UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 29, 2002
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-29764
INTERNATIONAL SPECIALTY PRODUCTS INC.
(Exact name of registrant as specified in its charter)
Delaware 51-0376469
(State of Incorporation) (I. R. S. Employer
Identification No.)
300 Delaware Avenue, Suite 303, Wilmington, Delaware 19801
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (302) 427-5715
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 / /
As of November 8, 2002, 65,138,376 shares of International Specialty
Products Inc. common stock (par value $.01 per share) were outstanding.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
INTERNATIONAL SPECIALTY PRODUCTS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Thousands, except per share amounts)
Third Quarter Ended Nine Months Ended
--------------------- -------------------
Sept. 30, Sept. 29, Sept. 30, Sept. 29,
2001 2002 2001 2002
--------- --------- -------- ---------
Net sales............................ $ 188,633 $ 208,363 $ 595,124 $ 642,211
-------- -------- -------- --------
Costs and Expenses:
Cost of products sold.............. (114,896) (132,105) (370,491) (416,137)
Selling, general and administrative (39,177) (40,606) (120,485) (126,972)
Gain on sale of assets............. - - - 5,468
Gains on settlement of contracts... - - - 6,760
Amortization of goodwill and
intangibles...................... (4,048) (125) (12,144) (680)
--------- --------- --------- ---------
Total costs and expenses ....... (158,121) (172,836) (503,120) (531,561)
--------- --------- --------- ---------
Operating income..................... 30,512 35,527 92,004 110,650
Interest expense..................... (25,052) (20,569) (62,780) (64,604)
Investment income (loss), net of
investment-related expenses of
$1,009, $1,006, $3,569 and $3,504,
respectively....................... (7,312) 1,227 13,481 26,467
Other expense, net................... (1,014) (4,364) (10,054) (6,541)
--------- --------- --------- ---------
Income (loss) before income taxes.... (2,866) 11,821 32,651 65,972
Income tax (provision) benefit....... 989 (4,052) (11,473) (22,427)
--------- --------- --------- ---------
Income (loss) before extraordinary
item and cumulative effect of
accounting change................. (1,877) 7,769 21,178 43,545
Extraordinary item - loss on early
retirement of debt, net of income
tax benefit of $2,434.............. - - - (4,725)
Cumulative effect of change in
accounting principle, net of
income tax benefit of $216 in 2001. - - (440) (155,400)
--------- --------- --------- ---------
Net income (loss).................... $ (1,877) $ 7,769 $ 20,738 $(116,580)
========= ========= ========= =========
1
INTERNATIONAL SPECIALTY PRODUCTS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) - (CONTINUED)
(Thousands, except per share amounts)
Third Quarter Ended Nine Months Ended
-------------------- -------------------
Sept. 30, Sept. 29, Sept. 30, Sept. 29,
2001 2002 2001 2002
-------- --------- -------- --------
Earnings per common share:
Basic:
Income (loss) before extraordinary
item and cumulative effect of
accounting change.............. $ (.03) $ .12 $ .32 $ .67
Extraordinary item............... - - - (.07)
Cumulative effect of accounting
change........................ - - (.01) (2.40)
--------- --------- --------- -------
Net income (loss)................ $ (.03) $ .12 $ .31 $ (1.80)
========= ========= ========= =======
Diluted:
Income (loss) before extraordinary
item and cumulative effect of
accounting change.............. $ (.03) $ .12 $ .32 $ .67
Extraordinary item............... - - - (.07)
Cumulative effect of accounting
change........................ - - (.01) (2.40)
--------- --------- --------- -------
Net income (loss)................ $ (.03) $ .12 $ .31 $ (1.80)
========= ========= ========= =======
Weighted average number of common
and common equivalent shares
outstanding:
Basic.............................. 65,641 64,959 66,050 64,873
========= ========= ======== =======
Diluted............................ 65,770 65,038 66,137 64,929
========= ========= ======== =======
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
2
INTERNATIONAL SPECIALTY PRODUCTS INC.
CONSOLIDATED BALANCE SHEETS
Sept. 29,
December 31, 2002
2001 (Unaudited)
------------ -----------
(Thousands)
ASSETS
Current Assets:
Cash and cash equivalents.......................... $ 79,509 $ 65,820
Investments in trading securities.................. 54,437 233,667
Investments in available-for-sale securities....... 239,273 227,409
Other short-term investments....................... 2,299 -
Restricted cash.................................... 307,866 -
Accounts receivable, trade, net.................... 86,574 90,861
Accounts receivable, other......................... 20,357 24,322
Receivable from related parties, net............... 9,009 14,537
Inventories........................................ 190,582 177,584
Deferred income tax benefits....................... 32,929 36,844
Other current assets............................... 8,635 10,089
---------- ----------
Total Current Assets............................. 1,031,470 881,133
Property, plant and equipment, net................... 560,844 563,202
Goodwill, net........................................ 502,607 330,911
Intangible assets, net............................... 15,167 8,385
Other assets......................................... 62,480 63,074
---------- ----------
Total Assets......................................... $2,172,568 $1,846,705
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term debt.................................... $ 143 $ 89,190
Current maturities of long-term debt............... 310,265 2,609
Accounts payable................................... 49,088 75,200
Accrued liabilities................................ 97,659 96,044
Income taxes....................................... 9,799 15,906
---------- ----------
Total Current Liabilities........................ 466,954 278,949
---------- ----------
Long-term debt less current maturities............... 919,557 834,332
---------- ----------
Deferred income taxes................................ 109,297 136,916
---------- ----------
Other liabilities.................................... 72,703 66,887
---------- ----------
Stockholders' Equity:
Preferred stock, $.01 par value per share;
20,000,000 shares authorized:
no shares issued................................. - -
Common stock, $.01 par value per share; 300,000,000
shares authorized: 69,546,456 shares issued...... 695 695
Additional paid-in capital......................... 487,156 488,096
Unearned compensation - restricted stock awards.... (1,166) (3,063)
Treasury stock, at cost - 4,831,939 and
4,457,964 shares, respectively................... (35,621) (33,050)
Retained earnings.................................. 214,095 97,515
Accumulated other comprehensive loss............... (61,102) (20,572)
---------- ----------
Total Stockholders' Equity....................... 604,057 529,621
---------- ----------
Total Liabilities and Stockholders' Equity........... $2,172,568 $1,846,705
========== ==========
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
3
INTERNATIONAL SPECIALTY PRODUCTS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended
-------------------
Sept. 30, Sept. 29,
2001 2002
-------- ---------
(Thousands)
Cash and cash equivalents, beginning of period............... $ 18,181 $ 79,509
-------- --------
Cash provided by (used in) operating activities:
Net income (loss).......................................... 20,738 (116,580)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Extraordinary item..................................... - 4,725
Cumulative effect of change in accounting principle.... 440 155,400
Gain on sale of assets................................. - (5,468)
Depreciation........................................... 39,542 42,503
Amortization of goodwill and intangibles............... 12,144 680
Deferred income taxes.................................. (785) 12,004
Unrealized (gains) losses on securities and other
short-term investments............................... 4,584 (1,445)
(Increase) decrease in working capital items............... (46,949) 27,066
Purchases of trading securities............................ (405,621) (456,059)
Proceeds from sales of trading securities.................. 610,191 302,682
Proceeds (repayments) from sale of accounts receivable..... (7,791) 3,932
Increase in net receivable from related parties............ (4,074) (5,372)
Change in cumulative translation adjustment................ (734) 9,469
Other, net................................................. 5,441 (4,151)
-------- --------
Net cash provided by (used in) operating activities.......... 227,126 (30,614)
-------- --------
Cash provided by (used in) investing activities:
Capital expenditures and acquisitions...................... (58,716) (42,551)
Net proceeds from sale of assets........................... - 27,271
Purchases of available-for-sale securities................. (298,850) (205,050)
Proceeds from sales of available-for-sale securities....... 92,456 236,321
Proceeds from sales of other short-term investments........ 12,765 2,299
-------- --------
Net cash provided by (used in) investing activities.......... (252,345) 18,290
-------- --------
Cash provided by (used in) financing activities:
Increase (decrease) in short-term debt..................... (27,037) 89,047
Proceeds from issuance of debt............................. 527,332 -
Decrease in borrowings under revolving credit facility..... (115,400) (85,250)
Repayments of long-term debt............................... (65,059) (308,045)
Call premium on redemption of debt......................... - (4,621)
(Increase) decrease in restricted cash..................... (257,649) 307,866
Financing fees and expenses................................ (13,789) (1,613)
Repurchases of common stock................................ (12,257) (1,506)
Other, net................................................. 1,284 2,121
-------- --------
Net cash provided by (used in) financing activities.......... 37,425 (2,001)
-------- --------
Effect of exchange rate changes on cash...................... (219) 636
-------- --------
Net change in cash and cash equivalents...................... 11,987 (13,689)
-------- --------
Cash and cash equivalents, end of period..................... $ 30,168 $ 65,820
======== ========
4
INTERNATIONAL SPECIALTY PRODUCTS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) -- (CONTINUED)
Nine Months Ended
-------------------
Sept. 30, Sept. 29,
2001 2002
--------- ---------
(Thousands)
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest (net of amount capitalized)................. $ 49,874 $ 72,054
Income taxes......................................... 7,114 5,351
Acquisition of FineTech Ltd.:
Fair market value of assets acquired................. $ 26,547
Purchase price of acquisition........................ 22,450
--------
Liabilities assumed.................................. $ 4,097
========
Acquisition of mineral products facility:
Fair market value of assets acquired................. $ 11,421
Purchase price of acquisition........................ 11,421
--------
Liabilities assumed.................................. $ -
========
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
5
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The consolidated financial statements for International Specialty Products
Inc. and its consolidated subsidiaries (the "Company") reflect, in the opinion
of management, all adjustments necessary to present fairly the financial
position of the Company and its consolidated subsidiaries at September 29, 2002,
and the results of operations and cash flows for the third quarter and nine
months ended September 30, 2001 and September 29, 2002. All adjustments are of a
normal recurring nature. These consolidated financial statements should be read
in conjunction with the annual consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2001 (the "Form 10-K").
