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OMN > SEC Filings for OMN > Form 10-K on 24-Jan-2014All Recent SEC Filings

Show all filings for OMNOVA SOLUTIONS INC

Form 10-K for OMNOVA SOLUTIONS INC


24-Jan-2014

Annual Report


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

Overview

The Company is an innovator of emulsion polymers, specialty chemicals, and engineered surfaces for a variety of commercial, industrial and residential end uses. As discussed in Item 1. Business, the Company operates two reportable business segments: Performance Chemicals and Engineered Surfaces. The Performance Chemicals segment produces a broad range of emulsion polymers and specialty chemicals based primarily on styrene butadiene (SB), styrene butadiene acrylonitrile (SBA), styrene butadiene vinyl pyridine, nitrile butadiene (NBR), polyvinyl acetate, acrylic, styrene acrylic, vinyl acrylic, glyoxal, fluorochemicals and bio-based chemistries. Performance Chemicals' custom-formulated products include hollow plastic pigment, resins, binders, adhesives, specialty rubbers, antioxidants and elastomeric modifiers which are used in paper and packaging, specialty coatings, carpet, nonwovens, construction, oil/gas drilling and recovery, adhesives, tape, tires, floor care, textiles, graphic arts, polymer stabilization, industrial rubbers & hoses, bio-based polymers and various other specialty applications. The Engineered Surfaces segment develops, designs, produces and markets a broad line of functional and decorative surfacing products, including coated fabrics, surface laminates and performance films. These products are used in numerous applications, including commercial building refurbishment, remodeling and new construction, kitchen and bath cabinets, transportation including automotive, bus and other mass transit, marine and motorcycle, recreational vehicles and manufactured housing, flooring, commercial and residential furniture, retail display fixtures, home furnishings and commercial appliances, and performance films for pool liners, banners, tents, ceiling tiles and medical devices. Please refer to Item 1. Business, of this Annual Report on Form 10-K for further description of and background on the Company's operating segments.

The Company primarily sells its products directly to manufacturers.

The Company has strategically located manufacturing facilities in the United States, France, China, India and Thailand.

The Company has historically experienced stronger sales and income in its second, third and fourth quarters, comprised of the three-month periods ending May 31, August 31, and November 30. The Company's performance in the first quarter (December through February) has historically been weaker and less profitable due to generally lower levels of customer manufacturing, construction and refurbishment activities during the holidays and cold weather months.

The Company's chief operating decision maker, its CEO, evaluates performance and allocates resources by operating segment. Segment information has been prepared in accordance with authoritative guidance promulgated by the Financial Accounting Standards Board ("FASB"). The Company's two operating segments were determined based on products and services provided. Accounting policies of the segments are the same as those described in Note A-Significant Accounting Policies, of the Company's Consolidated Financial Statements. For a reconciliation of the Company's segment operating performance information, please refer to Note R of the Company's Consolidated Financial Statements.

A majority of the Company's raw materials are derived from petrochemicals and chemical feedstocks whose prices are cyclical and volatile. Generally, the Company attempts to pass along increased raw material prices to customers in the form of price increases of its products, however, due to sales contracts with certain customers, there may be a time delay between increased raw material prices and the Company's ability to increase the prices of its products. Additionally, the Company may also experience, from time to time, competitive price pressures and other factors which may not allow it to increase the prices of its products.

OMNOVA's Performance Chemicals segment had sales price index contracts related to approximately 44% of its sales in 2013 and 2012 and approximately 45% for 2011. Customers with sales price index contracts are primarily in the Performance Materials product line. The index is generally comprised of a negotiated fixed amount per pound and the market price of key raw materials (i.e., styrene and butadiene). The contract mechanisms generally allow for the pass-through of the changes, either increases or decreases, in the prices of key raw materials within a 30 to 60 day period. Contracts vary in length from 12 to 36 months.

The remainder of Performance Chemicals' sales are not indexed. OMNOVA periodically negotiates with each customer regarding pricing changes based on the raw material components and the value-added and performance attributes of OMNOVA's product. OMNOVA's pricing objective, which may or may not be met, is to recover raw material price increases within a 30 to 60 day period.

