UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from______to______
Commission File Number 333-57170
RESOLUTION PERFORMANCE PRODUCTS LLC
(Exact name of registrant as specified in its charter)
Delaware 76-0607613
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Commission File Number 333-57170-01
RPP CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 76-0660306
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1600 SMITH STREET, SUITE 2400
HOUSTON, TEXAS 77002
(888) 949-2502
(Address of principal executive offices and telephone number, including
area code)
N/A
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrants (1) have 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
Registrants were required to file such reports), and (2) have 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 Exchange Act Rule 12b-2).
Yes [ ] No [X]
At October 31, 2003, there were 1,000,000 outstanding membership units of
Resolution Performance Products LLC and 1,000 outstanding shares of common stock
of RPP Capital Corporation.
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002
(unaudited) 3
Consolidated Statements of Income for the three and nine month periods ended
September 30, 2003 and 2002 (unaudited) 4
Consolidated Statement of Owner's Deficit for the nine month period ended September
30, 2003 (unaudited) 5
Consolidated Statements of Cash Flows for the nine month periods ended September 30,
2003 and 2002 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Controls and Procedures 26
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
2
ITEM 1. FINANCIAL STATEMENTS
RESOLUTION PERFORMANCE PRODUCTS LLC
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN MILLIONS OF U. S. DOLLARS, EXCEPT FOR UNITS)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 5 $ 4
Receivables, less allowance of $2 and $2, respectively ................... 112 105
Due from related parties ................................................. 3 3
Prepaid assets ........................................................... 2 10
Inventories, less allowance of $1 and $1, respectively ................... 164 145
Taxes receivable ......................................................... 12 3
Deferred income taxes .................................................... 6 11
------ ------
Total current assets ................................................. 304 281
Property, plant and equipment, at cost, less accumulated depreciation ..... 439 441
Intangible assets, at cost, less accumulated amortization ................. 19 19
Investments in equity affiliate ........................................... 10 11
Deferred income taxes ..................................................... 59 41
------ ------
Total assets ......................................................... $ 831 $ 793
====== ======
LIABILITIES AND OWNER'S DEFICIT
Current liabilities:
Accounts payable-trade ................................................... $ 128 $ 156
Other payables and accruals .............................................. 40 17
Deferred credit .......................................................... - 5
Due to related parties ................................................... - 1
Taxes payable ............................................................ 1 2
Current portion of long-term debt ........................................ 1 1
------ ------
Total current liabilities ............................................ 170 182
Capital lease obligation .................................................. 1 2
Deferred revenue .......................................................... 5 5
Deferred income taxes ..................................................... 75 66
Pensions and other retirement plan obligations ............................ 24 22
Long-term debt ............................................................ 621 565
------ ------
Total liabilities .................................................... 896 842
Commitments and contingencies (Note 15)
Owner's deficit:
Member interest, 1,000,000 units authorized and issued ................... 102 102
Accumulated deficit ...................................................... (110) (80)
Accumulated other comprehensive loss ..................................... (57) (71)
------ ------
Total owner's deficit ................................................ (65) (49)
------ ------
Total liabilities and owner's deficit ................................ $ 831 $ 793
====== ======
See accompanying notes to consolidated financial statements.
3
RESOLUTION PERFORMANCE PRODUCTS LLC
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN MILLIONS OF U.S. DOLLARS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------
2003 2002 2003 2002
------ ------ ------ ------
Revenues ................................ $ 188 $ 179 $ 585 $ 571
Other revenues .......................... 1 - 1 2
------ ------ ------ ------
Total ......................... 189 179 586 573
Cost and expenses:
Purchases and variable product costs 130 106 412 332
Operating expenses ................. 29 30 83 89
Selling, general and administrative 13 13 39 44
Depreciation and amortization ...... 12 9 35 26
Research and development ........... 4 6 12 16
Special charges .................... - 3 - 6
------ ------ ------ ------
Total ......................... 188 167 581 513
------ ------ ------ ------
Operating income ........................ 1 12 5 60
Income from equity investment ........... - - 1 1
Interest expense, net ................... 18 15 57 49
------ ------ ------ ------
Income (loss)before income taxes ........ (17) (3) (51) 12
Income tax expense (benefit) ............ (9) (1) (21) 5
------ ------ ------ ------
Net income (loss) ....................... $ (8) $ (2) $ (30) $ 7
====== ====== ====== ======
See accompanying notes to consolidated financial statements.
4
RESOLUTION PERFORMANCE PRODUCTS LLC
CONSOLIDATED STATEMENT OF OWNER'S DEFICIT (UNAUDITED)
(IN MILLIONS OF U. S. DOLLARS)
ACCUMULATED
OTHER
MEMBER ACCUMULATED COMPREHENSIVE COMPREHENSIVE
INTEREST DEFICIT LOSS(a) TOTAL INCOME(LOSS)
-------- ----------- ------------- ----- -------------
Balance, December 31, 2002..................... $ 102 $ (80) $ (71) $ (49)
Net loss....................................... (30) (30) $ (30)
Currency translation gain, net of $5 tax....... 13 13 13
Interest rate swap, net of tax................. 1 1 1
Comprehensive loss............................. $ (16)
------ ------ ------ ----- ======
Balance, September 30, 2003.................... $ 102 $ (110) $ (57) $ (65)
====== ====== ====== =====
- ------------
(a) Accumulated Other Comprehensive Loss at September 30, 2003 is made up of the
following components: $58 million net loss for foreign currency translation and
$1 million net gain for interest rate swap.
See accompanying notes to consolidated financial statements.
