1998 Annual Report - MDA
Annual Report ContentsManagement's Discussion and Analysis Of Financial Condition and Results of Operations
This annual report contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These statements present (without limitation) the expectations, beliefs, plans and objectives of management and future financial performance and/or assumptions underlying or judgments concerning matters discussed in this document. These discussions and any other discussions contained in this annual report, except to the extent that they contain historical facts, are forward-looking and accordingly involve estimates, assumptions, judgments and uncertainties; in particular, this pertains to management's comments on financial resources, capital spending and the outlook for each of the Company's business segments. In addition to certain contingency matters and their respective cautionary statements discussed elsewhere in this annual report, the Forward-Looking Statements section of this Management's Discussion and Analysis indicates some important factors that could cause actual results or outcomes to differ materially from those addressed in the forward-looking statements.
Total sales for GenCorp in 1998 increased 11 percent to $1.74 billion versus $1.57 billion in 1997. Total segment operating profit, excluding unusual items, increased to $160 million in 1998 from $152 million in 1997, a 5 percent improvement. Net income was $84 million in 1998 compared to $137 million in 1997. Excluding unusual items and tax settlements, net income increased to $79 million in 1998 from $70 million in 1997. Diluted earnings per share totaled $1.99 per share in 1998. Earnings per diluted share before unusual items and a tax settlement were $1.88 in 1998, an increase of 9 percent compared to $1.72 in 1997.
Other (income) expense as disclosed in the Company's Consolidated Statement of Income was favorably impacted in fiscal 1997 by the collection of a note receivable and interest from a 1996 divestiture and reimbursement of expenses related to an environmental settlement.
Financial Resources and Capital Spending
Cash flow provided by operating activities for fiscal 1998 was $134 million compared to $169 million in 1997 and $59 million in 1996. Excluding tax settlements, cash flow for 1998 improved due to better operating performance and lower working capital requirements. Cash flow for 1997 was favorably impacted by the receipt of a federal income tax settlement (see Note G - Income Taxes) and reimbursement of expenses related to an environmental settlement. Cash flow from operating activities for 1997 excluding those items was $98 million.
In fiscal 1998, $363 million was used for investing activities including $294 million for acquisitions and capital expenditures of $88 million offset by proceeds of $19 million from asset dispositions. The acquisitions included Sequa Corporation's specialty chemicals unit for $108 million, Walker Greenbank's commercial wallcovering business for $112 million and The Goodyear Tire & Rubber Company's Calhoun, Georgia latex facility for $74 million. This is compared to $79 million used for investing activities in fiscal 1997, which included the acquisition of Printworld for $47 million and capital expenditures of $58 million offset by proceeds of $26 million from asset dispositions.
Cash flow provided by financing activities in fiscal 1998 primarily included a $261 million increase in debt offset by payments of $25 million in dividends. The net increase in debt as of November 30, 1998 was primarily due to the three acquisitions made during 1998 related to the Performance Chemicals (formerly Specialty Polymers) and Decorative & Building Products businesses. At November 30, 1997, total debt decreased to $109 million primarily due to the conversion of $115 million in debentures and the application of the proceeds from the tax settlement.
Capital expenditures were made and are planned principally for capacity expansion and asset replacement, cost reduction, safety and productivity improvements and environmental protection. Capital expenditures totaled $88 million in 1998, $58 million in 1997 and $47 million in 1996. The Company's total capital expenditures in 1999 are currently projected to be approximately $110 million. The increased capital expenditure program includes support of Aerojet's Space-Based Infrared System (SBIRS) and Sense and Destroy Armor (SADARM) programs and the Fine Chemicals product line, program launches for automotive, enhanced printer and coater capabilities within the Decorative & Building Products business unit and the pilot plant renovation of the Performance Chemicals business unit.
Management believes that funds generated from operations and existing borrowing capacity are adequate to finance planned capital expenditures, company-sponsored research and development programs and dividend payments to shareholders.
Unusual Items
During 1998, the Company incurred unusual items resulting in income of $5 million. Unusual items included charges of $8 million primarily related to exiting the plastic extrusions appliance gasket and residential wallcovering businesses offset by a gain of $13 million from the sale of surplus land in Nevada by Aerojet.