Styrene, a key raw material component, is generally available worldwide, and OMNOVA has supply contracts with several producers. OMNOVA believes there is adequate global capacity to serve demand. OMNOVA's styrene purchases for 2010 through 2013 and an estimated range of market prices are as follows:

     Pounds Purchased (in millions)   Market Price Range Per Pound
2013              172                        $0.71 - $0.93
2012              177                        $0.57 - $0.78
2011              205                        $0.65 - $0.77
2010              180                        $0.54 - $0.68


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Butadiene, a key raw material component, is generally available worldwide, but its price is volatile. OMNOVA has supply contracts with several producers. At times, when the demand of butadiene exceeds supply, it is sold on an allocated basis. OMNOVA's butadiene purchases for 2010 through 2013 and an estimated range of market prices are as follows:

     Pounds Purchased (in millions)   Market Price Range Per Pound
2013              139                        $0.44 - $1.01
2012              158                        $0.84 - $1.98
2011              175                        $0.86 - $1.77
2010              135                        $0.63 - $0.94

OMNOVA's Engineered Surfaces segment does not utilize sales price index contracts with its customers; rather, it negotiates pricing with each customer. OMNOVA's pricing objective, which may or may not be met, is to recover raw material price increases within a 90 day period. Key raw materials utilized by the Engineered Surfaces segment include polyvinyl chloride (PVC) resins, textiles and plasticizers. These raw materials are generally readily available worldwide from multiple suppliers.

Key Indicators
Key economic measures relevant to the Company include global economic growth rates, discretionary spending for durable goods, print advertising, oil and gas drilling levels, U.S. commercial real estate occupancy rates, U.S. office furniture sales, manufactured housing shipments, housing starts and sales of existing homes and forecasts of raw material pricing for certain petrochemical feed stocks. Key OEM industries which provide a general indication of demand drivers to the Company include paper, commercial and residential construction and refurbishment, automotive and tire products, furniture manufacturing, flooring manufacturing and ABS manufacturing. These measures provide general information on trends relevant to the demand for the Company's products but the trend information does not necessarily directly correlate with demand levels in the markets which ultimately use the Company's products.
Key operating measures utilized by the business segments include orders, sales and pricing, working capital turnover, inventory, productivity, new product vitality, cost of quality and order fill-rates which provide key indicators of business trends. These measures are reported on various cycles including daily, weekly and monthly depending on the needs established by operating management. Key financial measures utilized by management to evaluate the results of its businesses and to understand the key variables impacting the current and future results of the Company include: sales and pricing; gross profit; selling, general and administrative expenses; adjusted operating profit; adjusted net income; and consolidated earnings before interest, taxes, depreciation and amortization ("EBITDA") as set forth in the Net Leverage Ratio in the Company's $200,000,000 Term Loan Credit Agreement, working capital, operating cash flows, capital expenditures, cash interest expense and adjusted earnings per share, including applicable ratios such as inventory turnover, working capital turnover, return on sales and assets and leverage ratios. These measures, as well as objectives established by the Board of Directors of the Company, are reviewed at monthly, quarterly and annual intervals and compared with historical periods.

Results of Operations of 2013 Compared to 2012

The Company's net sales in 2013 were $1,018.1 million compared to $1,125.5 million in 2012. The Performance Chemicals business segment revenue decreased by 10.6% and the Engineered Surfaces business segment revenue decreased 6.1%. Contributing to the net sales decrease in 2013 were reduced volumes of $50.5 million, or 4.5%, and reduced pricing of $58.3 million, partially offset by favorable currency exchange translation effects of $1.4 million. Lower pricing in Performance Chemicals, which was due to lower year-over-year raw material costs, was partially offset by improved pricing in Engineered Surfaces.

Gross profit in 2013 was $212.7 million with a gross profit margin of 20.9% compared to gross profit of $227.2 million and a gross profit margin of 20.2% in 2012. The increase in gross profit margin was primarily due to better sales mix and cost reduction actions.

Selling, general and administrative expense in 2013 decreased $3.1 million, to $118.1 million, or 11.6% of sales, compared to $121.2 million, or 10.8% of net sales in 2012. The decrease in 2013 was primarily due to lower employee headcount and reduced annual incentive compensation expense.

Interest expense was $31.9 million and $36.5 million for 2013 and 2012, respectively. The decrease is primarily due to lower borrowing spreads as a result of a March 2013 refinancing and lower foreign borrowings. Also, included in interest expense for 2012 is approximately $1.3 million related to an expired interest rate swap.

