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 MARCH 31, 2004
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 (Commission File Number) (IRS Employer
incorporation) 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 May 14, 2004, there is 1 share of registrant's common stock
outstanding.
1
NOVEON, INC.
Index to Form 10-Q for the Quarter Ended March 31, 2004
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Income Statement--Three months
ended March 31, 2004 and 2003............................3
Condensed Consolidated Balance Sheet--March 31, 2004 and
December 31, 2003........................................4
Condensed Consolidated Statement of Cash Flows--Three
months ended March 31, 2004 and 2003.....................5
Notes to Condensed Consolidated Financial Statements.....6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.....................20
Item 3. Quantitative and Qualitative Disclosures of Market
Risk....................................................33
Item 4. Controls and Procedures.................................35
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K........................36
2
NOVEON, INC.
Condensed Consolidated Income Statement
(dollars in millions)
THREE MONTHS
ENDED
MARCH 31,
2004 2003
------------------
(unaudited)
Sales $321.6 $282.3
Cost of sales 227.6 200.5
------------------
Gross profit 94.0 81.8
Selling and administrative expenses 55.7 50.4
Amortization expense 3.8 3.6
Restructuring and severance costs 2.8 2.0
------------------
Operating income 31.7 25.8
Interest expense--net 17.1 18.0
Gain on sale of assets (0.7) -
Other expense (income)--net 0.1 (0.1)
------------------
Income before income taxes and cumulative effect
of accounting change 15.2 7.9
Income tax expense 2.9 2.1
------------------
Income before cumulative effect of accounting
change 12.3 5.8
Cumulative effect of accounting change--net of tax - 0.5
------------------
Net income $ 12.3 $ 5.3
==================
See notes to condensed consolidated financial statements.
3
NOVEON, INC.
Condensed Consolidated Balance Sheet
(dollars in millions)
MARCH 31, DECEMBER 31,
2004 2003
------------------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 93.6 $115.6
Accounts and notes receivable, net of
allowances ($7.7 and
$7.5 at March 31, 2004 and December 31,
2003, respectively) 180.9 149.8
Inventories 164.7 161.7
Deferred income taxes 11.5 11.5
Prepaid expenses and other current assets 12.2 7.9
------------------------
TOTAL CURRENT ASSETS 462.9 446.5
Property, plant and equipment--net 671.7 682.9
Goodwill 420.7 414.2
Identifiable intangible assets--net 170.2 172.9
Receivable from Parent 1.4 1.4
Other assets 40.4 41.3
------------------------
TOTAL ASSETS $1,767.3 $1,759.2
========================
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Accounts payable $134.2 $130.1
Accrued expenses 63.1 73.1
Income taxes payable 8.8 6.7
Current maturities of long-term debt 16.2 15.8
------------------------
TOTAL CURRENT LIABILITIES 222.3 225.7
Long-term debt 853.8 848.6
Postretirement benefits other than pensions 5.8 5.7
Accrued pensions 32.5 31.0
Deferred income taxes 29.6 29.6
Accrued environmental 18.6 18.2
Other non-current liabilities 14.5 15.4
STOCKHOLDER'S EQUITY
Common stock - -
Paid in capital 498.0 498.0
Retained earnings 22.9 10.6
Accumulated other comprehensive income 69.3 76.4
------------------------
TOTAL STOCKHOLDER'S EQUITY 590.2 585.0
------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $1,767.3 $1,759.2
========================
See notes to condensed consolidated financial statements.
4
NOVEON, INC.
Condensed Consolidated Statement of Cash Flows
(dollars in millions)
THREE MONTHS ENDED
MARCH 31,
2004 2003
------------------------
(unaudited)
OPERATING ACTIVITIES
Net income $ 12.3 $ 5.3
Adjustments to reconcile net income to net
cash (used) provided by operating
activities:
Depreciation and amortization 23.6 21.8
Deferred income taxes - (0.1)
Gain on sale of assets (0.7) -
Debt issuance cost amortization in
interest expense 1.3 1.4
Cumulative effect of accounting
change--net of tax - 0.5
Change in operating assets and
liabilities, net of effects
of acquisitions of businesses (41.2) (28.6)
------------------------
NET CASH (USED) PROVIDED BY OPERATING
ACTIVITIES (4.7) 0.3
INVESTING ACTIVITIES
Purchases of property, plant and equipment (11.8) (16.5)
Payments made in connection with
acquisitions, net of cash acquired (13.3) (10.7)
Proceeds from sale of assets 0.8 -
------------------------
NET CASH (USED) BY INVESTING ACTIVITIES (24.3) (27.2)
FINANCING ACTIVITIES
Net proceeds from borrowings on revolving
credit facility 13.3 18.5
Payments on long-term borrowings (4.8) -
Decrease in short-term debt - (0.3)
------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 8.5 18.2
Effect of exchange rate changes on cash
and cash equivalents (1.5) (0.1)
------------------------
Net decrease in cash and cash equivalents (22.0) (8.8)
Cash and cash equivalents at beginning of
period 115.6 79.5
------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 93.6 $ 70.7
========================
See notes to condensed consolidated financial statements.
5
NOVEON, INC.
Period of Three Months Ended March 31, 2004 and 2003
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 months ended March 31,
2004 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2004.
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, 2003 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
In January 2004, the Company purchased Scher Chemicals, Inc., a
manufacturer of emollient and surfactant specialty chemicals used in
cosmetic and other personal care formulations for the Consumer Specialties
segment. Final determinations of the fair value of certain assets and
liabilities are in process. Accordingly, the preliminary purchase price
allocations are subject to revision. The aggregate purchase price of $13.3
million paid for this acquisition was allocated to the assets acquired and
liabilities assumed and resulted in goodwill of $11.2 million.
C. NEW ACCOUNTING STANDARDS
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,
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 Company adopted
this statement in 2003. The effect of adoption had no impact on the
Company's consolidated financial position or results of operations.
6
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
C. NEW ACCOUNTING STANDARDS (CONTINUED)
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.
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:
MARCH 31, DECEMBER 31,
2004 2003
------------------------
(IN MILLIONS)
Finished products $ 119.7 $ 120.8
Work in process 3.4 5.0
Raw materials 41.6 35.9
------------------------
$ 164.7 $ 161.7
========================
At March 31, 2004 and December 31, 2003, 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
7
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
E. ASSET RETIREMENT OBLIGATIONS (CONTINUED)
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.
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, 2003 are not material to the results of operations.
F. 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 months ended March 31, 2004 and, to a lesser extent, for the
three months ended March 31, 2003, the effective tax rate differed from the
federal statutory rate principally due to decreases in the income tax rate
as a result of the reversal of tax valuation allowances previously recorded
for the Company's domestic operations and certain income tax credits. The
decreases in the effective tax rate from the federal statutory rate were
partially offset by higher tax valuation allowance amounts associated with
losses incurred by the Company's foreign businesses, the impact of foreign
operations and other nondeductible business operating expenses.