NOTE 1. RETIREMENT OF DEBT
On January 14, 2002, the Company redeemed the remaining $307.9 million
aggregate principal amount of its 9% Senior Notes due 2003 (the "2003 Notes").
The 2003 Notes were redeemed at a redemption price of 101.5% of the principal
amount plus accrued and unpaid interest to the redemption date. As a result, the
Company recorded an extraordinary loss on the early retirement of debt of $4.7
million ($7.1 million before income tax benefit of $2.4 million), or $.07 per
diluted share. The extraordinary charge was comprised of $4.6 million of call
premium, $0.2 million of remaining discount amortization and the write-off of
$2.3 million of unamortized deferred financing fees. The redemption was funded
utilizing a restricted cash escrow account which had been established in 2001 in
connection with the issuances of long-term debt.
NOTE 2. RECENT ACCOUNTING DEVELOPMENT
On June 30, 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets". With the adoption of SFAS No. 142, goodwill is no longer
subject to amortization over its estimated useful life. However, goodwill will
be subject to at least an annual assessment for impairment and more frequently
if circumstances indicate a possible impairment. Companies must perform a
fair-value-based goodwill impairment test. In addition, under SFAS No. 142, an
acquired intangible asset should be separately recognized if the benefit of the
intangible is obtained through contractual or other legal rights, or if the
intangible asset can be sold, transferred, licensed, rented, or exchanged.
Intangible assets will be amortized over their useful lives. The Company adopted
SFAS No. 142 effective as of January 1, 2002. Accordingly, the Company completed
a transitional impairment test, effective January 1, 2002, and recognized a
goodwill impairment loss of $155.4 million as the cumulative effect of a change
in accounting principle. The Statement of Operations for the first quarter of
2002 has been restated to reflect this loss. The write-off represents the
goodwill associated with the Company's Performance Chemicals, Fine Chemicals and
Industrial business segment and was based upon the Company's estimate of fair
value for these businesses, considering expected future cash flows and
profitability. The Company intends to complete its annual test for impairment by
the end of the year 2002.
6
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
NOTE 2. RECENT ACCOUNTING DEVELOPMENT - (CONTINUED)
Following is a reconciliation showing "Income (loss) before extraordinary
item and cumulative effect of accounting change," "Net income (loss)" and
related earnings per share, as reported for the third quarters and nine months
ended September 30, 2001 and September 29, 2002, and as adjusted to exclude
amortization of goodwill.
Third Quarter Ended Nine Months Ended
-------------------- ------------------
Sept. 30, Sept. 29, Sept. 30, Sept. 29,
2001 2002 2001 2002
-------- --------- -------- --------
(Thousands, except per share amounts)
Income (loss) before extraordinary
item and cumulative effect of
accounting change, as reported..... $ (1,877) $ 7,769 $21,178 $ 43,545
Add back: goodwill amortization...... 4,048 - 12,144 -
--------- -------- ------- ---------
Income before extraordinary item and
cumulative effect of accounting
change, as adjusted................ $ 2,171 $ 7,769 $33,322 $ 43,545
========= ======== ======= =========
Net income (loss), as reported....... $ (1,877) $ 7,769 $20,738 $(116,580)
Add back: goodwill amortization...... 4,048 - 12,144 -
--------- -------- ------- ---------
Net income (loss), as adjusted....... $ 2,171 $ 7,769 $32,882 $(116,580)
========= ======== ======= =========
Earnings per common share:
Basic:
Net income (loss), as reported .. $ (.03) $ .12 $ .31 $ (1.80)
Goodwill amortization ........... .06 - .19 -
--------- -------- ------- ---------
Net income (loss), as adjusted... $ .03 $ .12 $ .50 $ (1.80)
========= ======== ======= =========
Diluted:
Net income (loss), as reported .. $ (.03) $ .12 $ .31 $ (1.80)
Goodwill amortization ........... .06 - .19 -
--------- -------- ------- ---------
Net income (loss), as adjusted... $ .03 $ .12 $ .50 $ (1.80)
========= ======== ======= =========
7
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
NOTE 3. GAIN ON SALE OF ASSETS
In April 2002, the Company sold its Haifa, Israel-based FineTech, Ltd.
business to Pharmaceutical Resources, Inc. ("PRI") for $32 million. The Company
recorded a second quarter pre-tax gain, after expenses, of $5.5 million related
to this transaction. Also see Note 4.
NOTE 4. GAINS ON SETTLEMENT OF CONTRACTS
In December 2001, the Company entered into a letter agreement to sell its
pharmaceutical fine chemicals business, including its Haifa, Israel-based
FineTech Ltd. business and its Columbus, Ohio manufacturing facility to PRI. In
February 2002, the Company received a $250,000 payment from PRI in consideration
of extending the negotiations pursuant to the letter agreement. In March 2002,
the Company announced that the sale would not be consummated due to the failure
of PRI to proceed with the transaction in a timely manner. Under the terms of
the letter agreement, the Company received a $3.0 million break-up fee.
Accordingly, the Company recognized a first quarter 2002 pre-tax gain of $2.8
million, representing the total cash received in February and March of $3.25
million less related expenses of $0.4 million.
In the second quarter of 2002, the Company received $4.0 million in
settlement of a manufacturing and supply contract with a customer of the Fine
Chemicals business. After related expenses, a pre-tax gain of $3.9 million was
recognized.
NOTE 5. INVESTMENT INCOME (LOSS)
Investment income (loss) for the third quarter and first nine months of
2002 reflects a $39.0 million other than temporary impairment charge related to
an available-for-sale equity security held in the Company's investment
portfolio. The Company regularly reviews investment securities for impairment
based on criteria that includes the length of time and the extent to which cost
exceeds market value.
NOTE 6. ACQUISITION
In April 2002, the Company acquired the roofing granules manufacturing
operations in Ione, California of Reed Minerals, a division of Harsco
Corporation. In a related transaction, the Company also acquired the adjacent
quarry operations and certain mining assets from Hanson Aggregates Mid-Pacific,
Inc. The total purchase price of the acquisitions was $11.4 million.
