UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission File Number 001-33124
INNOPHOS HOLDINGS, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware | 20-1380758 | |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) | |
259 Prospect Plains Road Cranbury, New Jersey |
08512 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrants Telephone Number, Including Area Code: (609) 495-2495
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 30, 2007, the registrant has 20,784,553 shares of common stock outstanding
Page | ||||
Item 1. |
Financial Statements | 3 | ||
Item 2. |
Managements Discussion and Analysis of Results of Operations and Financial Condition | 23 | ||
Item 3. |
Quantitative and Qualitative Disclosures About Market Risks | 28 | ||
Item 4. |
Controls and Procedures | 29 | ||
Item 1. |
Legal Proceedings | 29 | ||
Item 1A. |
Risk Factors | 32 | ||
Item 2. |
Unregistered Sales of Equity Securities and Use of Proceeds | 33 | ||
Item 3. |
Defaults Upon Senior Securities | 33 | ||
Item 4. |
Submission of Matters to a Vote of Security Holders | 33 | ||
Item 5. |
Other Information | 33 | ||
Item 6. |
Exhibits | 33 | ||
34 |
2
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except per share amounts, share amounts or where otherwise noted)
March 31, 2007 |
December 31, 2006 |
|||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 15,678 | $ | 31,760 | ||||
Accounts receivable - trade |
59,933 | 56,316 | ||||||
Inventories |
70,762 | 70,569 | ||||||
Other current assets |
16,183 | 13,652 | ||||||
Total current assets |
162,556 | 172,297 | ||||||
Property, plant and equipment, net |
270,660 | 277,222 | ||||||
Goodwill |
47,268 | 47,268 | ||||||
Intangibles and other assets, net |
66,477 | 68,533 | ||||||
Total assets |
$ | 546,961 | $ | 565,320 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Current portion of long-term debt |
$ | 1,524 | $ | 1,524 | ||||
Accounts payable: |
||||||||
Trade and other |
30,494 | 30,879 | ||||||
Other current liabilities |
35,923 | 40,200 | ||||||
Total current liabilities |
67,941 | 72,603 | ||||||
Long-term debt |
390,276 | 398,276 | ||||||
Other long-term liabilities |
32,392 | 33,729 | ||||||
Total liabilities |
490,609 | 504,608 | ||||||
Commitments and contingencies (note 9) |
||||||||
Stockholders equity: |
||||||||
Common stock, par value $.001 per share; authorized 100,000,000; issued and outstanding 20,740,622 and 20,270,463 shares |
21 | 20 | ||||||
Paid-in capital |
107,206 | 109,796 | ||||||
Retained deficit |
(47,356 | ) | (45,288 | ) | ||||
Other comprehensive loss |
(3,519 | ) | (3,816 | ) | ||||
Total stockholders equity |
56,352 | 60,712 | ||||||
Total liabilities and stockholders equity |
$ | 546,961 | $ | 565,320 | ||||
See notes to condensed consolidated financial statements
3
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Operations (Unaudited)
(In thousands, except per share amounts, share amounts or where otherwise noted)
Three months ended 2007 |
Three months ended 2006 |
|||||||
Net sales |
$ | 136,680 | $ | 130,335 | ||||
Cost of goods sold |
115,698 | 108,585 | ||||||
Gross profit |
20,982 | 21,750 | ||||||
Operating expenses: |
||||||||
Selling, general and administrative |
10,413 | 10,395 | ||||||
Research & development expenses |
542 | 282 | ||||||
Total operating expenses |
10,955 | 10,677 | ||||||
Operating income |
10,027 | 11,073 | ||||||
Interest expense, net |
9,921 | 13,400 | ||||||
Foreign exchange gains |
(134 | ) | (53 | ) | ||||
Other expense (income), net |
58 | (114 | ) | |||||
Income (loss) before income taxes |
182 | (2,160 | ) | |||||
Provision for (benefit from) income taxes |
2,250 | (870 | ) | |||||
Net loss |
$ | (2,068 | ) | (1,290 | ) | |||
Preference distribution to Class L shareholders |
464 | |||||||
Net loss attributable to Class A shareholders |
$ | (1,754 | ) | |||||
Per share data (see Note 1): |
||||||||
Income (loss) per share: |
||||||||
Basic |
||||||||
Common |
$ | (0.10 | ) | |||||
Class L |
$ | 0.17 | ||||||
Class A |
$ | (0.18 | ) | |||||
Diluted |
||||||||
Common |
$ | (0.10 | ) | |||||
Class L |
$ | 0.17 | ||||||
Class A |
$ | (0.18 | ) | |||||
Weighted average shares outstanding: |
||||||||
Basic |
||||||||
Common |
20,562,809 | |||||||
Class L |
2,678,383 | |||||||
Class A |
9,597,696 | |||||||
Diluted |
||||||||
Common |
20,562,809 | |||||||
Class L |
2,678,383 | |||||||
Class A |
9,597,696 | |||||||
Dividends paid per share of common stock |
$ | 0.11 | ||||||
Dividends declared per share of common stock |
$ | 0.17 |
See notes to condensed consolidated financial statements
4
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands)
Three months ended 2007 |
Three months ended 2006 |
|||||||
Cash flows from operating activities |
||||||||
Net loss |
$ | (2,068 | ) | $ | (1,290 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
11,565 | 11,138 | ||||||
Amortization of deferred financing charges |
822 | 1,386 | ||||||
Deferred income tax benefit |
(1,078 | ) | (1,846 | ) | ||||
Deferred profit sharing |
31 | 23 | ||||||
Stock-based compensation-Restricted stock |
231 | | ||||||
Non-cash interest for floating rate senior notes |
| 4,279 | ||||||
Changes in assets and liabilities: |
||||||||
Increase in accounts receivable |
(3,617 | ) | (640 | ) | ||||
Increase in inventories |
(193 | ) | (2,653 | ) | ||||
(Increase)/decrease in other current assets |
(2,531 | ) | 5,056 | |||||
(Decrease)/increase in accounts payable |
(385 | ) | 715 | |||||
Decrease in other current liabilities |
(2,003 | ) | (16,084 | ) | ||||
Changes in other long-term assets, liabilities and other, net |
(2,706 | ) | 2,493 | |||||
Net cash (used in) provided from operating activities |
(1,932 | ) | 2,577 | |||||
Cash flows from investing activities: |
||||||||
Capital expenditures |
(4,625 | ) | (2,706 | ) | ||||
Net cash used for investing activities |
(4,625 | ) | (2,706 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from exercise of stock options |
750 | | ||||||
Principal payments of term-loan |
(8,000 | ) | (18,500 | ) | ||||
Dividends paid |
(2,275 | ) | | |||||
Net cash used for financing activities |
(9,525 | ) | (18,500 | ) | ||||
Net change in cash |
(16,082 | ) | (18,629 | ) | ||||
Cash and cash equivalents at beginning of period |
31,760 | 61,402 | ||||||
Cash and cash equivalents at end of period |
$ | 15,678 | $ | 42,773 | ||||
See notes to condensed consolidated financial statements
5
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Statements of Stockholders Equity and Other Comprehensive Income (Loss)
(Dollars and shares in thousands)
Number of Common Shares |
Number of Class A Shares |
Number of Class L Shares |
Stock $0.001 Par Value |
Retained Deficit |
Paid-in Capital |
Officer Loans |
Accumulated Other Comprehensive Income/(Loss) |
Total Shareholders Equity |
||||||||||||||||||||
Balance, December 31, 2006 |
20,270 | | | $ | 20 | $ | (45,288 | ) | $ | 109,796 | $ | | $ | (3,816 | ) | $ | 60,712 | |||||||||||
Net loss |
(2,068 | ) | (2,068 | ) | ||||||||||||||||||||||||
Minimum pension liability adjustment, (net of tax $ 0) |
297 | 297 | ||||||||||||||||||||||||||
Other comprehensive (loss), net of tax |
(1,771 | ) | ||||||||||||||||||||||||||
Proceeds issuance of stock |
471 | 1 | 749 | 750 | ||||||||||||||||||||||||
Stock compensation |
231 | 231 | ||||||||||||||||||||||||||
Dividends declared |
(3,570 | ) | (3,570 | ) | ||||||||||||||||||||||||
Balance, March 31, 2007 |
20,741 | | | $ | 21 | $ | (47,356 | ) | $ | 107,206 | $ | | $ | (3,519 | ) | $ | 56,352 | |||||||||||
See notes to condensed consolidated financial statements
6
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
1. Basis of Statement Presentation:
Summary of Significant Accounting Policies
Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements of Innophos Holdings, Inc. and Subsidiaries (Company) have been prepared in accordance with generally accepted accounting principles for interim financial reporting and do not include all disclosures required by generally accepted accounting principles for annual financial reporting, and should be read in conjunction with the audited consolidated and combined financial statements of the Company at December 31, 2006 and for the years ended December 31, 2006 and 2005.
Innophos Holdings, Inc. is a holding company and the parent to Innophos Investments Holdings, Inc. and, indirectly, to Innophos, Inc. Innophos Investments Holdings, Inc., recognized under commonly controlled entities, was incorporated on January 31, 2005 in Delaware and is a wholly owned subsidiary of Innophos Holdings, Inc. On February 2, 2005, Innophos Holdings, Inc. contributed 100% of its interest in Innophos, Inc. to Innophos Investments Holdings, Inc. Innophos Investments Holdings, Inc. was considered a reorganization of commonly controlled entities under Innophos Holdings, Inc. and therefore, the statements have been presented consolidated, including results of Innophos, Inc., for all periods.
The accompanying unaudited condensed consolidated financial statements of the Company reflect all adjustments, consisting only of normal recurring accruals, which management considers necessary for a fair statement of the results of operations for the interim periods and is subject to year end adjustments. The results of operations for the interim periods are not necessarily indicative of the results for the full year. The December 31, 2006 condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
Initial Public Offering
In November 2006, the Company completed an initial public offering (IPO) in which the Company sold 8,000,000 issued shares of Common Stock at the price of $12.00 per share (before underwriting discounts and commissions). Prior to that offering, our capital structure was revised to convert two previously outstanding classes of common stock into our current single class Common Stock and was also modified by a reverse stock split affecting the then outstanding shares. Prior to the offering, there was no established trading market for our equity securities. The shares and earnings per share calculations have been retro-actively adjusted for all periods presented to reflect the reverse stock split.
Stock Options
Effective January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment. the Company was required to use the prospective transition method, therefore, prior period results were not restated. Prior to the adoption of SFAS 123(R), stock-based compensation expense related to stock options was not recognized in the results of operations if the exercise price was at least equal to the market value of the common stock on the grant date, in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
On April 1, 2005, the Company granted 448,819 Class L stock options and 4,039,372 Class A stock options, prior to giving effect to the reverse stock split and conversion of our Class L shares and Class A shares into our new class of common stock. This is equivalent to 448,819 stock option strips. Each option strip required the recipient to exercise in tandem one option of Class L stock and nine options of Class A stock. All stock option strips are granted with an aggregated exercise price equal to or greater than the total fair market value of the underlying Class L and Class A shares.
