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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
----------------------------------------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED JUNE 30, 2003. COMMISSION FILE NUMBER 1-16091.
POLYONE CORPORATION
-------------------
(Exact name of registrant as specified in its charter)
Ohio 34-1730488
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
Suite 36-5000, 200 Public Square, Cleveland, Ohio 44114-2304
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (216) 589-4000
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 in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
As of August 12, 2003, there were 91,721,882 common shares outstanding.
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POLYONE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In millions, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -----------------------
2003 2002 2003 2002
------------ ---------- ---------- ----------
Sales $ 650.9 $ 670.9 $ 1,296.4 $ 1,267.2
Operating costs and expenses:
Cost of sales 559.4 559.0 1,111.5 1,049.1
Selling and administrative 70.3 75.9 142.1 155.3
Depreciation and amortization 18.4 18.6 36.9 36.4
Employee separation and plant phase-out 2.1 - 27.0 0.9
Loss on divestiture of equity investment - - - 1.5
(Income) from equity affiliates and minority interest (10.1) (4.2) (15.7) (2.0)
------------ ---------- ---------- ----------
Operating income (loss) 10.8 21.6 (5.4) 26.0
Interest expense (17.3) (11.3) (29.8) (19.8)
Interest income 0.1 0.3 0.3 0.5
Other expense, net (3.5) (1.8) (6.6) (4.4)
------------ ---------- ---------- ----------
Income (loss) before income taxes, discontinued operations and
cumulative effect of a change in accounting (9.9) 8.8 (41.5) 2.3
Income tax (expense) benefit 3.9 (3.5) 16.2 (0.9)
------------ ---------- ---------- ----------
Income (loss) before discontinued operations and cumulative effect of
change in accounting (6.0) 5.3 (25.3) 1.4
Discontinued operations:
Income from operations, net of income taxes - 0.8 - 1.1
Cumulative effect of a change in goodwill accounting,
net of income tax benefit of $1.0 million - - - (53.7)
------------ ---------- ---------- ----------
Net income (loss) $ (6.0) $ 6.1 $ (25.3) $ (51.2)
============ ========== ========== ==========
Income (loss) per common share:
Basic income (loss) per share before discontinued operations and
effect of change in accounting $ (.07) $ .06 $ (.28) $ .02
Discontinued operations - .01 - .01
Cumulative effect of a change in accounting - - - (.60)
------------ ---------- ---------- ----------
Basic income (loss) per share $ (.07) $ .07 $ (.28) $ (.57)
============ ========== ========== ==========
Diluted income (loss) per share before discontinued operations and
effect of change in accounting $ (.07) $ .06 $ (.28) $ .02
Discontinued operations - .01 - .01
Cumulative effect of a change in accounting - - - (.58)
------------ ---------- ---------- ----------
Diluted income (loss) per share $ (.07) $ .07 $ (.28) $ (.55)
============ ========== ========== ==========
Weighted average shares used to compute earnings per share:
Basic 91.1 90.3 91.0 90.4
Diluted 91.1 92.5 91.0 92.3
Dividends paid per share of common stock $ - $ .0625 $ - $ .1250
See Accompanying Notes to the Unaudited Condensed Consolidated
Financial Statements.
2
POLYONE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In millions)
June 30, December 31,
2003 2002
-------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 63.2 $ 41.4
Restricted cash 53.7 -
Accounts receivable, net 297.8 164.3
Inventories 285.7 253.7
Deferred income tax assets 42.5 42.1
Other current assets 26.0 12.7
-------------- ------------
Total current assets 768.9 514.2
Property, net 667.9 682.1
Investment in equity affiliates 268.6 271.8
Goodwill, net 444.5 444.0
Other intangible assets, net 31.0 32.8
Other non-current assets 67.6 52.6
-------------- ------------
Total assets $ 2,248.5 $ 1,997.5
============== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank debt $ 1.0 $ 0.7
Accounts payable 269.4 242.0
Accrued expenses 126.2 160.2
Current portion of long-term debt 56.9 91.0
-------------- ------------
Total current liabilities 453.5 493.9
Long-term debt 796.4 492.2
Deferred income tax liabilities 16.8 39.0
Post-retirement benefits other than pensions 122.6 122.5
Other non-current liabilities, including pensions 274.4 261.2
Minority interest in consolidated subsidiaries 9.5 9.0
-------------- ------------
Total liabilities 1,673.2 1,417.8
Shareholders' equity:
Preferred stock, 40.0 shares authorized, no shares issued - -
Common stock, $.01 par, 400.0 shares authorized, 122.2
shares issued at June 30, 2003 and December 31, 2002 1.2 1.2
Other shareholders' equity 574.1 578.5
-------------- ------------
Total shareholders' equity 575.3 579.7
-------------- ------------
Total liabilities and shareholders' equity $ 2,248.5 $ 1,997.5
============== ============
See Accompanying Notes to the Unaudited Condensed Consolidated
Financial Statements.
3
POLYONE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In millions)
Six Months Ended
June 30,
-----------------------------
2003 2002
-------------- ------------
OPERATING ACTIVITIES
Net loss $ (25.3) $ (51.2)
Cumulative effect of a change in accounting - (53.7)
Income from discontinued operations - 1.1
-------------- ------------
Income (loss) from continuing operations (25.3) 1.4
Adjustments to reconcile net income (loss) to net cash used by
operating activities:
Employee separation and plant phase-out charges 27.0 0.9
Cash payments on employee separation and plant phase-out (23.3) (7.7)
Depreciation and amortization 36.9 36.4
Unrealized currency (gains) losses (6.9) (3.6)
Loss on sale of equity affiliate - 1.5
Loss on sale of assets 0.2 -
Companies carried at equity and minority interest:
(Income) from equity affiliates (16.2) (2.8)
Minority interest expense 0.5 0.8
Dividends and distributions received 2.0 3.0
Deferred income taxes (24.2) (1.4)
Change in assets and liabilities:
Operating working capital:
Accounts receivable (125.1) (89.3)
Inventories (26.0) (30.7)
Accounts payable 22.3 (19.6)
Accrued expenses and other (13.7) 29.9
-------------- ------------
NET CASH USED BY OPERATING ACTIVITIES FOR CONTINUING OPERATIONS (171.8) (81.2)
INVESTING ACTIVITIES
Capital expenditures (16.1) (33.0)
Increase in restricted cash (53.7) -
Return of cash from equity affiliates (0.1) (0.5)
Business acquired, net of cash received (15.8) -
Proceeds from sale of assets 22.6 1.1
-------------- ------------
NET CASH USED BY INVESTING ACTIVITIES FOR CONTINUING OPERATIONS (63.1) (32.4)
FINANCING ACTIVITIES
Change in short-term debt (34.0) (2.1)
Change in long-term debt 303.9 155.0
Debt issuance costs (14.0) (4.9)
Net proceeds from the exercise of stock options - 5.0
Dividends - (11.2)
-------------- ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES FOR CONTINUING OPERATIONS 255.9 141.8
NET CASH USED BY DISCONTINUED OPERATIONS - 1.4
Effect of exchange rate on changes on cash 0.8 (1.6)
-------------- ------------
INCREASE IN CASH AND CASH EQUIVALENTS 21.8 28.0
Cash and cash equivalents at beginning of period 41.4 18.2
-------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 63.2 $ 46.2
============== ============
See Accompanying Notes to the Unaudited Condensed Consolidated
Financial Statements.
4
POLYONE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
(In millions, shares in thousands)
Accumulated
Common Common Other Non-
Shares Additional Retained Stock Held Share Owner
Common Held in Common Paid-In Earnings in Ownership Equity
Shares Treasury Total Stock Capital (Deficit) Treasury Trust Changes
------------------------------------------------------------------------------------------------
BALANCE JANUARY 1, 2002 122,192 31,175 $ 713.4 $ 1.2 $ 1,072.7 $ 100.3 $ (350.1) $ (5.3) $ (105.4)
Non-owner equity changes:
Net loss (57.3) (57.3)
Translation adjustment (0.3) (0.3)
--------
Total non-owner equity changes (57.6)
Stock-based compensation and
benefits and exercise of
options (175) 3.4 (1.1) 2.6 1.6 0.3
Adjustment to market value - 2.3 (2.3)
Cash dividends (5.8) (5.8)
------------------------------------------------------------------------------------------------
BALANCE MARCH 31, 2002 122,192 31,000 $ 653.4 1.2 1,073.9 37.2 (347.5) (6.0) (105.4)
Non-owner equity changes:
Net loss 6.1 6.1
Translation adjustment 8.2 8.2
--------
Total non-owner equity changes 14.3
Stock-based compensation and
benefits and exercise of
options (200) 3.0 (0.9) 2.5 1.3 0.1
Adjustment to market value - (0.3) 0.3
Cash dividends (5.4) (5.4)
------------------------------------------------------------------------------------------------
BALANCE JUNE 30, 2002 122,192 30,800 $ 665.3 $ 1.2 $ 1,072.7 $ 37.9 $ (345.0) $ (4.4) $ (97.1)
================================================================================================
BALANCE JANUARY 1, 2003 122,192 30,517 $ 579.7 $ 1.2 $ 1,069.5 $ 18.7 $ (341.1) $ (1.8) $ (166.8)
Non-owner equity changes:
Net loss (19.3) (19.3)
Translation adjustment 11.3 11.3
Net unrealized loss on
securities 0.1 0.1
--------
Total non-owner equity changes (7.9)
Stock-based compensation and
benefits (35) 0.9 (0.4) 0.4 0.4 0.5
------------------------------------------------------------------------------------------------
BALANCE MARCH 31, 2003 122,192 30,482 572.7 1.2 1,069.1 (0.6) (340.7) (1.4) (154.9)
Non-owner equity changes:
Net loss (6.0) (6.0)
Translation adjustment 7.9 7.9
Net unrealized loss on
securities - -
--------
Total non-owner equity changes 1.9
Adjustment to market value - 0.1 (0.1)
Stock-based compensation and
benefits (23) 0.7 (0.2) 0.3 0.3 0.3
------------------------------------------------------------------------------------------------
BALANCE JUNE 30, 2003 122,192 30,459 $ 575.3 $ 1.2 $ 1,069.0 $ (6.6) $ (340.4) $ (1.2) $ (146.7)
================================================================================================
See Accompanying Notes to the Unaudited Condensed Consolidated
Financial Statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with Form 10-Q instructions and in the opinion of
management contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial position, results of operations and
cash flows for the periods presented. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. These interim statements should be read in
conjunction with the financial statements and notes thereto included in the
Annual Report on Form 10-K for the year ended December 31, 2002 of PolyOne
Corporation.
In December 2002, PolyOne sold its 70% ownership interest in Softer, a leading
Italian compounder of thermoplastic materials, while licensing certain
technologies. With the sale, all historical operating results of this business
have been reported separately as discontinued operations. The business was
previously included within PolyOne's Performance Plastics segment.
Operating results for the three-month and six-month periods ended June 30, 2003
are not necessarily indicative of the results expected in subsequent quarters or
for the year ending December 31, 2003.
NOTE B - ACCOUNTING POLICIES
STOCK-BASED COMPENSATION As provided under Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock Based Compensation," PolyOne has
elected to account for stock-based compensation under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees." Compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the PolyOne stock at the date of the grant
over the amount an option holder must pay to acquire the stock.