8
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
NOTE 7. COMPREHENSIVE INCOME (LOSS)
Third Quarter Ended Nine Months Ended
-------------------- --------------------
Sept. 30, Sept. 29, Sept. 30, Sept. 29,
2001 2002 2001 2002
-------- -------- --------- ---------
(Thousands)
Net income (loss)............................ $ (1,877) $ 7,769 $ 20,738 $(116,580)
-------- ------- -------- ---------
Other comprehensive income (loss), net of tax:
Change in unrealized losses on
available-for-sale securities:
Unrealized holding gains (losses) arising
during the period, net of income tax
(provision) benefit of $17,154, $8,435,
$58,890 and $(3,639), respectively........ (33,478) (13,803) (114,365) 13,147
Less: reclassification adjustment for
losses included in net income, net of
income tax benefit of $1,223, $13,405,
$1,534 and $10,723, respectively.......... (1,526) (25,815) (2,100) (16,314)
-------- ------- -------- ---------
Total change for the period................. (31,952) 12,012 (112,265) 29,461
-------- ------- -------- ---------
Change in unrealized losses on derivative
hedging instruments - cash flow hedges:
Net derivative losses, net of income tax
benefit of $443, $0, $1,070
and $12, respectively..................... (819) - (1,979) (22)
Less: reclassification adjustment for
losses included in net income, net of
income tax benefit of $151, $0, $341
and $534, respectively.................... (280) - (630) (986)
-------- ------- -------- ---------
Total change for the period................. (539) - (1,349) 964
-------- ------- -------- ---------
Foreign currency translation adjustment....... 8,023 (1,127) (953) 10,105
-------- ------- -------- ---------
Total other comprehensive income (loss)....... (24,468) 10,885 (114,567) 40,530
-------- ------- -------- ---------
Comprehensive income (loss)................... $(26,345) $18,654 $(93,829) $ (76,050)
======== ======= ======== =========
Changes in the components of "Accumulated other comprehensive loss" for the
nine months ended September 29, 2002 are as follows:
Unrealized Unrealized Cumulative
Gains (Losses) Losses on Foreign Accumulated
on Available- Derivative Currency Other
for-Sale Hedging Translation Comprehensive
Securities Instruments Adjustment Loss
------------ ----------- ----------- -------------
(Thousands)
Balance, December 31, 2001.. $ (32,443) $ (964) $ (27,695) $ (61,102)
Change for the period....... 29,461 964 10,105 40,530
------------ -------- --------- ---------
Balance, September 29, 2002. $ (2,982) $ - $ (17,590) $ (20,572)
============= ======== ========= ==========
9
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
NOTE 8. BUSINESS SEGMENT INFORMATION
Third Quarter Ended Nine Months Ended
--------------------- --------------------
Sept. 30, Sept. 29, Sept. 30, Sept. 29,
2001 2002 2001 2002
--------- --------- -------- ---------
(Thousands)
Net sales (1):
Personal Care............................. $ 45,487 $ 51,047 $ 150,599 $ 156,164
Pharmaceutical, Food and Beverage......... 57,846 62,269 169,645 181,039
Performance Chemicals, Fine Chemicals and
Industrial.............................. 61,510 70,493 211,068 230,751
--------- --------- --------- ---------
Total Specialty Chemicals............... 164,843 183,809 531,312 567,954
Mineral Products (2)...................... 23,790 24,554 63,812 74,257
--------- --------- --------- ---------
Net sales................................... $ 188,633 $ 208,363 $ 595,124 $ 642,211
========= ========= ========= =========
Operating income(1):
Personal Care............................. $ 5,743 $ 10,008 $ 27,026 $ 28,101
Pharmaceutical, Food and Beverage......... 12,430 16,990 39,354 43,429
Performance Chemicals, Fine Chemicals and
Industrial (3).......................... 7,322 2,959 16,907 20,776
--------- --------- --------- --------
Total Specialty Chemicals............... 25,495 29,957 83,287 92,306
Mineral Products.......................... 5,078 5,540 8,434 18,428
--------- --------- --------- --------
Total segment operating income............ 30,573 35,497 91,721 110,734
Unallocated corporate office.............. (61) 30 283 (84)
--------- --------- --------- ---------
Total operating income...................... 30,512 35,527 92,004 110,650
Interest expense, investment income (loss)
and other expense, net.................... (33,378) (23,706) (59,353) (44,678)
--------- --------- --------- ---------
Income (loss) before income taxes........... $ (2,866) $ 11,821 $ 32,651 $ 65,972
========= ========== ========== =========
(1) Net sales and operating income for the third quarter and the first nine
months of 2001 for the three Specialty Chemicals business segments have
been restated to conform to the 2002 presentation. In 2002, the Company
realigned its Alginates business based on the markets for its products.
Sales and operating income for the Alginates business are now included in
the Personal Care, Pharmaceutical, Food and Performance Chemicals
businesses. Prior to 2001, the sales and operating income of the Alginates
business represented the Food business of the Pharmaceutical, Food and
Beverage business segment.
(2) Includes sales to Building Materials Corporation of America, an affiliate,
and its subsidiaries, of $18.7 and $19.1 million for the third quarter of
2001 and 2002, respectively, and $50.5 and $57.9 million for the first nine
months of 2001 and 2002, respectively.
(3) Operating income for the Performance Chemicals, Fine Chemicals and
Industrial business segment for the first nine months of 2002 includes a
gain of $5.5 million from the sale of the FineTech business (see Note 3)
and a $3.9 million gain from the settlement of a manufacturing and supply
contract (see Note 4). For the first nine months of 2002, operating income
for the Performance Chemicals, Fine Chemicals and Industrial business
segment also includes a gain of $2.8 million from the termination of a
contract related to the sale of the FineTech business (see Note 4).
10
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
Note 9. HEDGING AND DERIVATIVES
In June 2001, ISP Chemco Inc., an indirect wholly owned subsidiary of the
Company, entered into $450.0 million of Senior Credit Facilities, which include
a $225.0 million term loan. The Company designated interest rate swaps, with a
notional amount of $100 million, as a hedge of its exposure to changes in the
eurodollar rate under the term loan. The interest rate swaps are structured to
receive interest based on the eurodollar rate and pay interest on a fixed rate
basis. A cash flow hedging relationship was established whereby the interest
rate swaps hedged the risk of changes in the eurodollar rate related to
borrowings against the term loan through July 2002. These swaps matured in June
and July of 2002. During the first nine months of 2002, $1.9 million related to
the interest rate swaps was reclassified and charged against interest expense.
NOTE 10. INVENTORIES
Inventories comprise the following:
December 31, September 29,
2001 2002
------------ -------------
(Thousands)
Finished goods................ $120,797 $110,739
Work-in-process............... 36,960 31,943
Raw materials and supplies.... 32,825 34,902
-------- --------
Inventories................... $190,582 $177,584
======== ========
At December 31, 2001 and September 29, 2002, $60.1 and $61.6 million,
respectively, of domestic inventories were valued using the LIFO method. If the
FIFO inventory method had been used for these inventories, the value of
inventories would have been $3.7 and $2.1 million higher at December 31, 2001
and September 29, 2002, respectively.
11
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
NOTE 11. CONTINGENCIES
Environmental Litigation
The Company, together with other companies, is a party to a variety of
proceedings and lawsuits involving environmental matters ("Environmental
Claims") under the Comprehensive Environmental Response Compensation and
Liability Act, Resource Conservation and Recovery Act and similar state laws, in
which recovery is sought for the cost of cleanup of contaminated sites or
remedial obligations are imposed, a number of which Environmental Claims are in
the early stages or have been dormant for protracted periods.