As of March 31, 2004, management has determined that it is uncertain that
future taxable income of the Company will be sufficient to recognize
certain of these net deferred tax assets. As a result, under the provisions
of SFAS No. 109, a valuation allowance of $49.4 million has been recorded
at March 31, 2004. 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. Any reversal of the
valuation allowance that was established in purchase accounting would
reduce goodwill. For the three months ended March 31, 2004, a reduction of
the valuation allowance of $0.7 million has been allocated to goodwill.
In determining the adequacy of the $49.4 million valuation allowance,
management assessed the Company's profitability taking into account
cumulative 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.
8
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
G. 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
severance 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.
The following tables summarize business segment information:
THREE MONTHS ENDED
MARCH 31,
2004 % 2003 %
--------------------------------
(DOLLARS IN MILLIONS)
Sales
Consumer Specialties $ 95.4 29.7% $ 82.9 29.4%
Specialty Materials 126.2 39.2 104.7 37.1
Performance Coatings 100.0 31.1 94.7 33.5
--------------------------------
Total sales $321.6 100.0% $282.3 100.0%
================================
Gross profit
Consumer Specialties $ 27.1 28.4% $ 22.4 27.0%
Specialty Materials 42.7 33.8 36.5 34.9
Performance Coatings 24.2 24.2 22.9 24.2
--------- -----------
Total gross profit $ 94.0 29.2% $ 81.8 29.0%
========= ===========
Operating income
Consumer Specialties $ 14.2 14.9% $ 11.7 14.1%
Specialty Materials 23.7 18.8 20.5 19.6
Performance Coatings 11.9 11.9 11.2 11.8
--------- -----------
Total segment
operating income $ 49.8 15.5% $ 43.4 15.4%
Corporate costs (15.3) (4.8) (15.6) (5.6)
Restructuring and
severance costs (2.8) (0.9) (2.0) (0.7)
--------------------------------
Total operating income $ 31.7 9.8% $ 25.8 9.1%
================================
H. COMPREHENSIVE INCOME
Total comprehensive income consists of the following:
THREE MONTHS ENDED
MARCH 31,
2004 2003
---------------------
(IN MILLIONS)
Net income $ 12.3 $ 5.3
Net change related to cash flow hedges 0.6 -
Cumulative translation adjustment (7.7) 0.2
---------------------
Total comprehensive income $ 5.2 $ 5.5
=====================
9
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
I. 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
MARCH 31,
2004 2003
---------------------
(IN MILLIONS)
Net income as reported $ 12.3 $ 5.3
Deduct: total stock-based employee
compensation expense determined
under the fair value based method
for all awards, net of related
tax effects (0.7) (0.7)
---------------------
Pro forma net income $ 11.6 $ 4.6
=====================
The effects of applying SFAS No. 123 may not be representative of the
effects on reportable net income in future years.
J. RESTRUCTURING AND SEVERANCE COSTS
In 2003, the Company announced the relocation of the Sancure(R)
polyurethane dispersions line, part of the Company's Performance Coatings
segment, to its Avon Lake, Ohio facility and the closing of the Leominster,
Massachusetts facility. Production is expected to be completely shifted to
the Avon Lake site by the end of 2004. In conjunction with the announced
closing of the Leominster facility, the Company performed an evaluation of
the ongoing value of the long-lived assets at that facility. The Company
determined that the long-lived assets were impaired and no longer
recoverable. As a result, the long-lived asset carrying value was written
down to its estimated fair value of $1.4 million, which was determined by
an independent appraisal, and an impairment charge of $5.7 million was
recorded. Additionally, in 2003, in order to increase efficiency and
productivity and to reduce costs, the Company reduced headcount at various
administrative and manufacturing facilities.
Through these restructuring efforts, we planned to eliminate approximately
80 positions across all segments. Approximately 70% of the affected
employees have left their positions as of March 31, 2004. In conjunction
with these restructuring plans, we recorded severance costs of $6.6 million
pursuant to our existing severance plan. As of March 31, 2004, $2.4 million
remains accrued related to these restructurings with substantially all of
the remaining costs anticipated to be paid by the end of 2004.
10
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
J. RESTRUCTURING AND SEVERANCE COSTS (CONTINUED)
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.
In June 2001, 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. Through these restructuring efforts, the
Company planned to eliminate approximately 440 positions. All of the
affected employees have left their positions as of March 31, 2004 and the
remaining personnel-related costs are anticipated to be paid by 2007. In
the first quarter of 2004, the Company recorded $2.4 million of
restructuring and severance costs in conjunction with this restructuring
plan, which consisted of expenses related to the buy-out of a foreign
pension plan associated with a closed facility as mandated by a change in
local employment laws. The restructuring accrual is summarized below:
BALANCE BALANCE
JANUARY 1, MARCH 31,
2004 PROVISION ACTIVITY 2004
--------- --------- --------- ---------
PERSONNEL-RELATED COSTS (IN MILLIONS)
2003 Restructurings........ $ 2.7 $ 0.4 $ (0.7) $ 2.4
2001 Restructurings....... 1.3 2.4 (0.2) 3.5
FACILITY CLOSURE COSTS
2002 Restructurings........ 0.1 - - 0.1
2001 Restructurings........ 0.3 - (0.1) 0.2
--------- --------- --------- ---------
$ 4.4 $ 2.8 $ (1.0) $ 6.2
========= ========= ========= =========
K. PENSIONS AND POSTRETIREMENT BENEFITS
Components of Net Periodic Benefit Cost
The components of net periodic benefit cost for the three months ended
March 31, 2004 and 2003 consists of the following:
UNITED UNITED
STATES EUROPEAN STATES
PENSION PENSION OTHER
BENEFITS BENEFITS BENEFITS
--------------------------------------
THREE MONTHS ENDED MARCH 31
2004 2003 2004 2003 2004 2003
------------ ------------- -----------
(IN MILLIONS)
Components of net
periodic benefit cost:
Service cost............ $1.0 $0.9 $0.5 $0.4 $- $-
Interest cost........... 0.8 0.7 0.3 0.3 0.1 0.1
Expected return on plan
assets.................. (0.2) (0.2) (0.1) (0.2) - -
Amortization of prior
service cost............ 0.1 - - - - -
------------ ------------- -----------
Total net periodic
benefit cost............ $1.7 $1.4 $0.7 $0.5 $0.1 $0.1
============ ============= ===========
11
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
K. PENSIONS AND POSTRETIREMENT BENEFITS (continued)
Medicare Prescription Drug Act
In March 2004, the FASB issued Financial Staff Position ("FSP") No. 106-b
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act 2003." FSP 106-b addresses the
accounting and disclosure implications that are required as a result of the
Medicare Prescription Drug, Improvement and Modernization Act (the "Act").