In connection with its initial public offering, the Company effected a recapitalization, through an amendment to our certificate of incorporation to declare a reverse stock split to reduce the number of Class A Common Stock and Class L Common Stock and reclassify the Class A Common Stock and the Class L Common Stock to a single class of Common Stock. As a result of the recapitalization, the historical stock option strips were converted, as required under the terms of the original plan, to 1,116,944 stock options of the new class of Common Stock currently outstanding with the same vesting schedule. The exercise price is $2.55 per option. The Company accounts for the stock option plan using the intrinsic value method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. The valuation method that the Company used under SFAS No. 123 dictated the transition method that the Company used under SFAS No. 123(R). As
7
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
permitted under SFAS No. 123, the Company valued its stock options at the grant date using the minimum value method. Because the Company used the minimum value method under SFAS No. 123, we adopted SFAS No. 123(R) using the prospective transition method and therefore, prior periods were not restated and we have not recognized in the financial statements the remaining compensation cost calculated under the minimum value method. The determination of the fair value of the underlying common stock used to determine the exercise prices for the stock options granted on April 1, 2005 was performed contemporaneously with the issuance of these common stock option grants.
Under the prospective method, only new awards (or awards modified, repurchased, or cancelled after the effective date) are accounted for under the provisions of SFAS No. 123(R). The Company will continue to account for the outstanding awards under APB 25 until they are settled. Upon the adoption of SFAS No. 123(R) and through December 31, 2006 and March 31, 2007, the Company did not modify any existing stock option awards that were granted under SFAS No. 123.
A summary of stock option activity during the three months ended March 31, 2007, is presented below:
Number of Options |
Exercise Price | |||||
Outstanding at January 1, 2007 |
1,116,944 | $ | 2.55 | |||
Granted |
| |||||
Forfeited |
(38,295 | ) | 2.55 | |||
Exercised |
(296,591 | ) | 2.55 | |||
Outstanding at March 31, 2007 |
782,058 | $ | 2.55 | |||
Exercisable at March 31, 2007 |
373,575 | $ | 2.55 | |||
Restricted Stock
On November 2, 2006, the Companys Board of Directors awarded 173,568 shares of restricted stock with a fair value of $2.1 million to directors and certain executive officers. These awards accounted for under SFAS 123(R) are classified as equity awards and vest over nine quarters in equal installments of 11.11% per quarter beginning January 1, 2007. Declared dividends will accrue on the restricted stock and will vest over the same period. Upon vesting, the restricted stock will convert into an equivalent number of shares of common stock. The related compensation expense is based on the date of grant share price of $12. The compensation expense is amortized on a straight-line basis over the requisite service period. The Company recognized approximately $0.2 million of compensation expense in the three months ended March 31, 2007 and will record approximately $0.7 million of compensation expense during the remainder of 2007. As of March 31, 2007, there are 154,283 unvested shares and 19,285 shares which have vested.
Earnings (Loss) Per Share
The Company accounts for earnings per share in accordance with SFAS No. 128, Earnings Per Share and related guidance, which requires two calculations of earnings per share (EPS) to be disclosed: basic EPS and diluted EPS. The Company presented EPS information in the periods prior to the IPO using the two-class method as the Class L shares participated in distributions together with the Class A shares after the payment of the Class L preferential rights. The Class L common stock had preferential rights over the Class A common stock whereby the Class L common stock was entitled to receive their original investment plus a 10% yield compounded quarterly on their original investment before the Class A common stock participated in company distributions. After payment of all preferential rights attributable to the Class L common stock, each share of the Class A common stock and Class L common stock participated ratably in all distributions by the Company to the shareholders of its capital stock.
The numerator in calculating Class L basic and diluted EPS is equal to the Class L preference amount of $464 for the three months ended March 31, 2006. The Company did not allocate remaining losses in accordance with EITF 03-6, Participating Securities and the Two-Class Method under SFAS No. 128, because of its preferential rights over Class A. The numerator in calculating Class A basic and dilutive EPS is an amount equal to consolidated net (loss) increased for the aforementioned Class L preference amount.
8
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
The following is the allocation of earnings (loss) used in the calculation of earnings per share:
Three Months Ended 2007 |
Three Months Ended 2006 |
|||||||
Net loss available to common shareholders |
$ | (2,068 | ) | $ | (1,290 | ) | ||
Allocation of net income (loss) to common shareholders: |
||||||||
Class A |
$ | (1,754 | ) | |||||
Class L |
$ | 464 |
As a result of the Companys net loss, the computation of diluted weighted average shares excludes options to purchase shares of common stock as inclusion of such shares would be anti-dilutive. The following is a reconciliation of the basic number of common shares outstanding to the diluted number of common and common stock equivalent shares outstanding:
Three Months Ended 2007 |
Three Months Ended 2006 | |||
Weighted average number of common and potential common shares outstanding: |
||||
Basic number of single class common shares outstanding |
20,562,809 | |||
Dilutive effect of stock equivalents |
| |||
Diluted number of weighted average single class common shares outstanding |
20,562,809 | |||
Weighted average number of common and potential common Class A shares outstanding: |
||||
Basic number of common Class A shares outstanding |
9,597,696 | |||
Dilutive effect of stock option grants |
| |||
Diluted number of common and potential common Class A shares outstanding |
9,597,696 | |||
Weighted average number of common and potential common Class L shares outstanding: |
||||
Basic number of common Class L shares outstanding |
2,678,383 | |||
Dilutive effect of stock option grants |
| |||
Diluted number of common and potential common Class L shares outstanding |
2,678,383 | |||
9
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
Three Months Ended 2007 |
Three Months Ended 2006 |
|||||||
Earnings (loss) per common share: |
||||||||
Loss per common share - Basic |
$ | (0.10 | ) | |||||
Loss per common share - Diluted |
$ | (0.10 | ) | |||||
Class A - Basic |
$ | (0.18 | ) | |||||
Class A - Diluted |
$ | (0.18 | ) | |||||
Class L - Basic |
$ | 0.17 | ||||||
Class L - Diluted |
$ | 0.17 |
Included in dividends paid per share was a cash dividend of $0.11 per share ($2,275 in the aggregate) declared on December 18, 2006 and paid on January 30, 2007 to holders of record on January 15, 2007.
Included in dividends declared per share was a cash dividend of $0.17 per share ($3,526 in the aggregate) declared on March 29, 2007 and payable on April 30, 2007 to holders of record on April 13, 2007.
Income Taxes
Effective January 1, 2007, the Company adopted FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109. This interpretation prescribes a model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return. The Company does not believe it had any material uncertain income tax positions therefore the adoption of FIN 48 had no effect on its consolidated financial position or results of operations. If any material uncertain tax positions did arise, the Companies policy is to accrue associated penalties in selling, general and administrative expenses and to accrue interest as part of net interest expense. All of the tax years since the Companys inception in 2004 are subject to examination by the Canadian, Mexican and United States revenue authorities. The Company does not anticipate that total unrecognized tax benefits will significantly change prior to March 31, 2008.
Employee Termination Benefits
The Company does not have a written severance plan for its Mexican operations, nor does it offer similar termination benefits to affected employees in all restructuring initiatives. Accordingly, in situations where minimum statutory termination benefits must be paid to the affected employees, the Company records employee severance costs associated with these restructuring activities in accordance with SFAS No. 112, Employers Accounting for Postemployment Benefits. Charges associated with these activities are recorded when the payment of benefits is probable and can be reasonably estimated. In all other situations where the Company pays out termination benefits, including supplemental benefits paid in excess of statutory minimum amounts and benefits offered to affected employees based on managements discretion, the Company records these termination costs in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
The timing of the recognition of charges for employee severance costs depends on whether the affected employees are required to render service beyond their legal notification period in order to receive the benefits. If affected employees are required to render service beyond their legal notification period, charges are recognized ratably over the future service period. Otherwise, charges are recognized when a specific plan has been confirmed by management and required employee communication requirements have been met.
10
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
Recently Issued Accounting Standards
The Financial Accounting Standards Board (FASB) recently issued SFAS No. 157 and SFAS No. 159, both of which are summarized below.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, which for the Company is January 1, 2008. The Company is currently assessing the impact this statement may have on its consolidated financial position or results of operations.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the Boards long-term measurement objectives for accounting for financial instruments. SFAS No. 159 is effective as of the beginning of an entitys first fiscal year that begins after November 15, 2007, which for the Company is January 1, 2008. The Company is currently assessing the impact this statement will have on its consolidated financial position or results of operations.
2. Inventories:
Inventories consist of the following:
March 31, 2007 |
December 31, 2006 | |||||
Finished products |
$ | 46,209 | $ | 46,789 | ||
Raw materials |
17,530 | 17,129 | ||||
Spare parts |
7,023 | 6,651 | ||||
$ | 70,762 | $ | 70,569 | |||
Inventory reserves as of March 31, 2007 and December 31, 2006 were $7,486 and $7,471, respectively.
3. Other Current Assets:
Other current assets consist of the following:
March 31, 2007 |
December 31, 2006 | |||||
Creditable taxes (value added taxes) |
$ | 2,804 | $ | 243 | ||
Prepaid income taxes |
2,240 | 2,718 | ||||
Prepaids |
11,042 | 10,585 | ||||
Other |
97 | 106 | ||||
$ | 16,183 | $ | 13,652 | |||
11
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
4. Intangibles and Other Assets, net:
Intangibles and other assets consist of the following:
Useful life (years) |
March 31, 2007 |
December 31, 2006 | ||||||
Developed technology and application patents, net of accumulated amortization of $4,972 for 2007 and $4,500 for 2006 |
10-20 | 31,628 | 32,100 | |||||
Customer relationships, net of accumulated amortization of $1,414 for 2007 and $1,240 for 2006 |
15 | 8,686 | 8,861 | |||||
Tradenames and license agreements, net of accumulated amortization of $1,698 for 2007 and $1,536 for 2006 |
5-20 | 7,602 | 7,764 | |||||
Capitalized software, net of accumulated amortization of $1,379 for 2007 and $1,210 for 2006 |
3-5 | 2,059 | 2,089 | |||||
Total Intangibles |
$ | 49,975 | $ | 50,814 | ||||
Deferred financing costs, net of accumulated amortization of $12,199 for 2007 and $11,377 for 2006 |
$ | 13,733 | $ | 14,555 | ||||
Deferred income taxes |
2,246 | 2,779 | ||||||
Other assets |
523 | 385 | ||||||
Total other assets |
$ | 16,502 | $ | 17,719 | ||||
$ | 66,477 | $ | 68,533 | |||||
5. Other Current Liabilities:
Other current liabilities consist of the following:
March 31, 2007 |
December 31, 2006 | |||||
Payroll related |
$ | 5,868 | $ | 8,902 | ||
Interest |
2,390 | 6,641 | ||||
Interest, floating rate senior notes |
1,038 | 1,039 | ||||
Freight and rebates |
6,066 | 4,668 | ||||
Benefits and pensions |
4,206 | 5,087 | ||||
Taxes |
5,233 | 4,418 | ||||
Legal |
212 | 307 | ||||
Dividends payable |
3,526 | 2,230 | ||||
Non-trade payable |
1,310 | 1,310 | ||||
Other |
6,074 | 5,598 | ||||
$ | 35,923 | $ | 40,200 | |||
12
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
6. Debt and Interest:
Short-term borrowings and long-term debt consist of the following:
March 31, 2007 |
December 31, 2006 | |||||
Senior credit facility |
$ | 141,000 | $ | 149,000 | ||
Senior subordinated notes |
190,000 | 190,000 | ||||
Floating rate senior notes |
60,800 | 60,800 | ||||
$ | 391,800 | $ | 399,800 | |||
Less current portion |
1,524 | 1,524 | ||||
$ | 390,276 | $ | 398,276 | |||
The senior credit facility provides for interest based upon a fixed spread above the banks prime lending rate or the LIBOR lending rate. The borrowings under the term loan portion of the senior credit facility bear interest at March 31, 2007 at 7.6%. The amount outstanding on the term loan facility as of March 31, 2007 was $141.0 million.