While the Company cannot predict whether adverse decisions or events can
occur in the future, in the opinion of the Company's management, the resolution
of the Environmental Claims should not be material to the business, liquidity,
results of operations, cash flows or financial position of the Company. However,
adverse decisions or events, particularly as to increases in remedial costs,
discovery of new contamination, assertion of natural resource damages, and the
liability and the financial responsibility of the Company's insurers and of the
other parties involved at each site and their insurers, could cause the Company
to increase its estimate of its liability in respect of those matters. It is not
currently possible to estimate the amount or range of any additional liability.
For further information regarding environmental matters, reference is made
to Note 19 to Consolidated Financial Statements contained in the Form 10-K.
Tax Claim Against G-I Holdings Inc.
The Company and certain of its subsidiaries were members of a consolidated
group for Federal income tax purposes that included G-I Holdings Inc., (the "G-I
Holdings Group") in certain prior years and, accordingly, would be severally
liable for any tax liability of the G-I Holdings Group in respect of those prior
years. Effective as of January 1, 1997, neither the Company nor any of its
subsidiaries are members of the G-I Holdings Group. In January 2001, G-I
Holdings filed a voluntary petition for reorganization under Chapter 11 of the
U.S. Bankruptcy Code due to its asbestos-related bodily injury claims relating
to the inhalation of asbestos fiber.
On September 15, 1997, G-I Holdings received a notice from the Internal
Revenue Service (the "IRS") of a deficiency in the amount of $84.4 million
(after taking into account the use of net operating losses and foreign tax
credits otherwise available for use in later years) in connection with the
formation in 1990 of Rhone-Poulenc Surfactants and Specialties, L.P. (the
"surfactants partnership"), a partnership in which G-I Holdings held an
interest. G-I Holdings has advised the Company that it believes that it will
prevail in the tax matter arising out of the surfactants partnership, although
there can be no assurance in this
12
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
NOTE 11. CONTINGENCIES - (CONTINUED)
regard. The Company believes that the ultimate disposition of this matter
will not have a material adverse effect on its business, financial position or
results of operations. On September 21, 2001, the IRS filed a proof of claim
with respect to such deficiency against G-I Holdings in the G-I Holdings
bankruptcy. On May 7, 2002, G-I Holdings filed an objection to that proof of
claim. On July 13, 2002, the IRS filed a motion with the U.S. District Court for
a withdrawal of the reference to the bankruptcy court of G-I Holdings' objection
to the proof of claim, which motion remains pending. If such proof of claim is
sustained, the Company and/or some of the Company's subsidiaries, together with
G-I Holdings and several current and former subsidiaries of G-I Holdings, would
be severally liable for such taxes and interest in the amount of approximately
$250.0 million should G-I Holdings be unable to satisfy such liability. For
additional information relating to G-I Holdings, reference is made to Notes 8,
16 and 19 to Consolidated Financial Statements contained in the Form 10-K.
NOTE 12. NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 establishes accounting and reporting
standards for legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and the
normal operation of a long-lived asset. SFAS No. 143 requires that the fair
value of a liability for an asset retirement obligation be recognized in the
period in which it is incurred. Upon initial recognition of such liability, an
entity must capitalize the asset retirement cost by increasing the carrying
amount of the related long-lived asset and subsequently depreciating the asset
retirement cost over the useful life of the related asset. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002, although earlier
application is encouraged. The Company is in the process of assessing the impact
of this Statement on its financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 eliminates the requirement of SFAS No. 4 that gains
and losses on the early extinguishments of debt be recorded as an extraordinary
item unless such gains and losses meet the criteria of APB No. 30 for
classification as extraordinary. The rescission of SFAS No. 4 is effective for
fiscal years beginning after May 15, 2002, although early application is
encouraged. The Company intends to adopt SFAS No. 145 effective January 1, 2003,
which will result in the Company's first quarter 2002 pre-tax loss of $7.1
million on the early extinguishment of debt being reclassified to other expense,
net.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or
13
INTERNATIONAL SPECIALTY PRODUCTS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
NOTE 12. NEW ACCOUNTING PRONOUNCEMENTS - (CONTINUED)
disposal activities and supercedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred,
and concludes that an entity's commitment to an exit plan does not by itself
create a present obligation that meets the definition of a liability. This
Statement also establishes that fair value is the objective of initial
measurement of the liability. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. The Company is in the process of assessing the impact of this
Statement on its financial statements.
NOTE 13. PROPOSED PURCHASE OF SHARES OF COMMON STOCK
On July 8, 2002, the Company announced that its Board of Directors had
received a letter from Samuel J. Heyman, the Chairman of the Board, proposing
that the Board consider a going private transaction whereby holders of shares of
the Company's common stock (other than those shares beneficially owned by Mr.
Heyman) would receive $10 in cash per share. The Board of Directors formed a
Special Committee that consists of Company directors who are not officers of the
Company to evaluate this proposal.
On November 7, 2002, the Company announced that the Special Committee and
Mr. Heyman reached an agreement on such transaction whereby the holders of the
Company's publicly traded shares (other than Mr. Heyman) would receive $10.30 in
cash per share.
On November 8, 2002, the Company's Board of Directors approved the
agreement reached by the Special Committee and Mr. Heyman and also approved the
definitive merger agreement, as the transaction is expected to proceed as a
merger. Completion of the merger will be subject to certain closing conditions,
including approval by holders of a majority of the Company's shares and holders
of a majority of the votes cast by holders of shares not beneficially owned by
Mr. Heyman or the Directors or officers of the Company. The transaction has a
value of approximately $130 million.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Unless otherwise indicated by the context, "we," "us," "our," and "ISP"
refer to International Specialty Products Inc. and its consolidated
subsidiaries.
CRITICAL ACCOUNTING POLICIES
The preparation of our financial statements in conformity with accounting
principles generally accepted in the United States requires our management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues, and expenses, and related disclosure of contingent
liabilities. On an on-going basis, we evaluate our estimates, including but not
limited to those related to doubtful accounts, inventory valuation, investments,
environmental liabilities, goodwill and intangible assets, pensions and other
postemployment benefits, and contingent liabilities. We base our estimates on
historical experience adjusted for current conditions, and on various other
assumptions that are believed to be reasonable under the current circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities. Actual results may differ from these estimates
under different assumptions or conditions. We do not anticipate any changes in
management estimates that would have a material impact on our operations,
liquidity or capital resources. We believe the following critical accounting
policies are the most important to the portrayal of our financial condition and
results of operations and require our management's more significant judgments
and estimates in the preparation of our consolidated financial statements.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. Management
continuously assesses the financial condition of our customers and the markets
in which these customers participate. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required.
Inventories
Inventories are valued at the lower of cost or market. The LIFO (last-in,
first-out) method is utilized to determine cost for substantially all domestic
acetylene-based finished goods and work-in-process and the raw materials to
produce these products. All other inventories are valued on the FIFO (first-in,
first out) method. We write down our inventories for estimated obsolescence or
unmarketable inventories equal to the difference between the cost of inventories
and their estimated market value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than those
projected by management, additional inventory write-downs may be required.
15
Short-Term Investments
Our investment strategy is to seek returns in excess of money market rates
on our available cash while minimizing market risks. There can be no assurance
that we will be successful in implementing such a strategy. We invest primarily
in international and domestic arbitrage and securities of companies involved in
acquisition or reorganization transactions. From time to time, we invest in
securities of companies that we consider undervalued. With respect to our equity
positions, we are exposed to the risk of market loss.
Our short-term investments are reported at fair value. For securities
classified as "trading" (including short positions), unrealized gains and losses
are reflected in the results of operations. For securities classified as
"available-for-sale," unrealized gains and losses, net of income tax effect, are
included in a separate component of shareholder's equity, "Accumulated other
comprehensive income (loss)." The determination of cost in computing realized
and unrealized gains and losses is based on the specific identification method.
We periodically review available-for-sale securities for other than temporary
impairment when the cost basis of a security exceeds the market value. Declines
in the value of these investments or adverse changes in market conditions could
result in impairment charges in the future.