Income tax expense was $6.0 million in 2013, a 22.6% effective income tax rate, compared to income tax expense of $11.2 million, or a 30.3% effective tax rate in 2012. The lower rate in 2013 was primarily due to income in foreign jurisdictions where the rate is lower than the U.S. domestic federal statutory rate, one-time tax benefits relating to operations that were sold, other discrete foreign tax items and a U.S. item, all of which totaled $2.4 million. Cash tax payments in the U.S. are expected to be minimal for the next few years as the Company has $113.6 million of U.S. federal net operating loss carryforwards, $108.9 million of state and local net operating loss carryforwards, $0.4 million of foreign tax credit carryforwards and $0.2 million of AMT credit carryforwards. The majority of the federal, state and local net operating loss carryforwards expire between 2022 and 2032.

The Company has not provided for U.S. income taxes on certain of its non-U.S. subsidiaries' undistributed earnings as such amounts are considered permanently reinvested outside the U.S. To the extent that foreign earnings previously treated as permanently reinvested are repatriated, the related U.S. tax liability may be reduced by any foreign income taxes paid on these earnings. However, based on the Company's policy of permanent reinvestment, it is not practicable to determine the U.S. federal income tax liability, if any, which would be payable if such earnings were not permanently reinvested. As of November 30, 2013, the non-U.S. subsidiaries have a cumulative unremitted foreign earnings income position of $62.5 million.


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The Company generated income from continuing operations of $20.5 million or $0.44 per diluted share in 2013 compared to $25.7 million or $0.56 per diluted share in 2012. Included in 2013 are gains on asset sales of $4.9 million primarily due to the sale of the Company's Taicang, China facility and Columbus, Mississippi property, plant and equipment, and a write-off of deferred financing fees of $1.5 million as a result of refinancing actions and an impairment charge of $0.9 million on a note receivable. Included in 2012 are asset impairment charges of $1.0 million relating to equipment at the Columbus, Mississippi and Taicang, China facilities.

Segment Discussion

The following Segment Discussion presents information used by the Company in assessing the results of operations by business segment. The Company believes that this presentation is useful for providing the investor with an understanding of the Company's business and operating performance because these measures are used by the chief operating decision maker, the CEO, in evaluating performance and allocating resources.

The following table reconciles segment sales to consolidated net sales and segment operating profit (loss) to consolidated income before income taxes. The Company's commercial wallcovering businesses, which have historically been included in the Engineered Surfaces segment, have been reclassified to discontinued operations due to actions taken by the Company to sell those businesses and, as such, the following discussion does not include results of operations for the commercial wallcovering businesses.

                                                                         Year Ended
                                                                        November 30,
                                                                     2013           2012
                                                                    (Dollars in millions)
Segment Sales:
Performance Chemicals
Performance Materials                                            $     272.2     $   343.2
Specialty Chemicals                                                    500.8         521.3
Total Performance Chemicals                                      $     773.0     $   864.5

Engineered Surfaces
Coated Fabrics                                                   $     108.9     $   117.0
Laminates and Performance Films                                        136.2         144.0
Total Engineered Surfaces                                              245.1         261.0
Consolidated Net Sales                                           $   1,018.1     $ 1,125.5

Segment Gross Profit:
Performance Chemicals                                            $     155.4     $   177.2
Engineered Surfaces                                                     57.3          50.0
Consolidated Gross Profit                                        $     212.7     $   227.2

Segment Operating Profit:
Performance Chemicals                                            $      64.1     $    89.6
Engineered Surfaces                                                     15.6           3.8
Interest expense                                                       (31.9 )       (36.5 )
Corporate expense                                                      (19.8 )       (20.0 )
Deferred financing fees write-off                                       (1.5 )           -
Consolidated income from continuing operations before income tax $      26.5     $    36.9

Performance Chemicals

Performance Chemicals' net sales decreased $91.5 million to $773.0 million during 2013 compared to $864.5 million during 2012. The decrease was primarily due to reduced customer pricing of $61.1 million, or 7.1%, as a result of lower raw material costs and their impact on index pricing as well as competitive pricing pressure in Performance Materials product lines. Also impacting net sales were reduced volumes of $29.8 million, or 3.4%, and unfavorable foreign currency translation effects of $0.6 million. Net sales for the Performance Materials product line decreased $71.0 million to $272.2 million during 2013 compared to $343.2 million during 2012 driven by lower volumes in both paper and chemical markets of $41.3 million and reduced pricing of $29.7 million. Net sales for the Specialty Chemicals product line decreased $20.5 million to $500.8 million during 2013 compared to $521.3 million during 2012 due to reduced customer pricing of $31.4 million and unfavorable foreign currency translation, partially offset by improved volumes of $11.5 million as sales increased in oilfield solutions, coatings, nonwovens and antioxidants.