The following table illustrates the effect on net loss and loss per share if
PolyOne had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation, using the fair value estimate computed by the
Black-Scholes option-pricing model. The Black-Scholes option-pricing model was
developed for use in estimating the fair value of traded options that have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the
expected share price volatility. Because PolyOne's share options have
characteristics significantly different from traded options, and because changes
in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of our share options.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------
(In millions, except per share data) 2003 2002 2003 2002
--------- -------- -------- --------
Net income (loss), as reported $ (6.0) $ 6.1 $ (25.3) $ (51.2)
Deduct: Total stock-based employee compensation expense
determined under fair value-based method for all
awards 1.3 1.3 2.5 2.1
--------- -------- -------- --------
Pro forma net income (loss) $ (7.3) $ 4.8 $ (27.8) $ (53.3)
========= ======== ======== ========
Net income (loss) per share:
Basic - as reported $ (0.07) $ 0.07 $ (0.28) $ (0.57)
Basic - pro forma (0.08) 0.06 (0.31) (0.59)
Diluted - as reported $ (0.07) $ 0.07 $ (0.28) $ (0.55)
Diluted - pro forma (0.08) 0.06 (0.31) (0.57)
NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting
Standards Board (FASB) issued Interpretation No. 46 (FIN 46), "Consolidation of
Variable Interest Entities." FIN 46 requires companies to consolidate, at fair
value, the assets, liabilities and results of operations of variable interest
entities (VIEs) in which the equity investment at risk is not sufficient to
permit the entity to finance its activities without additional subordinated
financial support from other parties or in which they hold a controlling
financial interest through means other than the majority ownership of voting
equity. Controlling financial interests typically are present when a company
either 1) has the direct or indirect ability to make decisions about the VIE's
activities, 2) holds an obligation to absorb expected losses of a VIE, or 3) is
entitled to receive the expected residual returns of a VIE. FIN 46 requires
disclosures by companies, effective with financial statements issued after
January 31, 2003, about the nature, purpose, size and activities of VIEs covered
by its provisions, and their maximum exposure to loss. Fin 46 also requires
companies to consolidate VIEs created before February 1, 2003, in financial
statements for periods beginning after June 15, 2003. We will finalize our
assessment related to the adoption of FIN 46 in the third quarter of 2003,
however, we currently don't believe the adoption of FIN 46 will have a
significant impact on our statement of financial position or net operating
results.
PolyOne Funding Corporation, a qualified SPE that purchases certain of the
Company's domestic accounts receivable, is excluded from the scope of FIN 46 as
it is accounted for in accordance with Statement of Financial Accounting
Standards No. 140 (SFAS 140), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities."
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," which amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and
6
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 except for the provisions that were
cleared by the FASB in prior pronouncements. The adoption of this statement is
not expected to have a material impact on PolyOne's consolidated financial
statements.
RECLASSIFICATION Certain amounts for 2002 have been reclassified to conform with
the 2003 presentation.
NOTE C - GOODWILL AND INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the six months ended June 30,
2003, by business segment are as follows:
Elastomers &
Performance Performance
(In millions) Plastics Additives Distribution Other Total
------------ ------------- ------------ ----------- ------------
December 31, 2002 $ 329.7 $ 111.9 $ 1.1 $ 1.3 $ 444.0
Reversal of business
combination reserve (0.3) - - - (0.3)
Currency translation 1.1 - - - 1.1
Other (0.3) - - - (0.3)
------------ ------------- ------------ ----------- ----------
June 30, 2003 $ 330.2 $ 111.9 $ 1.1 $ 1.3 $ 444.5
============ ============== ============ =========== ==========
Information regarding PolyOne's other intangible assets follows:
As of December 31, 2002
---------------------------------------------------------
Acquisition Accumulated Currency
(In millions) Cost Amortization Translation Net
------------ ------------- ------------ -----------
Non-contractual customer
relationships $ 16.7 $ (3.0) $ - $ 13.7
Sales contract 12.9 (4.1) - 8.8
Patents, technology and other 15.5 (5.6) 0.4 10.3
------------ ------------- ------------ -----------
Total $ 45.1 $ (12.7) $ 0.4 $ 32.8
============ ============= ============ ===========
As of June 30, 2002
---------------------------------------------------------
Acquisition Accumulated Currency
(In millions) Cost Amortization Translation Net
------------ ------------- ------------ -----------
Non-contractual customer
relationships $ 16.7 $ (3.6) $ - $ 13.1
Sales contract 12.9 (5.0) - 7.9
Patents, technology and other 15.5 (6.4) 0.9 10.0
------------ ------------- ------------ -----------
Total $ 45.1 $ (15.0) $ 0.9 $ 31.0
============ ============= ============ ===========
Amortization of other intangible assets was $1.2 million for the three-month
period ended June 30, 2003 and $2.3 million for the six-month period ended June
30, 2003. Amortization of other intangible assets was $1.3 million for the
three-month period ended June 30, 2002 and $2.4 million for the six-month period
ended June 30, 2002. Amortization expense for each of the five succeeding fiscal
years is expected to be approximately $4.5 million per year.
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets," requires each company to establish an annual measurement
date for assessing any impairment of goodwill. PolyOne's annual measurement date
is July 1. SFAS No. 142 requires a "phase one" valuation of each reporting unit
to determine if its fair value exceeds its book carrying value, thereby
resulting in no impairment of goodwill. Where a reporting unit's fair value does
not exceed the book carrying value, then a more detailed "phase two" valuation
is required to quantify the goodwill impairment.
7
As of June 30, 2003, PolyOne had recorded goodwill on the balance sheet totaling
$444.5 million. Most of the goodwill is associated with three identified
reporting units - Plastic Compounds and Colors ($270.5 million), Specialty
Resins and Formulators ($59.7 million) and Elastomers and Performance Additives
($111.9 million). We engaged a third party valuation expert to value the three
reporting units noted above. The third party valuation expert has issued a
report on each noted reporting unit, concluding for each reporting unit that its
fair value exceeds its book carrying value. With the issuance of the valuation
reports, we have completed the required 2003 "phase one" goodwill impairment
assessment and concluded that no impairment has occurred.
NOTE D - INVENTORIES
Components of inventories are as follows:
June 30, December 31,
(In millions) 2003 2002
------------- ------------
Finished products and in-process inventories $ 184.8 $ 159.1
Raw materials and supplies 130.3 118.5
------------- ------------
315.1 277.6
LIFO Reserve (29.4) (23.9)
------------- ------------
Total Inventories $ 285.7 $ 253.7
============= ============
NOTE E - INCOME TAXES
The effective income tax rate benefit on the loss from continuing operations for
the second quarter 2003 was 39.4% compared with expense on income from
continuing operations of 39.8% for the second quarter 2002. The effective income
tax rate benefit on the loss from continuing operations for the first six months
of 2003 was 39.0% compared with expense on the income from continuing operations
of 39.1% for the same period in 2002.
The tax benefit recorded on domestic losses was $9.0 million in the 2003 second
quarter and $24.2 million in the first half of 2003. PolyOne has recognized the
2003 domestic tax benefit after considering its projected full year earnings for
2003 and its ability to generate domestic earnings through the payment of
dividends from foreign subsidiaries. A distributon of foreign dividends to the
parent company would streamline the foreign subsidiaries cash management and
capital structure and have no significant impact on PolyOne's overall liquidity.
Any foreign dividends would result in higher recorded income tax expense because
of the inability to utilize foreign tax credits.
8
NOTE F - INVESTMENT IN EQUITY AFFILIATES
PolyOne owns 24% of Oxy Vinyls LP (OxyVinyls), a manufacturer and marketer of
PVC resins. OxyVinyls is a leading producer of PVC resins in North America. The
following table presents OxyVinyls' summarized results of operations for the six
months ended June 30, 2003 and 2002, and summarized balance sheet information as
of June 30, 2003 and December 31, 2002.
Six Months Ended
June 30,
-------------------
(In millions) 2003 2002
-------- --------
Net sales $ 840.9 $ 636.0
Employee severance and liabilities associated with the temporary
idling of a plant (4.0) (3.7)
Operating income 51.1 26.5
Partnership income as reported by OxyVinyls 36.5 22.8
PolyOne's ownership of OxyVinyls 24% 24%
-------- ---------
PolyOne's proportionate share of OxyVinyls' earnings 8.8 5.5
Amortization of the difference between PolyOne's investment and its
underlying share of OxyVinyls' equity 0.3 0.3
-------- --------
Earnings of equity affiliate recorded by PolyOne $ 9.1 $ 5.8
======== ========
June 30, December 31,
(In millions) 2003 2002
-------- ----------
Current assets $ 340.2 $ 275.1
Non-current assets 1,460.8 979.1
-------- ----------
Total assets 1,801.0 1,254.2
Current liabilities 132.5 164.0
Non-current liabilities 623.1 81.3
-------- ----------
Total liabilities $ 755.6 $ 245.3
-------- ----------
Partnership capital $1,045.4 $ 1,008.9
======== ==========
OxyVinyls' income during the first half of 2003 reported above includes a charge
of $3.4 million in connection with a change in accounting from the adoption of
SFAS No. 143, "Accounting for Asset Retirement Obligations," and a charge of
$4.0 million for employee severance costs associated with a personnel reduction
undertaken by OxyVinyls. Our proportionate share of these charges was $0.8
million for the change in accounting and $1.0 million for the severance costs.
OxyVinyls income during the first half of 2002 reported above includes a
special, pre-tax charge of $3.7 million, related to employee severance costs and
costs associated with the temporary idling of a plant. Our proportionate share
of the 2002 special items was $0.8 million.
In April 2003, OxyVinyls exercised its purchase option related to its LaPorte,
Texas VCM plant lease for approximately $180 million.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." FIN 46 requires a company to consolidate a variable interest entity
if it is designated as the primary beneficiary of that entity even if the
company does not have a majority of voting interest. OxyVinyls adopted the
provisions of this Interpretation on April 1, 2003 which resulted in the
consolidation of its 50% owned OxyMar VCM joint venture that was previously
accounted for as an equity investment. As a result of the OxyMar consolidation,
OxyVinyls' assets increased by approximately $373 million, liabilities increased
by approximately $399 million and negative minority interest of approximately
$27 million. There was no effect on OxyVinyls' net income or partnership capital
as a result of the consolidation.
9
PolyOne's Resin and Intermediates segment also includes the SunBelt Chlor-Alkali
Partnership (owned 50%) and Welvic Australia Pty Ltd. (owned 37.4%) equity
affiliates. The Performance Plastics segment includes the DH Compounding Company
(owned 50%) and Geon/Polimeros Andinos (owned 50%) equity affiliates. For the
one-month period ended January 31, 2003, the Performance Plastics segment
included the results for Techmer PM, LLC, an equity affiliate (owned 51%). In
January 2003, we sold our unconsolidated equity ownership interest in Techmer.
Further, for the two-month period ended February 28, 2002, the Resin and
Intermediates segment included the results for Australian Vinyls Corporation, an
equity affiliate (owned 37.4%) and the Performance Plastics segment included
SPCGeon PTE Limited (owned 50%). In February 2002, Australian Vinyls Corporation
was sold and SPCGeon PTE Limited was dissolved. Combined summarized financial
information for these equity affiliates is presented below.
Six Months Ended
June 30,
------------------------
(In millions) 2003 2002
--------- ------------
Net sales $ 83.0 $ 157.5
Operating income 22.3 2.3
Net income (loss) 14.3 (5.3)
In July 2003, Welvic Australia Pty Ltd agreed to sell effective September 1,
2003 its net operating assets to Orica Ltd, the other partner in the joint
venture with PolyOne. Following the sale of assets, Welvic Australia Pty Ltd
will be liquidated. Through the sale of operating assets and liquidation,
PolyOne estimates it will realize approximately $2.5 million of cash, which
approximates its book carrying value.