Goodwill and Other Intangibles
Through December 31, 2001, we amortized goodwill and certain other
intangible assets on a straight-line basis over the expected useful lives of the
underlying assets. In accordance with the provisions of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets," effective
January 1, 2002, goodwill is no longer being amortized over its estimated useful
life, but rather will be subject to at least an annual assessment for impairment
and more frequently if circumstances indicate a possible impairment. We adopted
SFAS No. 142 on January 1, 2002. Accordingly, we completed a transitional
impairment test, effective January 1, 2002, and recognized a goodwill impairment
loss of $155.4 million as the cumulative effect of a change in accounting
principle. The write-off represents the goodwill associated with our Performance
Chemicals, Fine Chemicals and Industrial business segment. We use both a market
comparable approach and income approach to determine the fair value of our
reporting units. We will perform our annual test for impairment before the end
of the year 2002.
Other intangible assets will be amortized over their useful lives. The
useful life of an intangible asset is based on management's assumptions
regarding the expected use of the asset and other assumptions. If events or
circumstances indicate that the life of an intangible asset has changed, it
could result in higher future amortization charges or recognition of an
impairment loss.
Environmental Liability
We accrue environmental costs when it is probable that we have incurred a
liability and the expected amount can be reasonably estimated. The amount
accrued reflects our assumptions about remedial requirements at
16
the contaminated site, the nature of the remedy, the outcome of discussions
with regulatory agencies and other potential responsible parties at multi-party
sites, and the number and financial viability of other potentially responsible
parties. Adverse decisions or events, particularly as to increases in remedial
costs, discovery of new contamination, assertion of natural resource damages,
plans for development of our Linden, New Jersey property, and the liability and
the financial responsibility of our insurers and of the other parties involved
at each site and their insurers, could cause us to increase our estimate of
liability in respect of those matters. It is not currently possible to estimate
the amount or range of any additional liability.
Pension and Other Postemployment Benefits
We maintain defined benefit plans that provide eligible employees with
retirement benefits. In addition, while we generally do not provide
postretirement medical and life insurance benefits, we subsidize such benefits
for certain employees and certain retirees. The costs and obligations related to
these benefits reflect our assumptions related to general economic conditions
(particularly interest rates), expected return on plan assets, and rate of
compensation increases for employees. Projected health care benefits
additionally reflect our assumptions about health care cost trends. The cost of
providing plan benefits also depends on demographic assumptions including
retirements, mortality, turnover, and plan participation. If actual experience
differs from these assumptions, the cost of providing these benefits could
increase or decrease.
RESULTS OF OPERATIONS - THIRD QUARTER 2002 COMPARED WITH
THIRD QUARTER 2001
We recorded third quarter 2002 net income of $7.8 million ($.12 diluted
earnings per share) compared with a net loss of $1.9 million ($.03 per diluted
share) in the third quarter of 2001. Third quarter 2001 results reflected $4.0
million of goodwill amortization. Net income for the third quarter of 2001,
adjusted to exclude the goodwill amortization, was $2.1 million ($.03 diluted
earnings per share). On a comparable basis, the improved results for the third
quarter of 2002 reflected $8.5 million higher investment income, $4.5 million
lower interest expense and $1.0 million higher operating income, partially
offset by $3.4 million increased other expense, net.
Net sales for the third quarter of 2002 were $208.4 million compared with
$188.6 million for the same period in 2001. The 10.5% increase in sales resulted
primarily from the contribution to sales from the biocides business ($7.9
million), which was acquired on December 31, 2001, higher unit volumes in the
Personal Care, Pharmaceutical, Performance Chemicals and Industrial businesses
(totaling $13.4 million), and the favorable impact of the weaker U.S. dollar in
Europe ($4.4 million). Lower pricing in the Industrial and Personal Care
businesses (totaling $4.7 million) partially offset the sales gains.
Gross margins for the third quarter of 2002 were 36.6% compared with 39.1%
in the third quarter of 2001. The decline in margins
17
resulted primarily from a reduction in the Fine Chemicals business due to
the Polaroid bankruptcy and price declines in the Industrial business.
Operating income for the third quarter of 2002 was $35.5 million compared
with $30.5 million for the third quarter of 2001. Excluding the $4.0 million of
goodwill amortization in the third quarter of 2001, operating income was $34.5
million for the third quarter of 2001. On a comparable basis, operating income
in the Personal Care business was up $3.0 million mainly due to higher volumes,
while in the Pharmaceutical, Food and Beverage business, operating income
increased $3.5 million primarily due to improved volumes and mix in
pharmaceutical products. Operating income was lower in Performance Chemicals,
Fine Chemicals and Industrial, as strength in Performance Chemicals (up $3.9
million), which includes the additional profit contribution from the biocides
business, did not offset unfavorable pricing and higher manufacturing costs in
Industrial (totaling $5.8 million) and lower volumes in Fine Chemicals ($7.0
million). Operating income for the Mineral Products business decreased by $0.3
million on 3% higher sales due to increased manufacturing costs. Selling,
general and administrative expenses for the third quarter of 2002 increased 4%
to $40.6 million from $39.2 million in the same period last year, primarily due
to the biocides acquisition and to higher selling and distribution costs, but
those expenses as a percentage of sales were 19.5% compared with 20.8% in last
year's third quarter.
Interest expense for the third quarter of 2002 was $20.6 million versus
$25.1 million for the same period last year. The 18% decrease was due to lower
average borrowings. Investment income in the third quarter of 2002 was $1.2
million compared with investment losses of $7.3 million in the same period last
year. Investment income for the third quarter of 2002 reflects a $39.0 million
impairment charge related to an available-for-sale equity security held in our
investment portfolio. Other expense, net, for the third quarter of 2002 was $4.3
million compared with $1.0 million in last year's third quarter, with the
increased expense due to unfavorable foreign exchange.
Business Segment Review
A discussion of operating results for each of our business segments
follows. We operate our Specialty Chemicals business through three reportable
business segments, in addition to the Mineral Products segment. Each business
segment was favorably impacted in the third quarter of 2002 by the absence of
goodwill amortization. The business segment discussion that follows excludes the
impact of goodwill amortization on third quarter 2001 results. Goodwill
amortization in the third quarter of 2001 by business segment was as follows:
(Millions)
----------
Personal Care $1.2
Pharmaceutical, Food and Beverage 1.0
Performance Chemicals, Fine Chemicals
and Industrial 1.0
Mineral Products 0.8
18
Personal Care
Sales in the third quarter of 2002 were $51.0 million compared with $45.5
million for the same period last year, while operating income for the third
quarter of 2002 increased to $10.0 million from $7.0 million in last year's
third quarter. The 12% increase in sales resulted from higher unit volumes in
both hair care and skin care products ($5.2 million), mainly in North America
and Europe, and also as a result of the favorable impact of the weaker U.S.
dollar in Europe ($1.2 million). The higher operating income resulted from the
favorable volumes ($3.7 million), the favorable impact of the weaker dollar
($0.9 million) and $1.0 million lower operating expenses, partially offset by
unfavorable manufacturing costs ($1.8 million).
Pharmaceutical, Food and Beverage
Sales for the Pharmaceutical, Food and Beverage segment were $62.3 million
for the third quarter of 2002 compared with $57.8 million for the third quarter
of 2001. The 8% sales growth reflected higher unit volumes ($3.1 million),
primarily in the pharmaceutical excipients market in North America and Asia, and
also reflected the favorable impact of the weaker U.S dollar in Europe ($1.4
million).
Operating income for the Pharmaceutical, Food and Beverage segment was
$17.0 million in the third quarter of 2002 compared with $13.5 million in the
same period last year. The 26% increase in earnings primarily resulted from
improved volumes ($3.3 million) in pharmaceutical products, and the favorable
impact of the weaker dollar ($1.1 million), partially offset by unfavorable
manufacturing costs ($0.9 million).
