currently the company is involved in various environmental investigations, clean-up activities and administrative proceedings or lawsuits. In many of these matters, the company has entered into participation agreements, consent decrees or tolling agreements. One of these environmental matters involves the investigation of environmental contamination at the company’s Sorocaba, Brazil facility. The company is working with Brazilian regulatory authorities to determine the necessary scope of remediation at the facility. As of May 28, 2005, $1.3 million was recorded as a liability for expected investigation and remediation expenses remaining for this site. Once the full scope of any necessary remediation is determined, the company may be required to record additional liabilities related to investigation and remediation costs at the Sorocaba facility.
The company’s management reviews the circumstances of each individual site, considering the number of parties involved, the level of potential liability or contribution of the company relative to the other parties, the nature and magnitude of the hazardous wastes involved, the method and extent of remediation, the estimated legal and consulting expense with respect to each site and the time period over which any costs would likely be incurred. The company accrues appropriate reserves for potential environmental liabilities, which are continuously reviewed and adjusted as additional information becomes available. As of May 28, 2005, the company had reserved $2.8 million, which represents its best estimate of probable liabilities with respect to environmental matters, inclusive of the accrual related to the Sorocaba facility as described above. However, the full extent of the company’s future liability for environmental matters is difficult to predict because of uncertainty as to the cost of investigation and cleanup of the sites, the company’s responsibility for such hazardous waste and the number of and financial condition of other potentially responsible parties.
From time to time, management becomes aware of compliance matters relating to, or receives notices from federal, state or local entities regarding possible or alleged violations of environmental, health or safety laws and regulations. In some instances, these matters may become the subject of administrative proceedings or lawsuits and may involve monetary sanctions of $0.1 million or more (exclusive of interest and litigation costs).
While uncertainties exist with respect to the amounts and timing of the company’s ultimate environmental liabilities, based on currently available information, management does not believe that these matters, individually or in the aggregate, will have a material adverse effect on the company’s financial condition, results of operations or cash flows. However, adverse developments could negatively impact earnings or cash flows in a particular future period.
Other Legal Proceedings. From time to time and in the ordinary course of business, the company is a party to, or a target of, lawsuits, claims, investigations and proceedings, including product liability, contract, patent and intellectual property, antitrust and employment matters. While the company is unable to predict the outcome of these matters, it does not believe, based upon currently available facts, that the ultimate resolution of any pending matter, including the EIFS and asbestos litigation described in the following paragraphs, will have a material adverse effect on its overall financial condition, results of operations or cash flows. However, adverse developments could negatively impact earnings or cash flows in a particular future period.
As disclosed in prior filings, a subsidiary of the company is a defendant or co-defendant in numerous exterior insulated finish systems (“EIFS”) related lawsuits. As of May 28, 2005, the company’s subsidiary was a defendant or co-defendant in approximately 70 lawsuits and 6 claims related primarily to single-family homes. The EIFS product was used primarily in the residential construction market in the southeastern United States. Claims and lawsuits related to this product line seek monetary relief for water intrusion related property damages. One of the lawsuits is a class action lawsuit purportedly involving 186 members, and some of the lawsuits involve EIFS in commercial or multi-family structures. As of May 28, 2005, the company had recorded $3.6 million for the probable liabilities remaining and $1.1 million for insurance recoveries for all such matters. The company has insurance coverage for certain years with respect to this product line. The company continually reevaluates these amounts. Management does not believe that the ultimate outcome of any pending legal proceedings and claims related to this product line, individually or in aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows. However, projecting future events, such as the number of new claims to be filed each year, the average cost of disposing of each such claim, as well as the numerous uncertainties surrounding litigation in the United States, could cause the actual costs to be higher or lower than the current estimated reserves or insurance recoveries.
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As previously reported, over the years, the company has been named as a defendant in lawsuits in various state courts in which plaintiffs alleged injury due to exposure to products manufactured by the company more than 20 years ago that contained asbestos. These cases generally seek unspecified damages for asbestos-related diseases. These lawsuits frequently seek both actual and punitive damages, often in very large amounts. In many cases, plaintiffs are unable to demonstrate that they have suffered any compensable loss as a result of such exposure or that injuries incurred in fact resulted from exposure to products manufactured by the company or its subsidiaries. In such cases, the company is generally dismissed without payment. With respect to those cases where compensable disease, exposure and causation are established with respect to one of the company’s products, the company generally settles for amounts that reflect the confirmed disease, the seriousness of the case, the particular jurisdiction and the number and solvency of other parties in the case. Substantially all of these cases have involved multiple co-defendants and the company is typically a de minimis party.
During fiscal years 2004 and 2005, insurance or indemnification from solvent third parties in accordance with applicable policies or contracts paid virtually all of the defense costs associated with the company’s asbestos litigation. As previously reported, during 2003, the company’s insurers replaced the cost sharing agreement, which had previously provided for the allocation of settlement payments among the insurers with an interim allocation formula. Under this formula, the company has funded settlement amounts allocable to years in which the responsible insurer is insolvent. The company and its insurers have also engaged in negotiations with respect to the terms of a new cost sharing arrangement, which may result in a continuation or alteration of the interim allocation formula. As previously reported and accounted for during the third quarter of 2004, the company and a group of other defendants entered into negotiations with a group of plaintiffs to settle a number of asbestos-related lawsuits. Subject to finalization of certain terms and conditions of settlement, the company has agreed to contribute $3.5 million towards the settlement amount to be paid to the plaintiffs in exchange for a full release of claims by the plaintiffs. Of this amount, the company’s insurers have agreed to pay approximately $1.2 million. To the extent the company can reasonably estimate the amount of its probable liability in asbestos-related matters, the company will establish a financial provision in an amount that it deems to be adequate and a corresponding receivable amount for insurance coverage if certain criteria are met.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Upon vesting of restricted stock awarded by the company to employees, shares are withheld to cover the employees’ withholding taxes. Information on the company’s purchases of equity securities during the first quarter follows:
Period
(a)
Number
of Shares
Purchased
(b)
Average
Price
Paid
per Share
(c)
Total Number
Purchased as
Part of Publicly
Announced
Plans or
Programs
(d)
Maximum
Number of
Shares that
May Yet Be
Under the
Programs (at
end of period)
February 27, 2005 – April 2, 2005
April 3, 2005 – April 30, 2005
May 1, 2005 – May 28, 2005
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Item 4. Submission of Matters to a Vote of Security Holders
Proposal 1 - Election of Directors for a term expiring at the 2008 Annual Meeting of Shareholders:
Director Name
J. Michael Losh
Lee R. Mitau
R. William Van Sant
Knut Kleedehn, Richard L. Marcantonio, Alfredo L. Rovira, Albert P. L. Stroucken and John C. van Roden, Jr. continued to serve as directors following the meeting.
Proposal 2 - Proposal to Ratify the Appointment of KPMG LLP as the Registrant’s independent auditors for the fiscal year ending December 3, 2005:
For
25,688,963
Item 6.
Exhibits
Lean Six SigmaSM is a registered service mark of The George Group Incorporated.
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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.
Dated: July 1, 2005
/s/ John A. Feenan
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Exhibit Index