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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________.
NOVEON, INC.
----------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware File No. 333-61812 13-4143915
------------------------ ------------------------ -------------------
(State of incorporation) (Commission File Number) (IRS Employer
Identification No.)
9911 Brecksville Road
Cleveland Ohio 44141
-------------------------------------------------
(Address of Principal Executive Offices)
(Zip Code)
(216) 447-5000
----------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 10, 2003, there is 1 share of registrant's common stock
outstanding.
NOVEON, INC.
Index to Form 10-Q for the Quarter Ended September 30, 2003
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Income Statement--Three and nine months
ended September 30, 2003 and 2002...................................3
Condensed Consolidated Balance Sheet--September 30, 2003 and
December 31, 2002...................................................4
Condensed Consolidated Statement of Cash Flows--Nine months ended
September 30, 2003 and 2002.........................................5
Notes to Condensed Consolidated Financial Statements................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................23
Item 3. Quantitative and Qualitative Disclosures of Market Risk............39
Item 4. Controls and Procedures............................................40
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K...................................41
2
NOVEON, INC.
Condensed Consolidated Income Statement
(dollars in millions)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ----------------------------
2003 2002 2003 2002
-----------------------------------------------------------
(unaudited)
Sales $ 278.8 $ 273.2 $ 855.1 $ 813.5
Cost of sales 199.5 184.2 608.2 547.5
--------------------------- -----------------------------
Gross profit 79.3 89.0 246.9 266.0
Selling and administrative expenses 49.9 51.3 150.6 151.7
Amortization expense 3.6 3.5 11.0 10.5
Restructuring and consolidation costs 0.5 1.1 3.6 2.9
--------------------------- -----------------------------
Operating income 25.3 33.1 81.7 100.9
Interest expense--net 17.3 18.9 53.5 57.4
Other expense--net 0.5 0.1 0.6 0.2
--------------------------- -----------------------------
Income before income taxes and cumulative effect
of accounting change 7.5 14.1 27.6 43.3
Income tax expense 1.8 1.8 5.4 6.7
--------------------------- -----------------------------
Income before cumulative effect of accounting change 5.7 12.3 22.2 36.6
Cumulative effect of accounting change--net of tax - - 0.5 -
--------------------------- -----------------------------
Net income $ 5.7 $ 12.3 $ 21.7 $ 36.6
=========================== =============================
See notes to condensed consolidated financial statements.
3
NOVEON, INC.
Condensed Consolidated Balance Sheet
(dollars in millions)
SEPTEMBER 30, DECEMBER 31,
2003 2002
---------------------------------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 86.4 $ 79.5
Accounts and notes receivable, net of allowances ($7.6 and
$9.0 at September 30, 2003 and December 31, 2002, respectively) 164.2 135.7
Inventories 149.8 144.1
Prepaid expenses and other current assets 6.4 7.2
---------------------------------------
TOTAL CURRENT ASSETS 406.8 366.5
Property, plant and equipment--net 667.0 670.7
Goodwill 403.2 365.5
Identifiable intangible assets--net 175.7 182.1
Receivable from Parent 1.4 1.2
Other assets 46.3 43.1
---------------------------------------
TOTAL ASSETS $ 1,700.4 $ 1,629.1
=======================================
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Short-term bank debt $ - $ 0.4
Accounts payable 119.6 111.2
Accrued expenses 53.5 70.6
Income taxes payable 8.5 5.3
Current maturities of long-term debt 12.2 -
---------------------------------------
TOTAL CURRENT LIABILITIES 193.8 187.5
Long-term debt 840.5 847.1
Postretirement benefits other than pensions 5.9 5.8
Accrued pensions 38.5 34.9
Deferred income taxes 18.0 18.1
Accrued environmental 18.2 18.2
Other non-current liabilities 16.9 17.8
STOCKHOLDER'S EQUITY
Common stock - -
Paid in capital 498.0 498.0
Retained earnings (deficit) 19.8 (1.9)
Accumulated other comprehensive income 50.8 3.6
---------------------------------------
TOTAL STOCKHOLDER'S EQUITY 568.6 499.7
---------------------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 1,700.4 $ 1,629.1
=======================================
See notes to condensed consolidated financial statements.
4
NOVEON, INC.
Condensed Consolidated Statement of Cash Flows
(dollars in millions)
NINE MONTHS ENDED
SEPTEMBER 30,
2003 2002
---------------------------------------
(unaudited)
OPERATING ACTIVITIES
Net income $ 21.7 $ 36.6
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 67.1 61.3
Deferred income taxes 0.1 2.2
Debt issuance cost amortization in interest expense 4.0 4.2
Cumulative effect of accounting change--net of tax 0.5 -
Change in assets and liabilities, net of effects of
acquisitions of businesses (31.9) (7.5)
---------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 61.5 96.8
INVESTING ACTIVITIES
Purchases of property, plant and equipment (39.2) (27.7)
Payments made in connection with acquisitions,
net of cash acquired (16.6) (20.6)
---------------------------------------
NET CASH (USED) BY INVESTING ACTIVITIES (55.8) (48.3)
FINANCING ACTIVITIES
Debt issuance costs (1.8) -
Decrease in short-term debt (0.3) (0.4)
Payments on long-term borrowings - (18.9)
---------------------------------------
NET CASH (USED) BY FINANCING ACTIVITIES (2.1) (19.3)
Effect of exchange rate changes on cash and cash equivalents 3.3 2.7
---------------------------------------
Net increase in cash and cash equivalents 6.9 31.9
Cash and cash equivalents at beginning of period 79.5 120.0
---------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 86.4 $ 151.9
=======================================
See notes to condensed consolidated financial statements.
5
NOVEON, INC.
Periods of Three and Nine Months Ended September 30, 2003 and 2002
Notes to Condensed Consolidated Financial Statements (unaudited)
A. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles
for interim financial information and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the three and nine months ended
September 30, 2003 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2003.
Earnings per share data are not presented because the common stock of
Noveon, Inc. (the "Company") is not publicly traded and the Company is a
wholly owned subsidiary of Noveon International, Inc. ("International" or
"Parent").
The balance sheet at December 31, 2002 has been derived from the audited
financial statements at that date but does not include all of the
information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements.
B. ACQUISITIONS
The Company's Specialty Materials segment purchased selected assets and
technology from a European extruder of electrostatic dissipative sheet in
February 2003 and made an investment in a company that produces TPU-based
cushion technology in March 2003. Also, in March 2003, the Company's
Performance Coatings segment purchased certain coatings technology and
manufacturing assets. In August 2003, the Company's Consumer Specialties
segment purchased the remaining minority shares of Indiamalt Private Ltd.
and in September 2003 acquired an ownership interest in and formed a joint
venture with Specialty Natural Products Co. Ltd. ("SNP"), a manufacturer of
botanical extracts used in personal care product formulations based in
Thailand. The aggregate purchase price paid for these acquisitions and
investment was $16.6 million, which was allocated to the assets acquired
and resulted in goodwill of $9.3 million. Other changes in goodwill for the
nine months ended September 30, 2003 were associated with foreign currency
translation.
6
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
C. NEW ACCOUNTING STANDARDS
In June 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities." SFAS No. 146
requires recording costs associated with exit or disposal activities at
their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to
an exit plan, which is generally before an actual liability has been
incurred. The provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company adopted
this Statement effective January 1, 2003. The effect of adoption had no
impact on the Company's consolidated financial position or results of
operations.
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21 ("Issue 00-21"), "Revenue Arrangements with
Multiple Deliverables." Issue 00-21 provides guidance on how to account for
arrangements that involve delivery or performance of multiple products,
services and/or rights to use assets. The adoption of Issue 00-21 in July
2003 had no impact on the Company's consolidated financial position or
results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation No. 46 clarifies the
application of Accounting Research Bulletin ("ARB") No. 51, "Consolidated
Financial Statements" for certain entities in which equity investors do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties.
Interpretation No. 46 requires that variable interest entities, as defined,
should be consolidated by the primary beneficiary, which is defined as the
entity that is expected to absorb the majority of the expected losses,
receive a majority of the expected residual returns, or both. The effect of
adoption had no impact on the Company's consolidated financial position or
results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and
for hedging activities under SFAS No. 133. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of this statement
had no impact on the Company's consolidated financial position or results
of operations.
7
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
C. NEW ACCOUNTING STANDARDS (CONTINUED)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 also requires that an issuer classify
a financial instrument that is within its scope as a liability, many of
which were previously classified as equity. SFAS No. 150 was effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise was effective on July 1, 2003. The Company's adoption of this
statement had no impact on its consolidated financial statements.
D. INVENTORIES
The components of inventory consist of the following:
SEPTEMBER 30, DECEMBER 31,
2003 2002
----------------------------------------
(IN MILLIONS)
Raw materials $ 35.6 $ 33.1
Work in process 3.6 3.6
Finished products 110.6 107.4
----------------------------------------
$ 149.8 $ 144.1
========================================
At September 30, 2003 and December 31, 2002, LIFO inventory approximated
first-in, first-out (FIFO) cost.
E. ASSET RETIREMENT OBLIGATIONS
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," that requires the fair value of the liability for
closure and removal costs associated with the resulting legal obligations
upon retirement or removal of any tangible long-lived assets be recognized
in the period in which it is incurred. The initial recognition of the
liability will be capitalized as part of the asset cost and depreciated
over its estimated useful life. The Company adopted this statement
effective January 1, 2003. Under the new standard, the Company recognizes
asset retirement obligations in the period in which they are incurred if a
reasonable estimate of a fair value can be determined. The associated asset
retirement costs are capitalized as part of the carrying amount of the
long-lived asset.
8
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
E. ASSET RETIREMENT OBLIGATIONS (CONTINUED)
The cumulative effect of this change in accounting principle resulted in a
charge of $0.5 million (net of income taxes of $0.2 million) in the first
quarter of 2003. The pro forma effects as if the Company had adopted SFAS
No. 143 on January 1, 2002 are not material to the results of operations.