There was no amount outstanding on the revolving portion of the senior credit facility at March 31, 2007. The Company has issued approximately $4.5 million of letters of credit under the sub-facility as of March 31, 2007.
In April 2006, Innophos, Inc. executed two rate cap derivative instruments each with a notional amount of $100 million. The terms of the first instrument is a rate cap of 7%, a referenced index based on a three month LIBOR and an expiration date of this instrument is April 2009. The fair value of this rate cap derivative instrument is $3 as of March 31, 2007. The second rate cap instrument is a rate cap of 7%, a referenced index based on a one month LIBOR and an expiration date of this instrument is April 2008. The fair value of this rate cap derivative instrument is $0 as of March 31, 2007.
The Company is required within five days from the issuance of the 2006 annual financial statements to make a prepayment of the term loan in an amount equal to 75% of the excess cash flow (as defined in our credit agreement) in addition to the quarterly principal payments. The Company made a voluntary prepayment of the term loan on October 30, 2006 in the amount of $30.0 million which satisfied the required excess cash flow payment for the 2006 calendar year which was due within five days from the issuance of the 2006 annual financial statements.
The Company made an $8.0 million voluntary prepayment of the term loan on March 30, 2007. In the first quarter of 2007 these prepayments resulted in an approximate $0.2 million charge to earnings for the acceleration of deferred financing charges.
In connection with the refinancing transaction (See Note 13), we and our lenders amended our senior credit facility to permit us to, among other things, (i) incur up to $120.0 million in unsecured indebtedness of Innophos Holdings, Inc. or Innophos Investments Holdings, Inc., including the notes offered in the refinancing and any other future debt issuances, (ii) redeem the entire outstanding amount of our Floating Rate Senior Notes, as well as any premiums and penalties resulting from such redemption, (iii) service the interest on the notes offered hereby through Innophos, Inc. making payments of such amounts to Innophos Investments Holdings, Inc. and Innophos Holdings, Inc. and (iv) to permit Innophos, Inc. to make payments to Innophos Investments Holdings, Inc. and Innophos Holdings, Inc. for the payment by Innophos Holdings, Inc. of dividends on its common stock of $0.75 per share (adjusted pro-rata for any future stock splits) up to a maximum of $17.5 million per year.
As of March 31, 2007, management believes the Company was in full compliance with all debt covenant requirements.
The interest installment paid on February 15, 2007 for Innophos Investments Holdings, Inc. Floating Rate Senior Notes was $2.0 million. Innophos Investments Holdings, Inc. is dependent on the earnings and distributions from Innophos, Inc. and subsidiaries to fund this obligation.
Total interest cash payments by the Company for all indebtedness for the three month period ended March 31, 2007 and March 31, 2006 was $13,807 and $13,127, respectively.
13
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
Interest expense, net consists of the following:
Three months ended | ||||||||
March 31, 2007 |
March 31, 2006 |
|||||||
Interest expense |
$ | 9,554 | 12,684 | |||||
Deferred financing cost |
822 | 1,386 | ||||||
Interest income |
(455 | ) | (670 | ) | ||||
Total interest expense, net |
$ | 9,921 | $ | 13,400 | ||||
7. Other Long-term liabilities:
Other long-term liabilities consist of the following:
March 31, 2007 |
December 31, 2006 | |||||
Environmental liabilities |
$ | 1,100 | 1,100 | |||
Profit sharing liabilities |
1,157 | 1,127 | ||||
Deferred income taxes |
20,116 | 21,511 | ||||
Pension and post retirement liabilities (US and Canada only) |
5,773 | 6,035 | ||||
Other Liabilities |
4,246 | 3,956 | ||||
$ | 32,392 | $ | 33,729 | |||
8. Income Taxes:
Three months ended 2007 |
Three months ended 2006 |
|||||||||||||||
Income (loss) before Income taxes |
Income tax expense/ (benefit) |
Loss before Income taxes |
Income tax expense/ (benefit) |
|||||||||||||
US |
$ | (6,841 | ) | 70 | $ | (2,156 | ) | $ | 70 | |||||||
Canada/Mexico |
7,023 | 2,180 | (4 | ) | (940 | ) | ||||||||||
Total |
$ | 182 | 2,250 | (2,160 | ) | (870 | ) | |||||||||
Current income taxes |
3,328 | $ | 976 | |||||||||||||
Deferred income taxes |
(1,078 | ) | (1,846 | ) | ||||||||||||
Total |
$ | 2,250 | $ | (870 | ) | |||||||||||
A reconciliation of the U.S statutory rate and income tax follows:
14
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
Three months ended 2007 |
Three months ended 2006 |
|||||||
Income tax expense (benefit) at the U.S. statutory rate |
$ | 64 | $ | (756 | ) | |||
State Income taxes (net of federal tax effect) |
21 | 19 | ||||||
Foreign tax rate differential |
(282 | ) | (939 | ) | ||||
Change in valuation allowance |
2,347 | 788 | ||||||
Non-deductible permanent items |
100 | 18 | ||||||
Provision (Benefit) for income taxes |
$ | 2,250 | $ | (870 | ) | |||
Income taxes paid were $1,950 and $3,715 for the three months ended March 31, 2007 and March, 2006, respectively.
Pursuant to Section 382 of the Internal Revenue Code, as amended, the annual utilization of the Companys U.S. net operating loss carryforwards may be limited, if the Company experiences a change in ownership of more than 50% within a three year period. The Company believes it has experienced an ownership change on April 2, 2007 that limits the utilization of net operating losses to offset future taxable income. The Company maintains a full valuation allowance for its U.S. net deferred tax assets and net operating loss carryforwards as realization of the U.S. net deferred tax asset is not reasonably assured. Therefore, as a result of the full valuation allowance for the U.S. net deferred tax assets, the Company believes that the ownership change pursuant to Section 382 will not have a financial statement impact.
9. Commitments and Contingencies:
Environmental
The Companys operations are subject to extensive and changing federal and state environmental laws and regulations. The Companys manufacturing sites have an extended history of industrial use, and soil and groundwater contamination have or may have occurred in the past and might occur or be discovered in the future.
Environmental efforts are difficult to assess for numerous reasons, including the discovery of new remedial sites, discovery of new information and scarcity of reliable information pertaining to certain sites, improvements in technology, changes in environmental laws and regulations, numerous possible remedial techniques and solutions, difficulty in assessing the involvement of and the financial capability of other potentially responsible parties and the extended time periods over which remediation occurs. Other than the items listed below, the Company is not aware of material environmental liabilities which are reasonably probable and estimable. As the Companys environmental contingencies are more clearly determined, it is reasonably possible that amounts accrued may be necessary. However, management does not believe, based on current information, that environmental remediation requirements will have a material impact on the Companys results of operations, financial position or cash flows.
Under the Agreement of Purchase and Sale between the Company and several affiliates within the Rhodia S.A. Group according to which the Company acquired the Phosphates Business and related assets, the Company has certain rights of indemnification from the sellers for breach of representations, warranties, covenants and other agreements. With respect to undisclosed environmental matters, such indemnification rights are subject to certain substantial limitations and exclusions.
Future environmental spending is probable at our site in Nashville, Tennessee, the eastern portion of which had been used historically as a landfill, and a western parcel previously acquired from a third party, which reportedly had housed, but no longer does, a fertilizer and pesticide manufacturing facility. We have an estimated liability with a range of $0.9-$1.2 million. The remedial action plan has yet to be finalized, and as such, the Company has recorded a liability, which represents the Companys best estimate, of $1.1 million as of March 31, 2007.
Maintaining compliance with health and safety and environmental laws and regulations has resulted in ongoing costs for us. Currently, we are involved in several compliance and remediation efforts and agency inspection matters concerning health and safety and environmental matters. The EPA has indicated that compliance at facilities in the phosphate industry is a high enforcement priority. In 2004, the EPA conducted a multi-media inspection and in 2005 followed up on issues regarding compliance with air, water and hazardous waste regulations at our Geismar, Louisiana plant. In August 2006, we received a report in connection with that inspection identifying certain areas of concern raised by the EPA under its hazardous waste regulations. We believe that we operate our Geismar facility in material compliance with all applicable environmental laws and regulations, including those of the EPA, and have responded to those concerns by explaining how in
15
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
our judgment our operations meet applicable regulations or exclusions. Nevertheless, we could incur significant expenses pursuant to new laws, regulations or governmental policies, or new interpretations of existing laws, regulations or governmental policies, or as a result of the development or discovery of new facts, events, circumstances or conditions at any of our facilities. In March 2007, we received a further EPA request for additional information concerning hazardous waste, air pollution controls and materials handling at the Geismar plant. We are working on providing the requested information.
Litigation
Mexican Tax Claims
On November 1, 2004, our Mexican subsidiary, Innophos Fosfatados, received notice of claims from the Tax Audit and Assessment Unit of the National Waters Commission, or CNA, demanding payment of governmental duties, taxes and other charges for failure to have certain permits allowing extraction of salt water for processing in 1998 and 1999, or Salt Water Claims, and for the underpayment of governmental duties, taxes and other charges for the extraction and use of fresh water from national waterways from 1998 through 2002 at our Coatzacoalcos manufacturing plant, or Fresh Water Claims.
As initially assessed by the CNA, and as shown in the table below, the claims total approximately $137.3 million at current exchange rates as of April 23, 2007.
Tax Item |
Salt Water Claims | Fresh Water Claims | Total | ||||||
(dollars in millions) | |||||||||
Basic Charges |
$ | 27.1 | $ | 10.6 | $ | 37.7 | |||
Interest, Inflation and Penalties |
79.5 | 20.1 | 99.6 | ||||||
Total |
$ | 106.6 | $ | 30.7 | $ | 137.3 | |||
Management believes that Innophos Fosfatados has valid bases for challenging the amount of the CNA claims, and we are vigorously defending the matter.