The Act introduced a prescription drug benefit under Medicare (Medicare
Part D) as well as a federal subsidy to sponsors of retiree health care
benefit plans that provide a benefit that is a least actuarially equivalent
to Medicare Part D. Under FSP No. 106-b, a plan sponsor may elect to defer
recognizing the effects of the Act until authoritative guidance on the
accounting for the federal subsidy is issued. The Company has not adopted the
provisions of the Act and, accordingly, any measures of accumulated
postretirement benefit obligation or net periodic postretirement benefit cost
in the financial statements or accompanying notes do not reflect the Act. The
adoption of this FSP could require the Company to change previously reported
information.
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 and non-hazardous wastes, the treatment, storage, transportation
and disposal of which are regulated by various laws and governmental
regulations. Although the Company believes past operations were in
substantial compliance with the then-applicable regulations, either the
Company or the Performance Materials Segment of Goodrich have been
designated as a potentially responsible party ("PRP") by the U.S.
Environmental Protection Agency ("EPA"), 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
12
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
L. CONTINGENCIES (CONTINUED)
resulting in one responsible party being held responsible for the entire
obligation. Liability may also include damages to natural resources.
The Company initiates corrective and/or preventive environmental projects
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'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 selection and
implementation, as well as negotiations with other PRPs and governmental
agencies. Our estimates of environmental liabilities are based on the
results of this process.
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 March 31, 2004 balance sheet includes liabilities,
measured on an undiscounted basis, of $19.4 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 $18.6 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. The Company believes 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. Additionally, as the indemnification from Goodrich extends through
2011, changes in assumptions regarding when costs will be incurred may
result in additional expenses to the Company. However, the additional
costs, if any, cannot currently be estimated.
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,
13
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
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. 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 MARCH 31, 2004
--------------------------------------------------------
COMBINED COMBINED
INCOME STATEMENT THE GUARANTOR NON-GUARANTOR
DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- ---------------------------------------------------------------------------
(IN MILLIONS)
Sales $181.1 $ 51.3 $ 118.5 $ (29.3) $321.6
Cost of sales 120.5 47.4 89.0 (29.3) 227.6
---------------------------------------------------------
Gross profit 60.6 3.9 29.5 - 94.0
Selling and
administrative
expenses 35.7 3.5 16.5 - 55.7
Amortization
expense 0.1 2.4 1.3 - 3.8
Restructuring and
severance costs 0.1 - 2.7 - 2.8
---------------------------------------------------------
Operating income
(loss) 24.7 (2.0) 9.0 - 31.7
Interest
expense--net 15.3 1.7 0.1 - 17.1
Gain on sale of
assets (0.7) - - - (0.7)
Other expense--net - - 0.1 - 0.1
---------------------------------------------------------
Income (loss)
before income
taxes 10.1 (3.7) 8.8 - 15.2
Income tax
expense
(benefit) 2.3 (1.6) 2.2 - 2.9
---------------------------------------------------------
Net income (loss) $ 7.8 $ (2.1) $ 6.6 $ - $ 12.3
=========================================================
14
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
MARCH 31, 2004
----------------------------------------------------
COMBINED COMBINED
BALANCE SHEET THE GUARANTOR NON-GUARANTOR
DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- -----------------------------------------------------------------------------
(IN MILLIONS)
CURRENT ASSETS
Cash and cash
equivalents $ 6.9 $ 1.0 $ 85.7 $ - $ 93.6
Accounts and notes
receivable 77.2 25.6 78.1 - 180.9
Inventories 73.4 36.5 54.8 - 164.7
Deferred income taxes 11.5 - - - 11.5
Prepaid expenses and
other current assets 8.0 1.3 2.9 - 12.2
----------------------------------------------------
TOTAL CURRENT ASSETS 177.0 64.4 221.5 - 462.9
Property, plant and
equipment-net 380.0 99.6 192.1 - 671.7
Goodwill 242.4 11.9 166.4 - 420.7
Identifiable
intangible assets-net 3.0 111.5 55.7 - 170.2
Intercompany
receivables 456.8 - 34.3 (491.1) -
Investment in
subsidiaries 481.9 49.1 - (531.0) -
Receivable from Parent 1.4 - - - 1.4
Other assets 32.3 7.1 1.0 - 40.4
----------------------------------------------------
TOTAL ASSETS $1,774.8 $343.6 $671.0 $(1,022.1) $1,767.3
=====================================================
CURRENT LIABILITIES
Accounts payable $ 78.9 $ 13.9 $ 41.4 $ - $134.2
Accrued expenses 49.0 4.4 9.7 - 63.1
Income taxes payable - - 8.8 - 8.8
Current maturities of
debt 16.2 - - - 16.2
-----------------------------------------------------
TOTAL CURRENT
LIABILITIES 144.1 18.3 59.9 - 222.3
Long-term debt 853.5 - 0.3 - 853.8
Postretirement
benefits other
than pensions 4.6 1.2 - - 5.8
Accrued pensions 18.6 4.9 9.0 - 32.5
Deferred income taxes 11.5 - 18.1 - 29.6
Accrued environmental 1.2 17.4 - - 18.6
Intercompany payables 240.0 160.3 90.8 (491.1) -
Other non-current
liabilities 11.9 - 2.6 - 14.5
-----------------------------------------------------
TOTAL LIABILITIES 1,285.4 202.1 180.7 (491.1) 1,177.1
STOCKHOLDER'S EQUITY
Common stock - 164.8 366.2 (531.0) -
Paid in capital 498.0 - - - 498.0
Retained earnings
(deficit) 1.0 (23.3) 45.2 - 22.9
Accumulated other
comprehensive
income (loss) (9.6) - 78.9 - 69.3
-----------------------------------------------------
TOTAL STOCKHOLDER'S
EQUITY 489.4 141.5 490.3 (531.0) 590.2
-----------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $1,774.8 $343.6 $671.0 $(1,022.1) $1,767.3
=====================================================
15
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2004
-------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
CASH FLOW DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- ----------------------------------------------------------------------------------
(IN MILLIONS)
Net cash (used) provided
by operating activities $ (4.2) $ 0.7 $ (1.2) $ - $ (4.7)
Investing activities:
Purchases of property,
plant and equipment (8.9) (0.7) (2.2) - (11.8)
Payments made in
connection with
acquisitions, net of
cash acquired (13.3) - - - (13.3)
Proceeds from sale of
assets 0.8 - - - 0.8