Performance Chemicals, Fine Chemicals and Industrial
Sales in the third quarter of 2002 were $70.5 million compared with $61.5
million in the third quarter of 2001. The 15% increase in sales was primarily
attributable to the biocides business ($7.9 million), which was acquired on
December 31, 2001. The increased sales also reflected higher Performance
Chemicals and Industrial volumes (totaling $5.5 million) in the industrial
specialty, agriculture and specialty coatings markets, in addition to the
favorable impact of the weaker U.S dollar in Europe ($1.8 million). These sales
increases were partially offset by lower pricing in the Industrial business
($3.9 million). In the Fine Chemicals business, the lack of sales to Polaroid
more than offset increased sales volumes of bulk pharmaceuticals and
pharmaceutical intermediates.
Operating income for the Performance Chemicals, Fine Chemicals and
Industrial segment was $3.0 million in the third quarter of 2002 compared with
$8.4 million for the third quarter of 2001. The reduction in operating income
was attributable to losses from the Fine Chemicals business due to unfavorable
volumes and the loss of sales to Polaroid (totaling $7.0 million). In addition,
Industrial profits were lower due to the impact of unfavorable pricing ($3.9
million) and unfavorable manufacturing costs ($2.0 million). Partially
offsetting these reductions in operating profits was $3.9 million higher
operating income in Performance Chemicals due to
19
higher volumes and favorable manufacturing efficiencies (totaling $1.9
million) and also to the additional profit contribution from the biocides
business.
Mineral Products
Sales for the Mineral Products segment for the third quarter of 2002 were
$24.6 million compared with $23.8 million for the third quarter of 2001. The 3%
increase was due equally to higher sales to Building Materials Corporation of
America, an affiliate, and to higher third party sales. We are beginning to
experience competitive pricing pressures in the Mineral Products business as a
result of additional capacity coming on stream in the industry.
Operating income for the third quarter of 2002 was $5.5 million compared
with $5.8 million for the third quarter of 2001, reflecting unfavorable
manufacturing costs due to start-up costs associated with the Ione, California
roofing granules plant acquired in April 2002.
RESULTS OF OPERATIONS - FIRST NINE MONTHS 2002 COMPARED WITH
FIRST NINE MONTHS 2001
For the first nine months of 2002, we recorded a net loss of $116.6 million
($1.80 per diluted share) compared with net income of $20.7 million ($.31
diluted earnings per share) in the first nine months of 2001. In accordance with
the adoption of SFAS No. 142, we completed a transitional test for impairment of
goodwill, and, accordingly, recorded a $155.4 million ($2.40 per diluted share)
charge, effective January 1, 2002, for the cumulative effect of a change in
accounting principle. The write-off represents the goodwill associated with our
Performance Chemicals, Fine Chemicals and Industrial business segment and was
based upon our estimate of fair value for these businesses, considering expected
future cash flows and profitability.
First nine months 2002 results also include a $5.5 million pre-tax gain
from the sale of the FineTech business, $6.8 million of pre-tax gains from
contract settlements and an after-tax extraordinary charge of $4.7 million ($.07
per diluted share) on the early retirement of debt. First nine months 2001
results included $12.1 million of goodwill amortization, prior to the adoption
of SFAS No. 142, and an after-tax charge of $0.4 million ($.01 per diluted
share) for the cumulative effect of adopting SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." Excluding such charges and
nonrecurring gains discussed above, adjusted "Income before extraordinary item
and cumulative effect of accounting change" for the first nine months of 2002
was $35.5 million ($.55 diluted earnings per share) compared with $33.3 million
($.50 diluted earnings per share) for the first nine months of 2001. On a
comparable basis, the higher results for the first nine months of 2002 were
attributable to $13.0 million higher investment income and $3.5 million lower
other expense, net, partially offset by $5.7 million lower adjusted operating
income (excluding the nonrecurring gains) and $1.8 million higher interest
expense.
20
Net sales for the first nine months of 2002 were $642.2 million compared
with $595.1 million for the same period in 2001. The 8% increase in sales in the
first nine months of 2002 resulted primarily from the contribution to sales from
the biocides business ($25.6 million), which was acquired on December 31, 2001,
and by higher unit volumes in the Pharmaceutical, Mineral Products, Personal
Care and Industrial businesses (totaling $35.6 million). The weaker U.S. dollar
in Europe also had a favorable impact ($5.2 million) on net sales. Partially
offsetting these increases was lower pricing in the Industrial, Fine Chemicals
and Personal Care businesses (totaling $19.2 million).
Gross margins for the first nine months of 2002 were 35.2% compared with
37.7% in the first nine months of 2001. The decline in margins resulted
primarily from a reduction in the Fine Chemicals business due to the Polaroid
bankruptcy, unfavorable manufacturing costs, and the lower pricing in the
Industrial, Fine Chemicals and Personal Care businesses.
Operating income for the first nine months of 2002 was $110.7 million
compared with $92.0 million for the first nine months of 2001. Excluding the
$12.2 million of nonrecurring pre-tax gains on the sale of the FineTech business
and the settlements of contracts in the first nine months of 2002 and $12.1
million of goodwill amortization in the first nine months of 2001, adjusted
operating income was $98.4 million for the first nine months of 2002 compared
with $104.1 million for the first nine months of 2001. On a comparable basis,
the $5.7 million decrease in operating income in the first nine months of 2002
was primarily attributable to lower results in the Fine Chemicals, Industrial
and Personal Care businesses (totaling $19.7 million). Partially offsetting
these lower results were improved operating profits in the Mineral Products and
Pharmaceutical businesses (totaling $10.2 million) and the contribution to
income from the biocides business. Selling, general and administrative expenses
increased 5% in the first nine months of 2002 to $127.0 million from $120.5
million in the same period last year, primarily due to the biocides acquisition
and higher selling and distribution costs, but those expenses as a percentage of
sales were 19.8% compared with 20.2% last year.
Interest expense for the first nine months of 2002 was $64.6 million versus
$62.8 million for the same period last year. The increase was due to higher
average interest rates, partially offset by lower average borrowings. Investment
income for the first nine months of 2002 was $26.5 million compared with $13.5
million in the same period last year. Investment income for the first nine
months of 2002 reflects a $39.0 million impairment charge related to an
available-for-sale equity security held in our investment portfolio. Other
expense, net, for the first nine months of 2002 was $6.5 million compared with
other expense, net, of $10.1 million in last year's period, with the lower
expense due to the impact of a weaker U.S. dollar in Europe and Asia and a $1.4
million higher provision for environmental liability in last year's first nine
months.
21
Business Segment Review
A discussion of operating results for each of our business segments
follows. We operate our Specialty Chemicals business through three reportable
business segments, in addition to the Mineral Products segment. Each business
segment was favorably impacted in the first nine months of 2002 by the absence
of goodwill amortization. The business segment discussion that follows excludes
the impact of goodwill amortization on nine months 2001 results. Goodwill
amortization in the first nine months of 2001 by business segment was as
follows:
(Millions)
----------
Personal Care $3.6
Pharmaceutical, Food and Beverage 3.1
Performance Chemicals, Fine Chemicals
and Industrial 3.1
Mineral Products 2.3
Personal Care
Sales in the first nine months of 2002 were $156.2 million compared with
$150.6 million in the same period last year, while operating income for the
first nine months of 2002 decreased to $28.1 million from $30.7 million in the
same period last year. The 4% increase in sales resulted from higher unit
volumes in both hair care and skin care products ($7.3 million), mainly in North
America and Europe, and also as a result of the favorable impact of the weaker
U.S. dollar in Europe ($1.3 million). The lower operating income resulted
primarily from unfavorable manufacturing costs and pricing ($7.0 million),
partially offset by the impact of the favorable volumes ($3.5 million) and the
favorable impact of the weaker U.S. dollar ($0.9 million).
Pharmaceutical, Food and Beverage
Sales for the Pharmaceutical, Food and Beverage segment were $181.0 million
for the first nine months of 2002, a 7% increase compared with $169.6 million
for the first nine months of 2001. Sales for the Pharmaceutical business
increased by 11.5% in the first nine months of 2002, reflecting higher unit
volumes ($11.1 million), primarily in the excipients and oral care markets in
Europe and North America. Sales for the Beverage and alginates food businesses
decreased by 2% and 4%, respectively, due to lower unit volumes and pricing
(totaling $1.7 million), primarily in Europe and Latin America.