NOTE G - EARNINGS PER SHARE COMPUTATION
Weighted average shares outstanding are computed as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Shares in millions) 2003 2002 2003 2002
----------- --------- ---------- ---------
Weighted-average shares - Basic:
Weighted-average shares outstanding 91.7 90.9 91.6 91.0
Less unearned portion of restricted stock awards
included in outstanding shares (0.6) (0.6) (0.6) (0.6)
-------- ------- ------- -------
91.1 90.3 91.0 90.4
======== ======= ======= =======
Weighted-average shares - Diluted:
Weighted-average shares outstanding - basic 91.1 90.3 91.0 90.4
Plus unearned portion of restricted stock awards
included in outstanding shares - 0.6 - 0.6
Plus dilutive impact of stock options - 1.6 - 1.3
-------- ------- ------- -------
91.1 92.5 91.0 92.3
======== ======= ======= =======
Basic earnings (loss) per common share is computed as net income (loss)
available to common shareholders divided by weighted average basic shares
outstanding. Diluted earnings (loss) per common share is computed as net income
(loss) available to common shareholders divided by weighted average diluted
shares outstanding.
For the three and six months ended June 30, 2003, we excluded all outstanding
options from the calculation of diluted loss per share because they would have
had an anti-dilutive effect due to our net loss and due to the fact that the
exercise prices were greater than the average market price of our common shares
for the respective periods.
For the three and six months ended June 30, 2002, the above calculation of the
dilutive impact of stock options on the weighted-average shares reflects the
impact of the options that had exercise prices that were below the average
market price of our common shares for the respective periods. For the three and
six months ended June 30, 2002, there were 6.0 million and 6.6 million options
outstanding, respectively, that had exercise prices that exceeded the average
market price of our common shares and therefore were not included in the
calculation.
10
NOTE H - BUSINESS COMBINATIONS
On August 31, 2000, PolyOne was formed as a result of the consolidation of The
Geon Company (Geon) and M.A. Hanna Company (Hanna), with Geon as the acquiring
entity. As a result of the acquisition of Hanna, PolyOne announced plans to
incur employee separation and plant phase-out costs for incremental expenditures
to exit and consolidate activities at former Hanna locations, to sever employees
involuntarily, and to integrate operating locations and other activities of the
newly formed PolyOne.
In 2001, PolyOne announced the closing of 12 former Hanna manufacturing plants.
Of the announced sites for closings, nine were in the Performance Plastics
business segment and three were in the Elastomers & Performance Additives
segment. In 2001, one Performance Plastics and all designated Elastomers &
Performance Additives plants were closed. In 2002, five Performance Plastics
manufacturing sites closed. In January 2003, PolyOne committed to a refinement
to the original 2001 plan and decided to continue operating the remaining
facility. Accordingly, in the first quarter of 2003, the reserve of
approximately $0.3 million associated with this facility (which relates to an
acquired business) was reversed and recognized as a reduction to goodwill of the
acquired business. The two remaining facilities were closed during the second
quarter of 2003.
During the second quarter of 2003, PolyOne adjusted its estimate of the
remaining liabilities associated with the consolidation of Geon and Hanna. As a
result of the adjustment, net expense of $1.1 million was recorded.
The components of the acquisition integration liabilities are as follows:
Employee Separation Plant Phase-Out Costs
---------------------- -------------------------
Number of Cash Asset Write-
(In millions, except employee numbers) Employees Costs Closure Downs Total
--------- ---------- ---------- ------------ --------
Balance at December 31, 2002 159 $ 5.0 $ 1.5 $ 0.3 $ 6.8
Utilized in 2003 (102) (2.3) (1.1) 0.5 (2.9)
Goodwill adjustment - (0.3) - - (0.3)
Expense (income) adjustment - (0.4) 2.0 (0.5) 1.1
----- ---------- ---------- --------- --------
Balance at June 30, 2003 57 $ 2.0 $ 2.4 $ 0.3 $ 4.7
===== ========== ========== ========= ========
NOTE I - EMPLOYEE SEPARATION AND PLANT PHASE-OUT
PolyOne has undertaken various restructuring initiatives and incurred various
employee separation and plant phase-out costs. These costs include severance,
employee outplacement, external consulting, lease termination, facility closing
and the write-down of the carrying value of plants and equipment. These employee
separation and plant phase-out costs have been accrued and recognized as expense
in the Consolidated Statements of Operations.
2003 CHARGES Operating income in the first half of 2003 was reduced by charges
of $25.9 million ($15.8 million after tax). Of the 2003 expense, $20.7 million
relates to the January 16, 2003 announcement to reduce approximately 400 staff
personnel. The costs were for employee separation, which consisted of severance
and other employee benefits. An additional $5.6 million relates to the March 26,
2003 announcement to exit an Engineered Films plant by the end of the second
quarter of 2003, which primarily related to the impairment of plant and
equipment and related exiting costs. Restructuring costs related to the
Engineered Films plant are projected to total $6.3 million, of which $2.8
million would be cash closure costs. In June 2003, the decision was made to
close the Fort Worth, Texas color additives plant, for which an expense of $3.5
million was recorded. During the second quarter of 2003, PolyOne adjusted its
estimate for the remaining liabilities associated with restructuring
initiatives announced in prior years. As a result of the adjustment, net
reserves of $4.0 million were reversed. See Note L for the breakdown of the
second-quarter and year-to-date charges by segment.
2002 CHARGES Operating income in 2002 was reduced by charges of $1.1 million
($0.6 million after tax) for costs associated with the consolidation of certain
activities related to the Formulator operations in the Performance Plastics
segment. The costs were for employee separation, which consisted of severance
and other employee benefits. All 43 employees were terminated in 2002.
11
The following table summarizes the provisions, payments and remaining reserves
associated with these initiatives:
Employee Separation Plant Phase-Out Costs
------------------------------- ----------------------------
Number of Cash Asset Write-
(In millions, except employee numbers) Employees Costs Closure Downs Total
--------------- -------------- -------------- ------------ ----------
Balance at December 31, 2002 40 $ 13.5 $ 1.1 $ - $ 14.6
2003 Expense, net 531 17.0 1.4 7.5 25.9
Utilized in 2003 (494) (18.7) (1.2) (0.1) (20.0)
-------- ----------- ------------ ------------ ----------
Balance at June 30, 2003 77 $ 11.8 $ 1.3 $ 7.4 $ 20.5
======== =========== ============ ============ ==========
NOTE J - FINANCING ARRANGEMENTS
On May 6, 2003, we completed a debt refinancing. The refinancing provides the
necessary liquidity to repay $87.8 million of senior debt that matures in
September 2003, as well as to support normal operations and fund previously
announced restructuring initiatives intended to improve earnings. As part of
this refinancing, we issued $300 million of 10.625% unsecured senior notes that
mature in 2010, entered into a new three-year $225 million receivables sale
facility and amended and restated our revolving credit facility. The new
receivables sale facility replaced our former receivables sale facility. The
10.625% unsecured senior notes rank equally with all of our other senior
unsecured indebtedness. The security that had been extended in February 2003 to
our existing senior notes and debentures and to our guarantee of the SunBelt
notes terminated as part of the debt refinancing. Security was granted under the
terms of the 2003 amended and restated revolving credit agreement. As of June
30, 2003, our secured borrowings were not at levels that would trigger the
security on the public indentures.
Also on May 6, 2003, we amended and restated our revolving credit facility. As
amended and restated, it has a three-year term and provides for up to $50.0
million in borrowings. However, the maximum amount that we may borrow will be
limited to 95% of the amount that may be borrowed and secured from time to time
under the revolving credit facility without triggering the security provisions
of the indentures governing the existing unsecured senior notes and debentures.
The amended and restated revolving credit facility makes available up to $35.0
million for the issuance of standby letters of credit. Our obligations under the
revolving credit facility are secured by substantially all of our domestic
intellectual property and inventory and some of our domestic real property.
Our amended and restated revolving credit facility and our new receivables sale
facility require, among other things, that we comply with interest coverage and
borrowed debt-to-adjusted EBITDA earnings ratios. Further, our financing
arrangements contain various restrictions and limit payments for purposes such
as capital expenditures, acquisitions and dividends.
Following the debt refinancing in the second quarter of 2003, we purchased and
retired approximately $34 million of the unsecured senior debt that matures in
September 2003.
Effective June 19, 2003, PolyOne entered into interest rate swap agreements on
seven of its fixed-rate obligations in the aggregate amount of $120.0 million.
At June 30, 2003, these seven agreements had a net fair value obligation of
($2.6) million. The weighted-average interest rate for these seven agreements
was 5.462%.
NOTE K - SALE OF ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
June 30, December 31,
(In millions) 2003 2002
--------------- -------------
Trade accounts receivable $ 156.9 $ 120.1
Retained interest in securitized accounts receivable 154.1 56.5
Allowance for doubtful accounts (13.2) (12.3)
--------------- -------------
$ 297.8 $ 164.3
=============== =============
Through May 6, 2003, PolyOne participated in a receivables sale program that
provided up to $250 million in liquidity through the sale of certain domestic
trade accounts receivable at a cost similar to high-grade commercial paper. As
part of the May 6, 2003 debt refinancing, previously discussed in Note J, we
terminated the former program and entered into a new receivables sale facility.
12
Under the terms of the new facility, we continue to sell our accounts receivable
to PolyOne Funding Corporation (PFC). PFC is a wholly-owned subsidiary and a
qualifying special-purpose entity (QSPE) that is bankruptcy remote and accounted
for on an equity basis. At June 30, 2003, accounts receivable totaling $244.1
million were sold by PolyOne to PFC, and are thereby included as a reduction of
trade accounts receivable within accounts receivable on the PolyOne Condensed
Consolidated Balance Sheet. PFC in turn sells to certain purchasers an undivided
interest in our accounts receivable and realizes proceeds of up to $225.0
million, with the maximum amount of proceeds that PFC may receive under the
facility currently limited to 85% of the then-current amount of the accounts
receivable sold to PFC. At June 30, 2003, PFC had sold undivided interests in
accounts receivable totaling $90.0 million. PolyOne retains an interest in the
$154.1 million difference between the amount of trade receivables sold by
PolyOne to PFC and the undivided interests sold by PFC. This interest retained
by PolyOne is thereby included in accounts receivable on the PolyOne Condensed
Consolidated Balance Sheet at June 30, 2003. The new receivables sale facility
also makes available up to $50.0 million for the issuance of standby letters of
credit, as a sub-limit within the $225 million limit under the facility. Unlike
our former receivables sale facility, this new facility does not have
termination provisions tied to our senior debt rating.
Under this new arrangement, we receive the proceeds from collection of the
receivables after deduction for the aggregate yield payable on the undivided
interests in the receivables sold by PFC, a servicer's fee, an unused commitment
fee (between 0.5% and 0.75% depending upon the amount of the unused portion of
the facility), fees for any outstanding letters of credit, and an administration
and monitoring fee ($150,000/annum).
Under this new arrangement, PolyOne continues to service the underlying accounts
receivable and we receive a service fee of 1% per annum on the average daily
amount of the outstanding interests in our receivables. As payment of the
receivables occurs, PFC purchases additional receivables from us. PolyOne,
through PFC, retains the risk of credit loss on the receivables and, accordingly
the full amount of the allowance for doubtful accounts has been retained on the
PolyOne Condensed Consolidated Balance Sheet. The purchasers have collection
rights to recover accounts receivable payments.
NOTE L - SEGMENT INFORMATION
PolyOne operates primarily in four business segments: the Performance Plastics
segment, the Elastomers & Performance Additives segment, the Distribution
segment, and the Resin and Intermediates segment. Inter-segment sales are
accounted for at prices generally approximating those for similar transactions
with unaffiliated customers and the elimination of inter-segment sales revenue
is included in the "Other" segment. Certain other corporate expenses and
eliminations are included in the "Other" segment. Business segment assets
consist primarily of customer receivables, inventories, net property and
goodwill. Cash, accounts receivable sold to a third party and certain other
assets not identified with a specific segment are included in the "Other"
segment.