-------------------------------------------------------
Net cash (used) by
investing activities (21.4) (0.7) (2.2) - (24.3)
Financing activities:
Net proceeds from
borrowings on revolving
credit facility 13.3 - - - 13.3
Payments on long-term
borrowings (2.4) - (2.4) - (4.8)
-------------------------------------------------------
Net cash (used) provided by
financing activities 10.9 - (2.4) - 8.5
Effect of exchange rate
changes on cash and
cash equivalents - - (1.5) - (1.5)
-------------------------------------------------------
Net decrease in cash
and cash equivalents (14.7) - (7.3) - (22.0)
Cash and cash equivalents
at beginning of period 21.6 1.0 93.0 - 115.6
-------------------------------------------------------
Cash and cash equivalents
at end of period $ 6.9 $ 1.0 $ 85.7 $ - $ 93.6
=======================================================
16
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2003
-------------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
INCOME STATEMENT DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- -------------------------------------------------------------------------------------
(IN MILLIONS)
Sales $166.7 $ 47.5 $ 97.5 $ (29.4) $282.3
Cost of sales 112.2 44.8 72.9 (29.4) 200.5
-----------------------------------------------------
Gross profit 54.5 2.7 24.6 - 81.8
Selling and administrative
expenses 32.7 2.5 15.2 - 50.4
Amortization expense 0.1 2.3 1.2 - 3.6
Restructuring and severance
costs 1.6 - 0.4 - 2.0
-----------------------------------------------------
Operating income (loss) 20.1 (2.1) 7.8 - 25.8
Interest expense--net 16.1 1.7 0.2 - 18.0
Other (income) expense--net (0.2) (0.2) 0.3 - (0.1)
-----------------------------------------------------
Income (loss) before income
taxes and cumulative effect
of accounting change 4.2 (3.6) 7.3 - 7.9
Income tax expense (benefit) - (0.2) 2.3 - 2.1
-----------------------------------------------------
Income (loss) before cumulative
effect of accounting change 4.2 (3.4) 5.0 - 5.8
Cumulative effect of accounting
change--net of tax - - 0.5 - 0.5
-----------------------------------------------------
Net income (loss) $ 4.2 $ (3.4) $ 4.5 $ - $ 5.3
=====================================================
17
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
DECEMBER 31, 2003
-----------------------------------------------------
COMBINED COMBINED
BALANCE SHEET THE GUARANTOR NON-GUARANTOR
DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- -------------------------------------------------------------------------------
(IN MILLIONS)
CURRENT ASSETS
Cash and cash
equivalents $ 21.6 $ 1.0 $ 93.0 $ - $115.6
Accounts and notes
receivable 61.2 19.9 68.7 - 149.8
Inventories 71.9 33.1 56.7 - 161.7
Deferred income
taxes 11.5 - - - 11.5
Prepaid expenses
and other current
assets 4.5 1.4 2.0 - 7.9
--------------------------------------------------------
TOTAL CURRENT ASSETS 170.7 55.4 220.4 - 446.5
Property, plant and
equipment--net 382.3 100.8 199.8 - 682.9
Goodwill 243.1 0.9 170.2 - 414.2
Identifiable
intangible assets--
net 3.1 112.9 56.9 - 172.9
Intercompany
receivables 432.3 - 29.6 (461.9) -
Investment in
subsidiaries 476.1 49.1 - (525.2) -
Receivable from
Parent 1.4 - - - 1.4
Other assets 33.1 7.2 1.0 - 41.3
--------------------------------------------------------
TOTAL ASSETS $1,742.1 $326.3 $677.9 $(987.1) $1,759.2
========================================================
CURRENT LIABILITIES
Accounts payable $ 71.6 $ 13.0 $ 45.5 $ - $130.1
Accrued expenses 61.5 4.3 7.3 - 73.1
Income taxes
payable - - 6.7 - 6.7
Current maturities
of long-term debt 15.8 - - - 15.8
-------------------------------------------------------
TOTAL CURRENT
LIABILITIES 148.9 17.3 59.5 - 225.7
Long-term debt 848.3 - 0.3 - 848.6
Postretirement
benefits other than
pensions 4.4 1.3 - - 5.7
Accrued pensions 17.2 4.8 9.0 - 31.0
Deferred income
taxes 11.5 - 18.1 - 29.6
Accrued
environmental 1.2 17.0 - - 18.2
Intercompany
payables 217.4 148.5 96.0 (461.9) -
Other non-current
liabilities 12.2 - 3.2 - 15.4
-------------------------------------------------------
TOTAL LIABILITIES 1,261.1 188.9 186.1 (461.9) 1,174.2
STOCKHOLDER'S EQUITY
Common stock - 158.6 366.6 (525.2) -
Paid in capital 498.0 - - - 498.0
Retained (deficit)
earnings (6.8) (21.2) 38.6 - 10.6
Accumulated other
comprehensive
income (loss) (10.2) - 86.6 - 76.4
-------------------------------------------------------
TOTAL STOCKHOLDER'S
EQUITY 481.0 137.4 491.8 (525.2) 585.0
-------------------------------------------------------
TOTAL LIABILITIES
AND
STOCKHOLDER'S
EQUITY $1,742.1 $326.3 $677.9 $(987.1) $1,759.2
=======================================================
18
NOVEON, INC.
Notes to Condensed Consolidated Financial Statements (unaudited)(continued)
M. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2003
-----------------------------------------------------
COMBINED COMBINED
THE GUARANTOR NON-GUARANTOR
CASH FLOW DATA COMPANY SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- --------------------------------------------------------------------------------
(IN MILLIONS)
Net cash provided (used)
by operating activities $(19.5) $ 5.5 $ 14.3 $ - $ 0.3
Investing activities:
Purchases of property,
plant and equipment (7.1) (5.0) (4.4) - (16.5)
Payments made in
connection with
acquisitions, net of
cash acquired (10.4) - (0.3) - (10.7)
-----------------------------------------------------
Net cash (used) by
investing activities (17.5) (5.0) (4.7) - (27.2)
Financing activities:
Net proceeds from
borrowings on
revolving credit
facility 18.5 - - - 18.5
Decrease in short-term
debt - - (0.3) - (0.3)
-----------------------------------------------------
Net cash provided (used)
by financing activities 18.5 - (0.3) - 18.2
Effect of exchange rate
changes on cash and cash
equivalents - - (0.1) - (0.1)
-----------------------------------------------------
Net (decrease) increase
in cash and cash
equivalents (18.5) 0.5 9.2 - (8.8)
Cash and cash equivalents
at beginning of period 27.7 0.1 51.7 - 79.5
-----------------------------------------------------
Cash and cash equivalents
at end of period $ 9.2 $ 0.6 $ 60.9 $ - $ 70.7
=====================================================
N. SUBSEQUENT EVENT
In April 2004, The Lubrizol Corporation ("Lubrizol") signed a definitive
agreement to purchase the Company's Parent, Noveon International, Inc., in
a transaction valued at approximately $1.84 billion, which will include a
cash payment for equity and the assumption of the Company's debt. The
acquisition, which has been approved by the board of directors of both
companies, is subject to regulatory approval and is expected to close by
June 30, 2004. Following the close of the transaction, the Company's Parent
will be merged into a wholly owned subsidiary of Lubrizol.
19
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.