During 1996, the Company recognized net unusual charges of $42 million. These charges included a provision of $15 million for an early retirement program at the Company's headquarters and technology center, a net loss on the sale of divested businesses of $10 million (see Note D - Acquisitions, Divestitures and Subsequent Events), a provision for environmental remediation costs associated with the Company's Lawrence, Massachusetts facility of $8 million (see Note R - Contingencies), a restructuring charge of $3 million for the Company's Vehicle Sealing business unit, a charge of $2 million to reduce fixed assets to net realizable value and a provision of $4 million for pension and other related matters.
Subsequent Events
The Company announced on December 17, 1998, that it plans to spin off its Performance Chemicals and Decorative & Building Products businesses to GenCorp shareholders as a separate publicly traded polymer products company. Following the spin-off, GenCorp would continue to operate Aerojet, its aerospace, defense and fine chemicals segment, and its automotive Vehicle Sealing business unit. Implementation of the plan is subject to approval by GenCorp shareholders, the receipt of a favorable ruling from the Internal Revenue Service, as well as market conditions at the time of the proposed spin-off.
On December 2, 1998, the Company acquired the U.S. acrylic emulsion polymers business of PolymerLatex, located in Fitchburg, Massachusetts, for $9 million.
On December 14, 1998, the Company sold its residential wallcovering business to Blue Mountain Wallcoverings, Inc. for an aggregate consideration of approximately $9 million. The loss on the sale of this business was reflected in the 1998 results of operations.
Also on December 14, 1998, the Company announced it had initiated the process for divesting its Penn Racquet Sports division for which the Company expects to realize a gain on the divestiture.
Aerospace and Defense
Sales in 1998 for Aerojet were $673 million, an increase of 15 percent from 1997 sales of $584 million.
The increase is due to significantly higher volume in the SBIRS, EMD program and Fine Chemicals product line and modest increases in the Titan, Delta, F-22, Special Sensor Microwave Imager/Sounder (SSMIS) programs and Tactical product line. The increases were partially offset by lower volume in SADARM, Defense Support Program (DSP), Joint Tactical Ground Station (JTAGS) and Strategic & Space technology programs.
Aerojet's segment operating profit in 1998 was $68 million, as compared to $55 million in 1997. Operating profit margins improved to 10.1 percent in 1998 from 9.4 percent in 1997. The increase was due to the higher sales volume and improved contract performance.
Contract backlog for Aerojet was $1.7 billion at the end of fiscal 1998, compared to $1.9 billion at the end of fiscal 1997 and $2.0 billion at the end of fiscal 1996. Funded backlog, which includes only the amount of those contracts for which money has been directly authorized by Congress, totaled $0.6 billion at the end of fiscal 1998, compared to $0.7 billion at the end of fiscal 1997 and $0.6 billion at the end of fiscal 1996.
Outlook
Aerojet's contract base remains stable. Significant long-term contract awards received over the last three years will favorably affect all major product areas in 1999 and beyond and contribute to sustained sales growth. Contract backlog remains at a healthy level.
1997 Results
Sales in 1997 for Aerojet were $584 million, an increase of 18 percent from 1996 sales of $494 million. The increase was due to higher volume in the SBIRS, SSMIS, SADARM, Advanced Medium Range Air to Air Missile (AMRAAM) and HAWK tactical missile programs and the Fine Chemicals product line. The increase was partially offset by lower volume in the Titan, Standard Missile and Satellite Readout Station Upgrade (SRSU) programs.
Aerojet's segment operating profit in 1997 was $55 million, an increase of 31 percent compared to $42 million in 1996. The increase was primarily due to higher sales volume and improved contract performance. Aerojet's operating margins improved to 9.4 percent in 1997 from 8.5 percent in 1996.
Automotive
Sales for the automotive segment, the Vehicle Sealing business unit, totaled $375 million in 1998 compared to $369 million in 1997. The sales increase of 2 percent was due primarily to higher volumes on General Motors' GMT 325/330 Blazer/Jimmy, Ford Explorer and Mercedes AAV programs as well as several new program launches, which were partially offset by the impact of the General Motors strike. During 1998, Vehicle Sealing launched production on the General Motors Grand AM (GMX-130), Ford Ranger (PN-63),
Ford F-Series Full Size Pickup (PN-96) and General Motors Sierra Pickup (GMT-800). Although these programs added sales volume in 1998, the full year impact will be realized in 1999.