CNA Administrative Proceedings; Appeals. On January 17, 2005, Innophos Fosfatados filed documents with the CNA seeking revocation and dismissal of all claims made by that agency. On August 29, 2005, the CNA rejected the substantive challenges as to the Fresh Water Claims (although the CNA agreed that certain corrections were required as to its surcharge calculations), confirming the original claims. In addition, on technical grounds, the CNA ordered the revocation of the resolutions containing the Salt Water Claims in order to correct certain errors, and consequently did not address the substantive challenges. As a result of these rulings, the CNAs original assessments currently stand at $30.7 million for the Fresh Water Claims and no amount for the Salt Water Claims as they were revoked. CNA has, however, reserved its right to issue new resolutions correcting the technical errors as to both the Fresh Water and Salt Water Claims. On November 3, 2005, Innophos Fosfatados filed appeals with the Mexican Federal Court of Fiscal and Administrative Justice challenging all CNAs claims and some CNA rulings, including a discretionary appeal seeking a court ruling on the Companys substantive challenges to the Salt Water Claims that were not addressed by CNA. On May 11, 2007, a five judge panel of the court issued its decision unanimously overturning the Salt Water Claims. The CNA has a right to appeal, and we do not know whether it will do so. It is not known when our appeal of the Fresh Water Claims will be decided by the court.
Rhodia Indemnification. Under the terms of the Rhodia Agreement, according to which our business was purchased, we received indemnification against a number of contingencies, including claims for Mexican Taxes (as defined in the Rhodia Agreement) such as those alleged by CNA, as well as any additional duties, taxes and charges which may be assessed by the CNA for the period after 2002 but arising on or before the August 13, 2004 closing date of the acquisition. Rhodia has acknowledged its responsibility for such claims, but under a different indemnification obligation (described below) and under a reservation of rights, and has assumed control of the defense of the CNA claims. We asserted that we are entitled to full indemnification for liabilities relating to Taxes and for breach of covenants under the Rhodia Agreement (concerning what we have characterized as a known, undisclosed CNA audit). Rhodia has disagreed, asserting instead that the applicable indemnification under the Rhodia Agreement is for breach of representations and warranties, which in turn would subject the liabilities relating to the CNA claims to a deductible amount of $15.9 million and a limit of $79.5 million above that deductible amount.
On December 16, 2004, we sued Rhodia in New York State Supreme Court (New York County) seeking a determination that we are entitled to full indemnification under the Rhodia Agreement. We filed a motion for summary judgment with the court, seeking declarations that the CNA claims are Taxes under the Rhodia Agreement, and that Rhodia is
16
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
obligated to provide any necessary security to guarantee the claims to the Mexican government. The Court entered an order granting our summary judgment motion on both counts on June 13, 2005. Rhodia appealed the order to the Appellate Division, First Department, which on March 22, 2007 affirmed the lower courts rulings in our favor. On April 27, 2007, Rhodia filed with the Appellate Division a Motion for Leave to Appeal to New Yorks highest court, the New York Court of Appeals on the issue as to whether the CNA claims are Taxes under the Rhodia Agreement. That motion, together with our opposition to it, has now been submitted to the court for decision. If the motion is granted, the Court of Appeals is likely to allow the appeal, and the matter will be briefed and argued in the ordinary course. If the motion is denied, Rhodia would have an opportunity to file a similar request with the Court of Appeals. Rhodia did not seek an appeal of the Appellate Divisions decision that Rhodia is responsible for any security required by the Mexican authorities.
Security Pending Challenges. Security for the full amount of the matter in dispute, which approximates $170.2 million (at current exchange rates as of April 23, 2007 with the security amount projected to February 2008), was required by June 17, 2005. In light of the technical revocation of the Salt Water Claims and the invalidation of the Salt Water Claims by the recent order of the Court of Fiscal and Administrative Justice, we have been advised that the amount of security required would be reduced to $37.0 million at current exchange rates as of April 23, 2007. We believe the posting of security was an obligation of Rhodia under the New York court ruling (referenced above). Rhodia has acknowledged its obligation to post such security, but has taken the position that security is not currently required. If Rhodia does not or cannot timely post security, it is possible that Innophos Fosfatados will have to do so. There are multiple types of acceptable security, the most common type of security being an asset backed mortgage. In the event the Mexican Ministry of Finance determines that security was not provided in a timely manner, or that Innophos Fosfatados was otherwise not satisfying security requirements, the Ministry could seize certain Innophos Fosfatados assets or appoint a surveyor with certain administrative powers over Innophos Fosfatados assets and operations to ensure compliance pending appeals.
Further Proceedings. A final determination of the matter may require appeals to the Mexican Supreme Court and possible remands to the CNA or to lower courts, which might continue for several years. In the event that the CNA were to issue a full set of new resolutions confirming the original Salt Water Claims and Fresh Water Claims, and appeals were to be decided against us, we could be required to pay a judgment for the entire amount of the CNA claims (which could include accrual of additional interest and inflationary adjustments, as well as duties, taxes and other charges for periods after 2002, which management estimates under current operating conditions at approximately $1.7 million of additional basic charges per year, excluding interest, inflation adjustments, and penalties).
Based upon advice of counsel and our review of the CNA claims, the facts and applicable law, we have determined that liability is reasonably possible, but is neither probable nor reasonably estimable. Accordingly, we have not established a liability on the balance sheet as of March 31, 2007. As additional information is gained, we will reassess the potential liability and establish the amount of any loss reserve as appropriate.
Mexican Water Recycling System PAMCAR Agreement
Innophos Fosfatados is the successor to an agreement with the CNA (originally entered into in 1997 by Albright & Wilson-Troy de Mexico, S.A. de C.V., succeeded in 2000 by Rhodia Fosfatados de Mexico, S.A. de C.V.) to construct a water recycling system to reduce water effluents into the Gulf of Mexico, to comply with applicable discharge limits and regulations, and to reuse at least 95% of the water derived from the production processes at the Coatzacoalcos facility (the PAMCAR Agreement). The PAMCAR Agreement required that action plans be completed by December 31, 2004. Under the terms of the PAMCAR Agreement and subject to compliance, the CNA temporarily exempted Innophos Fosfatados from the payment of certain waste water discharge duties, taxes and related charges, which would normally have been payable.
All equipment to recycle water was in place and in operating condition as of December 31, 2004. On January 10, 2005, Innophos Fosfatados notified the CNA of its position that as of December 31, 2004, it complied with the applicable requirements of the PAMCAR Agreement. We have been advised by Mexican environmental counsel that compliance with the discharge limits aspect of the PAMCAR Agreement should be based upon limits which were issued in 2005.
Innophos Fosfatados relevant waste water discharges were the subject of a study by the National University of Mexico, which concluded in October 2004 that such discharges do not adversely impact the receiving water bodies or the environment. In addition to a previous request by Innophos Fosfatados to update the relevant waste water discharge permit with new operating information, in October 2004, Innophos Fosfatados filed a petition with the CNA to reflect the results of the university study and to revise discharge limits which the now-improved operations can satisfy. In 2005, Innophos Fosfatados received a government authorization known as a Concession Title (containing a waste water discharge permit and limits) granting the requested relief as to all discharge limits.
17
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
CNA regional officials may take the position that compliance with the PAMCAR Agreement will be determined by the previous Concession Title. Consequently, while Mexican counsel has advised us that compliance should be determined upon the new, revised, discharge limits as a matter of applicable law, CNA regional officials could find that Innophos Fosfatados was not in compliance for the duration of the PAMCAR Agreement. In the event Innophos Fosfatados is found not to be in compliance with the PAMCAR Agreements terms and deadlines, the exempted taxes, duties and related charges through December 31, 2004, could be reinstated. We estimate that the amount of exempted duties and related charges through December 31, 2004 may range up to $10.5 million at current exchange rates as of April 23, 2007 (including inflation and interest). In addition, we have been advised it is possible under applicable law that a penalty could be imposed of up to an additional $11.1 million at current exchange rates as of April 23, 2007. We believe that the above amounts represent the upper range of possible liability based on a finding of noncompliance involving pH levels rather than phosphorus, and, accordingly could be significantly reduced. We do not know whether the CNA will make a finding of noncompliance as to any aspect of the PAMCAR Agreement or what discharge limits would constitute the basis for a finding of noncompliance as to water quality requirements.
Based upon currently available information and advice of counsel, we would take appropriate steps to challenge any claim stemming from an alleged violation of the PAMCAR Agreement before the CNA and/or Mexican courts, and if any such claim were presented, evaluate potential indemnification rights against Rhodia. Based upon advice of counsel and our review of the CNA claims, the facts and applicable law, we have determined that liability is reasonably possible, but is neither probable nor reasonably estimable. Accordingly, we did not establish a liability on the balance sheet as of March 31, 2007.
Other Legal Matters
In June 2005, Innophos Canada, Inc. was contacted by representatives of Mosaic seeking a meeting to discuss the status of an ongoing remedial investigation and clean-up Mosaic is conducting at its currently closed fertilizer manufacturing site located north of Innophos Canadas Pt. Maitland, Ontario Canada plant site. The remediation is being overseen by the MOE. Mosaic stated that, in their view, we and Rhodia (our predecessor in interest prior to 2004) were responsible for some phosphorus compound contamination at a rail yard between the Innophos Canada, Inc. and Mosaic sites, and will be asked to participate in the clean-up. We have determined that this contingent liability is neither probable nor estimable at this time, but liability is reasonably possible. We have notified Rhodia of the Mosaic claim under the Rhodia Agreement, and we will seek all appropriate indemnification. Thus far, Rhodia has declined the claim stating that we have not provided sufficient information.
In connection with the Rhodia Agreement, various Rhodia entities and the Company, entered into sales representative agreements for the sale of certain of our products in various countries (other than North America). On September 29, 2004, the Company issued notices of termination under all those agreements, effective January 1, 2005. The Rhodia entities have claimed that they are entitled to indemnity payments equal to one-years commissions under the agreements, totaling approximately $1.4 million. The Company believes the indemnity payment applies solely to commissions on sales made after closing through August 31, 2004, which would total approximately $3 thousand. We believe we have meritorious defenses, and, if the claim is asserted in any proceeding, intend to contest liability vigorously.
In addition, we are party to legal proceedings that arise in the ordinary course of our business. Except as to the matters specifically discussed, we do not believe that these legal proceedings represent probable or reasonably possible liabilities. However, these matters cannot be predicted with certainty and an unfavorable resolution of one or more of them could have a material adverse effect on our business, results of operations, financial condition, and/or cash flows.
Other contingencies
In connection the acquisition of our business from Rhodia, the Company entered into certain ancillary agreements concerning transitional maters, and continuation of certain transactions and services between the two companies. One such agreement is the Utilities and Services Agreement (SilicaChicago Heights) (U&S Agreement) under which our Chicago Heights facility continues to provide certain services to Rhodias silica plant. Prior to the acquisition, our Chicago Heights phosphates facility and Rhodias Chicago Heights silica plant were integrated. Under the U&S Agreement certain utilities (electricity and natural gas) were to be separated following an initial one-year transition period (subject to extension), and other services were to continue for other terms (e.g., water for 5 years and steam for 10 years). Following an internal review of tax compliance, the Company identified issues as to whether the transactions under the U&S Agreement might be subject to certain sales, use and other state and local taxes. Management believes that our role under the U&S Agreement as to
18
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
utilities has been to continue to acquire utilities on Rhodias behalf, subject to reimbursement for actual cost, and that otherwise the nature of these post-acquisition transition services would not constitute a sale of these commodities of services subject to such taxes. Therefore, the Company believes this contingent matter does not represent a probable liability. Furthermore, should it be ultimately determined that such services are subject to such state and local taxes, the Company believes it can invoice Rhodia and obtain reimbursement of such taxes from Rhodia under the U&S Agreement. The current total amount of this contingent liability since our acquisition of the business from Rhodia as of August 13, 2004, is approximately $0.9 million, not including interest and penalties. The Company is working with Rhodias representatives to separate utilities and otherwise confirm the non-taxable nature of these services as to both prior and future periods.