F. FINANCING ARRANGEMENTS
As required by its credit agreement, the Company has interest rate swap
agreements to limit its exposure to interest rate fluctuations. In the
first quarter of 2003, the Company entered into an additional interest rate
swap agreement with a notional amount of $25.0 million. Under the terms of
the 2003 interest rate swap agreement, the Company will pay a fixed rate of
interest of 2.92% through 2007.
In July 2003, the Company amended the term loans within its existing credit
facilities. As a result of this amendment, the Company refinanced and
increased Term Loan B; the Company decreased Term Loan A, which offset the
increase in Term Loan B; the applicable margin of the majority of Term Loan
B was decreased by 0.75% and the maturity date on Term Loan B was extended
to December 31, 2009. The amendment and refinancing were not deemed to be a
substantial modification of the credit facilities, and accordingly, were
not accounted for as a debt extinguishment.
G. INCOME TAXES
The Company's operations are included in the consolidated income tax
returns filed by International. The provision for income taxes is
calculated in accordance with SFAS No. 109, "Accounting for Income Taxes,"
which requires the recognition of deferred income taxes using the liability
method.
For the three and nine months ended September 30, 2003 and to a lesser
extent for the three and nine months ended September 30, 2002, the
effective tax rate differed from the federal statutory rate principally due
to decreases in the income tax rate as a result of certain income tax
credits and from the effective tax rate differential on consolidated
foreign subsidiaries. In addition, for the three and nine months ended
September 30, 2002, decreases in the income tax rate resulted from reversal
of tax valuation allowances previously recorded for the Company's domestic
operations. The decreases in the effective tax rate from the federal
statutory rate were partially offset by higher tax valuation allowance
amounts associated with the Company's foreign operations, tax valuation
allowances associated with certain income tax credits and other
nondeductible items.
9
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
E. ASSET RETIREMENT OBLIGATIONS (CONTINUED)
As of September 30, 2003, management has determined, based on the Company's
capital structure and lack of prior earnings history based on this
structure, that it is uncertain that future taxable income of the Company
will be sufficient enough to recognize certain of these net deferred tax
assets. As a result, under the provisions of SFAS No. 109, a valuation
allowance of $42.8 million has been recorded at September 30, 2003. This
valuation allowance relates to net domestic deferred tax assets established
in purchase accounting, acquired foreign net deferred tax assets associated
with net operating losses and credits and deferred tax assets from domestic
and foreign tax net operating losses and credits arising subsequent to
March 1, 2001. The most significant portion of the valuation allowance is
associated with the deferred tax assets established in purchase accounting.
Any reversal of the valuation allowance that was established in purchase
accounting would reduce goodwill.
In determining the adequacy of the $42.8 million valuation allowance,
management assessed the Company's profitability taking into account the
present and anticipated amounts of domestic and international earnings as
well as the anticipated taxable income as a result of the reversal of
future taxable temporary differences. The Company will maintain the tax
valuation allowances for the balance of deferred tax assets until
sufficient positive evidence (for example, cumulative positive earnings and
future taxable income) exists to support a reversal of the tax valuation
allowances.
H. SEGMENT INFORMATION
Consistent with the Company's focus on industries and end-use applications,
its operations are organized into three reportable business segments:
Consumer Specialties, Specialty Materials and Performance Coatings.
Segment operating income is total segment revenue reduced by operating
expenses identifiable within that business segment. Restructuring and
consolidation costs are presented separately and corporate costs include
general corporate administrative expenses that are not specifically
identifiable with just one of the reportable business segments.
10
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
H. SEGMENT INFORMATION (CONTINUED)
The following tables summarize business segment information:
THREE MONTHS ENDED SEPTEMBER 30,
2003 % 2002 %
-------------------------------------------------------
(DOLLARS IN MILLIONS)
Sales
Consumer Specialties $ 80.8 29.0% $ 76.4 28.0%
Specialty Materials 102.8 36.9% 101.7 37.2%
Performance Coatings 95.2 34.1% 95.1 34.8%
-------------------------------------------------------
Total sales $ 278.8 100.0% $ 273.2 100.0%
=======================================================
Gross profit
Consumer Specialties $ 23.5 29.1% $ 23.7 31.0%
Specialty Materials 32.3 31.4% 40.1 39.4%
Performance Coatings 23.5 24.7% 25.2 26.5%
---------------- -----------------
Total gross profit $ 79.3 28.4% $ 89.0 32.6%
================ =================
Operating income
Consumer Specialties $ 12.7 15.7% $ 13.3 17.4%
Specialty Materials 16.4 16.0% 24.6 24.2%
Performance Coatings 11.0 11.6% 13.3 14.0%
---------------- -----------------
Total segment operating income 40.1 14.4% 51.2 18.7%
Corporate costs (14.3) (5.1)% (17.0) (6.2)%
Restructuring and consolidation costs (0.5) (0.2)% (1.1) (0.4)%
-------------------------------------------------------
Total operating income $ 25.3 9.1% $ 33.1 12.1%
=======================================================
NINE MONTHS ENDED SEPTEMBER 30,
2003 % 2002 %
-------------------------------------------------------
(DOLLARS IN MILLIONS)
Sales
Consumer Specialties $ 250.2 29.3% $ 218.1 26.8%
Specialty Materials 318.3 37.2% 305.6 37.6%
Performance Coatings 286.6 33.5% 289.8 35.6%
-------------------------------------------------------
Total sales $ 855.1 100.0% $ 813.5 100.0%
=======================================================
Gross profit
Consumer Specialties $ 70.2 28.1% $ 67.9 31.1%
Specialty Materials 105.5 33.1% 116.4 38.1%
Performance Coatings 71.2 24.8% 81.7 28.2%
---------------- ------------------
Total gross profit $ 246.9 28.9% $ 266.0 32.7%
================ ==================
Operating income
Consumer Specialties $ 37.7 15.1% $ 38.0 17.4%
Specialty Materials 57.2 18.0% 69.4 22.7%
Performance Coatings 34.4 12.0% 46.7 16.1%
---------------- ------------------
Total segment operating income 129.3 15.1% 154.1 18.9%
Corporate costs (44.0) (5.1)% (50.3) (6.2)%
Restructuring and consolidation costs (3.6) (0.4)% (2.9) (0.4)%
-------------------------------------------------------
Total operating income $ 81.7 9.6% $ 100.9 12.4%
=======================================================
11
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
I. COMPREHENSIVE INCOME
Total comprehensive income consists of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------------------------------------------------------
(IN MILLIONS)
Net income $ 5.7 $ 12.3 $ 21.7 $ 36.6
Net change related to cash flow hedges 2.5 (5.2) 2.3 (9.0)
Cumulative translation adjustment (6.5) 1.1 44.9 11.5
------------------------------ -----------------------------
Total comprehensive income $ 1.7 $ 8.2 $ 68.9 $ 39.1
============================== =============================
J. STOCK-BASED COMPENSATION
The Company's Parent has a stock option plan in which certain eligible
employees of the Company participate. The Company accounts for stock-based
employee compensation using the intrinsic value method in accordance with
the provisions of Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under the plan had an exercise price at or greater than the
market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income if the Company had
applied the fair value recognition provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," to stock-based employee compensation.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------------------------------------------------------
(IN MILLIONS)
Net income as reported $ 5.7 $ 12.3 $ 21.7 $ 36.6
Deduct: total stock-based employee
compensation expense determined under the
fair value based method for all awards,
net of related tax effects (0.5) (0.4) (1.5) (1.3)
------------------------------ -----------------------------
Pro forma net income $ 5.2 $ 11.9 $ 20.2 $ 35.3
============================== =============================
The effects of applying SFAS No. 123 may not be representative of the
effects on reportable net income in future years.
12
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
K. RESTRUCTURING AND CONSOLIDATION COSTS
In order to increase efficiency and productivity and to reduce costs, the
Company reduced headcount at various administrative and manufacturing
facilities in 2003. Through these restructuring efforts, the Company
eliminated approximately 30 positions. The restructuring accrual at
September 30, 2003 is summarized below:
BALANCE
JANUARY 1, BALANCE
(IN MILLIONS) 2003 PROVISION ACTIVITY SEPTEMBER 30, 2003
- -----------------------------------------------------------------------------------------------------------
Personnel-related costs $ - $ 2.7 $ 1.9 $ 0.8
===========================================================================
During 2002, the Company consolidated its static control manufacturing
facilities into its Malaysia facility and closed the Twinsburg, Ohio leased
facility in order to improve productivity in the electronics
industry-related product lines. In conjunction with this consolidation, the
Company incurred personnel-related charges as well as closure costs related
to this leased facility. The restructuring accrual at September 30, 2003 is
summarized below:
BALANCE
JANUARY 1, BALANCE
(IN MILLIONS) 2003 PROVISION ACTIVITY SEPTEMBER 30, 2003
- -----------------------------------------------------------------------------------------------------------
Facility closure costs $ 0.2 $ 0.2 $ 0.3 $ 0.1
===========================================================================
In order to increase efficiency and productivity, reduce costs and support
the Company's global growth strategy, the Company reduced headcount at
facilities throughout its global operations, restructured its colorants
business in Cincinnati, Ohio, and discontinued its flush pigments and
colorformers product lines in June 2001. Through these restructuring
efforts, the Company planned to eliminate approximately 440 positions.
Substantially all of the affected employees have left their positions as of
September 30, 2003. The restructuring accrual at September 30, 2003 is
summarized below:
BALANCE
JANUARY 1, BALANCE
(IN MILLIONS) 2003 PROVISION ACTIVITY SEPTEMBER 30, 2003
- -----------------------------------------------------------------------------------------------------------
Personnel-related costs $ 2.1 $ - $ 1.3 $ 0.8
Facility closure costs 0.6 - 0.2 0.4
Relocation and restructuring
expense - 0.7 0.7 -
---------------------------------------------------------------------------
$ 2.7 $ 0.7 $ 2.2 $ 1.2
===========================================================================
13
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
L. CONTINGENCIES
The Company has numerous purchase commitments for materials, supplies and
energy in the ordinary course of business. The Company has numerous sales
commitments for product supply contracts in the ordinary course of
business.
