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ACO > SEC Filings for ACO > Form 10-K/A on 3-Apr-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations


We are a global company focused on long term profitability growth through the development and application of minerals and technology products and services to various industrial and consumer markets. The majority of our revenue growth has been achieved by sustaining our products' technological advantages, developing new products and applying them in innovative ways, bringing additional products and services to markets we already serve, and overall growth in the industries we serve. We focus our research and development activities in areas where we can either leverage our current customer relationships and mineral reserves or enhance existing or related products and services.

The principal mineral that we utilize to generate revenues is bentonite. We own or lease bentonite reserves in the U.S., Australia, China and Turkey. Additionally, through our affiliates and joint ventures, we have access to bentonite reserves in Egypt, India, and Mexico. We also develop applications for other minerals, including chromite ore from our mine in South Africa.

Bentonite is surface mined when it is commercially feasible to have it shipped to a plant for further processing, including crushing, drying, milling and packaging. Bentonite deposits have varying physical properties which require us to identify which markets our reserves can serve. Nicknamed the mineral of a thousand uses, bentonite's unique characteristics include its ability to bind, swell, adsorb, control rheology, soften fabrics, and have its surface modified through chemical and physical reactions. Our research and development activities, including our understanding of bentonite properties, mining methods, processing and application to markets are some of the core components of our longevity and future prospects.

We operate in five segments: minerals and materials, environmental, oilfield services, transportation and corporate. Both our minerals and materials and environmental segments operate manufacturing facilities in North America, Europe, and the Asia-Pacific region. Our minerals and materials segment also owns and operates a chrome mine in South Africa. Our oilfield services segment principally operates in the Gulf of Mexico and surrounding states and also has a growing presence in South America, Africa and Asia. Additionally, we have a transportation segment that provides trucking services for our domestic minerals and materials and environmental segments as well as third parties.

Our customers are engaged in various end-markets and geographic regions. Customers in the minerals and materials segment range from foundries that produce castings for automotive, industrial, and transportation equipment, including heavy-duty trucks and railroad cars, to producers of consumer goods, including cat litter, cosmetics and laundry care. Customers in our environmental segment include construction contractors, engineering contractors and government agencies. The oilfield services segment's customer base is primarily comprised of oil and natural gas service or exploration companies.

A significant portion of our products have been used in the same applications for decades and have experienced minimal technological obsolescence. A majority of our sales are made pursuant to short-term agreements; therefore, terms of sale, such as pricing and volume, can change within our fiscal year.

A majority of our revenues are generated in the Americas, principally North America. Consequently, the state of the U.S. economy, and especially the metalcasting and commercial construction industries, impacts our revenues. Our fastest growing markets are in the Asia-Pacific and European regions, which have continued to outpace the U.S. in economic growth.

Sustainable, long-term profit growth is our primary objective. We employ a number of strategic initiatives to achieve this goal:

? Organic growth: The central component of our growth strategy is expansion of our product lines and market presence. We have a history of commitment to research and development activities directed at bringing innovative products to market. We believe this approach to growth offers the best probability of achieving our long-term goals at the lowest risk.

? Globalization: As we have done for decades, we continue to expand our manufacturing and marketing organizations into emerging geographic markets. We see significant opportunities in the Asia-Pacific and European regions for expanding our revenues and earnings over the long-term as a number of markets we serve, such as metalcasting and lining technologies, are expected to grow in these areas. We expect to take advantage of these growth areas, either through our wholly-owned subsidiaries or investments in affiliates and joint ventures.

? Mineral development: Bentonite is a component in many of the products we supply. Since it is a natural material, we must continually expand our reserve base to maintain a long-term business. Our goal is to add new reserves to replace the bentonite mined each year. Furthermore, we need to assure that new reserves meet the physical property requirements for our diverse product lines and are economical to mine. Our organization is committed to developing its global reserve base to meet these requirements.