Operating income for the Pharmaceutical, Food and Beverage segment was
$43.4 million in the first nine months of 2002 compared with $42.4 million in
the same period last year. Operating income for the Pharmaceutical business
increased 8% in the first nine months of 2002 compared with the same period in
2001. The improvement reflected the impact of the higher unit volumes ($5.0
million) and the favorable impact of the weaker U.S. dollar ($0.9 million),
partially offset by unfavorable manufacturing costs ($0.9 million). Operating
results for the Beverage and alginates food businesses decreased by a
22
total of $2.7 million in the first nine months of 2002 due primarily to
unfavorable manufacturing costs ($1.5 million) and, to a lesser extent, to the
lower volumes and pricing.
Performance Chemicals, Fine Chemicals and Industrial
Sales in the first nine months of 2002 were $230.8 million compared with
$211.1 million in the first nine months of 2001. The 9% higher sales were
attributable to the biocides business ($25.6 million), which was acquired on
December 31, 2001. Sales for the Performance Chemicals, Fine Chemicals and
Industrial businesses, excluding biocides, decreased by a total of $5.9 million
(3%) due to lower pricing in Industrial and Fine Chemicals (totaling $16.2
million). Partially offsetting these sales declines were higher Industrial
volumes ($8.7 million) and the favorable impact of the weaker U.S. dollar in
Europe ($2.5 million). Market selling prices of butanediol decreased in the
first nine months of 2002 compared with average 2001 levels due to weakening
demand and in anticipation of new capacity coming on stream in Europe. Sales for
the Fine Chemicals business were unfavorably impacted due to the loss of
Polaroid sales as a result of Polaroid's bankruptcy.
Operating income for the Performance Chemicals, Fine Chemicals and
Industrial segment was $20.8 million in the first nine months of 2002 compared
with $20.0 million for the first nine months of 2001. Excluding the $5.5 million
gain on the sale of the FineTech business and the $6.8 million of gains on
contract settlements, operating income for the first nine months of 2002 was
$8.5 million. The decline in operating profits was primarily attributable to
losses in the Fine Chemicals business due to the loss of Polaroid sales and
unfavorable pricing ($3.1 million). Operating profits for the Industrial
business were 56% lower for the first nine months of 2002 due to the impact of
unfavorable pricing ($13.0 million). Partially offsetting these unfavorable
factors were favorable manufacturing efficiencies ($4.4 million) due to
consolidation of our butanediol production at our Marl, Germany facility,
together with lower methanol and natural gas prices. The lower operating profits
from the Fine Chemicals and Industrial businesses were partially offset by $5.7
million higher operating income in Performance Chemicals, primarily reflecting
the profit contribution from the biocides business, and also due to favorable
manufacturing efficiencies and volumes (totaling $2.2 million).
Mineral Products
Sales for the Mineral Products segment for the first nine months of 2002
were $74.3 million compared with $63.8 million for the first nine months of
2001. The $10.5 million (16%) increase reflected $7.4 million (15%) higher sales
to Building Materials Corporation of America, an affiliate, and $3.1 million
(23%) higher third party sales. The increased sales reflected higher unit
volumes ($8.6 million) resulting from an increased market demand for roofing
granules. We are beginning to experience competitive pricing pressures in the
Mineral Products business as a result of additional capacity coming on stream in
the industry.
23
Operating income for the first nine months of 2002 was $18.4 million, a 72%
increase compared with $10.7 million for the same period in 2001, reflecting
favorable manufacturing efficiencies and lower natural gas costs ($3.9 million),
as well as the impact of the higher volumes.
LIQUIDITY AND FINANCIAL CONDITION
During the first nine months of 2002, our net cash outflow before financing
activities was $12.3 million, reflecting $30.6 million of cash used in
operations, the reinvestment of $42.6 million for capital programs and the
acquisition of a Mineral Products manufacturing facility, net cash proceeds of
$27.3 million from the sale of the FineTech business and $33.6 million of cash
generated from net sales of available-for-sale securities and other short-term
investments.
Cash used in operations in the first nine months of 2002 included a $153.4
million net cash outflow related to net purchases of trading securities.
Excluding this cash outflow, cash provided from operations totaled $122.8
million. Cash generated from a decrease in working capital items totaled $27.1
million during the first nine months of 2002, reflecting a $27.5 million net
increase in payables and accrued liabilities and a $13.8 million decrease in
inventories, partially offset by a $12.8 million increase in receivables. The
higher payables reflect a $16.7 million payable for investments purchased but
not settled as of the end of the third quarter, and the reduced inventories
resulted from an inventory reduction program. The higher receivables resulted
from $16.3 million higher sales in the third quarter of 2002 versus the fourth
quarter of 2001.
Net cash used in financing activities during the first nine months of 2002
totaled $2.0 million, primarily reflecting an $85.3 million decrease in
borrowings under our bank revolving credit facility and a $4.6 million call
premium on the redemption of debt, offset by an $89.0 million increase in
short-term borrowings. On January 14, 2002, we redeemed the remaining $307.9
million aggregate principal amount of our 9% Senior Notes due 2003, which we
refer to as the "2003 Notes." The 2003 Notes were redeemed at a redemption price
of 101.5% of the principal amount plus accrued and unpaid interest to the
redemption date. The redemption was funded utilizing a restricted cash escrow
account which had been established in 2001 in connection with the issuances of
long-term debt. In addition, financing activities included a $1.5 million cash
outlay for repurchases of 177,600 shares of our common stock pursuant to our
repurchase program. At September 29, 2002, 771,462 shares of common stock
remained available for purchase under our repurchase program.
As a result of the foregoing factors, cash and cash equivalents decreased
by $13.7 million during the first nine months of 2002 to $65.8 million,
excluding $461.1 million of trading and available-for-sale securities.
24
On July 8, 2002, we announced that our Board of Directors had received a
letter from Samuel J. Heyman, the Chairman of the Board, proposing that the
Board consider a going private transaction whereby holders of shares of our
common stock (other than those shares beneficially owned by Mr. Heyman) would
receive $10 in cash per share. Such shares total approximately 12.5 million
shares, or approximately 19% of our outstanding shares. The Board of Directors
formed a Special Committee that consists of Company directors who are not
officers of ISP to evaluate this proposal.
On November 7, 2002, we announced that the Special Committee and Mr. Heyman
reached an agreement on such transaction whereby the holders of our publicly
traded shares (other than Mr. Heyman) would receive $10.30 in cash per share.
The agreement followed a determination by the Special Committee that the
transaction consideration is fair to our public shareholders. The Special
Committee has been negotiating with Mr. Heyman regarding his previously
announced proposal of $10 per share. Lehman Brothers Inc. served as financial
advisor to the Special Committee.
On November 8, 2002, our Board of Directors approved the agreement reached
by the Special Committee and Mr. Heyman and also approved the definitive merger
agreement as the transaction is expected to proceed as a merger. Completion of
the merger will be subject to certain closing conditions, including approval by
holders of a majority of our shares and holders of a majority of the votes cast
by holders of shares not beneficially owned by Mr. Heyman or the Directors or
officers of ISP. The total consideration for such shares of approximately $130
million would be paid out of our available funds.
In December 2001, we entered into a letter agreement to sell our
pharmaceutical fine chemicals business to Pharmaceutical Resources Incorporated,
which we refer to as "PRI,", including our Haifa, Israel-based FineTech, Ltd.
business and our Columbus, Ohio manufacturing facility. In February 2002, we
received a $250,000 payment from PRI in consideration of extending the
negotiations pursuant to the letter agreement. In March 2002, we announced that
the sale would not be consummated due to the failure of PRI to proceed with the
transaction in a timely manner. Under the terms of the letter agreement, we
received a $3.0 million break-up fee, which was recorded as income in the first
quarter of 2002 (see Note 4 to Consolidated Financial Statements). Following
negotiations with PRI, in April 2002, we sold the Haifa-based business to PRI
for $32 million. We recorded a second quarter pre-tax gain, after expenses, of
$5.5 million related to this sale.