Senior management uses operating income before special items and EBITDA (defined
as operating income plus depreciation and amortization) before special items to
assess performance and allocate resources to business segments. Senior
management believes such metrics are useful in its assessment of the underlying
earnings power and operating cash flow of each business segment. EBITDA is a
metric used by stock market analysts, financial institutions and investors.
Special items include gains and losses associated with specific strategic
initiatives such as restructuring or consolidation of operations, gains and
losses attributable to divestment of joint ventures, and certain one-time items.
Operating income before special items and EBITDA before special items are
non-GAAP measures, and may not be comparable to financial performance measures
presented by other companies.
13
ELASTOMERS &
(In millions) PERFORMANCE PERFORMANCE RESIN AND
THREE MONTHS ENDED JUNE 30, 2003 TOTAL PLASTICS ADDITIVES DISTRIBUTION INTERMEDIATES OTHER
---------- ----------- ----------- ------------ ------------- ----------
Sales to external customers $ 650.9 $ 431.8 $ 87.5 $ 131.6 $ - $ -
Inter-segment sales - 28.7 - 1.5 - (30.2)
---------- ----------- ----------- ------------ ------------- ----------
$ 650.9 $ 460.5 $ 87.5 $ 133.1 $ - $ (30.2)
========== =========== =========== ============ ============= ==========
Operating income (loss) $ 10.8 $ 5.1 $ 1.2 $ 2.7 $ 6.5 $ (4.7)
Employee separation and plant phase-out
costs 2.1 1.9 - 0.1 - 0.1
Period plant phase-out costs incurred 0.3 0.3 - - - -
Employee severance costs incurred by
equity affiliate 1.0 - - - 1.0 -
---------- ----------- ----------- ------------ ------------- ----------
Operating income (loss) before employee
separation and plant phase-out costs 14.2 7.3 1.2 2.8 7.5 (4.6)
Depreciation and amortization 18.4 14.7 3.0 0.4 - 0.3
---------- ----------- ----------- ------------ ------------- ----------
EBITDA before employee separation and
plant phase-out costs $ 32.6 $ 22.0 $ 4.2 $ 3.2 $ 7.5 $ (4.3)
========== =========== =========== ============ ============= ==========
Total assets $ 2,248.5 $ 1,467.7 $ 259.6 $ 154.9 $ 245.2 $ 121.1
Capital expenditures $ 9.9 $ 8.6 $ 1.0 $ 0.1 $ - $ 0.2
ELASTOMERS &
(In millions) PERFORMANCE PERFORMANCE RESIN AND
THREE MONTHS ENDED JUNE 30, 2002 TOTAL PLASTICS ADDITIVES DISTRIBUTION INTERMEDIATES OTHER
---------- ----------- ----------- ------------ ------------- ----------
Sales to external customers $ 670.9 $ 439.2 $ 95.9 $ 135.8 $ - $ -
Inter-segment sales - 27.1 (0.1) 1.8 - (28.8)
---------- ----------- ----------- ------------ ------------- ----------
$ 670.9 $ 466.3 $ 95.8 $ 137.6 $ - $ (28.8)
========== =========== =========== ============ ============= ==========
Operating income (loss) $ 21.6 $ 17.9 $ 4.4 $ 4.1 $ 0.7 $ (5.5)
Period plant phase-out costs incurred 0.1 0.1 - - - -
Plant phase-out accelerated depreciation 0.5 0.5 - - - -
Restructuring and plant idling costs
incurred by equity affiliates* 0.1 - - - 0.1 -
---------- ----------- ----------- ------------ ------------- ----------
Operating income (loss) before plant
phase-out costs and restructuring and
plant idling costs incurred by equity
affiliate 22.3 18.5 4.4 4.1 0.8 (5.5)
Depreciation and amortization 18.1 14.2 3.2 0.5 - 0.2
---------- ----------- ----------- ------------ ------------- ----------
EBITDA before plant phase-out costs and
restructuring and plant idling costs
incurred by equity affiliate $ 40.4 $ 32.7 $ 7.6 $ 4.6 $ 0.8 $ (5.3)
========== =========== =========== ============ ============= ==========
Total assets $ 2,154.7 $ 1,523.6 $ 277.6 $ 163.6 $ 240.7 $ (50.8)
Capital expenditures $ 22.5 $ 17.2 $ 0.9 $ 0.2 $ - $ 4.2
* 2002 costs include PolyOne's share of OxyVinyls' employee severance, plant
phase-out costs and liabilities associated with the temporary idling of a
plant in December 2001.
14
ELASTOMERS &
(In millions) PERFORMANCE PERFORMANCE RESIN AND
SIX MONTHS ENDED JUNE 30, 2003 TOTAL PLASTICS ADDITIVES DISTRIBUTION INTERMEDIATES OTHER
---------- ----------- ----------- ------------ ------------- ----------
Sales to external customers $ 1,296.4 $ 849.2 $ 181.5 $ 265.7 $ - -
Inter-segment sales - 58.9 - 3.3 - (62.2)
---------- ----------- ----------- ------------ ------------- ----------
$ 1,296.4 $ 908.1 $ 181.5 269.0 - (62.2)
========== =========== =========== ============ ============= ==========
Operating income (loss) $ (5.4) $ (6.4) $ 1.5 $ 4.9 $ 9.7 $ (15.1)
Employee separation and plant phase-out
costs 27.0 17.3 1.9 0.8 - 7.0
Period plant phase-out costs incurred 1.2 1.2 - - - -
Equity affiliate - employee severance costs
and cumulative effect of a change in
accounting 1.8 - - - 1.8 -
---------- ----------- ----------- ------------ ------------- ----------
Operating income (loss) before employee
separation, plant phase-out costs and
equity affiliate employee
severance costs and cumulative effect
of a change in accounting 24.6 12.1 3.4 5.7 11.5 (8.1)
Depreciation and amortization 36.9 29.4 6.1 0.8 0.1 0.5
---------- ----------- ----------- ------------ ------------- ----------
EBITDA before employee separation, plant
phase-out costs and equity affiliate
employee severance costs and cumulative
effect of a change in accounting $ 61.5 41.5 9.5 6.5 11.6 (7.6)
========== =========== =========== ============ ============= ==========
Capital expenditures $ 16.1 13.9 1.7 0.3 - 0.2
ELASTOMERS
&
(In millions) PERFORMANCE PERFORMANCE RESIN AND
SIX MONTHS ENDED JUNE 30, 2002 TOTAL PLASTICS ADDITIVES DISTRIBUTION INTERMEDIATES OTHER
---------- ----------- ----------- ------------ ------------- ----------
Sales to external customers $ 1,267.2 $ 825.3 $ 187.5 $ 254.4 $ - $ -
Inter-segment sales - 47.7 - 3.6 - (51.3)
---------- ----------- ----------- ------------ ------------- ----------
$ 1,267.2 $ 873.0 $ 187.5 $ 258.0 $ - $ (51.3)
========== =========== =========== ============ ============= ==========
Operating income (loss) $ 26.0 $ 29.7 $ 6.7 $ 5.7 $ (6.8) $ (9.3)
Employee separation and plant phase-out
costs 0.9 0.9 - - - -
Period plant phase-out costs incurred 0.2 0.2 - - - -
Plant phase-out accelerated depreciation 1.0 1.0 - - - -
Loss on divestiture of equity investments 1.5 - - - 1.5 -
Restructuring and plant idling costs
incurred by equity affiliates* 0.8 - - - 0.8 -
---------- ----------- ----------- ------------ ------------- ----------
Operating income (loss) before employee
separation, plant phase-out costs,
plant idling costs and loss on equity
investment 30.4 31.8 6.7 5.7 (4.5) (9.3)
Depreciation and amortization 35.4 27.6 6.4 1.0 - 0.4
---------- ----------- ----------- ------------ ------------- ----------
EBITDA before employee separation, plant
phase-out costs, plant idling costs
and loss on equity investment $ 65.8 $ 59.4 $ 13.1 $ 6.7 $ (4.5) $ (8.9)
========== =========== =========== ============ ============= ==========
Capital expenditures $ 33.0 $ 23.1 $ 2.3 $ 0.3 - 7.3
* 2002 costs include PolyOne's share of OxyVinyls' employee severance, plant
phase-out costs and liabilities associated with the temporary idling of a
plant in December 2001.
15
A breakdown of the Performance Plastics segment's sales for the three and six
months ended June 30, 2003 and the changes versus the same periods in 2002, by
primary product group, is as follows:
Three months ended June 30, 2003 Six months ended June 30, 2003
----------------------------------------- -----------------------------------------
2003 2003 2003 2003 2003 2003
Sales $ Sales $ Shipment Lbs. Sales $ Sales $ Shipment Lbs.
% of % Change % Change % of % Change % Change
Total vs. 2002 vs. 2002 Total vs. 2002 vs. 2002
--------- -------- ------------- ------------ ----------- ------------
North American Plastics
Compounds and Colors (PC&C):
Vinyl Compounds 36% -4% -13% 36% - -5%
Colors and Additives 10% -13% -9% 10% -4% 1%
Engineered Materials 7% -17% -21% 7% -8% -13%
International PC&C 25% 23% 12% 24% 31% 19%
Specialty Resin and Formulators 14% -7% -11% 14% -3% -7%
Engineered Films 8% -12% -12% 9% -8% -5%
------ -------- ------- ------- ------- -------
Performance Plastics 100% -1% -12% 100% 4% -5%
NOTE M - COMMITMENTS AND CONTINGENCIES
There are pending or threatened against PolyOne or our subsidiaries various
claims, lawsuits and administrative proceedings, all arising from the ordinary
course of business with respect to employment, commercial, product liability and
environmental matters, which seek damages or other remedies. In addition, we
have been named in various lawsuits involving multiple claimants and defendants
relating to alleged asbestos exposure in the past by, among others, workers and
their families at plants owned by us or our predecessors or on board ships owned
or operated by us or our predecessors. We believe that any liability that may
finally be determined should not have a material adverse effect on our
consolidated financial position.
PolyOne has accrued for environmental liabilities based upon estimates prepared
by our environmental engineers and consultants to cover probable future
environmental expenditures related to previously contaminated sites. The
accrual, totaling approximately $54.7 million at June 30, 2003, represents our
best estimate for the remaining remediation costs based upon information and
technology currently available. Depending upon the results of future testing,
the ultimate remediation alternatives to be undertaken, changes in regulations,
new information, and other factors, it is possible that the ultimate costs to be
incurred could be in excess of the accrual recorded at June 30, 2003. Our
estimate of the liability may be revised as new regulations and technologies are
developed or additional information is obtained. Additional information related
to our environmental liabilities is included in Note P to the consolidated
financial statements included in our Annual Report on Form 10-K for the year
ended December 31, 2002.
In connection with the formation of OxyVinyls, PolyOne had guaranteed $42.3
million of OxyVinyls' borrowings from Occidental Petroleum Corporation. This
guarantee terminated effective June 30, 2003. PolyOne also has guaranteed $91.4
million of SunBelt's outstanding senior secured notes in connection with a
chlor-alkali facility in Macintosh, Alabama. The debt and guarantee thereon
mature in 2017.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Below is a summary of consolidated operating results for the three and six month
periods ended June 30, 2003 and 2002. Also summarized are the special items
included in these periods.