EXECUTIVE OVERVIEW
We are a leading global producer and marketer of technologically advanced
specialty materials and chemicals. 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. We derive our revenues from the
sale of our manufactured specialty chemicals and materials, with
approximately 59% of our sales from the United States, 21% of our sales
from Europe and 20% of our sales from the rest of the world in 2003.
20
Our business serves a multitude of industries and end-use applications
globally including various consumer, residential and commercial housing and
industrial applications, which diversity imparts a relative degree of
stability in our revenue. However, we are impacted by macroeconomic factors
that include available discretionary income, housing starts, industrial
production and overall levels of economic activity in the regions in which
we operate. In general, our revenues do not fluctuate with raw material and
other input prices.
The competitive environment for our products depends upon many factors,
including industry consolidation and capacity, general economic conditions
and availability of substitute materials. We have experienced pricing
pressure in parts of our business as a result of consolidation among some
of our competitors and customers and as some of the industries we serve
have matured.
Our cost base is most affected by changes in feedstock prices, which are
driven by crude oil and natural gas prices and supply and demand
characteristics in our various feedstock-related markets. For the three
months ended March 31, 2004, our raw material costs represented 42% of
sales as compared to 43% for the three months ended March 31, 2003. Our
most significant raw materials include toluene, ethyl and butyl acrylate,
glacial acrylic acid, chlorine, MDI, PTMEG, aniline, acetone, PVC and
styrene, although we do purchase approximately 1,500 other materials. Raw
materials tend to be specific to a particular product line, which can
result in significant fluctuations in results from product line to product
line. Other components of our costs include base manufacturing costs,
selling, research and development and administrative expenses.
We focus significant efforts on productivity initiatives with the goal of
lowering our overall cost structure. Productivity initiatives include
automation of processes, which have led to reduced production cycle times,
increased capacity and output, reductions in overall costs per pounds
produced, raw material usage efficiencies and the elimination of non-value
added processes. In addition, we have lowered our manufacturing and
corporate headcount. Since 2001, our annual savings from these productivity
initiatives have averaged between $15.0 million and $20.0 million, and we
expect to generate similar savings in 2004 as we continue to seek potential
opportunities to streamline, rationalize and consolidate our processes and
operations.
We are incurring higher sales, marketing and research and development costs
as we continue to add resources targeted at increasing the rate of new
product development and expand the use of our existing products on a global
basis.
We are also impacted by currency fluctuations. The depreciation of the U.S.
dollar versus the euro benefited our results in the first quarter of 2004
as compared to the same period in the prior year. In 2003, we generated
approximately 31% of our sales in foreign currencies and we incurred
approximately 28% of our costs in foreign currencies. We have attempted to
mitigate the impact of currency fluctuations by manufacturing products in
the countries in which the products are sold and offsetting our asset
exposure with local currency borrowings. Our hedging program is limited to
protecting known future cash flows due primarily from customers and
suppliers who pay or require payment in foreign currency.
21
SUBSEQUENT EVENT
In April 2004, The Lubrizol Corporation ("Lubrizol") signed a definitive
agreement to purchase our Parent, Noveon International, Inc., in a
transaction valued at approximately $1.84 billion, which will include a
cash payment for equity and the assumption of our debt. The acquisition,
which has been approved by the board of directors of both companies, is
subject to a regulatory approval and is expected to close by June 30, 2004.
Following the close of the transaction, our Parent will be merged into a
wholly owned subsidiary of Lubrizol.
RESTRUCTURING AND OTHER MATTERS
In 2003, we announced the relocation of the Sancure(R) polyurethane
dispersions line, part of our Performance Coatings segment, to our Avon
Lake, Ohio facility and the closing of the Leominster, Massachusetts
facility. Production is expected to be completely shifted to the Avon Lake
site by the end of 2004. In conjunction with the announced closing of the
Leominster facility, we performed an evaluation of the ongoing value of the
long-lived assets at that facility. We determined that the long-lived
assets were impaired and no longer recoverable. As a result, the long-lived
asset carrying value was written down to its estimated fair value of $1.4
million, which was determined by an independent appraisal, and an
impairment charge of $5.7 million was recorded. Additionally, in 2003, in
order to increase efficiency and productivity and to reduce costs, we
reduced headcount at various administrative and manufacturing facilities.
Through these restructuring efforts, we planned to eliminate approximately
80 positions across all segments. Approximately 70% of the affected
employees have left their positions as of March 31, 2004. In conjunction
with these restructuring plans, we recorded severance costs of $6.6 million
pursuant to our existing severance plan. As of March 31, 2004, $2.4 million
remains accrued related to these restructurings with substantially all of
the remaining costs anticipated to be paid by the end of 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 productivity in the electronics industry-related
product lines. In conjunction with this consolidation, we incurred
personnel-related charges as well as closure costs related to this leased
facility.
In June 2001, in order to increase efficiency and productivity, reduce
costs and support our global growth strategy, we reduced headcount at
facilities 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. All of the affected employees
have left their positions as of March 31, 2004 and the remaining
personnel-related costs are anticipated to be paid by 2007. In the first
quarter of 2004, we recorded $2.4 million of restructuring and severance
costs in conjunction with this restructuring plan, which consisted
primarily of personnel-related costs.
22
THREE MONTHS ENDED MARCH 31, 2004 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2003
TOTAL COMPANY ANALYSIS
SALES. Sales increased $39.3 million, or 13.9%, to $321.6 million for the
three months ended March 31, 2004 from $282.3 million for the three months
ended March 31, 2003. The increase in sales was attributable to higher
volumes of approximately 7% led by our Estane(R) TPU, personal care,
pharmaceutical and TempRite(R) CPVC product lines, the strength of the
euro, incremental sales of $8.8 million associated with acquisitions and
improved selling prices.
COST OF SALES. Cost of sales as a percentage of sales of 70.8% for the
three months ended March 31, 2004 was comparable to 71.0% for the three
months ended March 31, 2003.
GROSS PROFIT. Gross profit increased $12.2 million, or 14.9%, to $94.0
million for the three months ended March 31, 2004 from $81.8 million for
the three months ended March 31, 2003. The increase in gross profit was
primarily driven by higher volumes in our Estane(R) TPU, personal care,
pharmaceutical and TempRite(R) CPVC product lines, reduced manufacturing
costs related to ongoing productivity initiatives and improved selling
prices, offset slightly by higher raw material and utility costs across
each segment. As a percentage of sales, gross profit of 29.2% for the three
months ended March 31, 2004 was comparable to gross profit of 29.0% for the
three months ended March 31, 2003.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses
increased $5.3 million, or 10.5%, to $55.7 million for the three months
ended March 31, 2004 from $50.4 million for the three months ended March
31, 2003. The increase in selling and administrative expenses was primarily
related to higher spending in sales, marketing and research and development
as we continue to add growth resources to these areas and the impact of the
stronger euro. Selling and administrative expenses as a percentage of sales
declined to 17.3% for the three months ended March 31, 2004 from 17.9% for
the three months ended March 31, 2003.