In April 2002, we acquired the roofing granules manufacturing operations in
Ione, California of Reed Minerals, a division of Harsco Corporation. In a
related transaction, we also acquired the adjacent quarry operations and certain
mining assets from Hanson Aggregates Mid-Pacific, Inc. The total purchase price
of the acquisitions was $11.4 million.
As part of our acquisition of our Freetown, Massachusetts plant in 1998, we
entered into a multi-year agreement to supply the imaging dyes and polymers used
by Polaroid in its instant film business. In October 2001, Polaroid filed for
protection under Chapter 11 of the U.S. Bankruptcy Code. In the third quarter of
2002, the majority of Polaroid's
25
assets were acquired by a new owner. As a result, we no longer have a
long-term supply contract with Polaroid. These events have negatively impacted
the sale of our fine chemicals products and reduced the utilization of our
Freetown plant.
We have an operating lease for a sale-leaseback transaction related to the
Freetown facility, which was entered into in 1998. The lease had an initial term
of four years and, at our option, up to three one-year renewal periods. The
lease provides for a substantial guaranteed payment by us at the end of each
renewal period and includes purchase and return options at fair market values
determined at the inception of the lease. We have the right to exercise a
purchase option with respect to the leased facility, or the facility can be
returned to the lessor and sold to a third party. We are obligated to pay a
maximum guaranteed payment amount upon the return of the facility, currently
$35.8 million, reduced by 50% of any proceeds from the subsequent sale of the
facility in excess of $5.2 million. Under generally accepted accounting
principles, we cannot recognize this future obligation or recognize an
impairment loss relative to the Freetown facility since, as an operating lease,
the Freetown facility is not carried as a long-lived asset on our balance sheet.
However, given the current utilization of the Freetown facility as a result of
the Polaroid bankruptcy, if we should exercise the purchase option at the end of
any future renewal period or at the termination of the lease in 2005, we would
anticipate having to recognize a material impairment charge. However, we are
working toward increasing the utilization of the Freetown plant and have
transferred production of certain personal care products to this facility.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 establishes accounting and reporting
standards for legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and the
normal operation of a long-lived asset. SFAS No. 143 requires that the fair
value of a liability for an asset retirement obligation be recognized in the
period in which it is incurred. Upon initial recognition of such liability, an
entity must capitalize the asset retirement cost by increasing the carrying
amount of the related long-lived asset and subsequently depreciating the asset
retirement cost over the useful life of the related asset. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002, although earlier
application is encouraged. We are in the process of assessing the impact of this
Statement on our financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 eliminates the requirement of SFAS No. 4 that gains
and losses on the early extinguishments of debt be recorded as an extraordinary
item unless such gains and losses meet the criteria of APB No. 30 for
classification as extraordinary. The rescission of SFAS No. 4 is effective for
fiscal years beginning after May 15, 2002, although early application is
encouraged. We intend to adopt SFAS No. 145 effective January 1, 2003, which
will result in our first quarter 2002 pre-tax loss of $7.1 million on the early
extinguishment of debt being reclassified to other expense, net.
26
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supercedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred, and concludes that an entity's
commitment to an exit plan does not by itself create a present obligation that
meets the definition of a liability. This Statement also establishes that fair
value is the objective of initial measurement of the liability. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. We are in the process of assessing the
impact of this Statement on our financial statements.
See Note 11 to Consolidated Financial Statements for information regarding
contingencies.
* * *
Forward-looking Statements
This Quarterly Report on Form 10-Q contains both historical and
forward-looking statements. All statements other than statements of historical
fact are, or may be deemed to be, forward-looking statements within the meaning
of section 27A of the Securities Act of 1933 and section 21E of the Securities
Exchange Act of 1934. These forward-looking statements are only predictions and
generally can be identified by use of statements that include phrases such as
"believe", "expect", "anticipate", "intend", "plan", "foresee" or other words or
phrases of similar import. Similarly, statements that describe our objectives,
plans or goals also are forward-looking statements. Our operations are subject
to certain risks and uncertainties that could cause actual results to differ
materially from those contemplated by the relevant forward-looking statement.
The forward-looking statements included herein are made only as of the date of
this Quarterly Report on Form 10-Q and we undertake no obligation to publicly
update such forward-looking statements to reflect subsequent events or
circumstances. No assurances can be given that projected results or events will
be achieved.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Reference is made to Management's Discussion and Analysis of Financial
Condition and Results of Operations in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2001, for a discussion of "Market-Sensitive
Instruments and Risk Management." As of December 31, 2001, equity-related
financial instruments employed by us to reduce market risk included long
contracts valued at $13.5 million and short contracts valued at $7.2 million. At
September 29, 2002, the value of long contracts was $0.9 million and the value
of short contracts was $0.1 million. Such instruments are marked-to-market each
month, with unrealized gains and losses included in the results of operations.
The unrealized gain (loss) on equity-related long contracts at December 31, 2001
and September 29, 2002 was $176,000 and $(244,000), respectively, and the
unrealized gain on equity-related short contracts was $45,000 and $109,000 at
December 31, 2001 and September 29, 2002, respectively.
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer are
responsible for the design, maintenance and effectiveness of disclosure controls
and procedures (as defined in the Rules 13a-14(c) and 15d-14(c) of the
Securities Exchange Act of 1934).
The effectiveness of the disclosure controls and procedures have been
evaluated by the Chief Executive Officer and Chief Financial Officer within 90
days of the filing date of this report. Based on this evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that the disclosure
controls and procedures are adequate and effective.
There have been no significant changes in internal controls or in other
factors that could significantly affect these internal controls subsequent to
the date of the evaluation in connection with the preparation of this Quarterly
Report on Form 10-Q.
28
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 8, 2002, the Company announced that its Board of Directors received
a letter from Samuel J. Heyman, the Chairman of the Board, proposing that the
Board consider a going private transaction whereby holders of shares of the
Company's common stock (other than those shares beneficially owned by Mr.
Heyman) would receive $10 in cash per share. On November 7, 2002, the Company
announced that the Special Committee and Mr. Heyman reached an agreement on such
transaction whereby the holders of the Company's publicly traded shares (other
than Mr. Heyman) would receive $10.30 in cash per share. The agreement followed
a determination by the Special Committee that the transaction consideration is
fair to the Company's public shareholders. On November 8, 2002, the Company's
Board of Directors approved the agreement.
Subsequent to the July 8, 2002 announcement, six purported class actions
were filed in Chancery Court in New Castle County, Delaware, and one purported
class action was filed in the United States District Court for the District of
New Jersey against the Company and the individual members of the Board of
Directors. These various actions allege generally that the defendants breached
their fiduciary duties to the Company's public shareholders with respect to the
proposed transaction and seek to enjoin or rescind the transaction and obtain
unspecified damages and attorneys' fees.
The Company intends and has been advised that the individual directors also
intend to vigorously defend against these purported class actions. With the
November 7 and November 8 announcements, respectively, the Company believes that
the ultimate outcome of these various actions will not have a material adverse
effect on the Company's business, financial position or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit Number
--------------
99.1 Certification of CEO and CFO 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 filed during the current quarter:
No reports on Form 8-K were filed during the three-month period ended
September 29, 2002.
29
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.
INTERNATIONAL SPECIALTY PRODUCTS INC.
DATE: November 13, 2002 BY: /s/Neal E. Murphy
----------------- -----------------
Neal E. Murphy
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
DATE: November 13, 2002 BY: /s/Kenneth M. McHugh
----------------- --------------------
Kenneth M. McHugh
Vice President and Controller
(Principal Accounting Officer)
30
CERTIFICATION
I, Sunil Kumar, certify that:
1. I have reviewed this quarterly report on Form 10-Q of International Specialty
Products Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
31
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ Sunil Kumar
----------------------------
Name: Sunil Kumar
Title: President and Chief Executive Officer
32
CERTIFICATION
I, Neal E. Murphy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of International Specialty
Products Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
33
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ Neal E. Murphy
-------------------------------
Name: Neal E. Murphy
Title: Senior Vice President and
Chief Financial Officer
34