Three Months Ended Six Months Ended
June 30, June 30,
Summary of Consolidated Operating Results ----------------------------- ------------------------------
(In millions, except per share data) 2003 2002 2003 2002
------------- -------------- -------------- --------------
Sales $ 650.9 $ 670.9 $ 1,296.4 $ 1,267.2
Operating income (loss) $ 10.8 $ 21.6 $ (5.4) $ 26.0
Net income (loss) $ (6.0) $ 6.1 $ (25.3) $ (51.2)
(Income) from discontinued operations, net of taxes - (0.8) - (1.1)
Cumulative effect of a change in accounting, net of taxes - - - 53.7
------------- -------------- -------------- --------------
Income (loss) before discontinued operations and
cumulative effect of a change in accounting (6.0) 5.3 (25.3) 1.4
Income (loss) per share, diluted $ (0.07) $ 0.07 $ (0.28) $ (0.55)
Income (loss) per share before discontinued operations and
cumulative effect of a change in accounting $ (0.07) $ 0.06 $ (0.28) $ 0.02
Per share effect of excluding special costs, increase (1) $ (0.03) $ - $ (0.21) $ (0.03)
Other data:
Net cash provided (used) by:
Operating activities for continuing operations $ (137.2) $ (51.4) $ (171.8) $ (81.2)
Investing activities for continuing operations (65.9) (22.4) (63.1) (32.4)
Financing activities for continuing operations 214.4 97.0 255.9 141.8
EBITDA (2) $ 29.2 $ 40.2 $ 1.5 $ 62.4
Reconciliation (2):
Income (loss) before discontinued operations and
cumulative effect of a change in accounting $ (6.0) $ 5.3 $ (25.3) $ 1.4
Income tax expense (benefit) (3.9) 3.5 (16.2) 0.9
Interest expense, net 17.2 11.0 29.5 19.3
Other expense, net 3.5 1.8 6.6 4.4
Depreciation and amortization 18.4 18.6 36.9 36.4
------------- -------------- -------------- --------------
EBITDA $ 29.2 $ 40.2 $ 31.5 $ 62.4
============= ============== ============== ==============
(1) Special items in all years related primarily to restructuring
initiatives, the loss on sale of business operations and equity
investments, and equity affiliate charges for employee severance,
liabilities associated with the temporary idling of a plant and
cumulative effect of a change in accounting, and are summarized and
explained in the table that follows.
(2) EBITDA is defined as income before discontinued operations and
cumulative effect of a change in accounting, income taxes, net interest
expense, net other expense and depreciation and amortization expense.
EBITDA excludes net other expense because the financing cost of the
receivables sale facility is the largest component. EBITDA is a
non-GAAP measure and should not be considered an alternative to any
other measure of performance in accordance with GAAP. PolyOne presents
EBITDA because management believes that EBITDA could be useful for
investors in assessing our operating performance and our performance
relative to our financial obligations. Additionally, EBITDA is a
measure commonly used by financial analysts because of its usefulness
in evaluating operating performance. EBITDA, as used by PolyOne, is not
necessarily comparable with similarly titled measures of other
companies. The table above presents a reconciliation from loss before
discontinued operations and cumulative effect of a change in accounting
to EBITDA.
17
Three Months Ended Six Months Ended
June 30, June 30,
Summary of Special Items ---------------------------- --------------------------
(In millions) 2003 2002 2003 2002
----------- ------------- ------------- -----------
Employee separation and plant phase-out cost (1) $ (2.1) $ - $ (27.0) $ (0.9)
Period plant phase-out costs incurred (2) (0.3) (0.1) (1.2) (0.2)
Equity affiliate - employee severance, liabilities
associated with the temporary idling of a plant and
cumulative effect of a change in accounting (3) (1.0) (0.1) (1.8) (0.8)
Loss on divestiture of equity investment (4) - - - (1.5)
----------- ------------- ------------- -----------
Subtotal - impact on EBITDA (expense) (3.4) (0.2) (30.0) (3.4)
Plant phase-out accelerated depreciation (2) - (0.5) - (1.0)
----------- ------------- ------------- -----------
Subtotal - impact on operating (expense) (3.4) (0.7) (30.0) (4.4)
Loss on sale (5) (0.2) - (0.2) -
----------- ------------- ------------- -----------
Total - impact on pre tax (expense) (3.6) (0.7) (30.2) (4.4)
Income tax benefit 1.3 0.2 11.7 1.6
----------- ------------- ------------- -----------
Total after-tax (expense) before discontinued operations
and cumulative effect of a change in accounting $ (2.3) $ (0.5) $ (18.5) $ (2.8)
=========== ============= ============= ===========
(1) These costs include severance, employee outplacement, external
outplacement consulting, lease termination, facility closing costs and
the write-down of the carrying value of plants and equipment related to
restructuring initiatives. The 2003 expense relates to the January 16,
2003 announcement to reduce approximately 400 staff personnel, the
March 26, 2003 announcement to exit an Engineered Films plant, the
June 2003 decision to close the Fort Worth plant and the second quarter
reversal of restructuring costs provided for in prior years. The 2002
expense was associated with the consolidation of certain activities
related to the Formulator operations in the Performance Plastics
business segment.
(2) These are plant and phase-out costs associated with the 2001
restructuring initiatives associated with former Geon facilities that
are to be recognized as period costs versus when the restructuring
initiative was approved. In connection with the acquisition of Hanna
and resulting formation of PolyOne, management developed several
initiatives to capture the strategic value of the combined former
Geon and former Hanna businesses. Included in the initiatives was the
closing of excess manufacturing capacity of the Elastomers business
and establishing centers of manufacturing excellence within the North
American Plastics Compounds and Colors operations. This resulted in
several announcements in 2001 that former Geon plants and Hanna plants
would be closed. The initiatives also included the termination of
corporate and other positions at Geon and former Hanna locations.
These plans and activities related to the former Geon plants and
personnel were finalized and approved during 2001.
(3) The second quarter 2003 expense relates to employee severance costs
associated with a personnel reduction undertaken by OxyVinyls. In
addition, the 2003 first six months expense includes a charge for the
cumulative effect of a change in accounting upon OxyVinyls' adoption of
SFAS No. 143 "Accounting for Asset Retirement Obligations." The 2002
costs include PolyOne's share of OxyVinyls' employee severance, plant
phase-out costs and liabilities associated with the temporary idling of
a plant in December 2001.
(4) Includes the 2002 first quarter loss on our divestiture of our 37.4%
investment in the PVC resin operations of Australian Vinyls
Corporation.
(5) This is the loss recorded for the sale of our European vinyl
compounding business.
18
TOTAL COMPANY REPORTED RESULTS
The weakness in the manufacturing sector of the U.S. economy continued in the
second quarter of 2003. The Economic Index of U.S. Industrial Production
Manufacturing (Excluding Selected High Technology Industries) for the second
quarter of 2003 was below the same quarter in 2002 by approximately 2% and below
the first quarter of 2003 by approximately 1%. The 2003 second quarter Economic
Index of U.S. Industrial Production Manufacturing (Excluding Selected High
Technology Industries) was approximately 9% below the peak in the second quarter
of 2000.
Europe realized minimal economic growth to-date in 2003, versus a current
estimate per the July 2003 Consensus Forecasts of 0.5% for the year 2003. In
Asia, 2003 economic growth continues at a pace forecasted as 2.4% for the 2003
year.
Second quarter 2003 sales of $650.9 million were $20 million or 3% lower than
second quarter 2002. Each business segment reported sales decreases in the
second quarter of 2003 compared to the same period a year ago. The International
Plastic Compounds and Colors (PC&C) product group within the Performance
Plastics business segment realized a 23% sales increase in the quarter, which
included the effects of the December 2002 Transcolor acquisition and currency
translation. Excluding the effects of the Transcolor acquisition and currency
translation, the International PC&C sales decreased 5%. For the six months ended
June 30, 2003, sales were $1,296.4 million, which was $29.2 million, or 2% above
the same period in 2002. For the first six months of 2003, Performance Plastics
and Distribution both reported sales growth over the same 2002 period. Within
Performance Plastics, the International PC&C sales increase of 31% benefited
$21.4 million from the December 2002 acquisition of Transcolor and approximately
$30 million from favorable Euro-to-U.S. dollar currency exchange. Before the
effects of the Transcolor acquisition and currency translation, the 2003 first
six months International PC&C sales were flat with the 2002 same period.
PolyOne reported operating income of $10.8 million for the second quarter of
2003, a decrease of $10.8 million over the same period last year. In the second
quarter, EBITDA was $29.2 million in 2003 and $40.2 million in 2002. Of the 2003
EBITDA decrease of $11.0 million, special items represented $3.2 million of the
change. The special items in both second quarters primarily relate to
restructuring initiatives. In addition to previously announced restructuring
initiatives, the 2003 second quarter charge reflected the decision to close one
additional plant and employee severance costs at our equity affiliate OxyVinyls.
The 2003 second quarter $7.8 million decrease in EBITDA before special items was
largely the net result of decreases in the Performance Plastics
business segment of $10.7 million and Elastomers and Performance Additives of
$3.4 million, partially offset by a $6.7 million increase in the Resin &
Intermediates (R&I) business segment. Within PolyOne's operating businesses
(total Company excluding the R&I segment) the margin associated with lower
sales volumes and lower product material margins, particularly in vinyl
compounds, specialty resins and engineered films, more than offset benefits from
the 2001-2002 strategic value capture initiatives plus approximately $7 million
in cost savings from the staff reductions announced in January 2003 and
favorable currency translation of approximately $1.5 million. In comparing the
second quarter 2003 versus 2002, the 2001-2002 strategic value capture
initiatives are estimated to have contributed $20 million to pre-tax earnings of
which $5 million was from growth efforts and approximately $15 million from cost
reduction programs. The largest cost reductions came from the initiatives to
restructure our North American manufacturing operations and raw material
sourcing programs.
PolyOne had an operating loss of $5.4 million in the first six months of 2003
versus operating income of $26.0 million in the same 2002 period. In the first
six months of 2003 EBITDA was $31.5 million versus $62.4 million on a comparable
basis. For the six months ended June 30, the 2003 special items in EBITDA,
consisting primarily of restructuring costs and losses on divestments, were
expense of $30.0 million versus expense of $3.4 million for the same period in
2002. For the six month period, the 2003 versus 2002 decrease in EBITDA before
special items of $4.3 million primarily resulted from a decrease in Performance
Plastics of $17.9 million and a decrease in Elastomers and Performance Additives
of $3.6 million, which was partially offset by an increase in the R&I segment of
$16.1 million. The earnings decreases in Performance Plastics and Elastomers and
Performance Additives largely were due to higher material costs that have not
been fully recovered in higher selling prices and lower sales volumes. The
margin compression was most severe in the North American PC&C Vinyl Compounds,
Specialty Resins and Engineered Films operations. The improvement in the R&I
segment resulted from higher OxyVinyls earnings of $4.2 million and higher
SunBelt earnings of $12.3 million, due largely to increased selling prices and
margins which were partially offset by increased natural gas costs. When
comparing the six-month
19
periods, 2003 benefited from the 2001-2002 strategic value capture initiatives
of approximately $41 million plus approximately $11 million in cost savings from
the staff reductions announced in January 2003 and favorable currency
translation of approximately $2.8 million.
Interest expense in the second quarter of 2003 of $17.3 million increased $6.0
million compared to the same quarter in 2002. The higher 2003 interest expense
is primarily due to the issuance of $300 million of 10.625 percent unsecured
senior notes during the second quarter of 2003. For the first six months of
2003, interest expense was $29.8 million, an increase of $10.0 million when
compared to the same period in 2002. The higher 2003 interest expense primarily
is due to the issuance of $300 million of 10.625 percent unsecured senior notes
in the second quarter of 2003 and the issuance of $200 million of 8.875 percent
unsecured senior notes in the second quarter of 2002.