Segment operating profit for the automotive business in 1998 was $3 million compared to $29 million in 1997. Operating results were negatively impacted by the strike at General Motors, a work stoppage at the Company's Batesville, Arkansas facility, higher than anticipated launch costs and operating losses from the divested Plastic Extrusions division.
Outlook
The automotive business continues to target light trucks and sport utility vehicles, the most profitable and fastest growing segment of the automotive market. During 1999, the automotive business will experience full year vehicle volumes for the new programs on the GMT-800, GMX-130, PN-96 and PN-63. During 1999, launch costs for the automotive segment are expected to decrease as programs launched in 1998 mature and fewer launches occur in 1999. The automotive business segment will be well positioned in 1999 with a strong mix of the best selling and most popular cars, pickup trucks and sport utility vehicles. As launch and development costs subside, profit margins are expected to return to historical levels by year-end.
1997 Results
Sales for the automotive business segment totaled $369 million in 1997 compared to $448 million in 1996 which included $48 million related to businesses that were sold. The decrease in sales from continuing businesses of 8 percent was due primarily to the reduction in volume on several key automotive platforms and lower volume and competitive pricing pressure in the refrigerator gasket business.
Segment operating profit for the automotive business was $29 million in 1997 and $19 million in 1996. Excluding the negative operating profit of $6 million related to automotive businesses sold in 1996, operating profits were $25 million in 1996. The improvement was due primarily to cost reduction initiatives and improved profit margins on product lines for the Vehicle Sealing business unit. Automotive's operating margin for continuing businesses improved to 7.9 percent in 1997 from 6.3 percent in 1996.
Polymer Products
Sales increased 12 percent to $689 million in 1998 from $615 million in 1997. Performance Chemicals led the improvement with higher revenues, primarily related to recent acquisitions. Decorative & Building Products also had higher sales during the year, related to an increase in sales in its European wallcovering, building systems, decorative laminates and coated fabrics product lines. Penn Racquet Sports and residential wallcovering posted lower sales than in fiscal 1997.
Segment operating profit in 1998 increased to $89 million from $68 million in 1997, a 31 percent increase. The increase was primarily due to the increase in sales volume and lower raw material pricing. Similarly, polymer products' operating margins increased to 12.9 percent from 11.1 percent.
During 1998, Decorative & Building Products acquired Walker Greenbank's commercial wallcovering business, which resulted in the Company becoming the worldwide market share leader for commercial wallcovering. In December 1998, Decorative & Building Products sold its residential wallcovering product line, enabling it to focus on growth in more attractive commercial markets. As a result of the sale, the Company reduced its estimate for the valuation reserve for idle fixed assets that it recorded in the second quarter of 1998 by $5 million in the fourth quarter of 1998. Also in 1998, Performance Chemicals completed the acquisitions of the Calhoun, Georgia latex polymer plant and Sequa Corporation's U.S. specialty chemicals operations. This allowed Performance Chemicals to diversify its product lines and expand into markets for the acrylics, vinyl acetate and specialty areas. In December 1998, Performance Chemicals also announced the acquisition of the PolymerLatex acrylics plant in Fitchburg, Massachusetts, further enhancing the business unit's technologies and capacity to serve numerous end markets.
Outlook
The businesses within the polymer products segment are expected to maintain or strengthen their market positions. Sales growth in 1999 will be driven by the businesses acquired in 1998 and will be dependent on the economic conditions of the various markets. Segment operating profit will be influenced by sales growth and changes in raw material prices. As discussed under Subsequent Events, the Company announced that it plans to spin off the majority of its polymer products business segment to GenCorp shareholders as a separate publicly traded company. The Company has also announced that it has initiated the process of divesting its Penn Racquet Sports division and has sold its residential wallcovering business.
1997 Results Sales increased 7 percent to $615 million in 1997 from $573 million in 1996. The improvement was primarily due to volume increases across paper coating and Lytronš product lines at Performance Chemicals, as well as volume growth in the commercial wallcovering and roofing product lines, and the Printworld acquisition at Decorative & Building Products. This increase was partially offset by sales declines in the residential wallcovering and plastic film lines at Decorative & Building Products.