5
RESOLUTION PERFORMANCE PRODUCTS LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN MILLIONS OF U. S. DOLLARS)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2003 2002
------ ------
Cash flows (used for) provided by operating activities:
Net income (loss) ................................................................. $ (30) $ 7
Adjustments to reconcile net income to net cash (used for) provided by operating
activities:
Depreciation and amortization .................................................... 35 26
Amortization of deferred finance costs ........................................... 8 2
Equity earnings in affiliate ..................................................... (1) (1)
Deferred income taxes ............................................................ (6) 5
Pensions and other retirement plans obligation ................................... 2 (11)
Deferred revenue ................................................................. - 4
Changes in operating assets and liabilities:
Receivables, net ................................................................. (2) (1)
Due from related parties ......................................................... (1) -
Prepaid assets ................................................................... 8 8
Inventories ...................................................................... (13) (3)
Payables and accruals ............................................................ (14) 3
Taxes receivable ................................................................. (9) 12
Taxes payable .................................................................... - (2)
Deferred credit .................................................................. (5) -
------ ------
Net cash (used for) provided by operating activities...................... (28) 49
------ ------
Cash flows used for investing activities:
Capital expenditures ............................................................. (13) (41)
Distributions from equity affiliate .............................................. 1 1
------ ------
Net cash used for investing activities.................................... (12) (40)
------ ------
Cash flows provided by (used for) financing activities:
Repayments of capital lease obligation ........................................... (1) -
Increase in deferred finance costs ............................................... (9) -
Capital contribution ............................................................. - 3
Proceeds from long-term debt ..................................................... 522 48
Repayments of long-term debt ..................................................... (471) (63)
------ ------
Net cash provided by (used for) financing activities ..................... 41 (12)
------ ------
Net increase (decrease) in cash and cash equivalents .............................. 1 (3)
Cash and cash equivalents at beginning of period .................................. 4 6
------ ------
Cash and cash equivalents at end of period ........................................ $ 5 $ 3
====== ======
Supplemental cash flow information on non cash transactions:
Capital lease obligation incurred ................................................. $ - $ 2
Trade notes payable incurred ...................................................... $ - $ 4
See accompanying notes to consolidated financial statements.
6
RESOLUTION PERFORMANCE PRODUCTS LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
1. ORGANIZATION, FORMATION AND BASIS OF PRESENTATION
The consolidated financial statements include the consolidated
operations of Resolution Performance Products LLC ("RPP LLC", or the "Company"),
and its wholly owned subsidiaries including RPP Capital Corporation ("RPP CC").
RPP LLC is a wholly owned subsidiary of Resolution Performance Products Inc.
("RPPI").
RPP CC is a wholly owned finance subsidiary of RPP LLC that was formed
in October 2000 to co-issue the 13-1/2% Senior Subordinated Notes jointly and
severally with RPP LLC. RPP CC has nominal assets and no operations.
The Company is engaged in manufacturing and marketing resins in the
U.S. and internationally. Resins include epoxy resins, versatic acids and
derivatives. Epoxy resins are chemicals primarily used in the manufacture of
coatings, adhesives, printed circuit boards, fiber reinforced plastics and
construction materials.
Products containing epoxy resins serve a wide range of end-users,
including automotive, aerospace, electrical, construction and industrial
maintenance. Versatic acids and derivatives are specialty products that
complement epoxy resins product offerings in the coatings, adhesives and
construction industries.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments, consisting
only of normal, recurring adjustments considered necessary for a fair
presentation, have been included. You should read these interim consolidated
financial statements in conjunction with our consolidated financial statements
and related notes included in our Annual Report on Form 10-K for the year ended
December 31, 2002. Certain amounts from the prior period have been reclassified
to conform to the current period presentation.
2. INVENTORY ADJUSTMENT
During the third quarter 2003, we became aware that certain
manufacturing costs have not been included in finished goods inventory. The
cumulative effect of the exclusion of such costs resulted in a $2.4 million
overstatement of owner's deficit at December 31, 2002. The effect of not
including such costs in finished goods inventory was not material to our
historical financial statements or to our expected full year 2003 financial
position or results of operations. To properly reflect these costs in inventory,
an adjustment to the financial statements was made in third quarter 2003. The
impact of the adjustment was to increase inventory by $3.6 million and pretax
income for the three and nine months ended September 30, 2003 by $3.6 million
($2.4 million after tax). The adjustment is included in purchases and variable
product costs.
3. NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities", an Interpretation of Accounting
Research Bulletin No. 51 "Consolidated Financial Statements" (FIN 46). FIN 46
provides guidance related to identifying variable interest entities (VIEs),
including entities more commonly referred to as special purpose entities or
SPEs, and in determining whether such entities should be consolidated by the
entities' primary beneficiary, defined in FIN 46 as the entity that holds the
majority of the variable interests in the
7
VIE. In addition, FIN 46 requires disclosure for both consolidated and
non-consolidated VIEs. Certain disclosure provisions of FIN 46 are effective for
financial statements issued after January 31, 2003, and the consolidation
requirements applicable to the Company are effective for all periods beginning
after June 15, 2003. Although we are still assessing the impact, we do not
believe that this interpretation will have a material impact on our consolidated
financial statements.
In April 2003, the FASB issued SFAS No.149,"Amendment of Statement 133
on Derivative Instruments and Hedging Activities". SFAS No.149 amends and
clarifies the accounting guidance on (1) derivative instruments (including
certain derivative instruments embedded in other contracts) and (2) hedging
activities that fall within the scope of SFAS No.133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No.149 is effective (1) for contracts
entered into or modified after June 30, 2003, with certain exceptions, and (2)
for hedging relationships designated after June 30, 2003. Adoption of the
standard is not expected to have a material impact on the Company's consolidated
financial position, results of operations or cash flows.
In May 2003, SFAS No. 150, "Accounting for Certain Instruments with
Characteristics of Both Liabilities and Equity" was issued. The standard
establishes how an issuer classifies and measures certain freestanding financial
instruments with characteristics of liabilities and equity and requires that
such instruments be classified as liabilities. The standard is effective for
financial instruments entered into or modified after May 31, 2003 and is
otherwise effective at the beginning of the first interim period beginning after
June 15, 2003. Adoption of the standard is not expected to have a material
impact on the Company's consolidated financial position, results of operations
or cash flows.
4. INVENTORIES OF PRODUCTS
Product inventories are valued at the lower of cost or net realizable
value, cost being determined using a FIFO (First In First Out) method. Effective
October 2002, the Company changed its inventory accounting policy in Europe from
the weighted-average method to FIFO. The change was made for consistency with
the inventory accounting policy in the United States and because the FIFO method
provides for a better matching of revenues and expenses. The effect of this
change was not material.
Total inventories, less allowance for obsolescence at September 30, 2003 and
December 31, 2002 were comprised of the following (in millions of U. S.
dollars):
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
Raw materials............. $ 12 $ 10
Finished products......... 139 122
Materials and supplies.... 13 13
------ -------
Total............... $ 164 $ 145
====== =======
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at September 30, 2003 and December 31,
2002 consisted primarily of manufacturing assets as follows (in millions of U.
S. dollars):
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
Plant and equipment.............. $ 1,144 $ 1,084
Office buildings................. 42 33
Other assets..................... 67 65
------- -------
Total...................... $ 1,253 $ 1,182
------- -------
Less: accumulated depreciation.. (814) (741)
------- -------
Net property, plant and equipment $ 439 $ 441
------- -------
8
Property, plant and equipment include capital leased assets with a net book
value of $3 million. Substantially all current and future assets are pledged as
security under the Company's credit agreement. Expenditures for property, plant
and equipment totaled $4 million for the quarter ending September 30, 2003 and
$13 million for the nine months ending September 30, 2003.