GENERAL. There are pending or threatened claims, lawsuits and
administrative proceedings against the Company or its subsidiaries, all
arising from the ordinary course of business with respect to commercial,
product liability, and environmental matters, which seek remedies or
damages. The Company believes that any liability that may finally be
determined with respect to commercial and product liability claims should
not have a material adverse effect on the Company's consolidated financial
position, results of operations or cash flows. From time to time, the
Company is also involved in legal proceedings as a plaintiff involving
contract, patent protection, environmental and other matters. Gain
contingencies, if any, are recognized when they are realized.
ENVIRONMENTAL. The Company and its subsidiaries are generators of both
hazardous wastes and non-hazardous wastes, the treatment, storage,
transportation and disposal of which are regulated by various laws and
governmental regulations. Although past operations were in substantial
compliance with the then-applicable regulations, the Company has been
designated as a potentially responsible party (PRP) by the U.S.
Environmental Protection Agency (EPA), or similar state agencies, in
connection with several sites.
The Company initiates corrective and/or preventive environmental projects
of its own to ensure environmental compliance and safe and lawful
activities at its current operations. The Company also conducts a
compliance and management systems audit program. The Company believes that
compliance with current laws and regulations will not have a material
adverse effect on its capital expenditures, results of operations, cash
flows or competitive position.
The Company's environmental engineers and consultants review and monitor
environmental issues at past and existing operating sites, as well as
off-site disposal sites at which the Company has been identified as a PRP.
This process includes investigation and remedial action election and
implementation, as well as negotiations with other PRPs and governmental
agencies.
14
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
L. CONTINGENCIES (CONTINUED)
Goodrich Corporation ("Goodrich") provided the Company with an indemnity
for various environmental liabilities. The Company estimates Goodrich's
share of such currently identified liabilities under the indemnity, which
extends to 2011, to be about $8.1 million. In addition to Goodrich's
indemnity, several other indemnities from third parties such as past owners
relate to specific environmental liabilities. Goodrich and other third
party indemnitors are currently indemnifying the Company for several
environmental remediation projects. Goodrich's share of all of these
liabilities may increase to the extent such third parties fail to honor
their indemnity obligations through 2011. The Company's September 30, 2003
balance sheet includes liabilities, measured on an undiscounted basis, of
$19.0 million to cover future environmental expenditures either payable by
the Company or indemnifiable by Goodrich. Accordingly, the current portion
of the environmental obligations of $0.8 million is recorded in accrued
expenses and $1.4 million of the recovery due from Goodrich is recorded in
accounts receivable. Non-current liabilities include $18.2 million and
other non-current assets include $6.7 million, reflecting the recovery due
from Goodrich.
The Company believes that its environmental accruals are adequate based on
currently available information. Management believes that it is reasonably
possible that additional costs may be incurred beyond the amounts accrued
as a result of new information. However, the additional costs, if any,
cannot be estimated and management believes that they would not have a
material adverse effect on the Company's results of operations, financial
position or cash flows in a given period.
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION
The Company as presented herein represents Noveon, Inc. exclusive of its
guarantor subsidiaries and its non-guarantor subsidiaries.
The Company's domestic subsidiaries, all of which are directly or
indirectly wholly owned, are the only guarantors of the 11% Senior
Subordinated Notes. The guarantees are full, unconditional and joint and
several. Separate financial statements of these guarantor subsidiaries are
not presented as management has determined that they would not be material
to investors.
15
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
The Company's foreign subsidiaries are not guarantors of the 11% Senior
Subordinated Notes. Condensed consolidating financial information for the
Company, the guarantor subsidiaries, and the non-guarantor, foreign
subsidiaries is as follows:
THREE MONTHS ENDED SEPTEMBER 30, 2003
------------------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
INCOME STATEMENT DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- --------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Sales $ 166.2 $ 44.9 $ 99.9 $ (32.2) $ 278.8
Cost of sales 113.2 42.9 75.6 (32.2) 199.5
------------------------------------------------------------------------------------
Gross profit 53.0 2.0 24.3 - 79.3
Selling and administrative
expenses 32.9 2.4 14.6 - 49.9
Amortization expense 0.1 2.3 1.2 - 3.6
Restructuring and
consolidation costs 0.4 - 0.1 - 0.5
------------------------------------------------------------------------------------
Operating income (loss) 19.6 (2.7) 8.4 - 25.3
Interest expense--net 15.5 1.7 0.1 - 17.3
Other expense (income)--net - (0.1) 0.6 - 0.5
------------------------------------------------------------------------------------
Income (loss) before income
taxes 4.1 (4.3) 7.7 - 7.5
Income tax expense - - 1.8 - 1.8
------------------------------------------------------------------------------------
Net income (loss) $ 4.1 $ (4.3) $ 5.9 $ - $ 5.7
====================================================================================
16
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30, 2003
------------------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
INCOME STATEMENT DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- --------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Sales $ 508.4 $ 140.9 $ 301.0 $ (95.2) $ 855.1
Cost of sales 341.4 133.7 228.3 (95.2) 608.2
------------------------------------------------------------------------------------
Gross profit 167.0 7.2 72.7 - 246.9
Selling and administrative
expenses 98.8 7.5 44.3 - 150.6
Amortization expense 0.4 7.0 3.6 - 11.0
Restructuring and
consolidation costs 2.9 - 0.7 - 3.6
------------------------------------------------------------------------------------
Operating income (loss) 64.9 (7.3) 24.1 - 81.7
Interest expense--net 47.9 5.1 0.5 - 53.5
Other expense (income)--net (0.2) (0.5) 1.3 - 0.6
------------------------------------------------------------------------------------
Income (loss) before income
taxes and cumulative effect
of accounting change 17.2 (11.9) 22.3 - 27.6
Income tax expense - - 5.4 - 5.4
------------------------------------------------------------------------------------
Income (loss) before
cumulative effect of
accounting change 17.2 (11.9) 16.9 - 22.2
Cumulative effect of
accounting change--
net of tax - - 0.5 - 0.5
------------------------------------------------------------------------------------
Net income (loss) $ 17.2 $ (11.9) $ 16.4 $ - $ 21.7
====================================================================================
17
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
SEPTEMBER 30, 2003
-----------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
BALANCE SHEET DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- --------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
CURRENT ASSETS
Cash and cash equivalents $ 7.7 $ 0.8 $ 77.9 $ - $ 86.4
Accounts and notes receivable 68.8 24.4 71.0 - 164.2
Inventories 67.7 31.7 50.4 - 149.8
Prepaid expenses and other
current assets 3.2 1.3 1.9 - 6.4
-----------------------------------------------------------------------------
TOTAL CURRENT ASSETS 147.4 58.2 201.2 - 406.8
Property, plant and equipment-net 384.7 101.4 180.9 - 667.0
Goodwill 250.0 0.5 152.7 - 403.2
Identifiable intangible assets-net 3.2 115.2 57.3 - 175.7
Intercompany receivables 424.7 - 26.1 (450.8) -
Investment in subsidiaries 444.5 48.9 - (493.4) -
Receivable from Parent 1.4 - - - 1.4
Other assets 37.8 7.7 0.8 - 46.3
-----------------------------------------------------------------------------
TOTAL ASSETS $ 1,693.7 $ 331.9 $ 619.0 $ (944.2) $ 1,700.4
=============================================================================
CURRENT LIABILITIES
Accounts payable $ 72.0 $ 8.9 $ 38.7 $ - $ 119.6
Accrued expenses 39.1 4.3 10.1 - 53.5
Income taxes payable - - 8.5 - 8.5
Current maturities of debt 12.2 - - - 12.2
-----------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 123.3 13.2 57.3 - 193.8
Long-term debt 840.2 - 0.3 - 840.5
Postretirement benefits other
than pensions 4.6 1.3 - - 5.9
Accrued pensions 23.9 6.8 7.8 - 38.5
Deferred income taxes - - 18.0 - 18.0
Accrued environmental 1.2 17.0 - - 18.2
Intercompany payables 198.7 156.9 95.2 (450.8) -
Other non-current liabilities 14.7 - 2.2 - 16.9
-----------------------------------------------------------------------------
TOTAL LIABILITIES 1,206.6 195.2 180.8 (450.8) 1,131.8
STOCKHOLDER'S EQUITY
Common stock - 151.6 341.8 (493.4) -
Paid in capital 498.0 - - - 498.0
Retained earnings (deficit) 1.9 (14.9) 32.8 - 19.8
Accumulated other comprehensive
income (loss) (12.8) - 63.6 - 50.8
-----------------------------------------------------------------------------
TOTAL STOCKHOLDER'S EQUITY 487.1 136.7 438.2 (493.4) 568.6
-----------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 1,693.7 $ 331.9 $ 619.0 $ (944.2) $ 1,700.4
=============================================================================
18
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30, 2003
--------------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
CASH FLOW DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- --------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Net cash provided by
operating activities $ 14.7 $ 10.1 $ 36.7 $ - $ 61.5
Investing activities:
Purchases of property, plant
and equipment (19.0) (9.4) (10.8) - (39.2)
Payments made in connection
with acquisitions, net of
cash acquired (13.9) - (2.7) - (16.6)
--------------------------------------------------------------------------------
Net cash (used) by investing
activities (32.9) (9.4) (13.5) - (55.8)
Financing activities:
Debt issuance costs (1.8) - - - (1.8)
Decrease in short-term debt - - (0.3) - (0.3)
--------------------------------------------------------------------------------
Net cash (used) by financing
activities (1.8) - (0.3) - (2.1)
Effect of exchange rate changes
on cash and cash equivalents - - 3.3 - 3.3
--------------------------------------------------------------------------------
Increase (decrease) in cash
and cash equivalents (20.0) 0.7 26.2 - 6.9
Cash and cash equivalents
at beginning of period 27.7 0.1 51.7 - 79.5
--------------------------------------------------------------------------------
Cash and cash equivalents
at end of period $ 7.7 $ 0.8 $ 77.9 $ - $ 86.4