Segment operating profit in 1997 was $68 million compared to $72 million in 1996 excluding unusual items. Similarly, polymer products' operating margins declined to 11.1 percent from 12.6 percent. The decrease was attributable to lower average selling prices and increased raw material costs at Performance Chemicals and increased raw material costs and start-up market costs relative to new product offerings at Decorative & Building Products. The decrease was partially offset by increased profits at Penn Racquet Sports due to aggressive cost reduction programs.
Environmental Matters
GenCorp's policy is to conduct its businesses with due regard for the preservation and protection of the environment. The Company devotes a significant amount of resources and management attention to environmental matters and actively manages its ongoing processes to comply with extensive environmental laws and regulations. The Company is involved in the remediation of environmental conditions which resulted from generally accepted manufacturing and disposal practices in the 1950s and 1960s. In addition, the Company has been designated a potentially responsible party, with other companies, at sites undergoing investigation and remediation.
In 1998, capital expenditures for projects related to the environment were approximately $6 million, compared to $6 million in 1997 and $11 million in 1996. The Company currently forecasts that capital expenditures for environmental projects will approximate $11 million and $6 million in 1999 and 2000, respectively. During 1998, noncapital expenditures for environmental compliance and protection totaled $47 million, of which $16 million was for recurring costs associated with managing hazardous substances and pollution abatement in ongoing operations and $31 million was for investigation and remediation efforts at other sites. Similar noncapital expenditures were $43 million and $29 million in 1997 and 1996, respectively. It is presently expected that noncapital environmental expenditures will decrease slightly for the next several years.
The nature of environmental investigation and cleanup activities often makes it difficult to determine the timing and amount of any estimated future costs that may be required for remedial measures. However, the Company reviews these matters and accrues for costs associated with the remediation of environmental pollution when it becomes probable that a liability has been incurred and the amount of the liability (usually based upon proportionate sharing) can be reasonably estimated. The Company's Consolidated Balance Sheet at November 30, 1998 reflects accruals of $279 million and amounts recoverable of $165 million from the U.S. Government and other third parties for such costs.
The effect of resolution of environmental matters on results of operations cannot be predicted due to the uncertainty concerning both the amount and timing of future expenditures and future results of operations. However, management believes, on the basis of presently available information, that resolution of these matters will not materially affect liquidity, capital resources or the consolidated financial condition of the Company. The Company will continue its efforts to mitigate past and future costs through pursuit of claims for insurance coverage and continued investigation of new and more cost effective remediation alternatives and associated technologies. For additional discussion of environmental matters, refer to Note R - Contingencies.
Information Systems and the Year 2000
The Company is currently engaged in a comprehensive project to upgrade its information, technology, manufacturing and facilities computer hardware and software programs to address the Year 2000 issue at its domestic and international businesses. Many of the Company's systems include new hardware and updated software packages purchased from established vendors who have represented that these systems are Year 2000 ready. The Company does not have large centralized systems, a factor, which the Company believes, reduces the risk of a single point of failure having wide-spread impact on the Company.
As part of this project, the Company has formally communicated with all of its significant suppliers, vendors and large customers to determine the extent to which the Company is vulnerable to those parties' failures to correct their own Year 2000 issues. As of November 30, 1998, the Company has received approximately two-thirds of the responses, and those responses generally indicate that these parties will be Year 2000 ready.
The Company has completed an inventory and assessment of its information technology systems. Both internal and external resources are being utilized to test the Company's software for Year 2000 readiness and, where necessary, the systems are being remediated through upgrading, replacement or reprogramming. Also, the Company is taking an inventory of its non-information technology (embedded) systems, prioritizing the impact of each of these systems on the Company's ability to conduct its operations and, as necessary, obtaining vendor verification and/or remediation of those systems. The process of analyzing, prioritizing, remediating and testing will be an iterative process until all critical systems are Year 2000 ready.