10. Pension:
Net periodic benefit expense for the United States plans for the three months ended March 31, 2007:
2007 | ||||||||||||
Pension Plan |
Other Post-Retirement Benefits |
Total | ||||||||||
Service cost |
$ | 87 | $ | 84 | $ | 171 | ||||||
Interest cost |
43 | 35 | 78 | |||||||||
Expected return on assets |
(14 | ) | | (14 | ) | |||||||
Amortization of prior service cost |
34 | 72 | 106 | |||||||||
Amortization of unrecognized (gains)/losses |
| (27 | ) | (27 | ) | |||||||
Net periodic benefit expense |
$ | 150 | $ | 164 | $ | 314 | ||||||
Net periodic benefit expense for the United States plans for the three months ended March 31, 2006:
2006 | ||||||||||||
Pension Plan |
Other Post-Retirement Benefits |
Total | ||||||||||
Service cost |
$ | 91 | $ | 83 | $ | 174 | ||||||
Interest cost |
29 | 24 | 53 | |||||||||
Expected return on assets |
(4 | ) | 72 | 68 | ||||||||
Amortization of prior service cost |
34 | | 34 | |||||||||
Amortization of unrecognized (gains)/losses |
| (35 | ) | (35 | ) | |||||||
Net periodic benefit expense |
$ | 150 | $ | 144 | $ | 294 | ||||||
We made our entire cash contributions of $1.9 million for the year for our U.S. defined contribution plan during the first quarter of 2007 for the plan year 2006. The U.S. defined benefit cash contributions will be, at a minimum, approximately $0.6 million for 2007.
On April 26, 2007, the Company and the Union for the hourly employees at our Nashville facility agreed that it would freeze its defined benefit pension plan (the Plan) as of August 1, 2007. The accrual of additional benefits or increase in the current level of benefits under the Innophos, Inc. Hourly Pension Plan will cease effective August 1, 2007. After August 1, 2007, the Nashville Union employees will participate in a non contributory defined contribution benefit plan. As of January 1, 2007, Plan assets were less than the projected benefit obligation. Freezing of the Plan will be accounted for as a curtailment under SFAS No. 88, Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and the Company estimates it will have a $0.3 million to $0.5 million curtailment loss recorded in the second quarter of 2007.
19
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
Net periodic benefit expense for the Canadian plans for the three months ended March 31, 2007:
2007 | |||||||||||
Pension Plan |
Other Retirement |
Total | |||||||||
Service cost |
$ | 53 | 13 | $ | 66 | ||||||
Interest cost |
97 | 11 | 108 | ||||||||
Expected return on assets |
(130 | ) | | (130 | ) | ||||||
Amortization of initial transition obligation |
| 7 | 7 | ||||||||
Amortization of unrecognized (gains)/losses |
11 | 3 | 14 | ||||||||
Net periodic benefit expense |
$ | 31 | $ | 34 | $ | 65 | |||||
Net periodic benefit expense for the Canadian plans for the three months ended March 31, 2006:
2006 | |||||||||||
Pension Plan |
Other Post- Retirement Benefits |
Total | |||||||||
Service cost |
$ | 54 | 12 | $ | 66 | ||||||
Interest cost |
95 | 11 | 106 | ||||||||
Expected return on assets |
(101 | ) | | (101 | ) | ||||||
Amortization of initial transition obligation |
| 4 | 4 | ||||||||
Amortization of (gains)/losses |
18 | 8 | 26 | ||||||||
Net periodic benefit expense |
$ | 66 | $ | 35 | $ | 101 | |||||
We made cash contributions to our Canadian defined benefit plan of $0.4 million during the three months ended March 31, 2007. We expect to make cash contributions to our Canadian defined benefit plans of $1.1 million during the remainder of 2007.
11. Mexican Union Negotiations:
The Company and the Union in Mexico reached an agreement, which was ratified by the Union on March 27, 2007. As a result, the Company recorded pre-tax charges in the first quarter of 2007 of $0.9 million for severance under SFAS No. 112 and benefits for the elimination of 27 personnel and $0.5 million for benefit reductions for continuing employees. The combined 1.4 million pre-tax charge recorded in the first quarter of 2007 is included in cost of goods sold and in other current liabilities. The Company made no cash payments during the first quarter of 2007 and expects to make the cash payments in the second quarter of 2007.
12. Segment Reporting:
The Company discloses certain financial and supplementary information about its reportable segments, revenue by products and revenues by geographic area. Operating segments are defined as components of an enterprise about which separate discrete financial information is evaluated regularly by the chief operating decision maker, in order to decide how to allocate resources and assess performance. The primary key performance indicators for the chief operating decision maker are Sales and Operating Income. The Company reports its operations in three reporting segmentsUnited States, Mexico and Canada, each of which sells the entire portfolio of products.
20
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
For the three months ended March 31, 2007 |
United States | Mexico | Canada | Eliminations | Total | |||||||||||
Sales |
$ | 76,127 | $ | 53,039 | $ | 7,514 | $ | | $ | 136,680 | ||||||
Intersegment sales |
6,827 | 4,679 | 14,911 | (26,417 | ) | | ||||||||||
Total sales |
82,954 | 57,718 | 22,425 | (26,417 | ) | 136,680 | ||||||||||
Operating income (loss) |
$ | 652 | $ | 7,953 | $ | 1,422 | | $ | 10,027 | |||||||
For the three months ended March 31, 2006 |
United States | Mexico | Canada | Eliminations | Total | |||||||||||
Sales |
$ | 78,964 | $ | 44,672 | $ | 6,699 | $ | | $ | 130,335 | ||||||
Intersegment sales |
10,768 | 4,362 | 16,225 | (31,355 | ) | | ||||||||||
Total sales |
89,732 | 49,034 | 22,924 | (31,355 | ) | 130,335 | ||||||||||
Operating income (loss) |
$ | 8,687 | $ | 1,563 | $ | 823 | | $ | 11,073 | |||||||
Three months ended | ||||||
Geographic Revenues (1) |
March 31, 2007 |
March 31, 2006 | ||||
US |
$ | 69,621 | 72,683 | |||
Mexico |
38,717 | 34,191 | ||||
Canada |
7,844 | 7,629 | ||||
Other foreign countries |
20,498 | 15,832 | ||||
Total |
$ | 136,680 | $ | 130,335 | ||
(1) Based on destination of sale. |
21
INNOPHOS HOLDINGS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except where noted)
13. Subsequent event
On April 16, 2007, the Company issued and sold to qualified institutional buyers relying on Rule 144A under the Securities Act of 1933, as amended, a total of $66.0 million in principal amount of its 9 1/2 % Senior Unsecured Notes due April 15, 2012, or the Notes. The Notes were sold pursuant to a Purchase Agreement dated April 11, 2007, or the Purchase Agreement, between Innophos and Credit Suisse Securities (USA) LLC, or the Initial Purchaser, and issued under the provisions of an Indenture dated as of April 16, 2007, or the Notes Indenture, between Innophos and U.S. Bank National Association, as trustee, or the Trustee.
The Notes accrue interest from the issue date at a rate of 9 1/2% per annum, payable semi-annually in arrears on April 15 and October 15 of each year, commencing October 15, 2007.
The proceeds from the sale of the Notes, together with $0.5 million of cash on hand, were applied to pay expenses and redeem the entire remaining outstanding amount of Floating Rate Senior Notes due 2015 (including the payment of principal, premium and accrued interest) issued by our wholly-owned subsidiary, Innophos Investments Holdings, Inc.
On April 16, 2007,Innophos Investments Holdings, Inc. called for the redemption of the remaining $60.8 million in principal of its Floating Rate Senior Notes due 2015 effective May 17, 2007. In connection with the call, the full amount required for the redemption of the Floating Rate Senior Notes (principal, premium and accrued interest) was irrevocably deposited with the Trustee, satisfying the conditions precedent for releasing and discharging Investments under the terms of the indenture governing the Floating Rate Senior Notes.
Fees and expenses related to the Notes offering and the redemption of the Floating Rate Senior Notes will be approximately $1.9 million. The redemption of the Floating Rate Senior Notes will result in an approximate $1.6 million charge to earnings for the acceleration of deferred financing charges in the second quarter of 2007 and a $1.8 million call premium in the second quarter of 2007.
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ITEM 2. MANAGEMENTS DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS
This discussion contains forward-looking statements about our markets, the demand for our products and services and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons including those discussed in the Risk Factors as contained in our 2006 Annual Report on Form 10-K and Forward-Looking Statements sections of this report.
Overview
Innophos Holdings, Inc. is the parent of Innophos Investments Holdings, Inc., which owns 100% of Innophos, Inc; all are incorporated under the laws of the State of Delaware. On June 10, 2004, Innophos entered into a definitive purchase and sale agreement with affiliates of Rhodia to acquire certain assets and equity interests related to Rhodias North American specialty phosphates business, referred to herein as the Phosphates Business. The acquisition of the Phosphates Business from Rhodia, referred to herein as the Acquisition, was consummated on August 13, 2004, at a closing purchase price of $473.4 million, pending finalization of a working capital dispute relating to the closing balance sheet.
Below is a summary chart of the corporate structure of our direct subsidiaries.
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Historical Performance
Results of Operations
The following table sets forth a summary of the Companys operations and their percentages of total revenue for the periods indicated.
Three months ended 2007 |
Three months ended 2006 |
|||||||||||||
Amount | % | Amount | % | |||||||||||
Net sales |
$ | 136.7 | 100.0 | $ | 130.3 | 100.0 | ||||||||
Cost of goods sold |
115.7 | 84.6 | 108.5 | 83.3 | ||||||||||
Gross profit |
21.0 | 15.4 | 21.8 | 16.7 | ||||||||||
Operating expenses: Selling, general and administrative |
10.5 | 7.7 | 10.4 | 8.0 | ||||||||||
Research & Development Expenses |
0.5 | 0.4 | 0.3 | 0.2 | ||||||||||
Operating income |
10.0 | 7.3 | 11.1 | 8.5 | ||||||||||
Interest expense, net |
9.9 | 7.2 | 13.4 | 10.3 | ||||||||||
Foreign exchange (gains)/losses, net |
(0.1 | ) | (0.1 | ) | | | ||||||||
Other expense (income) |
0.1 | 0.1 | (0.1 | ) | (0.1 | ) | ||||||||
Provision (benefit) for income taxes |
2.2 | 1.6 | (0.9 | ) | (0.7 | ) | ||||||||
Net income (loss) |
$ | (2.1 | ) | (1.5 | ) | $ | (1.3 | ) | (1.0 | ) | ||||
Three months ended March 31, 2007 compared to the three months ended March 31, 2006
Net Sales
Net sales represent the selling price of the products, net of any customer-related rebates, plus freight and any other items invoiced to customers. Net sales for the three months ended March 31, 2007 were $136.7 million, an increase of $6.4 million, or 4.9%, as compared to $130.3 million for the same period in 2006. Volume and mix impact upon revenue across all product lines had a positive impact of 5.3% or $6.9 million while sales price had a negative impact of 0.4% or $0.5 million upon revenue.