================================================================================
19
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
THREE MONTHS ENDED SEPTEMBER 30, 2002
-----------------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
INCOME STATEMENT DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- ------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Sales $ 166.3 $ 45.8 $ 84.5 $ (23.4) $ 273.2
Cost of sales 104.2 38.8 64.6 (23.4) 184.2
-----------------------------------------------------------------------------------
Gross profit 62.1 7.0 19.9 - 89.0
Selling and administrative expenses 33.6 3.0 14.7 - 51.3
Amortization expense 0.1 2.1 1.3 - 3.5
Restructuring and consolidation
costs 1.1 - - - 1.1
-----------------------------------------------------------------------------------
Operating income 27.3 1.9 3.9 - 33.1
Interest expense (income)--net 19.1 (0.4) 0.2 - 18.9
Other expense (income)--net 0.1 (0.1) 0.1 - 0.1
-----------------------------------------------------------------------------------
Income before income taxes 8.1 2.4 3.6 - 14.1
Income tax expense - - 1.8 - 1.8
-----------------------------------------------------------------------------------
Net income $ 8.1 $ 2.4 $ 1.8 $ - $ 12.3
===================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 2002
-----------------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
INCOME STATEMENT DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- ------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Sales $ 507.2 $ 131.9 $ 252.3 $ (77.9) $ 813.5
Cost of sales 324.6 111.9 188.9 (77.9) 547.5
-----------------------------------------------------------------------------------
Gross profit 182.6 20.0 63.4 - 266.0
Selling and administrative expenses 103.2 8.3 40.2 - 151.7
Amortization expense 0.2 6.8 3.5 - 10.5
Restructuring and consolidation
costs 2.8 - 0.1 - 2.9
-----------------------------------------------------------------------------------
Operating income 76.4 4.9 19.6 - 100.9
Interest expense (income)--net 57.7 (1.1) 0.8 - 57.4
Other expense (income)--net 0.1 (0.2) 0.3 - 0.2
-----------------------------------------------------------------------------------
Income before income taxes 18.6 6.2 18.5 - 43.3
Income tax expense 0.1 0.1 6.5 - 6.7
-----------------------------------------------------------------------------------
Net income $ 18.5 $ 6.1 $ 12.0 $ - $ 36.6
===================================================================================
20
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
DECEMBER 31, 2002
--------------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
BALANCE SHEET DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- --------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
CURRENT ASSETS
Cash and cash equivalents $ 27.7 $ 0.1 $ 51.7 $ - $ 79.5
Accounts and notes receivable 58.4 20.0 57.3 - 135.7
Inventories 66.3 30.3 47.5 - 144.1
Prepaid expenses and other
current assets 4.0 0.9 2.3 - 7.2
---------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 156.4 51.3 158.8 - 366.5
Property, plant and
equipment--net 399.3 98.2 173.2 - 670.7
Goodwill 246.2 0.5 118.8 - 365.5
Identifiable intangible assets--net 2.6 121.8 57.7 - 182.1
Intercompany receivables 358.6 0.7 23.8 (383.1) -
Investment in subsidiaries 430.8 48.9 - (479.7) -
Receivable from Parent 1.2 - - - 1.2
Other assets 35.0 7.6 0.5 - 43.1
---------------------------------------------------------------------------------
TOTAL ASSETS $ 1,630.1 $ 329.0 $ 532.8 $ (862.8) $ 1,629.1
=================================================================================
CURRENT LIABILITIES
Short-term bank debt $ - $ 0.1 $ 0.3 $ - $ 0.4
Accounts payable 62.5 11.8 36.9 - 111.2
Accrued expenses 57.5 5.0 8.1 - 70.6
Income taxes payable - - 5.3 - 5.3
---------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 120.0 16.9 50.6 - 187.5
Long-term debt 846.8 - 0.3 - 847.1
Postretirement benefits
other than pensions 4.5 1.3 - - 5.8
Accrued pensions 22.1 6.2 6.6 - 34.9
Deferred income taxes - - 18.1 - 18.1
Accrued environmental 1.4 16.8 - - 18.2
Intercompany payables 151.5 142.6 89.0 (383.1) -
Other non-current liabilities 15.8 - 2.0 - 17.8
---------------------------------------------------------------------------------
TOTAL LIABILITIES 1,162.1 183.8 166.6 (383.1) 1,129.4
STOCKHOLDER'S EQUITY
Common stock - 148.2 331.5 (479.7) -
Paid in capital 498.0 - - - 498.0
Retained (deficit) earnings (15.3) (3.0) 16.4 - (1.9)
Accumulated other
comprehensive income (loss) (14.7) - 18.3 - 3.6
---------------------------------------------------------------------------------
TOTAL STOCKHOLDER'S EQUITY 468.0 145.2 366.2 (479.7) 499.7
---------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 1,630.1 $ 329.0 $ 532.8 $ (862.8) $ 1,629.1
=================================================================================
21
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited) (continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30, 2002
------------------------------------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
CASH FLOW DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- -------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
Net cash provided by operating
activities $ 57.0 $ 4.5 $ 35.3 $ - $ 96.8
Investing activities:
Purchases of property, plant
and equipment (17.0) (4.5) (6.2) - (27.7)
Payments made in connection
with acquisitions, net of
cash acquired (20.6) - - - (20.6)
------------------------------------------------------------------------------------
Net cash (used) by investing
activities (37.6) (4.5) (6.2) (48.3)
Financing activities:
Decrease in short-term debt - - (0.4) - (0.4)
Payments on long-term borrowings (18.9) - - - (18.9)
------------------------------------------------------------------------------------
Net cash (used) by financing
activities (18.9) - (0.4) - (19.3)
Effect of exchange rate changes on
cash and cash equivalents - - 2.7 - 2.7
------------------------------------------------------------------------------------
Net increase in
cash and cash equivalents 0.5 - 31.4 - 31.9
Cash and cash equivalents
at beginning of period 94.6 0.3 25.1 - 120.0
------------------------------------------------------------------------------------
Cash and cash equivalents
at end of period $ 95.1 $ 0.3 $ 56.5 $ - $ 151.9
====================================================================================
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements in this section and elsewhere in this report include
forward-looking statements, including those that relate to our future
plans, objectives, expectations and intentions. Statements that are
predictive in nature, that depend upon or refer to future events or
conditions or that include the words "expects," "anticipates," "intends,"
"plans," "believes," "estimates," "seeks," "thinks" and variations of these
words and similar expressions are forward-looking statements. These
statements involve known and unknown risks, uncertainties and other factors
that may cause our actual results and performance to be materially
different from any future results or performance expressed or implied by
these forward-looking statements. Although we believe that these statements
are based upon reasonable assumptions, our goals may not be achieved. These
forward-looking statements are made as of the date of this report, and,
except as required under the federal securities laws and the rules and
regulations of the Securities and Exchange Commission, we assume no
obligation to update or revise them or provide reasons why actual results
may differ.
Important factors that may affect our expectations, estimates or
projections include:
o the effects of the substantial debt we have incurred in connection
with our acquisition of the Performance Materials Segment from
Goodrich and our ability to refinance or repay that debt;
o changes in customer requirements in markets or industries we serve;
o general economic and market conditions;
o competition within our industry;
o our access to capital markets and any restrictions placed on us by
any current or future financing arrangements;
o environmental and government regulations;
o the effect of risks of investing in and conducting operations in
foreign countries, including political, social, economic, currency
and regulatory factors;
o changes in the price and supply of major raw materials; and
o the effect of fluctuations in currency exchange rates on our
international operations.
23
OVERVIEW
We are a leading global producer and marketer of technologically advanced
specialty materials and chemicals used in a broad range of consumer and
industrial applications. We have a number of high growth, industry-leading
franchises marketed under some of the industry's most recognized brand
names including Carbopol(R), TempRite(R), Estane(R) and Hycar(R). These
global brands are complemented by a diverse portfolio of historically
stable, cash generating businesses. We have a significant presence in many
niche product categories, where customers value our long-standing ability
to provide need-specific formulations and solutions. Our products and
services enhance the value of customers' end-products by improving
performance, providing essential product attributes, lowering cost,
simplifying processing or making them more environmentally friendly.
Through our worldwide network of 28 strategically located manufacturing
facilities, we service more than 7,000 customers operating in over 25
industries. In 2002, we derived approximately 63% of our sales from the
United States, 18% of our sales from Europe and 19% of our sales from the
rest of the world.
Consistent with our focus on industries and end-use applications, we have
organized our business into three segments: Consumer Specialties, Specialty
Materials and Performance Coatings.
ACQUISITIONS
The Specialty Materials segment purchased selected assets and technology
from a European extruder of electrostatic dissipative sheet in February
2003 and made an investment in a company that produces TPU-based cushion
technology in March 2003. Also, in March 2003, the Performance Coatings
segment purchased certain coatings technology and manufacturing assets. In
August 2003, the Consumer Specialties segment purchased the remaining
minority shares of Indiamalt Private Ltd. and in September 2003 acquired an
ownership interest in and formed a joint venture with Specialty Natural
Products Co. Ltd. ("SNP"), a manufacturer of botanical extracts used in
personal care product formulations based in Thailand. The aggregate
purchase price paid for these acquisitions and investment was $16.6
million, which was allocated to the assets acquired and resulted in
goodwill of $9.3 million.
In October 2003, the Specialty Materials segment purchased selected assets
of Thermedics Polymer Products, LLC, a manufacturer of aliphatic
thermoplastic polyurethane, from VIASYS Healthcare, Inc.
RESTRUCTURING MATTERS
In order to increase efficiency and productivity and to reduce costs, we
reduced headcount at various administrative and manufacturing facilities in
2003. Through these restructuring efforts, we eliminated approximately 30
positions. As of September 30, 2003, approximately $0.8 million remains
accrued for restructuring costs with the remaining costs to be paid by
2004.