? Acquisitions: We continually seek to acquire complementary businesses, as appropriate, when we believe those businesses are fairly valued and fit into our growth strategy.

There can be no assurance that we will achieve success in implementing any one or more of the strategic initiatives described above.

A number of risks will challenge us in meeting our long-term objectives. We describe certain of these risks, such as competition and our reliance on economically sensitive markets, under "Item 1A. Risk Factors" and "Item 7A. Quantitative and Qualitative Disclosures About Market Risk." We intend to manage these risks actively, but there can be no assurance of our success to do so.

Critical Accounting Policies and Estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations describes relevant aspects of our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to select accounting policies that are appropriate for our business, and to make certain estimates, judgments and assumptions about matters that are inherently uncertain in applying those policies. On an ongoing basis, we re-evaluate these estimates, judgments and assumptions for reasonableness because of the critical impact that these factors have on the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results may differ from these estimates.

Our financial statements are based in part upon critical accounting policies that involve complex and subjective decisions and assessments. Our senior management has discussed the development, selection and disclosure of these policies with the members of the Audit Committee of our Board of Directors. We believe our selection of accounting policies has resulted in actual results approximating the estimated amounts in each respective area. These policies are discussed below and also in Note 1 of the Notes to Consolidated Financial Statements. The discussion which follows should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K/A.

Valuation of Accounts Receivable

We provide credit to customers in the ordinary course of business and perform ongoing credit evaluations. Our customer base is diverse and includes customers located throughout the world. Payment terms in certain of the foreign countries in which we do business are longer than those that are customary in the U.S., and, as a result, may give rise to additional credit risk related to outstanding accounts receivable from these non-U.S. customers. Likewise, a change in the financial position, liquidity or prospects of any of our customers could have an impact on our ability to collect amounts due. While concentrations of credit risk related to trade receivables are somewhat limited by our large customer base, we do extend significant credit to some of our customers.

We make estimates of the amounts of our gross accounts receivable that will not be collectible, and record an allowance for doubtful accounts to reduce the carrying value of accounts receivable to the amount that is expected to be realized. The allowance for doubtful accounts is established based upon our historical bad debt experience, a review of the overall aging of the accounts, and an analysis of specific customer accounts, particularly those with past-due balances. The recorded allowance for doubtful accounts is intended to cover specific customer collection issues identified by management at the balance sheet date and to provide for potential losses from other accounts based on our historical experience. Increases in the allowance for doubtful accounts are recorded as an expense and included in general, selling and administrative expenses in the period identified. Our estimate of the required allowance for doubtful accounts is a critical accounting estimate because it is susceptible to changes in customer payment patterns, dynamics of the industries in which we operate, our judgments about the future collectibility of customer accounts, and other factors.

Inventory Valuation

Inventories are recorded at the lower of cost or net realizable value. In addition, we regularly review inventory quantities on hand and evaluate significant items to determine whether they are excess or obsolete. We record the value of estimated excess or obsolete inventory as a reduction of inventory and as an expense in cost of sales in the period it is identified. Our estimate of excess and obsolete inventory is a critical accounting estimate because it is susceptible to changes in estimates of the future demand for inventory, customer purchasing behaviors, competition, and other factors.

Our process to evaluate inventories for excess or obsolete items is comprehensive. We quantify the amount of inventory on hand that, based on projected demand, is not anticipated to be sold within the next 12 to 24 months or, based on our current product offerings, is excess or obsolete. This involves a review by sales and production management personnel to determine whether this list of potential excess or obsolete inventory is complete. Factors which impact this evaluation include, for example, whether there has been a change in the market or packaging for particular products, and whether there are components of inventory that incorporate obsolete formulations or technology. In certain businesses in which we are engaged, such as our domestic cat litter and personal care business, product and packaging changes can occur rapidly and expose us to excess and obsolete inventories.