The following table illustrates for the three months ended March 31, 2007 the percentage changes in net sales by reportable segment compared with the prior year, including the effect of price and volume/mix changes upon revenue:
Price | Volume/Mix | Total | |||||||
United States |
(1.0 | )% | (2.6 | )% | (3.6 | )% | |||
Canada |
(1.5 | )% | 13.7 | % | 12.2 | % | |||
Mexico |
0.9 | % | 17.8 | % | 18.7 | % |
The following table illustrates for the three months ended March 31, 2007 the percentage changes for net sales by major product lines compared with the prior year, including the effect of price and volume/mix changes upon revenue:
Price | Volume/Mix | Total | |||||||
Purified Phosphoric Acid |
(2.9 | )% | 3.6 | % | 0.7 | % | |||
Specialty Salts and Specialty Acids |
(1.0 | )% | 0.3 | % | (0.7 | )% | |||
STPP & Other Products |
3.6 | % | 18.2 | % | 21.8 | % |
The volume/mix increase in STPP & Other Products is due to strong demand, primarily in our Other Products.
Gross Profit
Gross profit represents net sales less cost of goods sold. Gross profit for the three months ended March 31, 2007 was $21.0 million, a decrease of $0.8 million, or 3.7%, as compared to $21.8 million for the same period in 2006. Gross profit decreased to 15.4% for the three months ended March 31, 2007 versus 16.7% for the same period in 2006. The change in gross profit was primarily due to positive volume and mix impacts upon revenue being offset by slightly lower selling prices, higher raw material and higher freight costs which had a combined negative impact of $2.4 million. In addition, there was a charge in the period of $1.4 million for the involuntary separation of twenty seven people and the fringe benefit buy-back program in Mexico. The change in gross profit was favorably impacted by $3.0 million due to a sulfuric acid maintenance outage at our Coatzacoalcos facilities during the same period in the first quarter of 2006.
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Operating Expenses and Research and Development
Operating expenses for the three months ended March 31, 2007 consist primarily of selling, general and administrative and R&D expenses. For the three months ended March 31, 2007 were $11.0 million, an increase of $0.3 million, or 2.8%, as compared to the same period in 2006.
Operating Income
Operating income for the three months ended March 31, 2007 was $10.0 million, a decrease of $1.1 million, or 9.9%, as compared to $11.1 million for the same period in 2006. Operating income as a percentage of net sales was 7.3% for the three months ended March 31, 2007 and 8.5% for the same period in 2006.
Interest Expense, net
Net interest expense, including deferred financing amortization expense, for the three months ended March 31, 2007 was $9.9 million, a decrease of $3.5 million, compared to $13.4 million for the same period in 2006. This decrease is due to the lower debt level of our Floating Rate Senior Notes which was paid down in the fourth quarter of 2006 from the proceeds of our IPO resulting in a decrease of $2.3 million of interest expense. Interest expense was lower by $0.7 million due to the decreased debt level of our Term Loan, and lower deferred financing amortization charges of $0.6 million associated with our Term Loan debt repayments in 2006.
Foreign Exchange
Foreign exchange gain for the three months ended March 31, 2007 was $0.1 million compared to zero for the same period in 2006. The U.S. dollar is the functional currency of our Mexican and Canadian operations. Consequently, foreign exchange gain or loss is recorded on remeasurement of non-U.S. dollar denominated monetary assets and liabilities. Such gains and losses fluctuate from period to period as the foreign currencies strengthen or weaken against the U.S. dollar and the amount of non-U.S. dollar denominated assets and liabilities increases or decreases.
Provision for Income Taxes
Provision for income tax expense for the three months ended March 31, 2007 was a charge of $2.2 million, compared to a benefit of $0.9 million for the comparable period of 2006. Income from Mexico is fully taxable, so increases in our Mexican earnings, as we had in the first quarter 2007, would normally be expected to result in increased income tax expense.
Net Loss
Net loss for the three months ended March 31, 2007 was $2.1 million, an increase of $0.8 million, compared to a net loss of $1.3 million for the same period in 2006, due to the factors described above.
Segment Reporting
The company reports its operations in three reporting segmentsUnited States, Mexico and Canada, each of which sells the entire portfolio of products. The primary performance indicators for the chief operating decision maker are sales and operating income, with sales on a ship-from basis. The following table sets forth the historical results of these indicators by segment:
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Three months ended 2007 |
Three months ended 2006 |
Net Sales % Change | |||||||||
Segment Net Sales |
|||||||||||
United States |
$ | 76,127 | $ | 78,964 | (3.6 | %) | |||||
Mexico |
53,039 | 44,672 | 18.7 | % | |||||||
Canada |
7,514 | 6,699 | 12.2 | % | |||||||
Total |
$ | 136,680 | $ | 130,335 | 4.9 | % | |||||
Segment Operating Income |
|||||||||||
United States |
$ | 652 | $ | 8,687 | |||||||
Mexico |
7,953 | 1,563 | |||||||||
Canada |
1,422 | 823 | |||||||||
Total |
$ | 10,027 | $ | 11,073 | |||||||
Segment Operating Income % of net sales |
|||||||||||
United States |
0.9 | % | 11.0 | % | |||||||
Mexico |
15.0 | % | 3.5 | % | |||||||
Canada |
18.9 | % | 12.3 | % |
Segment Net Sales:
The United States shows a decrease in net sales of 3.6% for the three months ended March 31, 2007 when compared with 2006. Selling prices decreased sales 1.0%, mainly in Purified Phosphoric Acid. Volume and mix impacts upon revenue, primarily in Specialty Salts and Specialty Acids, decreased sales 2.6%.
In Mexico, the three months ended March 31, 2007 net sales increased 18.7% when compared with 2006. Selling prices increased sales 0.9% primarily in STPP & Other Products. Volume and mix impacts upon revenue, primarily in STPP & Other Products and Specialty Salts and Specialty Acids, increased sales 17.8%.
For the three months ended March 31, 2007, net sales in Canada increased 12.2% when compared with 2006. Selling price decreased 1.5% in STPP & Other Products. Volume and mix impacts upon revenue in Specialty Salts and Specialty Acids increased sales 13.7%.
Segment Operating Income % of Net Sales:
The 10.1% decrease in the United States for the period March 31, 2007 compared to the period March 31, 2006 is due to increases in raw material prices and freight costs in combination with unfavorable volume and mix impacts upon revenue, as well as decreased selling prices.
The 11.5% increase in Mexico from March 31, 2007 to March 31, 2006 is due to favorable selling prices and higher volume and mix impacts upon revenue partially offset by the increased cost associated with the involuntary separation of 27 personnel and the fringe benefit buy-back program. In addition results for the prior period were favorably impacted by $3.0 million associated with the planned non-annual sulfuric acid maintenance outage that occurred at our Coatzacoalcos facility in the period ended March 31, 2006.
The 6.6% increase in Canada from March 31, 2007 to March 31, 2006 is due to positive volume and mix impacts upon revenue which offset lower prices.
During the three month period ending March 31, 2007 depreciation and amortization expense was $6.9 million in the United States, $0.3 in Canada, and $4.4 million in Mexico.
Liquidity and Capital Resources
The following table sets forth a summary of the Companys cash flows for the periods indicated.
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Three months ended 2007 |
Three months ended 2006 |
|||||||
Operating Activities |
$ | (1.9 | ) | $ | 2.6 | |||
Investing Activities |
(4.6 | ) | (2.7 | ) | ||||
Financing Activities |
(9.5 | ) | (18.5 | ) |
Three months ended March 31, 2007 compared to March 31, 2006
Net cash provided by operating activities was a use of $1.9 million for the three months ended March 31, 2007 as compared to a source of $2.6 million for the same period in 2006, a decrease of $4.5 million. The decrease in operating activities is due to unfavorable changes of $0.8 million in net income, as described earlier, $3.3 million in non-cash items affecting net income, and $5.3 million in non-current accounts offset by a $4.9 million favorable change in net working capital.
Non-cash items affecting net income were unfavorable by $3.3 million primarily due to the interest on our Floating Rate Senior Notes being paid in cash rather than being capitalized in the form of new notes. Decreased deferred financing expense resulting from our debt retirement in 2006 also added to the unfavorable result. These affects were partially offset by decreased benefits from deferred taxes, new stock based compensation-restricted stock expense, favorable movements in profit sharing and depreciation and amortization.
The change in net working capital is a use of cash of $8.7 million in 2007 compared to a use in 2006 of $13.6 million, a decrease in the use of cash of $4.9 million. Changes in non-current accounts had an unfavorable impact on cash of $5.3 million. This was due to increased long term liabilities in 2006, mostly pension related, and the recording of dividends declared of $3.5 million in the first quarter of 2007.
Net cash used for investing activities was $4.6 million for the three months ended March 31, 2007, compared to $2.7 million for the same period in 2006, a reduction in cash of $1.9 million. This is mainly due to increased capital spending related to the cogeneration project in Coatzacoalcos.
Net cash from financing activities for the three months ended March 31, 2007 was a use of $9.5 million, compared to a use of $18.5 million in 2006, a decrease in the use of cash of $9.0 million. This is due to $10.5 million lower Term Loan principal payments in 2007 and $0.7 million in proceeds from stock option exercises, offset by a $2.3 million payment of dividends.
On April 16, 2007 Innophos Holdings, Inc. issued $66.0 million of 9.5% Senior Unsecured notes due 2012, and used the net proceeds plus approximately $0.5 million of cash on hand for full redemption of the $60.8 million Floating Rate Senior notes issued by Innophos Investments Holdings, Inc. and to pay related expenses. Since this transaction was subsequent to March 31, 2007, it had no effect on the Companys consolidated financial position or results of operations as of March 31, 2007.
The Company and the Union in Mexico reached an agreement, which was ratified by the Union on March 27, 2007. As a result, the Company will pay approximately $0.9 million for the severance and benefits for the elimination of 27 personnel and approximately $0.5 million for benefit reductions for continuing employees all in the second quarter of 2007.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks as part of our ongoing business operations. Primary exposures include changes in interest rates, as borrowings under our senior credit facility will bear interest at floating rates based on LIBOR or the base rate, in each case plus an applicable borrowing margin. We will manage our interest rate risk by balancing the amount of fixed-rate and floating-rate debt. For fixed-rate debt, interest rate changes do not affect earnings or cash flows. Conversely, for floating-rate debt, interest rate changes generally impact our earnings and cash flows, assuming other factors are held constant.