6. INTANGIBLE ASSETS
Intangible assets consist of the following (in millions of U. S.
dollars):
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
Patents and trademarks......... $ 12 $ 12
Deferred finance costs......... 31 23
----- ----
Total.......................... 43 35
Less accumulated amortization 24 16
----- ----
$ 19 $ 19
===== ====
The amortization expense for 2003 includes a $6 million write-off of deferred
financing costs related to the prepayments, refinancing and credit agreement
amendments.
7. LONG-TERM DEBT
Long-term debt at September 30, 2003 and December 31, 2002 consisted of
the following (in millions of U. S. dollars):
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
13 1/2 % Senior Subordinated Notes..................................... $ 328 $ 328
9 1/2 % Senior Second Secured Notes.................................... 200 -
Term Loan A............................................................ 28 69
Term Loan B............................................................ 58 155
Revolver............................................................... - 6
Other.................................................................. 2 3
------- -------
Total long-term debt................................................... 616 561
Net premium on 13 1/2% senior subordinated notes....................... 5 5
Premium on 9 1/2% senior second secured notes.......................... 1 -
Less current portion of long-term debt................................. (1) (1)
------- -------
$ 621 $ 565
======= =======
During the nine months ended September 30, 2003, we borrowed $522
million and made payments of $471 million, which includes a mandatory principal
payment of $6 million as a result of the excess cash flow calculation under the
credit agreement. Other long-term debt consists of trade notes payable totaling
$2 million that bear interest rates ranging from 6.75 percent to 8.18 percent
and are unsecured and payable over thirty-nine months with one of our vendors
for the purchase of computer equipment and related services. Annual payments
will average approximately $1 million.
On April 9, 2003, the Company completed a private offering, together
with RPP CC, its wholly-owned subsidiary, of $175 million aggregate principal
amount of 9 -1/2% Senior Second Secured Notes Due 2010 (the "Original Notes").
Interest will be payable semi-annually in cash on April 15 and October 15,
beginning October 15, 2003. The proceeds, net of $5 million estimated debt issue
costs, from the offering of the Original Notes were used to repay borrowings
under the Credit Agreement among the Company, RPP CC, RPPI, Resolution Europe
B.V.
9
(the "Borrowers") and the various lenders party thereto, dated as of November
14, 2000 (as amended by the First Amendment thereto, dated as of November 5,
2001, the Second Amendment thereto, dated as of June 25, 2002, the Third
Amendment thereto, dated as of December 2, 2002, and the Fourth Amendment
thereto, dated as of April 1, 2003, the "Credit Agreement") and for general
corporate purposes, including working capital.
The Company and the other Borrowers executed the Fourth Amendment to
the Credit Agreement dated as of April 1, 2003 (the "Credit Agreement
Amendment"). The Credit Agreement Amendment, among other things, (a) permitted
the Borrowers to issue up to $200 million of the Original Notes and Additional
Notes (as defined below) so long as they used at least the first $135 million of
net proceeds from the offering of the Notes to prepay the term loans outstanding
under the Credit Agreement, (b) amended the financial covenants by eliminating
the consolidated interest coverage ratio covenant and the adjusted total
leverage ratio covenant and added an adjusted bank leverage ratio covenant, and
(c) reduced the size of the revolving credit facility from $100 million to $75
million.
In May 2003, the Company and RPP CC registered an identical series of
$175 million 9 -1/2% Senior Second Secured Notes due 2010 with the Securities
and Exchange Commission and subsequently completed an offer to exchange the
unregistered notes for the registered notes.
On May 22, 2003, the Company completed a private offering, together
with RPP CC, its wholly-owned subsidiary, as co-issuer, of an additional $25
million aggregate principal amount of 9-1/2% Senior Second Secured Notes Due
2010 (the "Additional Notes"). The Additional Notes, together with the $175
million aggregate principal amount of Original Notes that were originally issued
on April 9, 2003, are treated as a single class of securities under RPP's
existing indenture. The net proceeds, net of $2 million estimated debt issue
costs from the offering of the Additional Notes, were used for general corporate
purposes, including working capital.
In July 2003, the Company and RPP CC registered an identical series of
9 -1/2% Senior Second Secured Notes Due 2010 with the Securities and Exchange
Commission and subsequently completed an offer to exchange all of the
unregistered notes for registered notes. As a result of these two exchange
offers, all of the outstanding $200 million of 9 -1/2% Senior Second Secured
Notes due 2010 are registered notes.
8. OBLIGATIONS UNDER CAPITAL LEASES
Capital leases at September 30, 2003 and December 31, 2002 consisted of
the following (in millions of U. S. dollars):
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
Total capital leases obligation........................................ $ 2 $ 3
Less current portion of capital leases obligation...................... (1) (1)
---- ----
$ 1 $ 2
==== ====
The capital leases were recorded at the present value of the minimum lease
payments which also approximated the fair market value of the obligation.
9. INTEREST RATE CAP
Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on the type of
derivative and the effectiveness of the hedge. The Company does not enter into
derivative instruments for trading purposes; however, an interest rate cap
agreement was entered into during 2002 in connection with the Company's credit
facility. The Company uses the interest rate cap to protect against interest
rate fluctuation by limiting the exposure to increases in the variable portion
of interest rates in its credit facility.
As of September 30, 2003, the Company has an interest rate cap
agreement for the notional amount of $150 million. The interest rate cap
agreement caps the floating rate at 3% and expires on February 28, 2004. The
cost of the interest rate cap agreement was $0.2 million.
10
10. PENSION PLANS, OTHER POST RETIREMENT BENEFITS AND 401(k) PLAN
The funded pension and unfunded other retirement obligations had the
following activity (in millions of U. S. dollars):
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
Balance at beginning of period................... $ 22 $ 31
Currency translation adjustment.................. - 2
Net periodic expense accrual..................... 2 4
Cash contributions............................... - (15)
---- ----
Balance at end of period......................... $ 24 $ 22
==== ====
The Company accrues net periodic expense based on an estimate from its
consulting actuary. During the nine months ended September 30, 2003, the Company
revised the average retirement age and average turn-over rate to age 60 and 7
percent from age 58 and 5 percent. This revision in assumptions is expected to
have approximately $0.4 million dollar decrease in obligations for the U. S. for
2003. Net periodic pension expense for 2003 is trending to be lower than the
2002 level as a result of recognizing the amortization of benefits related to
prior year plan amendments and changes in assumptions.