Performance Chemicals' gross profit was $155.4 million with a gross profit margin of 20.1% in 2013 compared to $177.2 million with a gross profit margin of 20.5% in 2012. Better sales mix and lower raw material costs were offset by reduced pricing and decreased volumes. Raw material costs decreased $40.6 million during 2013.


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This segment generated an operating profit of $64.1 million in 2013 compared to $89.6 million in 2012. The decrease in segment operating profit was primarily due to lower customer pricing and the incremental margin impact of the lower sales volume in Performance Materials, partially offset by lower raw material costs and cost reduction actions. The segment operating profit also includes items which management excludes when evaluating the results of the Company's segments. Those items for 2013 include $2.1 million of severance costs, $1.0 million of accelerated depreciation expense related to assets for which production will be transferred to another Performance Chemicals facility, a non-cash intangible asset impairment charge of $0.2 million and a gain of $0.3 million on an asset sale. In July, 2013, the Company announced a plan to transfer the manufacture of styrene acrylics and other latices from its Akron, Ohio facility to its Mogadore, Ohio facility in an effort to consolidate, upgrade and improve this process. As a result, certain styrene butadiene (SB) latex capacity at the Mogadore, Ohio facility will be re-purposed to the production of styrene acrylic and other specialty emulsion polymer chemistries. This project is expected to be completed near the end of 2014 and will require an estimated $11.0 million in capital investments while generating expected annual savings of $4.0 million after completion.

Engineered Surfaces

Engineered Surfaces' net sales decreased $15.9 million, or 6.1%, to $245.1 million in 2013 from $261.0 million in 2012 primarily due to lower volumes of $20.7 million, or 7.9%, which was partially offset by positive pricing actions of $2.8 million, or 1.1%, and favorable foreign currency translation effects of $2.0 million. Coated Fabrics net sales decreased to $108.9 million in 2013, compared to $117.0 million in 2012 due to the lower sales volumes. Net sales for the Laminates and Performance Films product lines decreased to $136.2 million during 2013, compared to $144.0 million million during 2012, as sales were lower across most markets.

Engineered Surfaces' gross profit was $57.3 million with a gross profit margin of 23.4% during 2013, compared to $50.0 million and a gross profit margin of 19.2% in 2012. The improvement in 2013 was primarily due to positive pricing actions, lower raw material costs and improved product mix.

Segment operating profit was $15.6 million for 2013 compared to $3.8 million for 2012. The improvement was primarily due to better sales mix, lower raw material costs, positive pricing actions and cost reduction actions. Segment operating profit also includes items which management excludes when evaluating the results of the Company's segments. Those items for 2013 include gains on asset sales of $5.1 million, workforce reduction and other costs of $3.0 million, and facility closure and transition costs of $3.3 million and a non-cash impairment charge of $0.9 million on a note receivable. Those items for 2012 include facility closure and transition costs of $4.0 million, workforce reduction costs of $1.0 million, non-cash asset impairment charges of $1.0 million and net charges relating to a non-product claim against the Company of $0.5 million (see Item 3 Legal Proceedings).

Interest and Corporate

Interest expense was $31.9 million and $36.5 million for 2013 and 2012, respectively. The decrease is primarily due to lower borrowing spreads as a result of a March 2013 refinancing and lower foreign borrowings. Also, included in interest expense for 2012 is approximately $1.3 million related to an expired interest rate swap.

Corporate expenses were $19.8 million in 2013 compared to $20.0 million in 2012.

Results of Operations of 2012 Compared to 2011

The Company's net sales in 2012 were $1,125.5 million compared to $1,201.1 million in 2011. The Performance Chemicals business segment revenue decreased by 9.2% while the Engineered Surfaces business segment revenue increased 4.7%. Contributing to the net sales decrease in 2012 were reduced volumes of $60.4 million, or 5.0%, and unfavorable currency exchange translation effects of $16.0 million, or 1.3%, partially offset by pricing improvements of $0.8 million. Lower pricing in Performance Chemicals, which was due to lower year-over-year raw material costs as well as reduced volumes for that segment, were offset by improved pricing and volumes in Engineered Surfaces.

Gross profit in 2012 was $227.2 million with a gross profit margin of 20.2% compared to gross profit of $218.6 million and a gross profit margin of 18.2% in 2011. The increase in gross profit margin was primarily due to better sales mix and lower raw material costs, which were partially offset by a decline in selling prices during the second half of 2012.