At March 31, 2007, we had $190 million principal amount of fixed-rate debt, $191.0 million of available floating-rate debt, and $60.8 million Floating Rate Senior Notes. Based on $141.0 million outstanding as floating rate debt as borrowings under our senior credit facility, an immediate increase of one percentage point would cause an increase to cash interest expense of approximately $1.4 million per year. The $60.8 million, excluding accrued interest, Floating Rate Senior Notes maturing in 2015 will pay interest in cash or in the form of issuing new notes in-lieu of cash until 2010. Therefore, an increase of one percentage point would cause an increase of $0.6 million per year in the form of cash or additional notes due in 2015. As all of the business for Innophos Holdings, Inc. is transacted through Innophos, Inc. and its subsidiaries, Innophos Holdings, Inc. is dependent on earnings and the distribution of funds from Innophos, Inc. and subsidiaries.
On April 16, 2007 Innophos Holdings, Inc. issued $66.0 million of 9.5% Senior Unsecured notes due 2012, and used the net proceeds plus approximately $0.5 million of cash on hand for full redemption of the $60.8 million Floating Rate Senior notes issued by Innophos Investments Holdings, Inc. and to pay related expenses. Since this transaction was subsequent to March 31, 2007, it had no effect on the Companys consolidated financial position or results of operations as of March 31, 2007.
Changes in economic conditions could result in higher interest rates, thereby increasing our interest expense and other operating expenses and reducing our funds available for capital investment, operations or other purposes. In addition, a substantial portion of our cash flow must be used to service debt, which may affect our ability to make future acquisitions or capital expenditures. We may from time to time use interest rate protection agreements to minimize our exposure to interest rate fluctuation. However, there can be no assurance that hedges will achieve the desired effect. We may experience economic loss and a negative impact on earnings or net assets as a result of interest rate fluctuations.
We do not currently hedge our commodity or currency rate risks. In April 2006, we entered into two interest rate cap derivative instruments each with a notional amount of $100 million with the first interest rate cap instrument expiring in April 2008 and the other interest rate cap instrument expiring in April 2009.
We believe that our concentration of credit risk related to trade accounts receivable is limited since these receivables are spread among a number of customers and are geographically dispersed. No one customer accounted for more than 10% of our sales in the last 3 years.
Foreign Currency Exchange Rates
The U.S. dollar is the functional currency of the Canadian and Mexican operations. Accordingly, these operations monetary assets and liabilities are translated at current exchange rates, non-monetary assets and liabilities are translated at historical exchange rates, and revenue and expenses are translated at average exchange rates and at historical exchange rates for the related revenue and expenses of non-monetary assets and liabilities. All translation gains and losses are included in net income.
Our principal source of exchange rate exposure in our foreign operations consists of expenses, such as labor expenses, which are denominated in the foreign currency of the country in which we operate. A decline in the value of the U.S. dollar relative to the local currency would generally cause our operational expenses (particularly labor costs) to increase (conversely, a decline in the value of the foreign currency relative to the U.S. dollar would cause these expenses to decrease). We believe that normal exchange rate fluctuations consistent with recent historical trends would have a modest impact on our expenses, and would not materially affect our financial condition or results of operations. Nearly all of our sales are denominated in U.S. dollars and our exchange rate exposure in terms of sales revenues is minimal.
Inflation and changing prices
Our costs and expenses will be subject to inflation and price fluctuations. Significant price fluctuations in raw materials, freight, and energy costs, could have a material effect on our financial condition and results of operations.
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Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) that are designed to provide reasonable assurance that information required to be reported in the Companys consolidated financial statements and filings is recorded, processed, summarized and reported within the periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to the Companys management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
As of March 31, 2007, the Company completed an evaluation under the supervision and with the participation of the Companys management, including the Companys principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective.
For the year ending December 31, 2007, pursuant to Section 404 of the Sarbanes-Oxley Act, management will be required to deliver a report that assesses the effectiveness of our internal controls over financial reporting and our auditors will be required to independently certify the effectiveness of our internal controls over financial reporting. We have a substantial effort ahead of us to implement appropriate processes, document the system of internal control over key processes, assess their design, remediate any deficiencies identified and test their functionality.
There have been no changes in our internal control over financial reporting during or with respect to the first quarter of 2007 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
Mexican Tax Claims
On November 1, 2004, our Mexican subsidiary, Innophos Fosfatados, received notice of claims from the Tax Audit and Assessment Unit of the National Waters Commission, or CNA, demanding payment of governmental duties, taxes and other charges for failure to have certain permits allowing extraction of salt water for processing in 1998 and 1999, or Salt Water Claims, and for the underpayment of governmental duties, taxes and other charges for the extraction and use of fresh water from national waterways from 1998 through 2002 at our Coatzacoalcos manufacturing plant, or Fresh Water Claims.
As initially assessed by the CNA, and as shown in the table below, the claims total approximately $137.3 million at current exchange rates as of April 23, 2007.
Tax Item |
Salt Water Claims | Fresh Water Claims | Total | ||||||
(dollars in millions) | |||||||||
Basic Charges |
$ | 27.1 | $ | 10.6 | $ | 37.7 | |||
Interest, Inflation and Penalties |
79.5 | 20.1 | 99.6 | ||||||
Total |
$ | 106.6 | $ | 30.7 | $ | 137.3 | |||
Management believes that Innophos Fosfatados has valid bases for challenging the amount of the CNA claims, and we are vigorously defending the matter.
CNA Administrative Proceedings; Appeals. On January 17, 2005, Innophos Fosfatados filed documents with the CNA seeking revocation and dismissal of all claims made by that agency. On August 29, 2005, the CNA rejected the substantive challenges as to the Fresh Water Claims (although the CNA agreed that certain corrections were required as to its surcharge calculations), confirming the original claims. In addition, on technical grounds, the CNA ordered the revocation of the resolutions containing the Salt Water Claims in order to correct certain errors, and consequently did not address the
29
substantive challenges. As a result of these rulings, the CNAs original assessments currently stand at $30.7 million for the Fresh Water Claims and no amount for the Salt Water Claims as they were revoked. CNA has, however, reserved its right to issue new resolutions correcting the technical errors as to both the Fresh Water and Salt Water Claims. On November 3, 2005, Innophos Fosfatados filed appeals with the Mexican Federal Court of Fiscal and Administrative Justice challenging all CNAs claims and some CNA rulings, including a discretionary appeal seeking a court ruling on the Companys substantive challenges to the Salt Water Claims that were not addressed by CNA. On May 11, 2007, a five judge panel of the court issued its decision unanimously overturning the Salt Water Claims. The CNA has a right to appeal, and we do not know whether it will do so. It is not known when our appeal of the Fresh Water Claims will be decided by the court.
Rhodia Indemnification. Under the terms of the Rhodia Agreement, according to which our business was purchased, we received indemnification against a number of contingencies, including claims for Mexican Taxes (as defined in the Rhodia Agreement) such as those alleged by CNA, as well as any additional duties, taxes and charges which may be assessed by the CNA for the period after 2002 but arising on or before the August 13, 2004 closing date of the acquisition. Rhodia has acknowledged its responsibility for such claims, but under a different indemnification obligation (described below) and under a reservation of rights, and has assumed control of the defense of the CNA claims. We asserted that we are entitled to full indemnification for liabilities relating to Taxes and for breach of covenants under the Rhodia Agreement (concerning what we have characterized as a known, undisclosed CNA audit). Rhodia has disagreed, asserting instead that the applicable indemnification under the Rhodia Agreement is for breach of representations and warranties, which in turn would subject the liabilities relating to the CNA claims to a deductible amount of $15.9 million and a limit of $79.5 million above that deductible amount.
On December 16, 2004, we sued Rhodia in New York State Supreme Court (New York County) seeking a determination that we are entitled to full indemnification under the Rhodia Agreement. We filed a motion for summary judgment with the court, seeking declarations that the CNA claims are Taxes under the Rhodia Agreement, and that Rhodia is obligated to provide any necessary security to guarantee the claims to the Mexican government. The Court entered an order granting our summary judgment motion on both counts on June 13, 2005. Rhodia appealed the order to the Appellate Division, First Department, which on March 22, 2007 affirmed the lower courts rulings in our favor. On April 27, 2007, Rhodia filed with the Appellate Division a Motion for Leave to Appeal to New Yorks highest court, the New York Court of Appeals on the issue as to whether the CNA claims are Taxes under the Rhodia Agreement. That motion, together with our opposition to it, has now been submitted to the court for decision. If the motion is granted, the Court of Appeals is likely to allow the appeal, and the matter will be briefed and argued in the ordinary course. If the motion is denied, Rhodia would have an opportunity to file a similar request with the Court of Appeals. Rhodia did not seek an appeal of the Appellate Divisions decision that Rhodia is responsible for any security required by the Mexican authorities.
Security Pending Challenges. Security for the full amount of the matter in dispute, which approximates $170.2 million (at current exchange rates as of April 23, 2007 with the security amount projected to February 2008), was required by June 17, 2005. In light of the technical revocation of the Salt Water Claims and the invalidation of The Salt Water Claims by the recent order of the Court of Fiscal and Administrative Justice, we have been advised that the amount of security required would be reduced to $37.0 million at current exchange rates as of April 23, 2007. We believe the posting of security was an obligation of Rhodia under the New York court ruling (referenced above). Rhodia has acknowledged its obligation to post such security, but has taken the position that security is not currently required. If Rhodia does not or cannot timely post security, it is possible that Innophos Fosfatados will have to do so. There are multiple types of acceptable security, the most common type of security being an asset backed mortgage. In the event the Mexican Ministry of Finance determines that security was not provided in a timely manner, or that Innophos Fosfatados was otherwise not satisfying security requirements, the Ministry could seize certain Innophos Fosfatados assets or appoint a surveyor with certain administrative powers over Innophos Fosfatados assets and operations to ensure compliance pending appeals.
Further Proceedings. A final determination of the matter may require appeals to the Mexican Supreme Court and possible remands to the CNA or to lower courts, which might continue for several years. In the event that the CNA were to issue a full set of new resolutions confirming the original Salt Water Claims and Fresh Water Claims, and appeals were to be decided against us, we could be required to pay a judgment for the entire amount of the CNA claims (which could include accrual of additional interest and inflationary adjustments, as well as duties, taxes and other charges for periods after 2002, which management estimates under current operating conditions at approximately $1.7 million of additional basic charges per year, excluding interest, inflation adjustments, and penalties).
Based upon advice of counsel and our review of the CNA claims, the facts and applicable law, we have determined that liability is reasonably possible, but is neither probable nor reasonably estimable. Accordingly, we have not established a liability on the balance sheet as of March 31, 2007. As additional information is gained, we will reassess the potential liability and establish the amount of any loss reserve as appropriate.
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Mexican Water Recycling System PAMCAR Agreement
Innophos Fosfatados is the successor to an agreement with the CNA (originally entered into in 1997 by Albright & Wilson-Troy de Mexico, S.A. de C.V., succeeded in 2000 by Rhodia Fosfatados de Mexico, S.A. de C.V.) to construct a water recycling system to reduce water effluents into the Gulf of Mexico, to comply with applicable discharge limits and regulations, and to reuse at least 95% of the water derived from the production processes at the Coatzacoalcos facility (the PAMCAR Agreement). The PAMCAR Agreement required that action plans be completed by December 31, 2004. Under the terms of the PAMCAR Agreement and subject to compliance, the CNA temporarily exempted Innophos Fosfatados from the payment of certain waste water discharge duties, taxes and related charges, which would normally have been payable.