11. TRANSACTIONS WITH RELATED PARTIES AND CERTAIN OTHER PARTIES
During the nine months ended September 30, 2003, we have continued our
numerous agreements with Royal Dutch/Shell Group of Companies, ("Shell"),
including the purchase of feedstock, site services, utilities, materials,
facilities and operator type services. There were no material changes regarding
our commitments surrounding certain agreements with Shell during the period.
During the nine months ended September 30, 2003, we have paid Shell $231 million
and Shell has paid the Company $13 million.
In the ordinary course of business, we dispute charges arising from our
numerous agreements with Shell as well as with other third party vendors. As
with other third party vendors, resolution of disputes may have a significant
impact on our financial results.
12. SEGMENT INFORMATION
Using guidelines set forth in SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information, the Company has identified three
reportable segments based on geographic and customer information: (i) U. S.,
(ii) Europe and Africa, and (iii) Asia Pacific and Middle East. Management
operates its business through geographic regions and is not organized nor does
it prepare discreet financial information by product line within the geographic
regions.
11
Selected financial data by geographic region are presented below (in millions of
U. S. dollars):
ASIA
PACIFIC
EUROPE AND
AND MIDDLE
U.S. AFRICA EAST ELIMINATION TOTAL
----- ------ ---- ----------- -----
AS OF AND FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2003:
Revenues from external customers........................ $ 89 $ 100 $ -- $ -- $ 189
Inter-segment revenues.................................. 3 2 -- (5) --
Operating income(loss).................................. 6 (4) (1) -- 1
Net loss................................................ (6) (2) -- -- (8)
Total assets............................................ 462 368 1 -- 831
AS OF AND FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2002:
Revenues from external customers........................ $ 80 $ 98 $ 1 $ -- $ 179
Inter-segment revenues.................................. 4 2 1 (7) --
Operating income (loss)................................. 18 (6) -- -- 12
Net income (loss)....................................... 3 (6) 1 -- (2)
Total assets............................................ 438 318 2 -- 758
ASIA
PACIFIC
EUROPE AND
AND MIDDLE
U.S. AFRICA EAST ELIMINATION TOTAL
----- ------ ---- ----------- -----
AS OF AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2003:
Revenues from external customers........................ $ 263 $ 321 $ 2 $ -- $ 586
Inter-segment revenues.................................. 7 7 -- (14) --
Operating income (loss)................................. 15 (10) -- -- 5
Net income (loss)....................................... (24) (7) 1 -- (30)
Total assets............................................ 462 368 1 -- 831
AS OF AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2002:
Revenues from external customers........................ $ 281 $ 284 $ 8 $ -- $ 573
Inter-segment revenues.................................. 9 10 4 (23) --
Operating income (loss)................................. 74 (13) (1) -- 60
Net income (loss)....................................... 17 (10) -- -- 7
Total assets............................................ 438 318 2 -- 758
Sales revenues are attributed to geographic regions based on the
location of the manufacturing facility and/or marketing company, and are not
based on location of customer. Inter-segment amounts represent sales
transactions within and between geographic regions.
13. INCOME TAXES
The Company provides for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS
109"). SFAS 109 requires the recognition of deferred tax assets and
12
liabilities for the expected future tax consequences of temporary differences
between the financial statement carrying amounts and the tax basis of the assets
and liabilities. Deferred tax assets also include net operating losses ("NOL")
that will be carried forward or are pending carry back.
Deferred taxes result from differences between the financial and tax
basis for assets and liabilities, and are adjusted for changes in tax rates and
tax laws when changes are enacted. Valuation allowances are recorded to reduce
deferred tax assets when it is more likely than not that a tax benefit will not
be realized.
As of September 30, 2003, the Company has reclassified to Tax
Receivable a total of $12 million. The Tax Receivable is the result of a 2001
and 2002 Netherlands net operating loss being carried back. We expect to collect
this Tax Receivable in the next twelve months.
14. RESTRUCTURING CHARGES
The Company accrued a charge for employee severance and other exit
costs of $6 million in the fourth quarter of 2002 related to a cost reduction
program implemented in response to a significant decline in profitability. The
global reduction in work force affected approximately 90 employees or 9% of the
global work force. Other exit costs relate to a modification of the OMS
agreement previously entered into with Shell covering employee termination
expenses to be absorbed by the Company. As of September 30, 2003, all the
employees related to the reduction in work force have been terminated and the
remaining liability will be paid out through early 2004. The following is a
reconciliation of the severance liability (in millions of U. S. dollars):
December 31, 2002 Additions Deductions September 30, 2003
----------------- --------- ---------- ------------------
Severance.................. $ 6 - $ 5 $ 1
------ -- ---- -----
15. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company is subject to various
laws and regulations and, from time to time, litigation. In the opinion of
management, compliance with existing laws and regulations will not materially
affect the financial position or results of operations of the Company.
Management is not aware of any material pending actions against the Company.
As mentioned above, our business is subject to various federal, state,
local and foreign laws and regulations which govern environmental health and
safety ("EHS") related matters. Compliance with these laws and regulations
requires substantial continuing financial commitments and planning. Moreover,
the laws and regulations directly affect how we operate our business. The
financial commitments consist of environmental costs for normal day to day
operations, voluntary and mandatory matters as well as remediation issues.
As of September 30, 2003, we have assessed that an environmental
remediation liability accrual is not needed based on the current available
facts, present laws and regulations, and current technology.
The Company is not aware of any claims or possible claims against us
from the closing date of the recapitalization. For environmental conditions that
existed prior to the closing date, our environmental remediation liability is
influenced by agreements associated with the transactions whereby Shell will
indemnify us for environmental damages associated with environmental conditions
that occurred or existed before the closing date of the recapitalization,
subject to certain limitations. In addition, management believes that we
maintain adequate insurance coverage, subject to deductibles, for environmental
remediation activities.
16. SUPPLEMENTAL CASH FLOW INFORMATION
The Company translates its foreign subsidiary's financial statements
for consolidation in accordance with SFAS 52 (Foreign Currency Translation),
using the current rate method. As a result, consolidated balance sheets are
affected by the non-cash foreign currency translation adjustments. The statement
of cash flows has been adjusted to
13
exclude the non-cash effects of the foreign currency translation adjustments
coming from the consolidated balance sheets.