During 2002, we consolidated our static control manufacturing facilities
into our Malaysia facility and closed the Twinsburg, Ohio leased facility
in order to improve the productivity of our electronics industry-related
product lines.
24
In 2001, we implemented a plan to restructure and streamline our operations
to increase efficiency and productivity, reduce costs and support our
global growth strategy. As part of this plan, we reduced headcount
throughout our global operations, restructured our colorants business in
Cincinnati, Ohio, and discontinued our flush pigments and colorformers
product lines. Through these restructuring efforts, we planned to eliminate
approximately 440 positions. Substantially all of the affected employees
have left their positions as of September 30, 2003. As of September 30,
2003, approximately $1.2 million remains accrued for restructuring costs
with the remaining costs anticipated to be paid by 2004.
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2002
TOTAL COMPANY ANALYSIS
SALES. Sales increased $5.6 million, or 2.0%, to $278.8 million for the
three months ended September 30, 2003 from $273.2 million for the three
months ended September 30, 2002. The increase in sales was attributable to
the strength in the euro, incremental sales of $7.6 million associated with
acquisitions, and higher volumes in our Estane(R) TPU and personal care
product lines, partially offset by lower volumes within our Performance
Coatings and polymer additives product lines and competitive pricing
pressure across most of Specialty Materials.
COST OF SALES. Cost of sales as a percentage of sales increased to 71.6%
for the three months ended September 30, 2003 from 67.4% for the three
months ended September 30, 2002. The increase in cost of sales as a
percentage of sales was primarily attributable to an increase in raw
material and utility costs across each of our segments.
GROSS PROFIT. Gross profit decreased $9.7 million, or 10.9%, to $79.3
million for the three months ended September 30, 2003 from $89.0 million
for the three months ended September 30, 2002. As a percentage of sales,
gross profit decreased to 28.4% for the three months ended September 30,
2003 from 32.6% for the three months ended September 30, 2002. The decrease
in gross profit and gross profit as a percentage of sales was primarily
driven by higher raw material and utility costs across each segment and
competitive pricing pressure across most of Specialty Materials, partially
offset by increased sales.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses
decreased $1.4 million, or 2.7%, to $49.9 million for the three months
ended September 30, 2003 from $51.3 million for the three months ended
September 30, 2002. The decrease in selling and administrative expenses was
primarily related to lower spending and reduced costs associated with our
variable incentive plans, partially offset by planned increases in research
and development and the strength in the euro. Selling and administrative
expenses as a percentage of sales declined to 17.9% for the three months
ended September 30, 2003 from 18.8% for the three months ended September
30, 2002.
AMORTIZATION EXPENSE. Amortization expense totaled $3.6 million for the
three months ended September 30, 2003 and was comparable to $3.5 million
for the three months ended September 30, 2002.
25
RESTRUCTURING AND CONSOLIDATION COSTS. Restructuring and consolidation
costs decreased $0.6 million to $0.5 million for the three months ended
September 30, 2003 from $1.1 million for the three months ended September
30, 2002. These expenses relate to our continued efforts to increase
efficiency and productivity and to reduce costs.
OPERATING INCOME. Operating income decreased by $7.8 million, or 23.6%, to
$25.3 million for the three months ended September 30, 2003 from $33.1
million for the three months ended September 30, 2002. The decrease in
operating income was primarily attributable to higher raw material and
utility costs across each segment, competitive pricing pressure, and lower
volumes within our Performance Coatings product lines. The decrease was
partially offset by higher volumes within our personal care and Estane(R)
TPU product lines, lower selling and administrative expenses, lower
manufacturing spending and the impact of acquisitions.
INTEREST EXPENSE--NET. Interest expense was $17.3 million for the three
months ended September 30, 2003 and $18.9 million for the three months
ended September 30, 2002. The decrease in interest expense was attributable
to lower interest rates and the impact of debt reductions.
OTHER EXPENSE--NET. Other expense was $0.5 million for the three months
ended September 30, 2003 and $0.1 million for the three months ended
September 30, 2002.
INCOME TAX EXPENSE. Income tax expense was $1.8 million for the three
months ended September 30, 2003 compared to $1.8 million for the three
months ended September 30, 2002. The income tax expense for the three
months ended September 30, 2003 and 2002 was primarily associated with our
international operations. The effective tax rate for the three months ended
September 30, 2003 and 2002 was 24.0% and 12.8%, respectively.
The increase in the effective tax rate for the third quarter of 2003 as
compared to the third quarter of 2002 was principally related to a net
increase in tax valuation allowances recorded in the third quarter of 2003.
For the three months ended September 30, 2003 and to a lesser extent for
the three months ended September 30, 2002, the effective tax rate differed
from the federal statutory rate principally due to decreases in the income
tax rate as a result of certain income tax credits and from the effective
tax rate differential on consolidated foreign subsidiaries. In addition,
for the three months ended September 30, 2002, decreases in the income tax
rate resulted from the reversal of tax valuation allowances previously
recorded for the Company's domestic operations. The decreases in the
effective tax rate from the federal statutory rate were partially offset by
higher tax valuation allowance amounts associated with our foreign
operations, tax valuation allowances associated with certain income tax
credits, and other nondeductible items.
26
As of September 30, 2003, we have determined, based on our capital
structure and lack of prior earnings history based on this structure, that
it is uncertain that our future taxable income will be sufficient to
recognize certain of these net deferred tax assets. In accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 109,
we intend to maintain the tax valuation allowances recorded at September
30, 2003 for certain deferred tax assets until sufficient positive evidence
(for example, cumulative positive earnings and future taxable income)
exists to support the reversal of the tax valuation allowances. This
valuation allowance relates to net domestic deferred tax assets established
in purchase accounting, acquired foreign net deferred tax assets associated
with net operating losses and credits and deferred tax assets from domestic
and foreign tax net operating losses and credits arising subsequent to
March 1, 2001. The most significant portion of the valuation allowance is
associated with the deferred tax assets established in purchase accounting.
Any reversal of the valuation allowance that was established in purchase
accounting would reduce goodwill.
NET INCOME. As a result of the factors discussed above, net income
decreased by $6.6 million to $5.7 million for the three months ended
September 30, 2003 from $12.3 million for the three months ended September
30, 2002.
SEGMENT ANALYSIS
CONSUMER SPECIALTIES. Sales increased $4.4 million, or 5.8%, to $80.8
million for the three months ended September 30, 2003 from $76.4 million
for the three months ended September 30, 2002. The increase in sales was
primarily attributable to the impact of higher sales of $3.0 million in our
personal care and pharmaceutical product lines, principally due to higher
global Carbopol(R) acrylic thickener sales and the successful launch of new
products; the strength in the euro and higher sales of $1.4 million in our
food and beverage product lines, principally due to incremental sales
associated with acquisitions.
Gross profit decreased $0.2 million, or 0.8%, to $23.5 million for the
three months ended September 30, 2003 from $23.7 million for the three
months ended September 30, 2002. The decrease in gross profit was primarily
associated with substantially higher raw material and utility costs within
our food and beverage product lines offset by higher volumes within our
personal care product lines and the impact of acquisitions. As a percentage
of sales, gross profit decreased to 29.1% for the three months ended
September 30, 2003 from 31.0% for the three months ended September 30,
2002. The decrease in gross profit as a percentage of sales was due to
increases in raw material and utility costs.
Operating income decreased $0.6 million, or 4.5%, to $12.7 million for the
three months ended September 30, 2003 from $13.3 million for the three
months ended September 30, 2002. The decrease in operating income was
primarily associated with increased raw material and utility costs within
our food and beverage product lines offset by higher volumes within our
personal care product lines and the impact of acquisitions.
SPECIALTY MATERIALS. Sales increased by $1.1 million, or 1.1%, to $102.8
million for the three months ended September 30, 2003 from $101.7 million
for the three months ended September 30, 2002. The increase in sales was
primarily attributable to $3.6 million in higher sales within our Estane(R)
TPU product lines, principally related to higher volumes in Asia and North
America and a stronger euro, partially offset by $2.4 million in lower
sales within our
27
polymer additives product lines, principally related to lower volumes, and
competitive pricing pressure.
Gross profit decreased $7.8 million, or 19.5%, to $32.3 million for the
three months ended September 30, 2003 from $40.1 million for the three
months ended September 30, 2002. The decrease in gross profit was primarily
attributable to increased raw material and utility costs throughout all of
the segment product lines, competitive pricing pressure, and lower volumes
within our polymer additives product lines, partially offset by lower
manufacturing spending across most of the segment and higher volumes within
our Estane(R) TPU and TempRite(R) CPVC product lines. As a percentage of
sales, gross profit decreased to 31.4% for the three months ended September
30, 2003 from 39.4% for the three months ended September 30, 2002. The
decrease in gross profit as a percentage of sales was due primarily to
increases in raw material and utility costs.
Operating income decreased $8.2 million, or 33.3%, to $16.4 million for the
three months ended September 30, 2003 from $24.6 million for the three
months ended September 30, 2002. The decrease in operating income was
primarily attributable to increased raw material and utility costs
throughout all of the segment product lines, competitive pricing pressure,
and overall lower volumes within our polymer additives product lines,
partially offset by lower manufacturing spending across most of the segment
and higher volumes within our Estane(R) TPU and TempRite(R) CPVC product
lines.
PERFORMANCE COATINGS. Sales increased $0.1 million, or 0.1%, to $95.2
million for the three months ended September 30, 2003 from $95.1 million
for the three months ended September 30, 2002. The increase in sales was
primarily attributable to incremental sales associated with acquisitions
and the strength in the euro, offset by lower sales volumes.
Gross profit decreased $1.7 million, or 6.7%, to $23.5 million for the
three months ended September 30, 2003 from $25.2 million for the three
months ended September 30, 2002. The decrease in gross profit was primarily
attributable to lower sales volumes and substantially higher raw material
and utility costs, partially offset by lower manufacturing costs and the
impact of acquisitions. As a percentage of sales, gross profit decreased to
24.7% for the three months ended September 30, 2003 from 26.5% for the
three months ended September 30, 2002. The decrease in gross profit as a
percentage of sales was due to increases in raw material and utility costs.