All equipment to recycle water was in place and in operating condition as of December 31, 2004. On January 10, 2005, Innophos Fosfatados notified the CNA of its position that as of December 31, 2004, it complied with the applicable requirements of the PAMCAR Agreement. We have been advised by Mexican environmental counsel that compliance with the discharge limits aspect of the PAMCAR Agreement should be based upon limits which were issued in 2005.
Innophos Fosfatados relevant waste water discharges were the subject of a study by the National University of Mexico, which concluded in October 2004 that such discharges do not adversely impact the receiving water bodies or the environment. In addition to a previous request by Innophos Fosfatados to update the relevant waste water discharge permit with new operating information, in October 2004, Innophos Fosfatados filed a petition with the CNA to reflect the results of the university study and to revise discharge limits which the now-improved operations can satisfy. In 2005, Innophos Fosfatados received a government authorization known as a Concession Title (containing a waste water discharge permit and limits) granting the requested relief as to all discharge limits.
CNA regional officials may take the position that compliance with the PAMCAR Agreement will be determined by the previous Concession Title. Consequently, while Mexican counsel has advised us that compliance should be determined upon the new, revised, discharge limits as a matter of applicable law, CNA regional officials could find that Innophos Fosfatados was not in compliance for the duration of the PAMCAR Agreement. In the event Innophos Fosfatados is found not to be in compliance with the PAMCAR Agreements terms and deadlines, the exempted taxes, duties and related charges through December 31, 2004, could be reinstated. We estimate that the amount of exempted duties and related charges through December 31, 2004 may range up to $10.5 million at current exchange rates as of April 23, 2007 (including inflation and interest). In addition, we have been advised it is possible under applicable law that a penalty could be imposed of up to an additional $11.1 million at current exchange rates as of February 28, 2007). We believe that the above amounts represent the upper range of possible liability based on a finding of noncompliance involving pH levels rather than phosphorus, and, accordingly could be significantly reduced. We do not know whether the CNA will make a finding of noncompliance as to any aspect of the PAMCAR Agreement or what discharge limits would constitute the basis for a finding of noncompliance as to water quality requirements.
Based upon currently available information and advice of counsel, we would take appropriate steps to challenge any claim stemming from an alleged violation of the PAMCAR Agreement before the CNA and/or Mexican courts, and if any such claim were presented, evaluate potential indemnification rights against Rhodia. Based upon advice of counsel and our review of the CNA claims, the facts and applicable law, we have determined that liability is reasonably possible, but is neither probable nor reasonably estimable. Accordingly, we did not establish a liability on the balance sheet as of March 31, 2007.
Other Legal Matters
In June 2005, Innophos Canada, Inc. was contacted by representatives of Mosaic seeking a meeting to discuss the status of an ongoing remedial investigation and clean-up Mosaic is conducting at its currently closed fertilizer manufacturing site located north of Innophos Canadas Pt. Maitland, Ontario Canada plant site. The remediation is being overseen by the MOE. Mosaic stated that, in their view, we and Rhodia (our predecessor in interest prior to 2004) were responsible for some phosphorus compound contamination at a rail yard between the Innophos Canada, Inc. and Mosaic sites, and will be asked to participate in the clean-up. We have determined that this contingent liability is neither probable nor estimable at this time, but liability is reasonably possible. We have notified Rhodia of the Mosaic claim under the Rhodia Agreement, and we will seek all appropriate indemnification. Thus far, Rhodia has declined the claim stating that we have not provided sufficient information.
In connection with the Rhodia Agreement, various Rhodia entities and the company, entered into sales representative agreements for the sale of certain of our products in various countries (other than North America). On September 29, 2004, Innophos, Inc. issued notices of termination under all those agreements, effective January 1, 2005. The Rhodia entities have claimed that they are entitled to indemnity payments equal to one-years commissions under the agreements, totaling approximately $1.4 million. We believe the indemnity payment applies solely to commissions on sales made after closing through August 31, 2004, which would total approximately $3 thousand. We believe we have meritorious defenses, and, if the claim is asserted in any proceeding, intend to contest liability vigorously.
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In addition, we are party to legal proceedings that arise in the ordinary course of our business. Except as to the matters specifically discussed, we do not believe that these legal proceedings represent probable or reasonably possible liabilities. However, these matters cannot be predicted with certainty and an unfavorable resolution of one or more of them could have a material adverse effect on our business, results of operations, financial condition, and/or cash flows.
There have been no material changes from the risk factors previously disclosed in our 2006 Annual Report on Form 10-K other than as mentioned below.
Environmental and Other Regulatory Concerns
Our operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials and some of our products are ingredients in foods, nutritional supplements or pharmaceutical excipients that are used to make in finished products consumed or used by humans or animals. As a result, we are subject to extensive and frequently changing environmental and other regulatory requirements and periodic inspection by federal, state, and local authorities, including the U.S. Environmental Protection Agency, or EPA, the Food and Drug Administration, or FDA and the U.S. Department of Agriculture or USDA, as well as other regulatory authorities and those with jurisdiction over our foreign operations. Our operations also expose us to the risk of claims for environmental remediation and restoration or for exposure to hazardous materials. Our production facilities require various operating permits that are subject to renewal or modification. Violations of environmental laws, regulations, or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages, the rescission of operating permits, third-party claims for property damage or personal injury, or other costs.
Maintaining compliance with health and safety and environmental laws and regulations has resulted in ongoing costs for us. Currently, we are involved in several compliance and remediation efforts and agency inspections concerning health, safety and environmental matters. The EPA has indicated that compliance at facilities in the phosphate industry is a high enforcement priority. In 2004, the EPA conducted a multi-media inspection and in 2005 followed up on issues regarding compliance with air, water and hazardous waste regulations at our Geismar, Louisiana plant. In August 2006, we received a report in connection with that inspection identifying certain areas of concern raised by the EPA under its hazardous waste regulations. We believe that we operate our Geismar facility in material compliance with all applicable environmental laws and regulations, including those of the EPA, and have responded to those concerns by explaining how in our judgment our operations meet applicable regulations or exclusions. In March 2007, we received a further EPA request for additional information concerning hazardous waste, air pollution controls and materials handling at the Geismar plant. We are working on providing the requested information.
Some existing environmental laws and regulations impose liability and responsibility on present and former owners, operators or users of facilities and sites for contamination at those locations without regard to causation or knowledge of contamination. Many of our sites have an extended history of industrial use. Soil and groundwater contamination have been detected at some of our sites, and additional contamination might occur or be discovered at these sites or other sites (including sites to which we may have sent hazardous waste) in the future. We continue to investigate, monitor or clean-up contamination at most of these sites. Due to the uncertainties associated with environmental investigations and clean-ups and the ongoing nature of the investigations and clean-ups at our sites, we cannot predict precisely the nature, cost, and timing of our future remedial obligations with respect to our sites.
Additional laws or regulations focused on phosphate-based products may be implemented in the future. For example, a number of states are moving to effectively ban the use of phosphate-based products in consumer automatic dishwashing detergents (ADW). In 2006, Washington State enacted legislation of that type, effective in several counties in 2008 and state-wide in 2010. Maryland also has recently enacted similar legislation, while Vermont has passed such legislation pending action by its governor (both to be effective in 2010), and comparable bills are being considered by the legislatures of several other states. In 2007, the trade association that includes major manufacturers of consumer ADW began actively to support these efforts, increasing the likelihood they will become widespread. This trend and related changes in consumer preferences could have a significant impact on our business to the extent we are not able to react in a timely and adequate manner to our customers reformulations of ADW products and resulting market changes by adjusting our sales and manufacturing plans. Furthermore, although already banned in home laundry detergents in many U.S. States, phosphates are still permitted for those applications in many Latin American regions. We cannot be sure that such a ban may not be implemented in some or all of these Latin American markets in the future, although the geological and hydrological conditions (e.g., river and lake regions) differ substantially from the U.S. Additional laws or regulations focused on reduced use of other phosphate-based products could occur in the future. For example, some jurisdictions have threatened to further regulate or ban the use of polyphosphoric acid and orthophosphoric acid in asphalt road construction. Such a ban, if instituted in multiple jurisdictions or throughout the U.S., could have a significant impact on our business.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On November 7, 2006 the Company closed an initial public offering of 8,695,652 shares of common stock, of which the Company sold 8,000,000 newly issued shares of common stock and the selling stockholders sold 695,652 existing shares of common stock, priced at $12.00 per share. We did not receive any proceeds from the shares of common stock sold by the selling stockholders. In addition, the underwriters had an option to purchase up to an additional 1,304,348 existing shares at the IPO from the selling stockholders which was exercised on November 10, 2006 to cover over-allotments of shares. The Company did not receive any proceeds from the sale of over-allotments. The offering was effected pursuant to a Registration Statement on Form S-1/A (File No. 333-135851), which the SEC declared effective on November 2, 2006, and a final prospectus filed pursuant to Rule 424(b) under the Securities Act on November 3, 2006 (Reg. No. 333-135851). Credit Suisse Securities (USA) LLC and Bear, Stearns & Co. Inc. acted as co-managers for the offering. As of the date of the filing of this Quarterly Report, the offering has terminated.
The public offering price was $12.00 per share and the aggregate offering price was $120.0 million. The underwriting discounts and commissions were $0.84 per share and $8.4 million in the aggregate. Proceeds before expenses to us were $11.16 per share and $89.3 million in the aggregate. Proceeds before expenses to the selling stockholders were $11.16 per share and $22.3 in the aggregate. The Company did not receive any of the proceeds from the sale of shares by selling stockholders or upon the exercise of the underwriters over-allotment option.
The net proceeds received by the Company in the offering were $87.2 million, as follows:
($millions) | |||
Aggregate offering proceeds to the Company |
$ | 96.0 | |
Underwriting discounts and commissions |
6.7 | ||
Other fees and expenses in connection with the offering |
2.1 | ||
Total expenses |
8.8 | ||
Net proceeds to the Company |
$ | 87.2 | |
The Company used the offering proceeds to pay down approximately $83.3 million in aggregated principal of Innophos Investment Holdings Floating Rate Senior Notes due 2015, or the Floating Rate Senior Notes, on December 11, 2006. The remaining proceeds were applied to the related call premiums and interest of approximately $4.4 million.
There has been no material change in the planned use of proceeds from our initial public offering as described in our final prospectus filed with the SEC pursuant to Rule 424(b).
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
None.
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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.
INNOPHOS HOLDINGS, INC. | ||
/s/ Randolph Gress | ||
By: | Randolph Gress | |
Its: | Chief Executive Officer and Director (Principal Executive Officer) | |
Dated: May 14, 2007 | ||
INNOPHOS HOLDINGS, INC. | ||
/s/ Richard Heyse | ||
By: | Richard Heyse | |
Its: | Vice President and Chief Financial Officer (Principal Financial Officer) | |
Dated: May 14, 2007 |
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EXHIBIT INDEX
Exhibit No. | Description | |
31.1 | Certification of Principal Executive Officer dated May 14, 2007 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of Principal Financial Officer dated May 14, 2007 pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification of Principal Executive Officer dated May 14, 2007 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.2 | Certification of Principal Financial Officer dated May 14, 2007 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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