In the second quarter of 2003, other expense, net totaled $3.5 million, an
increase of $1.7 million over the same period in 2002. The 2003 other expense
includes a purchase premium of $.8 million on the early buy-back and retirement
of a portion of the unsecured senior notes maturing in September 2003. The early
retirement of these unsecured senior notes will lower the third quarter interest
expense and result in an overall $0.4 million net cash saving to PolyOne. In the
first six months of 2003, other expense, net totaled $6.6 million, an increase
of $2.2 million over the same period in 2002. The 2003 other expense includes a
purchase premium of $0.8 million on the early buy-back and retirement of a
portion of the unsecured senior notes maturing in September 2003.
The effective income tax rate benefit on the loss from continuing operations for
the second quarter 2003 was 39.4% compared with an expense on income from
continuing operations of 39.8% for the second quarter of 2002. The effective
income tax rate benefit on the loss from continuing operations for the first
six months of 2003 was 39.0% compared with expense on the income from
continuing operations of 39.1% for the same period in 2002.
The second quarter 2003 net loss was $6.0 million versus a net income of $6.1
million in the second quarter of 2002. The 2003 loss included special charges
after-tax of $2.3 million compared to 2002 charges of $0.5 million. The net loss
for the six months ended June 30, 2003 was $25.3 million versus a net loss of
$51.2 million in the comparable 2002 period. The 2003 loss included special
after-tax charges of $18.5 million compared to 2002 charges of $2.8 million.
20
BUSINESS SEGMENT INFORMATION
Senior management uses operating income before special items and EBITDA before
special items to assess performance and allocate resources to business segments.
For a reconciliation from operating income to operating income before special
items to EBITDA before special items and EBITDA to EBITDA before special items,
see the following table. Operating income before special items and EBITDA before
special items are non-GAAP measures and should not be considered an alternative
to any other measure of performance in accordance with GAAP. Senior management
presents operating income before special items and EBITDA before special items
when discussing the results of operations of the business segments because
senior management believes such measures are useful in assessing the underlying
earnings power and operating cash flows of each business segment. Special items
include gains and losses associated with the specific strategic initiatives such
as restructuring or consolidation of operations, gains and losses attributable
to divestment of joint ventures, and certain one-time items. Accordingly, senior
management believes that excluding special items provides insight into the
underlying results of operations of each of PolyOne's business segments.
Operating income before special items and EBITDA before special items may not be
comparable to financial performance measures presented by other companies.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
(In millions) 2003 2002 2003 2002
------------ ------------ ------------ ------------
Sales:
Performance Plastics $ 460.5 $ 466.3 $ 908.1 $ 873.0
Elastomers & Performance Additives 87.5 95.8 181.5 187.5
Distribution 133.1 137.6 269.0 258.0
Resin and Intermediates - - - -
Other (30.2) (28.8) (62.2) (51.3)
------------ ------------ ------------ ------------
$ 650.9 $ 670.9 $ 1,296.4 $ 1,267.2
============ ============ ============ ============
EBITDA before special items:
Performance Plastics $ 22.0 $ 32.7 $ 41.5 $ 59.4
Elastomers & Performance Additives 4.2 7.6 9.5 13.1
Distribution 3.2 4.6 6.5 6.7
Resin and Intermediates 7.5 0.8 11.6 (4.5)
Other (4.3) (5.3) (7.6) (8.9)
------------ ------------ ------------ ------------
$ 32.6 $ 40.4 $ 61.5 $ 65.8
============ ============ ============ ============
Operating income before special items:
Performance Plastics $ 7.3 $ 18.5 $ 12.1 $ 31.8
Elastomers & Additives 1.2 4.4 3.4 6.7
Distribution 2.8 4.1 5.7 5.7
Resin and Intermediates 7.5 0.8 11.5 (4.5)
Other (4.6) (5.5) (8.1) (9.3)
------------ ------------ ------------ ------------
$ 14.2 $ 22.3 $ 24.6 $ 30.4
============ ============ ============ ============
Reconciliation:
Operating income (loss) $ 10.8 $ 21.6 $ (5.4) $ 26.0
Special items, expense 3.4 0.7 30.0 4.4
------------ ------------ ------------ ------------
Operating income before special items 14.2 22.3 24.6 30.4
Depreciation and amortization 18.4 18.6 36.9 36.4
Accelerated depreciation in special items - (0.5) - (1.0)
------------ ------------ ------------ ------------
EBITDA before special items $ 32.6 $ 40.4 $ 61.5 $ 65.8
============ ============ ============ ============
EBITDA $ 29.2 $ 40.2 $ 31.5 $ 62.4
Impact of special items, expense 3.4 0.2 30.0 3.4
------------ ------------ ------------ ------------
EBITDA before special items $ 32.6 $ 40.4 $ 61.5 $ 65.8
============ ============ ============ ============
21
COMMENTARY ON BUSINESS SEGMENT OPERATING RESULTS
PERFORMANCE PLASTICS had second quarter 2003 sales of $460.5 million, compared
with sales of $466.3 million in the second quarter of 2002. For the six-month
period ended June 30, 2003, sales totaled $908.1 million or $35.1 million above
the same period in 2002. A breakdown of the 2003 second quarter and six months
segment sales, by primary product group, is as follows:
Three months ended June 30, 2003 Six months ended June 30, 2003
------------------------------------- ---------------------------------------
2003 2003 2003 2003 2003 2003
Sales $ Sales $ Shipment Lbs. Sales $ Sales $ Shipment Lbs.
% of % Change % Change % of % Change % Change
Total vs. 2002 vs. 2002 Total vs. 2002 vs. 2002
------- -------- --------------- ------- --------- -------------
North American Plastics
Compounds and Colors (PC&C):
Vinyl Compounds 36% -4% -13% 36% - -5%
Colors and Additives 10% -13% -9% 10% -4% 1%
Engineered Materials 7% -17% -21% 7% -8% -13%
International PC&C 25% 23% 12% 24% 31% 19%
Specialty Resin and Formulators 14% -7% -11% 14% -3% -7%
Engineered Films 8% -12% -12% 9% -8% -5%
--- --- --- --- --- ---
Performance Plastics 100% -1% -12% 100% 4% -5%
Second quarter 2003 sales were $5.8 million lower than the sales of the second
quarter of 2002. The only product group to report sales growth in the 2003
second quarter was International PC&C, which benefited $11.0 million from the
December 2002 acquisition of Transcolor and approximately $14.2 million from
favorable Euro to U.S. dollar currency exchange. Before the effects of the
Transcolor acquisition and currency translation, the 2003 second quarter
International PC&C sales were 5% below the 2002 second quarter and the volume of
pounds shipped was down 2% for the same period. The lower North American
Vinyl Compounds sales were due to 13% lower volumes, much of which was offset by
higher average selling prices. The lower Vinyl Compounds volume was led by the
weakness in the wire and cable market. The North American Colors and
Additives sales volume decrease was across all markets, except for Pipe and
Fittings, and while selling prices increased in most markets the sales mix
resulted in an overall lower average selling price per pound. The decrease in
North American Engineered Materials sales was primarily due to lower pounds
shipped in all markets except Pipe & Fittings and Wire & Cable which was
partially offset by increased selling prices in most markets and a sales mix
that resulted in an overall higher average selling price per pound. In the
Specialty Resins and Formulators product group, the lower sales volumes
(Specialty Resins down 15% and Formulators down 6%) were partially offset by
increased average selling prices in both Specialty Resins and in Formulators.
For Engineered Films both the custom and automotive operations reported lower
2003 second quarter sales with approximately three-quarters of the decrease in
automotive, primarily as the result of lower automotive industry sales and lower
sales on specific platform programs where our material has been specified.
Sales for the first six months of 2003 were $35.1 million above the same period
in 2002. Vinyl Compound volume was 5% lower largely due to weak demand in the
wire & cable market. Average selling prices were 6% higher offsetting the lower
volume. Overall, sales volumes increased 1%. In North American Engineered
Materials sales were down primarily due to lower sales volume. Average selling
prices increased due to a combination of a change in sales mix and increased
sales prices. International PC&C sales benefited $21.4 million from the December
2002 acquisition of Transcolor and approximately $30 million from the favorable
Euro to U.S. dollar currency exchange. Before the effects of the Transcolor
acquisition and currency translation, 2003 first half sales were flat with 2002
and pounds shipped were up 4%. In the Specialty Resins and Formulators product
group, the lower sales volumes were partially offset by increased average
selling prices and favorable sales mix in both Specialty Resins and Formulators.
In Engineered Films, sales of custom products were just slightly less than last
year while automotive products were down 15% as a result of lower automotive
industry sales and lower sales on specific platform programs where our material
has been specified.
EBITDA before special items in the second quarter of 2003 was $22.0 million, a
decrease of $10.7 million compared to the second quarter of 2002. The decrease
in EBITDA before special items resulted from lower
22
sales and margin compression in North American Vinyl Compounds, Specialty
Resins and Engineered Films due to the impact of higher PVC resin and VCM
costs, partially offset by lower costs from restructuring initiatives and
favorable currency translation of $1.5 million. The second quarter 2003 U.S.
industry average PVC resin selling price was approximately 8.5 cents per pound
or 25% above the same period in 2002. EBITDA before special items for the first
six months of 2003 was $41.5 million, a $17.9 million decline from the first six
months of 2002, due to lower sales volumes and margin compression due to the
impact of higher raw material costs partially offset by lower costs from
restructuring initiatives.
ELASTOMERS AND PERFORMANCE ADDITIVES sales were $87.5 million in the second
quarter of 2003, an $8.3 million or 9% decrease compared to the same quarter in
2002. The 2003 second quarter shipment volume in pounds was down 10% versus
2002. In the second quarter of 2003 compared to 2002, elastomer compounding
sales (excludes rolls and additives) decreased $7.8 million. Contributing to the
sales decrease was weak industrial and automotive industry production levels.
Year-to-date 2003 sales of $181.5 million were 3% below the same period in 2002.
Similar to the second quarter of 2003, the decline in year-over-year sales for
the first six months of 2003 was the result of decreased elastomer compounding
sales (excludes additives and rolls) of $4.7 million.
EBITDA before special items in the second quarter of 2003 was $4.2 million or
$3.4 million below the same quarter in 2002. The decrease resulted from lost
margin associated with lower sales levels and lower average margins resulting
from higher energy-related raw material costs that outpaced increases in
selling prices. EBITDA before special items for the first six months of 2003
was $9.5 million versus $13.1 million for the first six months of 2002.
DISTRIBUTION sales in the second quarter of 2003 were $133.1 million, 3% below
the same quarter in 2002. The shipment volume in pounds when comparing the same
periods was down 15% in 2003. For the 2003 second quarter versus the comparable
period in 2002, U.S. and Canada sales increased by 1% but were more than offset
by a decrease in sales in Mexico. Sales in the first six months of 2003 were
$269.0 million, 4% above the same period in 2002. U.S. and Canada sales
increased 8% and sales volumes increased 1% while Mexican sales and volumes
declined. In the U.S. volumes benefited from the continued strength of sales of
PolyOne produced vinyl compounds while sales of commodity resins were down.
Average selling prices increased due to sales mix and higher commodity resin
prices.
EBITDA before special items in the second quarter of 2003 was $3.2 million, or
$1.4 million below second quarter of 2002. The 2003 decrease in EBITDA before
special items was primarily due to the lost margin resulting from lower sales
volumes partially offset by lower selling and administrative costs. EBITDA
before special items for the first six months of 2003 was $6.5 million, or
nearly flat with the first six months of 2002.