Operating income decreased $2.3 million, or 17.3%, to $11.0 million for the
three months ended September 30, 2003 from $13.3 million for the three
months ended September 30, 2002. The decrease in operating income was
primarily attributable to lower sales volumes and substantially higher raw
material and utility costs, partially offset by lower manufacturing costs
and the impact of acquisitions.
CORPORATE. Corporate costs decreased $2.7 million, or 15.9%, to $14.3
million for the three months ended September 30, 2003 from $17.0 million
for the three months ended September 30, 2002. This decrease was primarily
the result of lower spending and reduced costs associated with our variable
incentive plans.
28
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 2002
TOTAL COMPANY ANALYSIS
SALES. Sales increased $41.6 million, or 5.1%, to $855.1 million for the
nine months ended September 30, 2003 from $813.5 million for the nine
months ended September 30, 2002. The increase in sales was attributable to
the strength in the euro, incremental sales of $25.8 million associated
with acquisitions, and higher volumes in our personal care, pharmaceutical
and Estane(R) TPU product lines, partially offset by lower volumes within
Performance Coatings. The strength in the euro and increased volumes were
principally responsible for sales increases of $18.2 million within our
personal care and pharmaceutical product lines and $12.1 million in our
Estane(R) TPU product lines. Increased sales of $13.9 million within our
food and beverage product lines were due primarily to the impact of
acquisitions. Decreased sales within our Performance Coatings segment were
due primarily to overall lower sales volumes offset by incremental sales
associated with acquisitions and the strength in the euro.
COST OF SALES. Cost of sales as a percentage of sales increased to 71.1%
for the nine months ended September 30, 2003 from 67.3% for the nine months
ended September 30, 2002. The increase in cost of sales as a percentage of
sales was primarily attributable to substantially higher raw material and
utility costs across each segment.
GROSS PROFIT. Gross profit decreased $19.1 million, or 7.2%, to $246.9
million for the nine months ended September 30, 2003 from $266.0 million
for the nine months ended September 30, 2002. As a percentage of sales,
gross profit decreased to 28.9% for the nine months ended September 30,
2003 from 32.7% for the nine months ended September 30, 2002. The decrease
in gross profit and gross profit as a percentage of sales was primarily
associated with higher raw material and utility costs, partially offset by
increased sales.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses
decreased $1.1 million, or 0.7%, to $150.6 million for the nine months
ended September 30, 2003 from $151.7 million for the nine months ended
September 30, 2002. The decrease in selling and administrative expenses was
primarily related to lower spending and reduced costs associated with our
variable incentive plans. The decrease was partially offset by the impact
of the stronger euro and the addition of sales, marketing and research and
development resources. Selling and administrative expenses as a percentage
of sales declined to 17.6% for the nine months ended September 30, 2003
from 18.6% for the nine months ended September 30, 2002.
AMORTIZATION EXPENSE. Amortization expense totaled $11.0 million for the
nine months ended September 30, 2003 and was comparable to $10.5 million
for the nine months ended September 30, 2002.
29
RESTRUCTURING AND CONSOLIDATION COSTS. Restructuring and consolidation
costs increased $0.7 million to $3.6 million for the nine months ended
September 30, 2003 from $2.9 million for the nine months ended September
30, 2002. These expenses relate to our continued efforts to increase
efficiency and productivity and to reduce costs.
OPERATING INCOME. Operating income decreased by $19.2 million, or 19.0% to
$81.7 million for the nine months ended September 30, 2003 from $100.9
million for the nine months ended September 30, 2002. The decrease in
operating income was primarily attributable to substantially higher raw
material and utility costs across each segment and decreased volumes within
our Performance Coatings segment. The decrease was partially offset by
increased volumes within our personal care, Estane(R) TPU, food and
beverage and pharmaceutical product lines, lower selling and administrative
expenses, lower manufacturing spending and the impact of acquisitions.
INTEREST EXPENSE--NET. Interest expense was $53.5 million for the nine
months ended September 30, 2003 and $57.4 million for the nine months ended
September 30, 2002. The decrease in interest expense was attributable to
lower interest rates and the impact of debt reductions.
OTHER EXPENSE--NET. Other expense was $0.6 million for the nine months
ended September 30, 2003 and $0.2 million for the nine months ended
September 30, 2002.
INCOME TAX EXPENSE. Income tax expense was $5.4 million for the nine months
ended September 30, 2003 compared to $6.7 million for the nine months ended
September 30, 2002. The income tax expense for the nine months ended
September 30, 2003 and 2002 was primarily associated with our international
operations. The effective tax rate for the nine months ended September 30,
2003 and 2002 was 19.6% and 15.5%, respectively.
The increase in the effective tax rate for the nine months ended September
30, 2003 as compared to the nine months ended September 30, 2002 was
principally related to a net increase in tax valuation allowances recorded
in 2003.
For the nine months ended September 30, 2003 and to a lesser extent for the
nine months ended September 30, 2002, the effective tax rate differed from
the federal statutory rate principally due to decreases in the income tax
rate as a result of certain income tax credits and from the effective tax
rate differential on consolidated foreign subsidiaries. In addition, for
the nine months ended September 30, 2002, decreases in the income tax rate
resulted from the reversal of tax valuation allowances previously recorded
for our domestic operations. The decreases in the effective tax rate from
the federal statutory rate were partially offset by higher tax valuation
allowance amounts associated with our foreign operations, tax valuation
allowance amounts associated with certain income tax credits and other
nondeductible items.
As of September 30, 2003, we have determined, based on our capital
structure and lack of prior earnings history based on this structure, that
it is uncertain that our future taxable income will be sufficient to
recognize certain of these net deferred tax assets. In accordance with the
provisions of SFAS No. 109, we intend to maintain the tax valuation
allowances recorded at September 30, 2003 for certain deferred tax assets
until sufficient positive evidence (for example, cumulative positive
earnings and future taxable income) exists to support the reversal of the
tax valuation allowances. This valuation allowance relates to net domestic
deferred tax assets established in purchase accounting, acquired foreign
net deferred tax assets associated with net operating losses
30
and credits and deferred tax assets from domestic and foreign tax net
operating losses and credits arising subsequent to March 1, 2001. The most
significant portion of the valuation allowance is associated with the
deferred tax assets established in purchase accounting. Any reversal of the
valuation allowance that was established in purchase accounting would
reduce goodwill.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE--NET OF TAX. The cumulative effect
of accounting change was $0.5 million for the nine months ended September
30, 2003 and relates to the adoption of SFAS No. 143, "Accounting for Asset
Retirement Obligations", effective January 1, 2003.
NET INCOME. As a result of the factors discussed above, net income
decreased by $14.9 million to $21.7 million for the nine months ended
September 30, 2003 from $36.6 million for the nine months ended September
30, 2002.
SEGMENT ANALYSIS
CONSUMER SPECIALTIES. Sales increased $32.1 million, or 14.7%, to $250.2
million for the nine months ended September 30, 2003 from $218.1 million
for the nine months ended September 30, 2002. The increase in sales was
primarily attributable to the impact of higher sales of $18.2 million in
our personal care and pharmaceutical product lines, principally due to the
strength in the euro, higher global Carbopol(R) acrylic thickener sales and
the successful launch of new products; and higher sales of $13.9 million in
our food and beverage product lines, principally due to incremental sales
associated with acquisitions.
Gross profit increased $2.3 million, or 3.4%, to $70.2 million for the nine
months ended September 30, 2003 from $67.9 million for the nine months
ended September 30, 2002. The increase in gross profit was primarily
associated with higher volumes within our personal care, food and beverage
and pharmaceutical product lines and the strength in the euro, offset by
substantially higher raw material and utility costs within our food and
beverage product lines. As a percentage of sales, gross profit decreased to
28.1% for the nine months ended September 30, 2003 from 31.1% for the nine
months ended September 30, 2002. The decrease in gross profit as a
percentage of sales was due to increases in raw material and utility costs.
Operating income decreased $0.3 million, or 0.8%, to $37.7 million for the
nine months ended September 30, 2003 from $38.0 million for the nine months
ended September 30, 2002. The decrease in operating income was primarily
associated with increased raw material and utility costs within our food
and beverage product lines and the impact of additional sales, marketing
and research and development resources, offset by higher volumes within our
personal care, food and beverage and pharmaceutical product lines and the
strength in the euro.
SPECIALTY MATERIALS. Sales increased by $12.7 million, or 4.2%, to $318.3
million for the nine months ended September 30, 2003 from $305.6 million
for the nine months ended September 30, 2002. The increase in sales was
primarily attributable to $12.1 million in higher sales within our
Estane(R) TPU product lines, principally related to a stronger euro and
higher volumes, partially offset by competitive pricing pressure.
31
Gross profit decreased $10.9 million, or 9.4%, to $105.5 million for the
nine months ended September 30, 2003 from $116.4 million for the nine
months ended September 30, 2002. The decrease in gross profit was primarily
attributable to substantially higher raw material and utility costs in our
TempRite(R) CPVC and polymer additives product lines and the impact of
competitive pricing pressure. This decrease was partially offset by lower
manufacturing spending across most of the segment and increased volumes in
our Estane(R) TPU product lines. As a percentage of sales, gross profit
decreased to 33.1% for the nine months ended September 30, 2003 from 38.1%
for the nine months ended September 30, 2002. The decrease in gross profit
as a percentage of sales was primarily due to increases in raw material and
utility costs.
Operating income decreased $12.2 million, or 17.6%, to $57.2 million for
the nine months ended September 30, 2003 from $69.4 million for the nine
months ended September 30, 2002. The decrease in operating income was
primarily attributable to substantially higher raw material and utility
costs and the impact of competitive pricing pressure. This decrease was
partially offset by lower manufacturing spending, increased volumes within
our Estane(R) TPU product lines and lower selling and administrative
expenses.