AMORTIZATION EXPENSE. Amortization expense totaled $3.8 million for the
three months ended March 31, 2004 and was comparable to $3.6 million for
the three months ended March 31, 2003.
RESTRUCTURING AND SEVERANCE COSTS. Restructuring and severance costs
increased $0.8 million to $2.8 million for the three months ended March 31,
2004 from $2.0 million for the three months ended March 31, 2003. The
majority of these expenses related to the buy-out of a foreign pension plan
associated with a closed facility as mandated by a change in local
employment laws.
OPERATING INCOME. Operating income increased by $5.9 million, or 22.9%, to
$31.7 million for the three months ended March 31, 2004 from $25.8 million
for the three months ended March 31, 2003. The increase in operating income
was primarily attributable to higher volumes in our Estane(R) TPU, personal
care, pharmaceutical and TempRite(R) CPVC product lines, reduced
manufacturing costs related to ongoing productivity initiatives and
improved selling prices, offset slightly by increased selling and
administrative expenses primarily associated with higher spending in sales,
marketing and research and development, higher raw material and utility
costs across each segment and increased restructuring and severance costs.
23
INTEREST EXPENSE--NET. Interest expense was $17.1 million for the three
months ended March 31, 2004 and $18.0 million for the three months ended
March 31, 2003. The decrease in interest expense was attributable to lower
interest rates and the impact of debt reductions.
GAIN ON SALE OF ASSETS. Gain on the sale of assets was $0.7 million for the
three months ended March 31, 2004 and related primarily to assets
associated with a product line at our Leominster, Massachusetts facility.
INCOME TAX EXPENSE. Income tax expense was $2.9 million for the three
months ended March 31, 2004 compared to $2.1 million for the three months
ended March 31, 2004. The income tax expense for the three months ended
March 31, 2004 and 2003 was primarily associated with our international
operations. The effective tax rate for the three months ended March 31,
2004 and 2003 was 19.1% and 26.6%, respectively.
The decrease in the effective tax rate for the first quarter of 2004 as
compared to the first quarter of 2003 was principally related to a net
reversal of tax valuation allowances recorded in the first quarter of 2004.
For the three months ended March 31, 2004 and to a lesser extent for the
three months ended March 31, 2003, the effective tax rate differed from the
federal statutory rate principally due to decreases in the income tax rate
as a result of the reversal of tax valuation allowances previously recorded
for our domestic operations and certain income tax credits. The decreases
in the effective tax rate from the federal statutory rate were partially
offset by higher tax valuation allowance amounts associated with losses
incurred by our foreign businesses, the impact of foreign operations and
other nondeductible business operating expenses.
As of March 31, 2004, we have determined, based on cumulative and
anticipated amounts of domestic and foreign earnings and our anticipated
taxable income, as a result of the reversal of future taxable temporary
differences, that it is uncertain whether we will be able to recognize
certain of these remaining net deferred tax assets. Therefore, in
accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 109, we intend to maintain the tax valuation
allowances recorded at March 31, 2004 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. Any reversal of the valuation
allowance that was established in purchase accounting would reduce
goodwill. For the three months ended March 31, 2004, a reduction of the
valuation allowance of $0.7 million has been allocated to goodwill.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE--NET OF TAX. The cumulative effect
of accounting change resulted in a charge of $0.5 million for the three
months ended March 31, 2003 and related to the adoption of SFAS No. 143,
"Accounting for Asset Retirement Obligations," effective January 1, 2003.
24
NET INCOME. As a result of the factors discussed above, net income
increased by $7.0 million to $12.3 million for the three months ended March
31, 2004 from $5.3 million for the three months ended March 31, 2003.
SEGMENT ANALYSIS
CONSUMER SPECIALTIES. Sales increased $12.5 million, or 15.1%, to $95.4
million for the three months ended March 31, 2004 from $82.9 million for
the three months ended March 31, 2003. The increase in sales was primarily
attributable to the impact of higher sales of $12.4 million in our personal
care and pharmaceutical product lines, principally due to higher global
Carbopol(R) acrylic thickener sales as well as the continued impact of new
products, the strength of the euro and the impact of acquisitions.
Gross profit increased $4.7 million, or 21.0%, to $27.1 million for the
three months ended March 31, 2004 from $22.4 million for the three months
ended March 31, 2003. The increase in gross profit was primarily associated
with higher volumes within our personal care and pharmaceutical product
lines, the strength of the euro and the impact of acquisitions, offset
partially by higher raw material and utility costs within our food and
beverage product lines. As a percentage of sales, gross profit increased to
28.4% for the three months ended March 31, 2004 from 27.0% for the three
months ended March 31, 2003. The increase in gross profit as a percentage
of sales was due primarily to increased volumes in our personal care and
pharmaceutical product lines.
Operating income increased $2.5 million, or 21.4%, to $14.2 million for the
three months ended March 31, 2004 from $11.7 million for the three months
ended March 31, 2003. The increase in operating income was primarily
associated with higher volumes within our personal care and pharmaceutical
product lines, the strength of the euro and the impact of acquisitions,
offset partially by higher raw material and utility costs within our food
and beverage product lines and the addition of growth resources in our
personal care product lines.
SPECIALTY MATERIALS. Sales increased by $21.5 million, or 20.5%, to $126.2
million for the three months ended March 31, 2004 from $104.7 million for
the three months ended March 31, 2003. The increase in sales was primarily
driven by $11.9 million within our Estane(R) TPU product lines primarily
due to increased volumes associated with strong North American demand,
continued growth in Asia and the impact of new products, and $5.9 million
within our TempRite(R) CPVC product lines due to increased plumbing volume.
Additionally, the strength of the euro and the impact of acquisitions
contributed to the increase in sales.
Gross profit increased $6.2 million, or 17.0%, to $42.7 million for the
three months ended March 31, 2004 from $36.5 million for the three months
ended March 31, 2003. The increase in gross profit was primarily
attributable to increased volumes across the segment and the impact of the
acquisitions, partially offset by increased raw material and utility costs
throughout most of the segment. As a percentage of sales, gross profit
decreased to 33.8% for the three months ended March 31, 2004 from 34.9% for
the three months ended March 31, 2003.
25
Operating income increased $3.2 million, or 15.6%, to $23.7 million for the
three months ended March 31, 2004 from $20.5 million for the three months
ended March 31, 2003. The increase in operating income was primarily
attributable to increased volumes across the segment and the impact of the
acquisitions, partially offset by the addition of growth resources and the
increased raw material and utility costs throughout most of the segment.
PERFORMANCE COATINGS. Sales increased $5.3 million, or 5.6%, to $100.0
million for the three months ended March 31, 2004 from $94.7 million for
the three months ended March 31, 2003. The increase in sales was primarily
attributable to the strength of the euro, the impact of incremental sales
associated with acquisitions and improved selling prices, offset slightly
by lower sales volumes.