The estimated cost for this project is projected to range between $7 million and $10 million, which is being funded through operating cash flows. The Company has spent approximately $1 million as of November 30, 1998 on this project, most of which has been for internal remediation efforts and expects to spend a significant amount of the remaining budget in the first quarter of 1999. The Company believes that approximately 40 percent of its systems are Year 2000 ready as of December 31, 1998, approximately another 30 percent will be Year 2000 ready by the end of first quarter 1999 and the remainder by mid-year 1999. For example, the Company has been audited by the Automotive Industry Action Group (AIAG) and General Motors and has received a "green" rating indicating that the Company's Automotive systems are on target to become Year 2000 ready.
Based upon currently available information and considering the Company's diversified business base, decentralized systems and Year 2000 efforts, management believes that the most reasonably likely worst case scenario could result in minor short-term business interruptions. The Company is preparing contingency plans which include alternative sourcing to minimize any disruptions to its businesses resulting from a vendor or supplier not being Year 2000 ready. However, failure by the Company and/or vendors and customers to complete Year 2000 readiness work in a timely manner could have a material adverse effect on certain of the Company's operations. The Company's exposure could increase or its timetable for Year 2000 readiness could be delayed as a result of any new acquisitions.
Adoption of the Euro
Based upon a preliminary evaluation, management believes that the adoption of the Euro by the European Economic Community will not have a material impact on the Company's international businesses. The Company's foreign operations currently are small and each operation conducts the majority of its business in a single currency with minimal price variations between countries.
Quantitative and Qualitative Disclosure About Market Risk
The Company is exposed to market risk from changes in interest rates on long-term debt obligations. The Company's policy is to manage interest rates through the use of a combination of fixed and variable rate debt. Currently, the Company does not use derivative financial instruments to manage its interest rate risk. Substantially all of the Company's long-term debt of $359 million which matures in the year 2001 is variable and had an average variable interest rate of 5.8 percent at November 30, 1998. The Company's long-term debt bears interest at market rates and therefore, the carrying value approximates fair value.
Although the Company conducts business in foreign countries, international operations were not material to the Company's consolidated financial position, results of operations or cash flows as of November 30, 1998. Additionally, foreign currency transaction gains and losses were not material to the Company's results of operations for the year ended November 30, 1998. Accordingly, the Company should not be subject to material foreign currency exchange rate risk with respect to future costs or cash flows from its foreign subsidiaries. To date, the Company has not entered into any significant foreign currency forward exchange contracts or other derivative financial instruments to hedge the effects of adverse fluctuations in foreign currency exchange rates. The Company is evaluating the future use of such financial instruments.
Forward-Looking Statements
This annual report contains information that is forward-looking, including material contingencies as described in the Notes to Consolidated Financial Statements. The outcomes of forward-looking statements and material contingencies could differ materially from those discussed due to inherent economic risks and changes in prevailing governmental policies and regulatory actions.
Some important factors that could cause the Company's actual results or outcomes to differ from those expressed in its forward-looking statements include, but are not limited to, the following:
- General economic trends affecting the Company's markets
- Governmental and regulatory policies including environmental regulations
- The Company's acquisition activities
- Vehicle sales and production rates of major automotive programs including Ford and General Motors' light trucks and SUVs
- Department of Defense, NASA and other funding for critical aerospace programs including SBIRS, SADARM, Titan and Kistler
- The market for the Company's Penn Racquet Sports division
- The market for the Company's real estate in Sacramento, California
- Raw material prices for chemical feed stocks including polyvinyl chloride, styrene and butadiene
- The ability of the Company and its customers and vendors to successfully modify and convert its systems to be Year 2000 ready
- Fluctuations in exchange rates of foreign currencies and other risks associated with foreign operations
In addition, some important factors that could affect the Company's ability to complete the proposed spin-off of the Performance Chemicals and Decorative & Building Products businesses, and the performance of the Company and the new company after the spin-off, include, but are not limited to, the following:
- The Company's ability to obtain a ruling from the Internal Revenue Service confirming the tax-free nature of the spin-off
- The Company's ability to obtain the approval of its shareholders for the spin-off
- General market conditions affecting the valuation of the Company and the new company
- The Company's ability to obtain debt ratings acceptable to it and the market
- The ability of the Company and the new company to allocate or refinance the Company's current indebtedness on terms acceptable to the companies and the market
Additional risk factors may be described from time to time in the Company's filings with the Securities and Exchange Commission. All such risk factors are difficult to predict, contain material uncertainties that may affect actual results and may be beyond the Company's control.