RESIN AND INTERMEDIATES EBITDA before special items, consisting of equity income
from joint ventures, allocated overhead support cost and costs associated with
past operations was $7.5 million for the second quarter of 2003, or $6.7 million
higher than the second quarter of 2002. PolyOne's share of equity earnings
before special items in the second quarter of 2003 compared to the same quarter
in 2002 increased from OxyVinyls by $0.8 million and from SunBelt by $6.9
million. OxyVinyls second quarter earnings in 2003 versus 2002 benefited from
higher average industry PVC resin selling prices of approximately 8.5 cents per
pound. However, most of the benefit from higher average resin selling prices
plus higher caustic soda selling prices was offset by lower PVC resin sales
volumes, increased ethylene and chlorine costs and higher energy costs.
Comparing the quarters the average industry spread of resin selling prices over
ethylene and chlorine costs increased by approximately 0.5 cents per pound. The
2003 first quarter run-up in natural gas costs continued into the second
quarter and averaged approximately $2 per million BTU's above the same quarter
in 2002. The SunBelt earnings improvement was primarily driven by higher average
selling prices of chlorine of approximately $145 per ton and of caustic soda of
$45 per ton in the second quarter of 2003 versus the same period a year ago.
The Resin and Intermediates business segment had EBITDA before special items of
$11.6 million for the first six months of 2003, an improvement of $16.1 million
over the same period in 2002. The 2003 six months were positively impacted by
the improvement in the equity earnings of SunBelt by $12.3 million and of
OxyVinyls by $4.2 million. The improvement in the equity earnings of SunBelt was
mainly primarily driven by higher average selling prices of chlorine of
approximately $315 per ton and of caustic soda of $20 per ton in the first half
of 2003 versus the same period a year ago.
OTHER consists primarily of corporate governance costs that are not allocated to
business segments and inter-segment profit elimination. EBITDA before special
items was an expense of $4.3 million in the second quarter and $7.6 million for
the first
23
six months of 2003. The inter-segment elimination of profit in inventory was
$0.8 million for both the second quarter of 2003 and the first six months of
2003.
CASH FLOWS
Operating activities utilized cash of $137.2 million in the second quarter of
2003 and $171.8 million for the first six months of 2003. Before changes in the
level of accounts receivable sold, operating activities utilized cash of $31.1
million in the second quarter of 2003 and utilized cash of $101.9 million in the
first six months of 2003. Commercial working capital (trade accounts receivables
before receivables sold plus FIFO inventories less accounts payables) increased
$15.8 million in the 2003 second quarter and increased $73.7 million in the six
months ended June 30, 2003 from the seasonally low 2002 year-end levels. Cash
funding of restructuring initiatives was $11.3 million in the second quarter of
2003 and $23.3 million in the first six months of 2003. In the second quarter of
2003, the level of accounts receivable sold decreased $106.1 million following
the May 2003 debt refinancing.
Investing activities utilized cash of $65.9 million in the second quarter of
2003 and $63.1 million in the first six months of 2003. Before the increase in
restricted cash, the investing activities utilized cash of $12.2 million in the
2003 second quarter and $9.4 million in the first six months of 2003. Cash
spending included capital expenditures for the 2003 second quarter of $9.9
million and $16.1 million year-to-date. Also, the six months year-to-date
includes spending for businesses acquired of $15.8 million and proceeds from the
sale of assets of $22.6 million. The May 2003 debt refinancing resulted in
restricted cash for the payment of the unsecured senior debt maturing in
September 2003. As of June 30, 2003 the cash restricted for future debt
repayment was $53.7 million.
Cash provided by financing activities during the second quarter of 2003 was
$214.4 million and in the first half of 2003 was $255.9 million, primarily
reflecting the issuance of $300 million of 10.625% unsecured senior notes.
Following the May 2003 debt refinancing, approximately $34 million of the
unsecured senior debt that matures in September 2003 was retired early. No
dividends were paid in the first half of 2003.
CAPITAL RESOURCES AND LIQUIDITY
As of June 30, 2003, we had existing facilities to access capital resources
(former receivables sale facility, revolving credit facility, uncommitted
short-term credit lines and senior unsecured notes and debentures) totaling
approximately $1,051.8 million. As of June 30, 2003, we had utilized
approximately $944.2 million of these facilities (long-term debt of $853.1
million, short-term debt of $1.0 million, capital leases of $0.1 million and
receivables sold of $90.0 million), including $836.5 million of senior unsecured
notes and debentures, of which $53.7 million is payable in September 2003 and,
therefore, is classified as a current liability.
Of the capital resource facilities available to us as of June 30, 2002, only the
portion of the receivables sale facility that was actually sold provided
security in connection with the transfer of ownership of these receivables. Each
indenture governing our senior unsecured notes and debentures and our guarantee
of the SunBelt notes allows for a specific level of secured debt, above which
security must be provided on each such indenture. The receivables sale facility
does not constitute debt under our senior unsecured notes and debentures. As of
June 30, 2003, we had guaranteed unconsolidated equity affiliate debt of $91.4
million for SunBelt. Effective June 30, 2003, the OxyVinyls guarantee was
terminated.
On May 6, 2003, we completed a debt refinancing. The refinancing provides the
necessary liquidity to repay the senior debt that matures in September 2003, as
well as to support normal operations and fund previously announced restructuring
initiatives intended to improve earnings. As part of this comprehensive
refinancing, we issued $300 million of 10.625% unsecured senior notes, entered
into a new three-year $225 million receivables sale facility and amended and
restated our revolving credit facility. The 10.625% unsecured senior notes rank
equally with all of our other senior unsecured indebtedness. The new receivables
sale facility replaced our former receivables sale facility. The security that
had been extended in February 2003 to our existing senior notes and debentures
and our guarantee of the SunBelt notes terminated as part of the debt
refinancing. Security was granted under the terms of the 2003 amended and
restated revolving credit agreement. As of June 30, 2003, our secured borrowings
were not at levels that would trigger the security on the public indentures.
On May 6, 2003, we amended and restated our revolving credit facility. As
amended and restated, it has a three-year term and provides for up to $50.0
million in borrowings. However, the maximum amount that we may borrow will be
limited to
24
95% of the amount that may be borrowed and secured from time to time under the
revolving credit facility without triggering the security provisions of the
indentures governing the existing senior unsecured notes and debentures. The
amended and restated revolving credit facility makes available up to $35.0
million for the issuance of standby letters of credit. Our obligations under the
revolving credit facility are secured by substantially all of our domestic
intellectual property and inventory and some of our domestic real property.
Our amended and restated revolving credit facility and our new receivables sale
facility require, among other things, that we comply with interest coverage and
borrowed debt-to-adjusted EBITDA earnings ratios. Further, our financing
arrangements limit payments for purposes such as capital expenditures,
acquisitions and dividends. The following table summarizes the defined financial
covenant ratios for the remainder of 2003 under the amended and restated
revolving credit facility and the new receivables sale facility:
Borrowed
Debt-to-
Interest Adjusted
Coverage Ratio EBITDA Ratio
(Minimum) (Maximum)
-------------- ------------
Agreement compliance
Second quarter of 2003 None None
Third quarter of 2003 1.00 11.00
Fourth quarter of 2003 1.00 9.00
On May 6, 2003, we terminated our former receivables sale facility and entered
into a new receivables sale facility. Under the terms of the agreement governing
the new facility, we are allowed to sell accounts receivable and realize
proceeds of up to $225.0 million. However, the maximum amount of proceeds that
we may receive is limited to 85% of the amount of eligible domestic accounts
receivable sold. The new receivables sale facility also makes available up to
$50.0 million for the issuance of standby letters of credit. Although our former
receivables sale facility contained a provision that would allow the purchasers
of the accounts receivable to terminate the facility if our senior debt ratings
fell below specified levels, the new receivables sale facility does not contain
such a provision.
The realization of profitable operations will be important to (1) maintaining
the existing levels of available capital resources, (2) any refinancing of a
portion of the existing capital resources, and (3) the execution of our
announced restructuring initiatives. The sum of EBITDA and special items totaled
approximately $124 million in the year 2002. In the first six months of 2003 the
sum of EBITDA and special items totaled $61.5 million or $4.3 million below the
comparable amount in 2002. EBITDA must cover expenditures for financing costs
(interest expense and discount on sale of accounts receivable, which are
projected to be approximately $39 million in the second half of 2003 and $71
million for the full year), spending associated with restructuring, cash taxes,
capital expenditures and cash to fund sales growth through increased working
capital requirements. Cash spending for the restructuring initiatives to-date
(North American PC&C manufacturing improvements, business unit initiatives and
the recent selling and administrative cost-reduction program) are projected to
be approximately $17 million in the last six months of 2003 and approximately
$40 million for the year. Capital expenditures for the year 2003 are projected
to be approximately $40 million. In December 2002, PolyOne announced that the
Company would suspend the payment of dividends commencing in the first quarter
of 2003.
PolyOne currently estimates minimum annual funding requirements for our
qualified defined benefit pension plans of approximately $1 million in 2003 and
$5 million in 2004. Market asset performance in 2003 will impact the final
minimum funding requirements in 2005. An assumed 8.75% long-term rate of return
on pension assets in 2003, combined with the minimum contributions required in
2003 and 2004, would produce a projected minimum funding requirement by
September 15, 2005 of approximately $45 million (each 1% return on asset
variance in 2003 from 8.75% impacts the 2005 minimum funding by approximately $1
million). However, PolyOne intends to continue funding in excess of the minimum
required for the qualified defined benefit pension plans during calendar 2003
and 2004, which would reduce any otherwise required funding by September 15,
2005.
Based on our current projected operations, PolyOne should be able to continue to
manage and control working capital, discretionary spending and capital
expenditures. We believe that cash flow generated from operations, along with
the new senior debt and borrowing capacity under the revised revolving credit
facility and new receivables sale facility, should be adequate to fund our
operations and to meet our debt service requirements.
25
ACCOUNTING POLICIES AND ESTIMATES
Note C of the 2002 Annual Consolidated Financial Statements contains a summary
of PolyOne's accounting policies and commentary on the nature of estimates made
in the preparation of the financial statements. Following is a description of
important management judgments relating to the PolyOne 2002 Annual Consolidated
Financial Statements and the Quarterly Condensed Consolidated Financial
Statements for the three and six-month periods ended June 30, 2003 (Unaudited).
ENVIRONMENTAL ACCRUED LIABILITY. PolyOne has accrued $54.7 million to cover
future environmental remediation expenditures, and believes none of these
matters, either individually or in the aggregate, should have a material adverse
effect on its capital expenditures, earnings, cash flow or liquidity. The
accrual represents PolyOne's best estimate of the remaining probable remediation
costs based upon information and technology currently available. For additional
discussion, refer to Note P to the Annual Consolidated Financial Statements and
to Note M to the Quarterly Condensed Consolidated Financial Statements.
RESTRUCTURING COSTS. In 2001, PolyOne announced several manufacturing
improvements and restructuring plans to close 17 U.S. and Canadian facilities.
As of December 31, 2002, all but four of these facilities had been closed. In
January 2003, we decided to continue operating the fourth facility. Accordingly,
in the first quarter of 2003, the reserve of approximately $0.3 million
associated with this facility (which relates to an acquired business) was
reversed and recognized as a reduction to goodwill of the acquired business. Two
of the three remaining facilities were closed during the second quarter of 2003.
As of June 30, 2003, an accrued liability of $25.2 million existed for future
employee severance and plant closing costs. In addition, as of June 30, 2002,
the net property carrying value to be realized for the plants closed or to be
closed was $21.3 million (some assets will be transferred to other locations as
production ceases).