Selling, general and administrative expense in 2012 increased $12.6 million, to $121.2 million, or 10.8% of sales, compared to $108.6 million, or 9.0% of net sales in 2011. The increase in 2012 was primarily due to increased staffing and employment costs, higher expenditures related to information technology system enhancements and research and development.

Other income was $1.4 million in 2012 compared to income of $0.8 million in 2011.

Interest expense was $36.5 million for 2012, compared to $38.0 million in 2011. Included in interest expense for 2012 and 2011 is approximately $1.3 million and $2.6 million, respectively, related to an interest rate swap that was settled in the fourth quarter of 2010. The interest rate swap settlement was being amortized over the original term of the swap which expired in May 2012.

The Company recorded income tax expense of $11.2 million, or a 30.3% effective income tax rate for 2012, compared to income tax expense of $13.4 million, or a 44.5% effective tax rate in 2011. The lower rate in 2012 was primarily due to income in foreign jurisdictions where the rate is lower than the U.S. domestic federal statutory rate. The higher rate in 2011 was primarily due to losses in jurisdictions where no offsetting tax benefit is recorded due to a valuation allowance position and one-time tax costs associated with the ELIOKEM acquisition. Cash tax payments in the U.S. are expected to be minimal for the next few years as the Company had $116.8 million of U.S. federal net operating loss carryforwards, $90.0 million of state and local net operating loss carryforwards, $0.6 million of foreign tax credit carryforwards and $0.2 million of AMT credit carryforwards. The majority of the federal, state and local net operating loss carryforwards expire between 2022 and 2032.

The Company generated income from continuing operations of $25.7 million or $0.56 per diluted share in 2012 and $16.7 million or $0.37 per diluted share in 2011. The Company reported net income of $27.6 million or $0.60 per diluted share in 2012 compared to net loss of $2.8 million or $0.06 per diluted share in 2011.


Table of Contents

Segment Discussion

The following Segment Discussion presents information used by the Company in assessing the results of operations by business segment. The Company believes that this presentation is useful for providing the investor with an understanding of the Company's business and operating performance because these measures are used by the chief operating decision maker, the CEO, in evaluating performance and allocating resources.

The following table reconciles segment sales to consolidated net sales and segment operating profit (loss) to consolidated income before income taxes. The Company's commercial wallcovering businesses, which have historically been included in the Engineered Surfaces segment have been reclassified to discontinued operations due to the sale of those businesses and, as such, the following discussion does not include results of operations for the commercial wallcovering businesses.

                                                                         Year Ended
                                                                        November 30,
                                                                     2012           2011
                                                                    (Dollars in millions)
Segment Sales:
Performance Chemicals
Performance Materials                                                  $343.2         $399.3
Specialty Chemicals                                                  521.3           552.6
Total Performance Chemicals                                            $864.5         $951.9

Engineered Surfaces
Coated Fabrics                                                         $117.0         $114.3
Laminates and Performance Films                                      144.0           134.9
Total Engineered Surfaces                                            261.0           249.2
Consolidated Net Sales                                               $1,125.5       $1,201.1

Segment Gross Profit:
Performance Chemicals                                                  $177.2         $175.2
Engineered Surfaces                                                   50.0            43.4
Consolidated Gross Profit                                              $227.2         $218.6

Segment Operating Profit (Loss):
Performance Chemicals                                                   $89.6          $86.5
Engineered Surfaces                                                    3.8            (1.3 )
Interest expense                                                     (36.5 )         (38.0 )
Corporate expense                                                    (20.0 )         (13.8 )
Deferred financing fees write-off                                        -            (1.0 )
Acquisition and integration related expenses                             -            (2.3 )
Consolidated income from continuing operations before income tax        $36.9          $30.1

Performance Chemicals

Performance Chemicals' net sales decreased $87.4 million to $864.5 million during 2012 compared to $951.9 million during 2011. The decrease was primarily due to reduced volumes of $66.1 million, or 6.9%, lower customer pricing of $4.4 million, or 0.5%, as raw material costs decreased and unfavorable foreign currency translation effects of $16.9 million. Net sales for the Performance Materials product line decreased $56.1 million to $343.2 million during 2012 compared to $399.3 million during 2011 driven by lower volumes in both markets and lower pricing. Net sales for the Specialty Chemicals product line decreased $31.3 million to $521.3 million during 2012 compared to $552.6 million during . . .

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