17. OTHER REVENUE
In 2002 and 2001, the Company entered into BPA technology license
agreements wherein the Company granted non-exclusive licenses to third parties
to use RPP LLC's technology to construct, operate and maintain and/or repair one
licensed plant for the manufacture of BPA. Along with the grant to use the
license, the Company will also provide technical assistance in the design,
engineering, procurement, training, commissioning and/or start-up of the
licensed plant. Revenues from the sale of the BPA technology license and related
support services have been and will be recognized using the percentage of
completion method. For the three months ended and nine months ended September
30, 2003, $0.36 million and $0.49 million, respectively, have been recognized as
Other Revenues related to the sale of the BPA technology licenses.
In May 2002, the Company entered into an exclusive and irrevocable
option with a third party to execute a long-term supply contract, wherein the
Company received $4.2 million. In June 2002, the Company executed a calcium
chloride supply agreement with the third party for fifteen years. Revenues from
the sale of the option will be recognized on a straight line basis over fifteen
years consistent with the duration of the supply agreement. For the three months
ended and nine months ended September 30, 2003, $0.07 million and $0.21 million,
respectively, have been recognized as Other Revenues related to the sale of the
option.
18. DEFERRED REVENUE
Deferred revenue includes the unamortized balances related to the sale
of the BPA technology licenses and the sale of the exclusive and irrevocable
option to execute a long-term supply contract. As of September 30, 2003 the
balance included in Deferred Revenue for the sale of BPA technology licenses and
the sale of the option was $1 million and $4 million, respectively.
19. DEFERRED CREDIT
Deferred credit includes the remaining balance of proceeds received
from Shell under the environmental agreement indemnity payments. The deferred
credit amounts are matched against specific environmental capital projects that
in effect will reduce the amount of gross environmental capital expenditures.
For the nine months ended September 30, 2003, the Company spent $6 million
related to environmental capital expenditures and utilized $5 million from the
environmental indemnification balance included in Deferred Credit. As of
September 30, 2003, there is no remaining balance to apply to future
environmental capital expenditures.
The following is a table of the deferred credit activity (in millions of U. S.
dollars):
December 31, 2002 Applied to Capital Expenditures September 30, 2003
----------------- ------------------------------- ------------------
Deferred Credit............ $ 5 $ 5 $ -
----- ------- -----
20. SUBSEQUENT EVENT
On November 14, 2003, a wholly owned subsidiary of the Company
completed the sale of forty percent of the outstanding shares in Japan Epoxy
Resins Co., Ltd to its joint venture partner, Mitsubishi Chemical Company for a
purchase price of over $20 million. In connection with the sale of its shares, a
new joint venture agreement, technology license agreement and trademark license
agreement were negotiated.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other items in this Quarterly Report on Form 10-Q contain
forward-looking statements and information that are based on management's
beliefs, as well as assumptions made by, and information currently available to,
management. When used in this document, the words "believe", "anticipate",
"estimate", "expect", "intend", and similar expressions are intended to identify
forward-looking statements. Although management believes that the expectations
reflected in these forward-looking statements are reasonable; it can give no
assurance that these expectations will prove to have been correct. These
statements are subject to certain risks; uncertainties and assumptions,
including those discussed under the heading "Cautionary Statements for Forward
Looking Information" and elsewhere in this report. Should one or more of these
risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those anticipated. The
Company undertakes no obligation to release publicly any revisions to these
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
You should read "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in conjunction with the corresponding
sections and the Company's audited consolidated and combined financial
statements included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2002.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, information
derived from the Company's consolidated statements of income, expressed as a
percentage of revenues.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues......................................... 100% 100% 100% 100%
Cost and expenses:
Purchases and variable product costs........ 69 59 70 58
Operating expenses.......................... 15 17 14 16
Selling, general and administrative......... 7 8 7 8
Depreciation and amortization............... 6 5 6 4
Research and development.................... 2 3 2 3
Special charges............................. - 2 - 1
--- --- --- ---
Total................................... 99 94 99 90
Operating income................................. 1 6 1 10
Income from equity investment.................... - - - -
Interest expense, net............................ 10 8 10 8
--- --- --- ---
Income (loss) before income taxes (benefit)..... (9) (2) (9) 2
Income tax expense (benefit)..................... (5) - (4) 1
--- --- --- ---
Net income (loss) ............................... (4)% (2)% (5)% 1%
=== === === ===
EBITDA (1)....................................... 7% 12% 7% 15%
=== === === ===
15
- -------------
(1) EBITDA represents income (loss) before income taxes, interest expense, net,
and depreciation and amortization. EBITDA is presented because it is used by
investors to analyze and compare operating performance, which includes a
company's ability to service and/or incur debt. In addition, management focuses
on EBITDA and adjustments to EBITDA because they are used as internal
performance measures. However, EBITDA should not be considered in isolation or
as a substitute for net income, cash flows or other income or cash flow data
prepared in accordance with United States generally accepted accounting
principles ("GAAP") or as a measure of a company's profitability or liquidity.
EBITDA is not calculated under GAAP and therefore is not necessarily comparable
to similarly titled measures of other companies. For a reconciliation of EBITDA
to net income (loss), see page 21.
The following is a discussion of significant financial statement items
related to our consolidated statements of income. See note 12 of the
consolidated financial statements for segment information.
Revenues
Our revenues are primarily generated through the sale of our three main
product lines: (1) epoxy resins, (2) versatic acids and derivatives, and (3)
sales of BPA to third parties. In addition, we sell small amounts of ECH to
third parties. Revenues have historically been driven by volumes, market prices
and foreign currency fluctuations. Revenues also include other income derived
primarily from royalty income and commission income.
Other revenues
Other revenues consist mainly of the sale of a BPA technology license and
related support services.
Purchases and Variable Product Costs
Purchases and variable product costs are primarily comprised of feedstock
costs. Feedstock costs are driven primarily by market conditions and volumes
fluctuate with production. The significant feedstocks for which we are highly
sensitive to the market prices are phenol, acetone, propylene and chlorine. We
purchase chlorine, a primary raw material for ECH, under long-term supply
contracts with third parties which provide us with producer-like economics by
allowing us to buy this raw material at a margin above production cost and
thereby lower our manufacturing costs. We also purchase propylene, the other
primary raw material for ECH, under long-term supply agreements with Shell that
are based on market price less negotiated volume discounts. We purchase phenol
and acetone, the primary raw materials for BPA, under supply contracts with
Shell and other third parties that are based on discounted market prices and an
input-cost formula. Because we are co-located with Shell at several of our
facilities, our transportation and logistics costs for certain raw materials
which Shell provides to us are also reduced. Variable manufacturing costs, which
are primarily utilities, are also a significant component of this line item.
Purchases and variable costs are reduced by the sale of by-products generated
during the manufacturing process, primarily hydrochloric acid.