Gross profit increased $1.3 million, or 5.7%, to $24.2 million for the
three months ended March 31, 2004 from $22.9 million for the three months
ended March 31, 2003. The increase in gross profit was primarily
attributable to reduced manufacturing costs related to ongoing productivity
initiatives and improved selling prices, partially offset by lower sales
volumes and higher raw material and utility costs. As a percentage of
sales, gross profit was 24.2% for each of the three months ended March 31,
2004 and 2003.
Operating income increased $0.7 million, or 6.3%, to $11.9 million for the
three months ended March 31, 2004 from $11.2 million for the three months
ended March 31, 2003. The increase in operating income was primarily
attributable to reduced manufacturing costs related to ongoing productivity
initiatives and improved selling prices, partially offset by lower sales
volumes and higher raw material and utility costs
CORPORATE. Corporate costs decreased $0.3 million, or 1.9%, to $15.3
million for the three months ended March 31, 2004 from $15.6 million for
the three months ended March 31, 2003.
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 amended credit
facilities include:
o Term Loan A facility that matures on March 31, 2007;
o Term Loan B facility that matures on December 31, 2009; and
o revolving credit facility in the amount of $125.0 million that matures
on March 31, 2007.
26
A portion of the revolving credit 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 reduces 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. Our direct and indirect material domestic subsidiaries guarantee
our obligations under the credit facilities. The credit facilities are
secured by substantially all of our assets and the assets of all of our
domestic subsidiaries, in addition to a pledge of 65% of the stock of our
first tier foreign subsidiaries. At March 31, 2004, there was $35.0 million
outstanding on Term Loan A and $546.4 million outstanding on Term Loan B.
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. The senior subordinated notes
are subordinated to our credit facility and other senior obligations that
we may incur. The senior subordinated notes contain customary covenants and
events of default typical of publicly traded high yield debt.
As of March 31, 2004, we had a cash balance of $93.6 million. We had $105.9
million available under the $125.0 million revolving credit facility, net
of $13.3 million of borrowings and $5.8 million of outstanding letters of
credit.
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
March 31, 2004, we were in compliance with all of the covenants of our
credit facilities and the senior subordinated notes.
The table below summarizes the maturities of our debt obligations as of
March 31, 2004 (dollars in millions):
PAYMENTS DUE BY PERIOD
---------------------------------------
LESS
THAN 1-3 4-5 AFTER
TOTAL 1 YEAR YEARS YEARS 5 YEARS
---------------------------------------
Term Loan A $ 35.0 $10.8 $24.2 $ - $ -
Term Loan B 546.4 5.4 11.0 11.0 519.0
Revolving credit
facility 13.3 - 13.3 - -
11% Senior 275.0 - - - 275.0
subordinated notes
Other debt 0.3 - 0.1 0.2 -
---------------------------------------
Total debt
obligations $870.0 $16.2 $48.6 $11.2 $794.0
=======================================
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
27
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 from operating activities decreased $5.0 million to $4.7 million
used by operating activities for the three months ended March 31, 2004 from
$0.3 million of cash provided by operating activities for the three months
ended March 31, 2003. The decrease was primarily related to increased
working capital related to sales growth period over period, offset slightly
by improved operating results.
Investing activities used $24.3 million for the three months ended March
31, 2004 and included payments made in connection with an acquisition of
$13.3 million and purchases of property, plant and equipment of $11.8
million. Investing activities used $27.2 million for the three months ended
March 31, 2003 and included payments made in connection with acquisitions
of $10.7 million and purchases of property, plant and equipment of $16.5
million.
In January 2004, we purchased Scher Chemicals, Inc., a manufacturer of
emollient and surfactant specialty chemicals used in cosmetic and other
personal care formulations for our Consumer Specialties segment. Final
determinations of the fair value of certain assets and liabilities are in
process. Accordingly, the preliminary purchase price allocations are
subject to revision. The aggregate purchase price of $13.3 million paid for
this acquisition was allocated to the assets acquired and liabilities
assumed and resulted in goodwill of $11.2 million.
Financing activities provided $8.5 million related to $13.3 million of
borrowings on our revolving credit facility and principal payments on debt
of $4.8 million for the three months ended March 31, 2004. Financing
activities provided $18.2 million for the three months ended March 31,
2003, primarily related to borrowings of $18.5 million on our revolving
credit facility.
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 three months ended March 31, 2004 were $11.8 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 2004 and 2005 to be between $55.0 million and
$65.0 million annually.
NEW ACCOUNTING STANDARDS
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
28
financial support from other parties. Interpretation No. 46 requires that
variable interest entities, as defined, 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. We adopted this statement in 2003. The 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 AND ESTIMATES
The preparation of these financial statements in conformity with generally
accepted accounting principles 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.
ALLOWANCES AND REBATES
We recognize our allowance for doubtful accounts based on our historical
experience of customer write-offs as well as specific provisions for
customer receivables balances. In establishing the specific provisions, we
make assumptions with respect to future collectibility based upon such
factors as the customer's ability to meet and sustain their financial
commitments, their current and projected financial condition and the
occurrence of changes in their general business, economic or market
conditions that could affect their ability to make
29
required payments to us in the future. The allowance for doubtful accounts
is reviewed monthly and changes to the allowance are updated as
appropriate. Our level of reserves for our customer accounts receivable
fluctuates depending upon the factors mentioned above.
Rebates, customer claims, allowances, returns and discounts are reflected
as reductions from gross sales in determining net sales. In the first
quarter of 2004, the total of rebates, customer claims, returns, allowances
and discounts amounted to 3.7% of gross sales. Rebates are accrued based on
contractual relationships with customers as shipments are made. Customer
claims, returns, allowances and discounts are accrued based on our history
of claims and sales returns and allowances.
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 $49.4
million as of March 31, 2004, management assesses our profitability by
taking into account cumulative and anticipated amounts of domestic and
international earnings or losses, as well as the anticipated taxable income
as a result of the reversal of future taxable temporary differences.
Although we generated sufficient income in the first quarter of 2004 to
realize certain deferred tax assets, it is uncertain whether future
domestic and international earnings, as well as anticipated taxable income
as a result of the reversal of future taxable temporary differences, will
be sufficient to recognize the remaining net deferred tax assets.
Therefore, we intend to maintain the recorded valuation allowances until
sufficient positive evidence (for example, cumulative positive earnings and
future taxable income) exists to support a reversal of the tax valuation
allowances.
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 June
2005. In 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 principle 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. For the quarter ended March 31, 2004,
we recorded $2.1 million of interest expense as a result of these swap
agreements. As of March 31, 2004, the fair value of these swap arrangements
included in other non-current liabilities totaled approximately $9.6
million. The offsetting impact of this hedge transaction is included in
accumulated other comprehensive income.