PERFORMANCE COATINGS. Sales decreased $3.2 million, or 1.1% to $286.6
million for the nine months ended September 30, 2003 from $289.8 million
for the nine months ended September 30, 2002. The decrease in sales was
primarily attributable to lower sales volumes, partially offset by the
impact of acquisitions and the strength in the euro.
Gross profit decreased $10.5 million, or 12.9% to $71.2 million for the
nine months ended September 30, 2003 from $81.7 million for the nine months
ended September 30, 2002. The decrease in gross profit was primarily
attributable to lower sales volumes and substantially higher raw material
and utility costs, offset by lower manufacturing costs and the impact of
acquisitions. As a percentage of sales, gross profit decreased to 24.8% for
the nine months ended September 30, 2003 from 28.2% for the nine months
ended September 30, 2002. The decrease in gross profit as a percentage of
sales was primarily due to increased raw material and utility costs.
Operating income decreased $12.3 million, or 26.3% to $34.4 million for the
nine months ended September 30, 2003 from $46.7 million for the nine months
ended September 30, 2002. The decrease in operating income was primarily
attributable to lower sales volumes and substantially higher raw material
and utility costs, partially offset by lower manufacturing costs and the
impact of acquisitions.
CORPORATE. Corporate costs decreased $6.3 million, or 12.5%, to $44.0
million for the nine months ended September 30, 2003 from $50.3 million for
the nine months ended September 30, 2002. This decrease was primarily the
result of lower spending and reduced costs associated with our variable
incentive plans.
RAW MATERIAL COST TRENDS
Financial results have been negatively impacted by higher costs for raw
materials for the three and nine months ended September 30, 2003 as
compared to the respective periods in 2002.
32
STRENGTH IN THE EURO
We have benefited from the strength in the euro for the three and nine
months ended September 30, 2003 compared to the three and nine months ended
September 30, 2002. Changes in the euro can have a significant impact on
our financial results.
LIQUIDITY AND CAPITAL RESOURCES
DEBT AND COMMITMENTS
In July 2003, we amended and refinanced the term loans within our existing
credit facilities. As a result of this amendment, our credit facilities
include (1) a Term Loan A facility with a balance at September 30, 2003 of
$34.2 million that matures on March 31, 2007, (2) a Term Loan B facility
with a balance at September 30, 2003 of $543.2 million that matures on
December 31, 2009 and (3) a revolving credit facility in the amount of
$125.0 million that matures in 2007. A portion of the revolving credit
facility is available in various foreign currencies. All of Term Loan A and
a portion of Term Loan B are denominated in euros. The domestic revolving
credit facility provides for a letter of credit subfacility, usage under
which will reduce the amount available under the domestic revolving credit
facility. Borrowings under the revolving credit facility may be used for
working capital and for general corporate purposes. We and each of our
direct and indirect material domestic subsidiaries guarantee our
obligations under the credit facilities.
Additionally, as part of the amendment, the applicable margin of the
majority of Term Loan B was decreased by 0.75%. The amendment and
refinancing were not deemed to be a substantial modification of the credit
facilities, and accordingly, was not accounted for as a debt
extinguishment. As a result of the amended terms to our credit facilities,
interest expense in the next twelve-month period will be reduced by $3.6
million as compared to the interest expense that would have resulted given
the terms of our credit facilities prior to the amendment.
As of September 30, 2003, we had a cash balance of $86.4 million. We had
$119.6 million available under the $125.0 million revolving credit
facility, net of $5.4 million of outstanding letters of credit.
Our $275.0 million senior subordinated notes mature on February 28, 2011
and interest accrues at 11% per year. Interest payments on the notes occur
on March 15 and September 15 of each year.
Principal and interest payments under the credit facilities and the senior
subordinated notes represent significant liquidity requirements for us.
Borrowings under the credit facilities bear interest at floating rates and
require periodic interest payments. Interest on the senior subordinated
notes is payable semi-annually and interest and principal on the credit
facilities is payable periodically but not less frequently than quarterly.
The credit facilities will be repaid in periodic installments until the
maturity of each of the term loans. The credit facilities contain customary
representations, covenants related to net worth requirements, capital
expenditures, interest coverage, leverage and events of default. As of
September 30, 2003, we were in compliance with all of the covenants of our
credit facilities.
33
The table below summarizes the maturities of our debt obligations as of
September 30, 2003 (dollars in millions):
PAYMENTS DUE BY PERIOD
----------------------------------------------------------------
TOTAL LESS THAN 1-3 4-5 AFTER
1 YEAR YEARS YEARS 5 YEARS
----------------------------------------------------------------
Term Loan A $ 34.2 $ 6.8 $ 21.4 $ 6.0 $ -
Term Loan B 543.2 5.4 10.9 10.9 516.0
11% Senior Subordinated Notes 275.0 - - - 275.0
Other debt 0.3 - 0.1 0.2 -
----------------------------------------------------------------
Total debt obligations $ 852.7 $ 12.2 $ 32.4 $ 17.1 $ 791.0
================================================================
We believe that our cash on hand, anticipated funds from operations, and
the amounts available to us under our revolving credit facilities will be
sufficient to cover our working capital needs, capital expenditures, debt
service requirements and tax obligations for the foreseeable future.
However, our ability to fund working capital, capital expenditures, debt
service requirements and tax obligations will be dependent upon our future
financial performance and our ability to repay or refinance our debt
obligations which in turn will be subject to economic conditions and to
financial, business and other factors, many of which are beyond our
control.
CASH FLOWS
Cash flows provided by operating activities decreased $35.3 million to
$61.5 million for the nine months ended September 30, 2003 from $96.8
million for the nine months ended September 30, 2002. The decrease was
primarily related to a reduction in operating results and increased working
capital related to sales growth period over period.
Investing activities included payments made in connection with acquisitions
of $16.6 million and purchases of property, plant and equipment of $39.2
million for the nine months ended September 30, 2003. Investing activities
used $20.6 million for payments made in connection with acquisitions,
including $14.5 million used to settle the working capital adjustment with
Goodrich, and $27.7 million for purchases of property, plant and equipment
for the nine months ended September 30, 2002.
Financing activities used $2.1 million related to debt issuance costs
incurred in conjunction with our debt refinancing and repayments of
short-term debt for the nine months ended September 30, 2003. Financing
activities used $19.3 million for the nine months ended September 30, 2002,
primarily related to principal payments on our Term Loans and our
short-term debt.
CAPITAL EXPENDITURES
We believe that our manufacturing facilities are generally in good
condition and we do not anticipate that major capital expenditures will be
needed to replace existing facilities in the near future. Our capital
expenditures for the nine months ended September 30, 2003 were $39.2
million. These expenditures were used to maintain our production sites,
implement our business strategy regarding operations and health and safety
and for strategic capacity expansion in our key product lines. These
capital expenditures were paid for using cash on hand. We expect capital
expenditures for the years 2003 and 2004 to be between $55.0 million and
$65.0 million annually.
34
CONTINGENCIES
We have numerous purchase commitments for materials, supplies and energy in
the ordinary course of business. We have numerous sales commitments to
supply product in the ordinary course of business.
GENERAL
There are pending or threatened claims, lawsuits and administrative
proceedings against us or our subsidiaries, all arising from the ordinary
course of business with respect to commercial, product liability, and
environmental matters, which seek remedies or damages. We believe that any
liability that may finally be determined with respect to commercial and
product liability claims should not have a material adverse effect on our
consolidated financial position, results of operations or cash flows. From
time to time, we are also involved in legal proceedings as a plaintiff
involving contract, patent protection, environmental and other matters.
Gain contingencies, if any, are recognized when they are realized.
ENVIRONMENTAL
We are generators of both hazardous and non-hazardous wastes, the
treatment, storage, transportation and disposal of which are regulated by
various laws and governmental regulations. Although we believe past
operations were in substantial compliance with the then-applicable
regulations, either we or the Performance Materials Segment of Goodrich
have been designated as potentially responsible parties by the U.S.
Environmental Protection Agency, or similar state agencies, in connection
with several disposal sites. These laws and regulations, including the
Comprehensive Environmental Response, Compensation and Liability Act of
1980 and similar state laws, generally impose liability for costs to
investigate and remediate contamination without regard to fault and under
certain circumstances liability may be joint and several resulting in one
responsible party being held responsible for the entire obligation.
Liability may also include damages to natural resources.
We initiate corrective and/or preventive environmental projects to ensure
environmental compliance and safe and lawful activities at our current
operations. We also conduct a compliance and management systems audit
program. We believe that compliance with current laws and regulations will
not have a material adverse effect on our capital expenditures, results of
operations or competitive position.
Our environmental engineers and consultants review and monitor
environmental issues at our existing operating sites. This process includes
investigation and remedial selection and implementation, as well as
negotiations with other potentially responsible parties and governmental
agencies.
Goodrich provided us with an indemnity for various environmental
liabilities. We estimate Goodrich's share of such currently identified
liabilities under the indemnity, which extends to 2011, to be about $8.1
million. In addition to Goodrich's indemnity, several other indemnities
from third parties such as past owners relate to specific environmental
liabilities. Goodrich and other third party indemnitors are currently
indemnifying us for several environmental remediation projects. Goodrich's
share of all these liabilities may increase to the extent such third
parties fail to honor their indemnity obligations through 2011. Our
September 30, 2003 balance
35
sheet includes liabilities, measured on an undiscounted basis, of $19.0
million to cover future environmental expenditures either payable by us or
indemnifiable by Goodrich. Accordingly, the current portion of the
environmental obligation of $0.8 million is recorded in accrued expenses
and $1.4 million of the recovery due from Goodrich is recorded in accounts
receivable. Non-current liabilities include $18.2 million and other
non-current assets include $6.7 million, reflecting the recovery due from
Goodrich.
We believe that our environmental accruals are adequate based on currently
available information. We believe that it is reasonably possible that
additional costs may be incurred beyond the amounts accrued as a result of
new information, newly discovered conditions or a change in the law.
However, the additional costs, if any, cannot be currently estimated and we
believe that they would not have a material adverse effect on our results
of operations, financial position or cash flows in a given period.
NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations," that requires the
fair value of the liability for closure and removal costs associated with
the resulting legal obligations upon retirement or removal of any tangible
long-lived assets be recognized in the period in which it is incurred. The
initial recognition of the liability will be capitalized as part of the
asset cost and depreciated over its estimated useful life. We adopted this
statement on January 1, 2003. In the first quarter of 2003 we recorded a
liability for the expected present value of future asset retirement
obligations costs of $1.1 million, increased net property, plant and
equipment by $0.4 million and recognized a charge of $0.5 million, net of
tax, related to the cumulative effect of this change in accounting
principle.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires
recording costs associated with exit or disposal activities at their fair
values when a liability has been incurred. Under previous guidance, certain
exit costs were accrued upon management's commitment to an exit plan, which
is generally before an actual liability has been incurred. The provisions
of SFAS No. 146 are effective for exit or disposal activities that are
initiated after December 31, 2002. We adopted this Statement effective
January 1, 2003. The effect of adoption had no impact on our consolidated
financial position or results of operations.
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21 ("Issue 00-21"), "Revenue Arrangements with
Multiple Deliverables." Issue 00-21 provides guidance on how to account for
arrangements that involve delivery or performance of multiple products,
services and/or rights to use assets. The adoption of Issue 00-21 in July
2003 had no impact on our consolidated financial position or results of
operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." Interpretation No. 46 clarifies the
application of Accounting Research Bulletin ("ARB") No. 51, "Consolidated
Financial Statements" for certain entities in which equity investors do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated
36
financial support from other parties. Interpretation No. 46 requires that
variable interest entities, as defined, should be consolidated by the
primary beneficiary, which is defined as the entity that is expected to
absorb the majority of the expected losses, receive a majority of the
expected residual returns, or both. The effect of adoption had no impact on
our consolidated financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and
for hedging activities under SFAS No. 133. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of this statement
had no impact on our consolidated financial position or results of
operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 also requires that an issuer classify
a financial instrument that is within its scope as a liability, many of
which were previously classified as equity. SFAS No. 150 was effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise was effective July 1, 2003. The adoption of this statement had no
impact on our consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements which have
been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates, including those related to product returns, bad
debts, inventories, investments, intangible assets, income taxes,
restructuring, pensions and other postretirement benefits, and
contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that
are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our
significant judgments and estimates used in the preparation of our
consolidated financial statements.
37
REVENUE AND INCOME RECOGNITION
Revenue from the sale of products is recognized at the point of passage of
title, which is at the time of shipment or consumption by the customer for
inventory on consignment. We require that persuasive evidence of a revenue
arrangement exists, delivery of product has occurred or services have been
rendered, the price to the customer is fixed and determinable and
collectibility is reasonably assured before revenue is realized and earned.
Rebates, customer claims, allowances, returns and discounts are reflected
as reductions from gross sales in determining net sales. In 2002, the total
of rebates, customer claims, returns and allowances and discounts amounted
to 3.5% of gross sales. Rebates are accrued based on contractual
relationships with customers as shipments are made. Customer claims,
returns and allowances and discounts are accrued based on our history of
claims and sales returns and allowances. Allowances for doubtful accounts
are maintained for estimated losses resulting from the inability of
customers to make required payments.
INVENTORIES
Inventories are stated at the lower of cost or market. The elements of
inventory cost include raw materials and labor and manufacturing overhead
costs attributed to the production process. Most domestic inventories are
valued by the last-in, first-out, or LIFO, cost method. Inventories not
valued by the LIFO method are valued principally by the average cost
method. We provide for allowances for excess and obsolete inventory based
on the age and quality of our products.
DERIVATIVE AND HEDGING ACTIVITIES
As required by our credit agreement, we have entered into interest rate
swap agreements to limit our exposure to interest rate fluctuations on
$180.0 million of the outstanding principal of our Term Loans through 2005.
In the first quarter of 2003, we entered into an additional interest rate
swap agreement to limit our exposure to interest rate fluctuations on $25.0
million of the outstanding principal of Term Loan B. These agreements
require us to pay a fixed rate of interest while receiving a variable rate.
The net payments or receipts under these agreements are recognized as an
adjustment to interest expense in our results of operations. As of
September 30, 2003, the fair value of these swap arrangements included in
other non-current liabilities totaled approximately $12.8 million. The
offsetting impact of this hedge transaction is included in accumulated
other comprehensive income.
We entered into currency forward exchange contracts, totaling $18.5 million
as of September 30, 2003, to hedge certain firm commitments denominated in
foreign currencies. The purpose of our foreign currency hedging activities
is to protect us from risk that the eventual dollar cash flows from the
sale of products to international customers will be adversely affected by
changes in the exchange rates. As of September 30, 2003, the fair value of
these forward exchange contracts included in prepaid expenses and other
current assets was approximately $0.4 million. The offsetting impact of
this hedge transaction is included in accumulated other comprehensive
income.
38
We have foreign denominated floating rate debt to protect the value of our
investments in our foreign subsidiaries in Europe. Realized and unrealized
gains and losses from these hedges are not included in the income
statement, but are shown in the cumulative translation adjustment account
included in accumulated other comprehensive income. During the three and
nine months ended September 30, 2003, we recognized $1.2 million of net
gains and $5.6 million of net losses, respectively, included in the
cumulative translation adjustment, related to the foreign denominated
floating rate debt.
DEFERRED INCOME TAXES
The provision for income taxes is calculated in accordance with SFAS No.
109, "Accounting for Income Taxes," which requires the recognition of
deferred income taxes using the liability method. Deferred income taxes
reflect the net tax effect of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. We provide valuation allowances
against the deferred tax assets if, based on available evidence, it is more
likely than not that some portion or all of the deferred tax assets will
not be realized.
In determining the adequacy of the valuation allowance, which totaled $42.8
million as of September 30, 2003, management assesses our profitability by
taking into account the present and anticipated amounts of domestic and
international earnings, as well as the anticipated taxable income as a
result of the reversal of future taxable temporary differences.
Although we generated sufficient income through September 30, 2003 to
realize certain deferred tax assets, we intend to maintain the recorded
valuation allowances until sufficient positive evidence (for example,
continuing cumulative positive earnings and future taxable income) exists
to support a reversal of the tax valuation allowances.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK
MARKET RISK
We are exposed to various market risk factors such as fluctuating interest
rates and changes in foreign currency rates. These risk factors can impact
results of operations, cash flows and financial position. We manage these
risks through regular operating and financing activities and periodically
use derivative financial instruments such as foreign exchange forward
contracts. These derivative instruments are placed with major financial
institutions and are not for speculative or trading purposes.
FOREIGN CURRENCY RISK
We limit our foreign currency risk by operational means, primarily by
locating our manufacturing operations in those locations where we have
significant exposures to major currencies. We have entered into forward
contracts to partially offset the transactional risk of foreign currency
fluctuations. The fair value of these contracts at September 30, 2003 was
approximately $0.4 million.
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We sell to customers in foreign markets through foreign operations and
through export sales from plants in the U.S. These transactions are often
denominated in currencies other than the U.S. dollar. The primary currency
exposure is the euro.
We have foreign denominated floating rate debt to protect the value of our
investments in our foreign subsidiaries in Europe. Realized and unrealized
gains and losses from these hedges are not included in the income
statement, but are shown in the cumulative translation adjustment account
included in accumulated other comprehensive income.
INTEREST RATE RISK
As required by our credit agreement, we are a party to interest rate swap
agreements with notional amounts of $180.0 million and for which we pay a
fixed rate of interest and receive a LIBOR-based floating rate. In the
first quarter of 2003, we entered into an additional interest rate swap
agreement to limit our exposure to interest rate fluctuations on $25.0
million of the outstanding principal of Term Loan B. Our interest rate swap
agreements as of September 30, 2003 qualify for hedge accounting under SFAS
No. 133 and as such the changes in the fair value of the interest rate swap
agreements are recognized as a component of equity. The change in the fair
value of the interest rate swap agreements was not material to
stockholder's equity for the three and nine months ended September 30,
2003.
At September 30, 2003, we carried $852.7 million of outstanding debt on our
balance sheet, with $372.7 million of that total, net of $205.0 million of
debt that is hedged, held at variable interest rates. Holding all other
variables constant, if interest rates hypothetically increased or decreased
by 10%, for the nine months ended September 30, 2003, interest expense
would increase or decrease by $1.9 million. In addition, if interest rates
hypothetically increased or decreased by 10% on September 30, 2003, with
all other variables held constant, the fair market value of our $275.0
million, 11% senior subordinated notes would decrease or increase by
approximately $15.2 million.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of our management, including the Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of the effectiveness of the design
and operation of our disclosure controls and procedures as of the end of
the period covered by this report. Based on that evaluation, our management
including the CEO and CFO, concluded that, as of the end of such period,
our disclosure controls and procedures were effective in alerting them in a
timely manner to material information required to be included in our SEC
reports. Our Disclosure Committee, which is comprised of members of
operations and functional management, reports directly to the CEO and CFO
regarding the committee's formal evaluation of disclosure controls and
procedures.
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CHANGES IN INTERNAL CONTROLS
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the
date of their evaluation, nor were there any significant deficiencies or
material weaknesses in our internal controls. Accordingly, no corrective
actions were required or undertaken.
PART II: OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
-------------- ----------------------------------------------------
31.1 Section 302 Certificates.
32.1 Section 906 Certificates.
(B) REPORTS ON FORM 8-K
July 24, 2003--The Registrant filed a Current Report on Form 8-K,
which was reported under Item 12, Results of Operations and
Financial Condition, and Item 7, Financial Statements and Exhibits,
with respect to a press release containing its financial results for
the second quarter of 2003.
No other reports on Form 8-K were filed during the third quarter of 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NOVEON, INC.
Date: November 10, 2003 By: /s/ Steven J. Demetriou
-----------------------
Steven J. Demetriou
President and Chief Executive Officer
By: /s/ Michael D. Friday
-----------------------
Michael D. Friday
Executive Vice President and
Chief Financial Officer
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