Operating Expenses
Operating expenses represent the costs associated with the non-variable
operations of our manufacturing facilities. Included in operating costs are
personnel related costs, manufacturing overhead, periodic maintenance,
turnaround costs and environmental costs. Depreciation relating to manufacturing
assets is included within depreciation and amortization.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are comprised primarily of
costs associated with non-manufacturing, non-research and development
operations, including management, accounting, treasury, information technology,
marketing and sales, and legal.
16
Depreciation and Amortization
Depreciation is computed on a straight-line basis over the estimated useful
lives of the respective assets. Estimated useful lives for plant and equipment,
office buildings, tanks and pipelines are twenty years and range from three to
ten years for other assets. Amortization is computed on a straight-line basis
for intangibles such as patents.
Research and Development Expenses
Research and development expenses are costs associated with new and
existing products or customer specific initiatives on new and existing products
and costs associated with projects that seek improvements in manufacturing
processes. Primarily all of our research and development expenses are generated
in one of our three research facilities. This includes costs associated with
health, safety and environmental projects.
Special Charges
Special charges consist of non-recurring type costs such as transaction,
transition and severance costs related to restructuring or cost reduction
programs.
Income from Equity Investment
Income from equity investment is related to our unconsolidated equity
investment.
Interest Expense, net
Interest expense, net consists of interest expense payable with respect to
borrowings under our credit agreement. existing notes and miscellaneous interest
expense, offset by our interest income from short-term cash investments.
Interest expense also includes amortization of deferred financing costs and
amortization of the premium and discount for the senior subordinated notes
issued in 2002, 2001 and 2000.
Income Tax Expense
The Company is organized as a limited liability company and is not subject
to U. S. income tax. Income tax information presented includes U. S. income
taxes attributed to the Company's operations that are the responsibility of the
Company's sole owner, RPP Inc.
As of September 30, 2003, we have accrued for income taxes, including both
deferred and current income tax provisions. Additionally, we made a Section
338(h)(10) election to allow our recapitalization to be treated as an
acquisition of assets for tax purposes. Accordingly, for tax purposes the basis
of our U.S. assets has been stepped-up to their fair market values, and we will
be able to depreciate our assets using higher basis than the historical amount.
This tax basis step-up may reduce cash payments for income taxes over the next
four years.
THIRD QUARTER OF 2003 AND 2002 COMPARED
Revenues
Revenues increased by $10 million, or 6%, to $189 million compared to the
prior year quarter. The increase in revenues is a result of increased average
prices, partially offset by decreased average volumes. Overall average prices
increased by 7% from the prior year period, however, excluding the impact of a
weaker dollar on our Euro-related sales, overall average prices decreased 2%.
Overall volumes decreased by 2% from the prior year period as a result of soft
demand related to the global recession. The increase in average prices was
primarily attributable to the impact of a weaker dollar on our Euro-related
sales and to a lesser extent due to modest price increases on certain products.
17
Purchases and Variable Product Costs
Purchases and variable product costs increased by $24 million,
or 23%, to $130 million. This increase was largely driven by higher prices for
feedstocks due to the increasing price of crude oil and related petrochemical
products and the higher cost of natural gas, partially offset by lower sales
volume and the inventory adjustment discussed in Note 2 of the consolidated
financial statements.
Operating Expenses
Operating expenses decreased by $1 million, or 3%, to $29
million. The decrease is principally related to the cost reduction program
implemented by the Company at the beginning of 2003, lower net periodic pension
expense and lower maintenance costs. Pension expense decreased due to the change
in estimates in connection with our postretirement medical benefit obligation
and to a lesser extent due a reduction of benefits in pension recognized in late
2002. In addition, pension expense also decreased due to a revision of the
retirement age and turnover percentage recognized in the second quarter of 2003.
Maintenance costs declined but we expect such a decline will be temporary and
that maintenance costs will return to historic levels.
Selling, General and Administrative Expenses
Selling, general and administrative expenses are flat and
totaled $13 million. Although flat, selling, general and administrative expenses
had significant activity which was primarily the result of the cost reduction
program implemented by the company at the beginning of 2003 and lower net
periodic pension expense. Pension expense decreased due to the change in
estimates in connection with our post retirement medical benefit obligation and
to a lesser extent due a reduction of benefits in pension recognized in late
2002. In addition, pension expense also decreased due to a revision of the
retirement age and turnover percentage recognized in the second quarter of 2003.
Also, included in the current period is an insurance refund of approximately $1
million related to prior periods. The current period does not include
capitalization of personnel costs related to the information technology project
that was reflected in the third quarter of 2002.
Depreciation and Amortization
Depreciation and amortization increased by $3 million, or 33%,
to $12 million. The increase is primarily attributable to an increase in
depreciation expense resulting from capital projects placed in service
subsequent to the prior year quarter such as the information technology project
completed in November 2002.
Research and Development Expenses
Research and development expenses decreased by $2 million, or
33%, to $4 million. The decrease is primarily due to the cost reduction program
implemented by the Company at the beginning of 2003.
Special Charges
Special charges decreased by $3 million. The decrease is related to the
completion of the Company's transition activities in the last quarter of 2002.
Transition activities for the quarter ended September 30, 2002 consisted of
non-recurring transition expenses from our predecessor's IT and accounting
systems.
Operating Income
Operating income decreased by $11 million, or 92%, to $1
million The decrease was primarily due increases in purchases and variable
product costs and depreciation and amortization expenses, partially offset by
increased revenue and decreased operating expenses, research and development and
special charges.
18
Interest expense, net
Interest expense, net increased by $3 million, or 20%, to $18
million. The increase is due to a higher average outstanding debt balances and
higher average interest rates.
Income (loss) before Income Taxes
Loss before income taxes increased by $14 million to a $17
million loss. The increase is due to the decrease in operating income and
increased interest expense, net.
Income Tax Expense (Benefit)
Income tax benefit increased by $8 million to a $9 million
benefit in 2003. The increase is primarily related to decreased taxable income
resulting from decreased operating income and increased interest expense, net.
Net Income (Loss)
Net loss increased by $6 million to $8 million net loss in
2003. The increase was due to increased loss before income taxes, partially
offset by increased income tax benefit.
EBITDA
EBITDA decreased by $8 million, or 38%, to $13 million. The
decrease was primarily due to increases in purchases and variable product costs
and depreciation and amortization expenses, partially offset by increased
revenue and decreased operating expenses, research and development.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
Revenues
Revenues increased by $13 million, or 2%, to $586 million
compared to the prior year period. The increase in revenues is a result of
increased average prices, partially offset by lower volume. The increase in
average prices was primarily attributable to the impact of a weaker dollar on
our Euro-related sales and to a lesser extent due to modest price increases on
certain products. Overall average prices increased by 9% from the prior year
period, however, excluding the impact of a weaker dollar on our Euro-related
sales, overall average prices were flat. Overall volumes decreased by 6% from
the prior year period as a result of soft demand related to the global
recession.