EQUITY INVESTMENT. In December 2001, OxyVinyls, of which PolyOne owns 24%
interest, announced the temporary idling of its Deer Park, Texas, chlor-alkali
plant due to low industry capacity utilization and low product market selling
prices. As of December 31, 2001, OxyVinyls had accrued $13.8 million for future
employee severance and liabilities associated with the temporary idling of the
Deer Park plant. In 2002, OxyVinyls recognized an additional $2.2 million of
expense associated with the temporary plant idling, plus an additional expense
of $17.0 million in the third quarter related to the permanent closing of
specific production assets included in the idled plant. The permanent closing
costs included $14.5 million for the impairment of the fixed assets as well as
$2.5 million for decommissioning costs. As of June 30, 2003, OxyVinyls had a
remaining accrual of $2.5 million for future employee severance liabilities and
decommissioning costs. The plant had a net property carrying value by OxyVinyls
at June 30, 2003 of approximately $118.2 million, which is anticipated to be
realized through future operations upon the restart of the plant. OxyVinyls will
maintain the Deer Park chlor-alkali plant in a standby mode pending further
strengthening in overall economic conditions and improved demand for caustic
soda.
GOODWILL. As of June 30, 2003, our recorded goodwill totaled $444.5 million.
Most of the goodwill is associated with three identified reporting units -
Plastic Compounds and Colors ($270.5 million), Specialty Resins and Formulators
($59.7 million) and Elastomers and Performance Additives ($111.9 million). SFAS
No. 142, Goodwill and Other Intangible Assets," requires an annual assessment
for potential impairment of goodwill. During 2002, we elected to make July 1 our
annual assessment date. During the second quarter of 2003, we engaged a third
party valuation expert to value the three reporting units noted above. In August
2003, the third party valuation expert issued a report on each noted reporting
unit, concluding for each reporting unit that its fair value exceeds its book
carrying value. With the issuance of the valuation reports, we have completed
the required 2003 "phase one" goodwill impairment assessment and concluded that
no impairment has occurred.
While we determined that there was no additional goodwill impairment as of the
annual assessment on July 1, 2003, the future occurrence of a potential
indicator of impairment, such as a significant adverse change in legal factors
or business climate, an adverse action or assessment by a regulator,
unanticipated competition, loss of key personnel or a more-likely-than-not
expectation that a reporting unit or a significant portion of a reporting unit
will be sold or disposed of, would result in our having to perform another
"phase-one" valuation analysis, as required under SFAS No. 142, for some or all
of our reporting units prior to the next required 2004 annual assessment. These
types of events and the resulting analysis could result in additional charges
for goodwill and other asset impairments in the future. Any future goodwill
impairment could impact our borrowings under the existing debt agreements.
DEFERRED TAX BENEFIT FOR OPERATING LOSS CARRYFORWARDS. As of June 30, 2003,
PolyOne had a net deferred tax asset of $25.7 million, which included a deferred
tax asset of $109.2 million for operating loss carryforwards for tax purposes.
26
The tax benefit recorded on domestic losses was $9.0 million in the 2003 second
quarter and $24.2 million in the first half of 2003. We have recognized the 2003
domestic tax benefit after considering our projected full year earnings for 2003
and our ability to generate domestic earnings through the payment of dividends
from foreign subsidiaries. A distribution of foreign dividends to the parent
company would streamline the foreign subsidiaries cash management and capital
structure and have no significant impact on our overall liquidity. Any foreign
dividends would result in higher recorded income tax expense because of the
inability to utilize foreign tax credits. See the discussion in Note R to the
Annual Consolidated Financial Statements.
27
CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS
In this report on Form 10-Q, statements that are not reported financial results
or other historical information are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements give our current expectations or forecasts of future events, and are
not guarantees of future performance. They are based on management's
expectations that involve a number of business risks and uncertainties, any of
which could cause actual results to differ materially from those expressed in or
implied by the forward-looking statements. You can identify these statements by
the fact that they do not relate strictly to historic or current facts. They use
words such as "anticipate," "estimate," "expect," "project," "intend," "plan,"
"believe," and other words and terms of similar meaning in connection with any
discussion of future operating or financial performance. In particular, these
include statements relating to future actions, prospective changes in raw
material costs or product pricing or product demand, future performance or
results of current and anticipated market conditions and market strategies,
sales efforts, expenses, the outcome of contingencies such as legal proceedings,
and financial results. Among the factors that could cause actual results to
differ materially are the following:
- - an inability to achieve or delays in achieving estimated and actual savings
related to restructuring programs
- - delays in achieving or inability to achieve the Company's strategic value
capture initiatives, including cost reduction and employee productivity
goals, or achievement of less than the anticipated financial benefit from
the initiatives
- - the effect on foreign operations of currency fluctuations, tariffs,
nationalization, exchange controls, limitations on foreign investment in
local businesses and other political, economic and regulatory risks
- - changes in U.S., regional or world polymer and/or rubber consumption growth
rates affecting the Company's markets
- - changes in global industry capacity or in the rate at which anticipated
changes in industry capacity come online in the polyvinyl chloride (PVC),
chlor-alkali, vinyl chloride monomer (VCM) or other industries in which the
Company participates
- - fluctuations in raw material prices, quality and supply and in energy
prices and supply, in particular fluctuations outside the normal range of
industry cycles
- - production outages or material costs associated with scheduled or
unscheduled maintenance programs
- - costs or difficulties and delays related to the operation of joint venture
entities
- - lack of day-to-day operating control, including procurement of raw
materials, of equity or joint venture affiliates
- - partial control over investment decisions and dividend distribution policy
of the OxyVinyls partnership and other minority equity holdings of the
Company
- - an inability to launch new products and/or services within the Company's
various businesses
- - the possibility of goodwill impairment
- - an inability to maintain any required licenses or permits
- - an inability to comply with any environmental laws and regulations
- - a delay or inability to achieve targeted debt levels through divestitures
or other means.
We cannot guarantee that any forward-looking statement will be realized,
although we believe we have been prudent in our plans and assumptions.
Achievement of future results is subject to risks, uncertainties and inaccurate
assumptions. Should known or unknown risks or uncertainties materialize, or
should underlying assumptions prove inaccurate, actual results could vary
materially from those anticipated, estimated or projected. Investors should bear
this in mind as they consider forward-looking statements.
We undertake no obligation to publicly update forward-looking statements,
whether as a result of new information, future events or otherwise. You are
advised, however, to consult any further disclosures we make on related subjects
in our Form 10-Q, 8-K and 10-K reports to the Securities and Exchange
Commission. You should understand that it is not possible to predict or identify
all such factors. Consequently, you should not consider any such list to be a
complete set of all potential risks or uncertainties.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PolyOne is exposed to market risk from changes in interest rates on debt
obligations and from changes in foreign currency exchange rates. Information
related to these risks and our management of the exposure is included in
"Management's Analysis - Consolidated Statements of Cash Flows" in the 2002
Annual Report under the caption "Market Risk Disclosures" included in our Annual
Report on Form 10-K. PolyOne periodically enters into interest rate swap
agreements that convert fixed-rate obligations to floating rates. Effective
June 19, 2003, PolyOne entered into interest rate swap agreements on seven of
its fixed-rate obligations in the aggregate amount of $120.0 million. These
exchange agreements are perfectly effective as defined by Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Financial
Instruments and Hedging Activities." At June 30, 2003, these seven agreements
had a net fair value of ($2.6) million. The weighted-average interest rate for
these seven agreements was 5.462%. There have been no material changes in the
market risk faced by us from December 31, 2002 to June 30, 2003. We have updated
the disclosure concerning our financing arrangements, which is included in Note
J in this form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management,
including our Principal Executive Officer and Principal Financial
Officer, we evaluated the effectiveness of the design and operation of
our disclosure controls and procedures, as defined in Rules 13a-14(c)
and 15d-14(c) under the Exchange Act, as of a date (the "Evaluation
Date") within 90 days prior to the filing date of this report. Based
upon that evaluation, the Principal Executive Officer and Principal
Financial Officer concluded that, as of the Evaluation Date, our
disclosure controls and procedures were effective in timely alerting
them to the material information relating to us (or our consolidated
subsidiaries) required to be included in our periodic SEC filings.
(b) Changes in internal controls.
There were no significant changes made in our internal controls during
the period covered by this report or, to our knowledge, in other
factors that could significantly affect these controls subsequent to
the date of their evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Stockholders on May 15, 2003. As
described in the 2003 Proxy Statement, the following action was taken:
(a) The ten nominees for directors were elected. The votes for
directors were as follows:
Number of Shares Number of Share
Voted For Votes Withheld
----------------- ---------------
J. Douglas Campbell 79,993,015 2,816,181
Carol A. Cartwright 79,954,814 2,854,382
Gale Duff-Bloom 80,790,460 2,018,736
Wayne R. Embry 80,786,914 2,022,282
Robert A. Garda 80,824,248 1,984,948
Gordon D. Harnett 79,997,097 2,812,099
David H. Hoag 80,794,930 2,014,266
D. Larry Moore 79,992,356 2,816,840
Thomas A. Waltermire 80,386,098 2,423,098
Farah M. Walters 80,804,424 2,004,772
29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit No.
Under Reg. Form 10-Q
S-K, Item 601 Exhibit No. Description of Exhibit
- ------------- ----------- --------------------------------------------------------------------
(31) 31.1 Certification of Thomas A. Waltermire, Chairman of the Board,
President and Chief Executive Officer, pursuant to Securities
Exchange Act Rules 13a-14 and 15d-14 as adopted pursuant to section
302 of the Sarbanes-Oxley Act of 2002.
(31) 31.2 Certification of W. David Wilson, Vice President and Chief Financial
Officer, pursuant to Securities Exchange Act Rules 13a-14 and 15d-14
as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
(32) 32.1 Certification of Thomas A. Waltermire, Chairman of the Board,
President and Chief Executive Officer, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act
of 2002.
(32) 32.2 Certification of W. David Wilson, Vice President and Chief Financial
Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K from April 1, 2003 through June 30, 2003:
- Form 8-K filed on April 17, 2003 announced a press release
filed on April 16, 2003, whereby we pre-announced earnings for
the first quarter of 2003.
- Form 8-K filed on April 17, 2003 announced a press release
filed on April 16, 2003, whereby we announced plans to
complete a debt refinancing.
- Form 8-K filed on April 17, 2003 whereby we announced our
intention to offer $250 million of senior notes in a
transaction exempt from the registration requirements of the
Securities Act of 1933.
- Form 8-K filed on April 25, 2003 announced a press release
filed on April 24, 2003, whereby we announced the formation of
BayOne Urethane Systems, LLC, a 50/50 joint venture with Bayer
Polymers LLC to develop and market polyurethane systems in the
United States and Canada.
- Form 8-K filed on April 30, 2003 announced a press release
filed on April 29, 2003, whereby we announced first quarter
2003 earnings.
- Form 8-K filed on May 2, 2003 whereby we announced that we had
agreed to sell $300 million of our senior notes in a
transaction exempt from the registration requirements of the
Securities Act of 1933.
- Form 8-K filed on May 7, 2003 announcing the completion of the
debt refinancing that had been initiated in April 2003.
30
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.
August 13, 2003 POLYONE CORPORATION
/s/ W. David Wilson
-------------------------------------
W. David Wilson
Vice President and Chief Financial
Officer
(Authorized Officer and Principal
Financial Officer)
/s/ Gregory P. Smith
-------------------------------------
Gregory P. Smith
Corporate Controller and Assistant
Treasurer
(Principal Accounting Officer)
31
POLYONE CORPORATION
Index to Exhibits
EXHIBIT DESCRIPTION
- --------------------------------------------------------------------------------
31.1 Certification of Thomas A. Waltermire, Chairman of the Board, President
and Chief Executive Officer, pursuant to Securities Exchange Act Rules
13a-14 and 15d-14 as adopted pursuant to section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of W. David Wilson, Vice President and Chief Financial
Officer, pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as
adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Thomas A. Waltermire, Chairman of the Board, President
and Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of W. David Wilson, Vice President and Chief Financial
Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
section 906 of the Sarbanes-Oxley Act of 2002.
32