30
We have entered into forward foreign currency exchange contracts, totaling
$29.3 million as of March 31, 2004, 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 cash flows
from the purchase or sale of products to international customers will be
adversely affected by changes in the exchange rates. The fair values of
these contracts at March 31, 2004 and 2003 were not material to our
consolidated results of operations, cash flow or financial position.
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 other comprehensive income. During the quarter ended March 31,
2004, the unrealized gain related to the impact of foreign currency
fluctuation on foreign-denominated debt was $2.9 million and was included
in cumulative translation adjustment.
ENVIRONMENTAL LIABILITIES
Our environmental engineers and consultants review and monitor
environmental issues at our existing operating sites. This process includes
investigation and remedial action selection and implementation, as well as
negotiations with other potentially responsible parties and governmental
agencies. Our estimates of environment liabilities are based on the results
of this process.
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 $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 of
these liabilities may increase to the extent such third parties fail to
honor their indemnity obligations through 2011. Our March 31, 2004 balance
sheet includes liabilities, measured on an undiscounted basis, of $19.4
million to cover future environmental expenditures either payable by us 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 $18.6 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.
Additionally, as the indemnification from Goodrich extends through 2011,
changes in assumptions regarding when costs will be incurred may result in
additional expenses to us. However, the additional costs, if any, cannot
currently be estimated.
GOODWILL
We have elected to test for goodwill impairment as of October 1 each year.
The goodwill impairment test is a two-step process, which requires
management to make judgments in
31
determining what assumptions to use in the calculation. The first step of
the process consists of estimating the fair value of each reporting unit
based on a discounted cash flow model using revenue and profit forecasts
and comparing those estimated fair values with the carrying values, which
includes allocated goodwill. Other key assumptions used to determine the
fair value of our reporting units include estimated cash flow periods,
terminal values based on our anticipated growth rates and the discount rate
used, which is based on our current cost of capital adjusted for the risks
associated with our operations. If the estimated fair value is less than
the carrying value, a second step is performed to compute the amount of the
impairment by determining an "implied fair value" of goodwill, which
requires us to allocate the estimated fair value of the reporting unit to
the assets and liabilities of the reporting unit. Any unallocated fair
value represents the "implied fair value" of goodwill, which is compared to
its corresponding carrying value.
We cannot predict the occurrence of certain future events that might
adversely affect the reported value of goodwill. Such events include, but
are not limited to, strategic decisions made in response to economic and
competitive conditions, the impact of the overall economic environment on
our customer base, or a material negative change in our relationships with
significant customers.
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 in inventory
based on the age and quality of our products.
LONG-LIVED ASSETS
We review the carrying value of long-lived assets to be held and used when
events or circumstances indicate that the carrying value may not be
recoverable. Factors that we consider important that could trigger an
impairment include current period operating or cash flow losses combined
with a history of operating or cash flow losses, a projection or forecast
that demonstrates continuing losses, significant adverse changes in the
business climate within a particular business or current expectations that
a long-lived asset will be sold or otherwise disposed of significantly
before the end of its estimated useful life. To test for impairment, we
compare the estimated undiscounted cash flows expected to be generated from
the use and disposal of the asset or asset group to its carrying value. If
these undiscounted cash flows are less than their respective carrying
values, an impairment charge would be recognized to the extent that the
carrying values exceed estimated fair values. Although third party
estimates of fair value are utilized when available, the estimation of
undiscounted cash flows and fair value requires us to make assumptions
regarding future operating results, as well as appropriate discount rates,
where necessary. The results of our impairment testing are dependent on
these estimates, which may be affected by the occurrence of certain events,
including changes in economic and competitive conditions.
32
PENSION AND POSTRETIREMENT BENEFITS
Our pension and postretirement costs are accrued based on an annual
analysis performed by our actuary. This analysis is based on assumptions
such as an assumed discount rate and an expected rate of return on plan
assets. Both the discount rate and expected rate of return on plan assets
require estimates and projections by management and can fluctuate from
period to period. Our expected rate of return on plan assets is a long-term
assumption based upon our target asset mix. Our objective in selecting a
discount rate is to select the best estimate of the rate at which the
benefit obligations could be effectively settled. In making this estimate,
we look at rates of return on high-quality fixed-income investments
currently available and expected to be available during the period to
maturity of the benefits. This process includes the construction of a
hypothetical bond portfolio whose cash flow from coupons and maturities
match the year-by-year, projected benefit cash flows from our pension and
retiree health plans. The yield on such a portfolio becomes the basis for
determining our best estimate of the effective settlement rate. If we
increased the discount rate by one half of one percent at December 31,
2003, the net periodic benefit costs in 2003 would have decreased by
approximately $0.4 million. A decrease in the discount rate by one half of
one percent in 2003 would have increased our net periodic benefit costs by
approximately $0.7 million.
Unrecognized actuarial gains and losses relating to changes in our
assumptions and actual experiences differing from them are being recognized
over a 10.3 year period, which represents the expected remaining service
life of the employer group. These unrecognized losses will be
systematically recognized as an increase in future net periodic benefit
costs in accordance with SFAS No. 87.
The actuarial assumptions used to determine pension and other
postretirement benefit plan retirement benefits may differ from actual
results due to changing market and economic conditions, higher or lower
withdrawal rates or longer or shorter life spans of participants. We do not
believe differences in actual experience or changes in assumptions will
materially affect our financial position or results of operations.
REVENUE 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK
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
33
fluctuations. The fair value of these contracts at March 31, 2004 was not
material to our consolidated financial position or results of operations.
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.
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.
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 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 through 2007. Our interest rate swap agreements as
of March 31, 2004 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 decreased to stockholder's equity by $0.6
million for the three months ended March 31, 2004.
At March 31, 2004, we carried $870.0 million of outstanding debt on our
balance sheet, with $389.8 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 three months ended March 31, 2004, interest expense would
increase or decrease by $0.6 million. In addition, if interest rates
hypothetically increased or decreased by 10% on March 31, 2004, 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
$14.5 million.
34
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.
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.
35
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
-------- -----------------------------------------------------
4.1 First Supplemental Indenture, dated March 29,
2004, by and among Noveon, Inc., the Guarantors
party thereto and Wells Fargo, National
Association, as trustee.
10.1 Amendment No. 1 to Employment Agreement, dated
February 24, 2004, by and among Noveon
International, Inc., Noveon, Inc. and Steven J.
Demetriou.
31.1 Section 302 Certificate.
31.2 Section 302 Certificate.
32.1 Section 906 Certificate.
32.2 Section 906 Certificate.
(B) REPORTS ON FORM 8-K
February 18, 2004 - 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 fourth quarter
of 2003 and year ended December 31, 2003.
No other reports on Form 8-K were filed during the first quarter of 2004.
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: May 14, 2004 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
36