Goodwill and Long-lived Assets

Our goodwill and intangible assets have largely arisen from business combinations or acquisitions that we have completed. We follow the guidance in Accounting Standard Codification ("ASC") Topic 805 related to business combinations when initially recognizing the fair value of assets and liabilities acquired in a business combination. Under these guidelines, we are required to recognize the fair value of the intangible assets we acquire in a business combination. These are typically customer related assets, trademarks and trade names and non-compete agreements. We are required to make significant estimates as to the nature of these customer relationships including future profitability and longevity of the relationships. We are also required to make significant estimates regarding the probability and impact of competition from former owners or management employees of businesses we acquire. These estimates are critical as we make them from the viewpoint of a market participant; they involve forecasting future results; and they contain uncertainties regarding the customers served by the acquired business.

For property, plant and equipment and intangible assets with finite lives, we evaluate the recoverability of these assets whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. For goodwill and indefinite lived intangible assets, we perform our impairment assessment annually or more frequently if impairment indicators arise. This assessment is made at the reporting unit level for goodwill and at the individual asset level for indefinite lived intangible assets.

In conducting our goodwill impairment tests and in testing the recoverability of long-lived assets, we primarily use discounted cash flow models to estimate the fair value of our reporting units and long-lived assets. Critical assumptions used in conducting these tests include expectations of our business performance and financial results, useful lives of assets, and discount rates as well as comparable market data and our market capitalization.

In evaluating the recoverability of our indefinite lived intangible assets, we make several critical assumptions as to the applicable market royalty rate and discount rates as well as the future performance of the assets underpinning those intangibles.

Our estimates related to the carrying values of these assets are considered to be critical accounting estimates because they are susceptible to change from period to period based on our judgments about a variety of factors and due to the uncontrollable variability of market factors underlying them. For example, judgment is required to determine whether events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. In addition, in performing assessments of the carrying values of these assets, we must make judgments about our future business; economic, regulatory, and political conditions affecting these assets; appropriate risk-related rates for discounting estimated future cash flows; and reasonable estimates of disposal values.

Based on business conditions and market values that existed at October 1, 2011, we concluded that no impairment loss was required. However, the market value of our common stock continues to fluctuate and if, among other factors, (1) our equity value declines, (2) the fair value of our reporting units decline, (3) we don't achieve our expected future results, or (4) the adverse impacts of economic or competitive factors are worse than anticipated, we could conclude in future periods that impairment losses are required in order to reduce the carrying value of our goodwill, other intangible assets, or other long-lived assets. Depending on the severity of the changes in the key factors underlying the respective impairment tests, such losses could be significant.

Retirement Benefits

We sponsor a qualified defined benefit pension plan for substantially all of our U.S. employees hired before January 1, 2004. We also sponsor a supplementary pension plan ("SERP") that provides benefits in excess of qualified plan limitations for certain employees. In order to measure the expense and obligations associated with these retirement benefits, we estimate various factors used in valuing the associated assets and liabilities, such as discount rates, expected return on plan assets, rate of compensation increases, employee turnover rates, retirement rates, mortality rates and other factors. Our benefit plan committee determines the key assumptions related to the discount rate, expected investment rate of return, long term rate of compensation increases, and other assumptions based on consultation with our actuaries. The most important assumptions that affect the computations are the discount rate and the expected long-term rate of return on plan assets.

Our discount rate assumption is intended to reflect the rate at which the retirement benefits could be effectively settled based upon the assumed timing of the benefit payments. In determining the discount rate for December 31, 2011, we utilized the Aon Hewitt AA Bond Universe yield curve, which is a hypothetical double A yield curve comprised of a series of annualized individual discount rates. The discount rates are derived from hypothetical zero coupon bonds which are given equal maturities within their maturity groups. The discount rate used to determine our retirement pension benefit obligation at December 31, 2011 was 4.70% for the qualified defined benefit plan and 4.63% for our SERP. A 50 basis point decrease in this discount rate would have increased the benefit obligation at December 31, 2011 by $5.7 million and would increase our net cost expected in 2012 by 16%, or $625 thousand. Likewise at December 31, 2011, a 50 basis point increase in the discount rate would have decreased the benefit obligation by $5.1 million and would decrease our net cost expected in 2012 by 15%, or $568 thousand.