Purchases and Variable Product Costs
Purchases and variable product costs increased by $80 million,
or 24%, to $412 million. This increase was largely driven by higher prices for
feedstocks due to the increasing price of crude oil and related petrochemical
products and the higher cost of natural gas, partially offset by lower sales
volume and the inventory adjustment discussed in Note 2 of the consolidated
financial statements.
Operating Expenses
Operating expenses decreased by $6 million, or 7%, to $83
million. The decrease is principally related to the cost reduction program
implemented by the Company at the beginning of 2003, lower net periodic pension
expense and lower maintenance costs. Pension expense decreased due to the change
in estimates in connection with our postretirement medical benefit obligation
and to a lesser extent due a reduction of benefits in pension recognized in late
2002. In addition, pension expense also decreased due to a revision of the
retirement age and turnover percentage recognized in the second quarter of 2003.
Maintenance costs declined but we expect such a decline will be temporary and
that maintenance costs will return to historic levels.
19
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased by $5
million, or 11%, to $39 million. The decrease is primarily a result of the cost
reduction program implemented by the company at the beginning of 2003 and lower
net periodic pension expense. Pension expense decreased due to the change in
estimates in connection with our post retirement medical benefit obligation and
to a lesser extent due a reduction of benefits in pension. In addition, pension
expense also decreased due to a revision of the retirement age and turnover
percentage. Also, included in the current period is an insurance refund of
approximately $1 million related to prior periods.
Depreciation and Amortization
Depreciation and amortization increased by $9 million, or 35%,
to $35 million. The increase is primarily attributable to an increase in
depreciation expense resulting from capital projects placed in service
subsequent to the prior year period, such as the information technology project
completed in November 2002.
Research and Development Expenses
Research and development expenses decreased by $4 million, or
25%, to $12 million. The decrease is primarily due to the cost reduction program
implemented by the Company at the beginning of 2003.
Special Charges
Special charges decreased by $6 million. The decrease is
primarily related to the completion of the Company's transition activities in
the last quarter of 2002. Transition activities for the nine months ended
September 30, 2002 consisted of non-recurring transition expenses from our
predecessor's IT and accounting systems.
Operating Income
Operating income decreased by $55 million, or 92%, to $5
million. The decrease was primarily due increases in purchases and variable
product costs and depreciation and amortization expenses, partially offset by
increased revenue and decreased operating expenses, research and development and
special charges.
Interest expense, net
Interest expense, net increased by $8 million, or 16%, to a
$57 million. The increase is due to a $6 million write-off of deferred financing
costs related to the prepayments, refinancing and credit agreement amendment. In
addition, the increase is also due to a higher average outstanding debt balances
and higher average interest rates. The current period does not include bank fees
related to a credit agreement amendment in the prior year period for
approximately $1 million.
Income (loss) before Income Taxes
Income (loss) before taxes decreased by $63 million to a $51
million loss. The decrease is due to the decrease in operating income and
increased interest expense, net.
Income Tax Expense (Benefit)
Income tax expense (benefit) decreased by $26 million to a $21
million benefit in 2003. The decrease is primarily related to decreased taxable
income resulting from decreased operating income and increased interest expense,
net.
Net Income (Loss)
Net income (loss) decreased by $37 million to a $30 million
net loss in 2003. The decrease was due to
20
decreased income (loss) before income taxes, partially offset by increased
income tax benefit.
EBITDA
EBITDA decreased by $46 million, or 53%, to $41 million. The
decrease was primarily due to increases in purchases and variable product costs
and depreciation and amortization expenses, partially offset by increased
revenue and decreased operating expenses, and research and development expenses.
EBITDA is presented because it is used by investors to analyze
and compare operating performance, which includes a company's ability to service
and/or incur debt. In addition, management focuses on EBITDA and adjustments to
EBITDA because they are used as internal performance measures. However, EBITDA
should not be considered in isolation or as a substitute for net income, cash
flows or other income or cash flow data prepared in accordance with GAAP or as a
measure of a company's profitability or liquidity. EBITDA is not calculated
under GAAP and therefore is not necessarily comparable to similarly titled
measures of other companies. The following table reconciles the differences
between net income (loss), as determined under GAAP and EBITDA (in millions).
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
---- ---- ---- ----
Net income (loss) $ (8) $ (2) $ (30) $ 7
Income tax expense (benefit) (9) (1) (21) 5
Interest expense, net 18 15 57 49
Depreciation and amortization 12 9 35 26
---- ---- ---- ----
EBITDA $ 13 $ 21 $ 41 $ 87
==== ==== ===== ====
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2003, our operating cash
flow was less than our working capital needs. However, we obtained additional
cash from the issuance of $200 million aggregate principal amount of 9 1/2 %
Senior Second Secured Notes Due 2010 and made some prepayments on our credit
facility, resulting in a modest increase of cash and cash equivalents for the
period. Our working capital requirements principally include accounts
receivable, product and raw materials inventory, labor, equipment and debt
service costs. We expect to finance our operations in the future through net
cash provided by operating activities, existing cash and cash equivalents on
hand, other refinancing vehicles, and borrowings under our revolving credit
facility and, to the extent needed, sales of non-core assets. As a result of our
high level of debt and the global recession, we will have to generate
significantly more cash flows through operating activities, borrowing and asset
sales to meet our current debt service requirements. For a discussion of factors
affecting our operating cash flows, see "Outlook for Remainder of 2003" below.
At September 30, 2003, we had $28 million outstanding under the Term
Loan A, $58 million outstanding under the Term Loan B, and no borrowings
outstanding under the revolving credit facility. This resulted in a borrowing
capacity of $56 million after considering $18 million related to letters of
credit. Subsequent to September 30, 2003, $15 million of the $18 million related
to letters of credit were released. During the nine months ended September 30,
2003, we borrowed $522 million and made payments of $471 million, which includes
a mandatory principal payment of $6 million as a result of the excess cash flow
calculation under the credit agreement. Also as of September 30, 2003, we were
in compliance with our financial covenant under the credit agreement.
On April 9, 2003, the Company completed a private offering, together
with RPP CC, its wholly-owned subsidiary, of $175 million aggregate principal
amount of 9 1/2% Senior Second Secured Notes Due 2010 (the "Original Notes").