The expected long-term rate of return on defined benefit plan assets was based on our current asset allocations and their historical long-term performance, adjusted for existing market conditions. Information regarding our asset allocations is included in the Notes to Consolidated Financial Statements in "Item 8. ­Financial Statements and Supplementary Data." We assumed a weighted-average expected long-term rate of return on pension plan assets of 7.50% to determine our net defined benefit pension plan expense in 2011. A 50 basis point decrease in the expected return would increase the net cost expected in 2012 by approximately 6%, or $173 thousand. Likewise, a 50 basis point increase in the expected return would decrease the net cost expected in 2012 by approximately 6%, or $173 thousand.

Income Taxes

Our effective tax rate is based on the income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our effective tax rate and in evaluating our tax positions. We account for our tax positions in accordance with the guidance for accounting for uncertainty in income taxes codified in ASC Topic 740, and thus our effective tax rate includes the impact of changes to our liability for uncertain tax positions.

Our estimates of income tax items, expenses and reserves are considered to be critical accounting estimates because they are susceptible to change from period to period based on rulings by various taxing authorities, changes in tax laws, changes in projected levels of taxable income and availability of future tax planning strategies. On a quarterly basis, these estimates are more critical as they involve estimates of our taxable income expected for the remainder of the fiscal year by taxing jurisdiction.

In addition, our effective tax rate reflects the impact of certain undistributed foreign earnings for which no U.S. taxes have been provided because such earnings are planned to be reinvested indefinitely outside the U.S. Most of the amounts held outside the U.S. could be repatriated to the U.S., but would be subject to U.S. federal income taxes and foreign withholding taxes, less applicable foreign tax credits or deductions.

Valuation allowances are recorded, if necessary, to measure a deferred tax asset at the amount that will more likely than not be realized. Both positive and negative evidence are considered in forming our judgment as to whether a valuation allowance is appropriate. Changes in a valuation allowance are recorded in the period when we determine events have occurred that will impact the realizable value of the asset.

A number of years may elapse before a particular matter is audited and finally resolved. Audits of our U.S. federal income tax returns have been completed for our income tax returns relating to fiscal years of 2009 and prior. State income tax returns are audited less frequently. Unfavorable settlement of any particular issue would require use of our cash and could result in the recording of additional tax expense. Favorable resolution would be recognized as a reduction to our tax provision in the year of resolution.

Accounting for Long Term Contracts

Our Environmental and Oilfield Services segments generate sales and revenues under long term contracts with customers. Where applicable, these revenues and related costs are accounted for under the percentage of completion revenue recognition method whereby revenues are recognized as completion occurs, which can be generally measured by either the costs incurred in relation to the total expected costs to complete the contract or the amount of product installed in relation to the total amount expected to be installed. In addition, we recognize losses on contracts in the period in which we first forecast a loss will occur on the overall contract. This revenue recognition methodology requires that we continually update our estimates of costs to complete a contract. Thus, our sales and revenues and related costs are subject to fluctuation depending on changes in estimates of the costs to complete a contract overall.

Results of Operations for the Three Years Ended December 31, 2011

The discussion below references the consolidated statement of operations included in "Item 8. Financial Statements and Supplementary Data" and, as more fully described in Note 2 to the Consolidated Financial Statements contained in this Amendment No. 1, is based on amounts which have been restated.

Consolidated Income Statement Review

The following table compares our operating results for the past three years.

                                                        Year Ended December 31,
         Consolidated               2011          2010          2009         2011 vs.       2010 vs.
                                  Restated      Restated      Restated         2010           2009
                                                        (Dollars in Thousands)
Continuing Operations
Net sales                         $ 943,796     $ 826,277     $ 687,485           14.2 %         20.2 %
Cost of sales                       691,479       612,092       503,194
Gross profit                        252,317       214,185       184,291           17.8 %         16.2 %
margin %                               26.7 %        25.9 %        26.8 %
Selling, general and
administrative expenses             166,231       145,173       134,947           14.5 %          7.6 %
Operating profit                     86,086        69,012        49,344           24.7 %         39.9 %
margin %                                9.1 %         8.4 %         7.2 %
Other income (expense):
Interest expense, net               (11,070 )      (9,584 )     (11,994 )         15.5 %        -20.1 %
Other, net                              233         1,241          (315 )            *              *
                                    (10,837 )      (8,343 )     (12,309 )

Income before income taxes and
income (loss) from affiliates
and joint ventures                   75,249        60,669        37,035
Income tax expense                   20,786        20,302         5,363            2.4 %        278.6 %
Income before income (loss)
from affiliates and joint
ventures                             54,463        40,367        31,672
Income (loss) from affiliates
and joint ventures                    5,235       (10,997 )           6              *              *
Income from continuing
operations                           59,698        29,370        31,678

Discontinued Operations
Income (loss) on discontinued
operations                           (1,162 )        (887 )         259              *              *

Net income (loss)                    58,536        28,483        31,937          105.5 %        -10.8 %

Net income (loss) attributable
to noncontrolling interests              15          (752 )        (105 )            *              *

Net income attributable to
AMCOL shareholders                   58,521        29,235        32,042          100.2 %         -8.8 %

* Not meaningful

The following analysis comments on the significant fluctuations in our results for the past three years by material category. The comments are organized in relation to our company's overall results in general followed by a detailed discussion of these general comments as they relate to each segment individually and in detail.

Net sales

The following tables detail components of consolidated 2011 and 2010 sales changes over their respective prior years:

             2011 vs. 2010                  Base Business      Acquisitions       Foreign         Total
                Restated                                                          Exchange
Minerals and materials                                 6.8 %             0.0 %          0.5 %         7.3 %
Environmental                                          2.4 %             0.1 %          0.7 %         3.2 %
Oilfield services                                      4.7 %             0.0 %          0.3 %         5.0 %
Transportation & intersegment sales                   -1.3 %             0.0 %          0.0 %        -1.3 %
Total                                                 12.6 %             0.1 %          1.5 %        14.2 %
% of change                                           88.9 %             0.7 %         10.4 %       100.0 %

             2010 vs. 2009                  Base Business      Acquisitions                              Total
                Restated                                                         Foreign Exchange
Minerals and materials                                10.7 %             0.0 %                 1.0 %        11.7 %
Environmental                                          2.8 %             0.2 %                 0.3 %         3.3 %
Oilfield services                                      4.5 %             0.0 %                 0.4 %         4.9 %
Transportation & intersegment sales                    0.3 %             0.0 %                 0.0 %         0.3 %
Total                                                 18.3 %             0.2 %                 1.7 %        20.2 %
% of change                                           90.6 %             1.0 %                 8.4 %       100.0 %

Base or organic business represents operations owned for more than one year whereas acquisitions are those owned less than one year. We did not make any significant acquisitions in the past three years. Foreign exchange isolates the impact of currency changes over the prior-year period.

The impact of the 2008 - 2009 recession is evident in our revenue fluctuations as shown in the above tables. As the global economic recovery was underway in 2010, sales increased organically in most of our segments. The largest increase was in our minerals and materials segment, which significantly benefitted from increased sales of its metalcasting products, especially to those service customers supplying the automotive industry. This growth continued into 2011 with approximately 47% of our consolidated revenue growth occurring in our metalcasting product line within our minerals and materials segment. Growth in our oilfield services segment comprised approximately 35% of our overall revenue growth in 2011, notably due to growth in our coil tubing services.

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