Interest is payable semi-annually in cash on April 15 and October 15, beginning
October 15, 2003. The proceeds, net of $5 million estimated debt issue costs,
from the offering of the Original Notes were used
21
to repay borrowings under the Credit Agreement among the Company, RPP CC, RPPI,
Resolution Europe B.V. , (the "Borrowers") and the various lenders party
thereto, dated as of November 14, 2000 (as amended by the First Amendment
thereto, dated as of November 5, 2001, the Second Amendment thereto, dated as of
June 25, 2002, the Third Amendment thereto, dated as of December 2, 2002, and
the Fourth Amendment thereto, dated as of April 1, 2003, the "Credit Agreement")
and for general corporate purposes, including working capital.
The Company and the other Borrowers executed the Fourth Amendment to
the Credit Agreement dated as of April 1, 2003 (the "Credit Agreement
Amendment"). The Credit Agreement Amendment, among other things, (a) permitted
the Borrowers to issue up to $200 million aggregate principal amount of the
Original Notes and the Additional Notes (as defined below) so long as they used
at least the first $135 million of net proceeds from the offering of such Notes
to prepay the term loans outstanding under the Credit Agreement, (b) amended the
financial covenants by eliminating the consolidated interest coverage ratio
covenant and the adjusted total leverage ratio covenant and added an adjusted
bank leverage ratio covenant, and (c) reduced the size of the revolving credit
facility from $100 million to $75 million.
In May 2003, the Company and RPP CC registered an identical series of
9 1/2% Senior Second Secured Notes due 2010 in the amount of $175 million with
the Securities and Exchange Commission and subsequently completed an offer to
exchange the unregistered notes for the registered notes.
On May 22, 2003, the Company completed a private offering, together
with RPP CC, its wholly-owned subsidiary, as co-issuer, of an additional $25
million aggregate principal amount of 9 1/2% Senior Second Secured Notes Due
2010 (the "Additional Notes"). The Additional Notes, together with the $175
million aggregate principal amount of Original Notes that were originally issued
on April 9, 2003, are treated as a single class of securities under RPP's
existing indenture. The proceeds, net of $2 million estimated debt issue costs
from the offering of the Additional Notes were used for general corporate
purposes, including working capital.
In July 2003, the Company and RPP CC registered an identical series of
9 1/2% Senior Second Secured Notes Due 2010 with the Securities and Exchange
Commission and subsequently completed an offer to exchange all of the
unregistered notes for registered notes. As a result of these two exchange
offers, all of the outstanding $200 million of 9 1/2% Senior Second Secured
Notes due 2010 are registered notes.
As of September 30, 2003, the Company has an interest rate cap
agreement for the notional amount of $150 million. The interest rate cap
agreement caps the floating rate at 3% and expires on February 28, 2004. The
cost of the interest rate cap agreement was $0.2 million and will be amortized
over its term.
For the nine months ended September 30, 2003, we used net cash for
operating activities of $28 million, used cash in investing activities of $12
million and provided cash from financing activities of $41 million. Investing
activities primarily consisted of expenditures for property, plant and
equipment. Financing activities primarily consisted of the $200 million of
Original Notes and Additional Notes (collectively, the "Notes") and the partial
early extinguishment of term loans A and B totaling $135 million. For the nine
months ended September 30, 2002, we generated net cash provided by operating
activities of $49 million, used cash in investing activities of $40 million and
used cash in financing activities of $12 million.
Expenditures for property, plant and equipment totaled $13 million and
$41 million for the nine months ending September 30, 2003 and 2002,
respectively. The $13 million spent in 2003 is made up of $18 million gross
amount for operational projects net of $5 million environmental indemnification
recovery. Of the $41 million spent in 2002, $24 million was related to the
information technology project and $17 million for other capital expenditures.
Because we have an established infrastructure in place, our capital
expenditures are generally not for the building of new plants but for their
maintenance, mandatory environmental projects, occasional incremental expansion
or cost reduction/efficiency improvement where justified by the expected return
on investment. We expect our gross capital expenditures for 2003 to be
approximately $21 to $22 million of which approximately $13 million has been
budgeted for maintenance capital expenditures.
22
On November 14, 2003, a wholly owned subsidiary of the Company
completed the sale of forty percent of the outstanding shares in Japan Epoxy
Resins Co., Ltd to its joint venture partner, Mitsubishi Chemical Company for a
purchase price of over $20 million. In connection with the sale of its shares, a
new joint venture agreement, technology license agreement and trademark license
agreement were negotiated
Our high level of debt may preclude us from borrowing any more funds
beyond those available under the revolving credit agreement. Based on our
current level of operations, anticipated recovery and cost reductions,
management believes that our cash flow from operations, together with existing
cash and cash equivalents on hand, net proceeds from the issuances of the Notes,
future borrowings under our revolving credit facility and sales of non-core
assets, if necessary, will be sufficient to fund our working capital needs and
expenditures, for property, plant and equipment and debt service obligations in
the foreseeable future, although no assurance can be given in this regard.
OUTLOOK FOR REMAINDER OF 2003
While the global economy remains in a low growth mode, we expect an
increase in demand coupled with relatively flat raw material costs compared to
the most recent quarter. Once a global recovery takes hold, volumes are expected
to rebound along with a continued reduction in average raw material prices,
which had increased in the first half of the year due to political instability
in the Middle East, including the recent conflict in Iraq, and supply
disruptions elsewhere. There can be no assurances that (a) the global recovery
will occur during 2003, (b) we will be able to realize margins we have
historically achieved as feedstock costs decline, or (c) our feedstock costs
will not rise faster than our product prices and reduce our margins.
ENVIRONMENTAL, HEALTH AND SAFETY
Our business is subject to various federal, state, local and foreign
laws and regulations which govern environmental health and safety ("EHS")
related matters. Compliance with these laws and regulations requires substantial
continuing financial commitments and planning. Moreover, the laws and
regulations directly affect how we operate our business. The financial
commitments consist of environmental costs for normal day to day operations,
voluntary and mandatory matters as well as remediation issues.
We accrue for environmental liabilities when the liability is probable
and the costs are reasonably estimable. As of September 30, 2003, we have
assessed that an environmental remediation liability accrual is not needed based
on the current available facts, present laws and regulations, and current
technology. This assessment is based on the lack of evidence of any claims or
possible claims against us from the closing date of the recapitalization. For
environmental conditions that existed prior to the closing date, our
environmental remediation liability is influenced by agreements associated with
the transactions whereby Shell generally will indemnify us for environmental
damages associated with environmental conditions that occurred or existed before
the closing date of the recapitalization, subject to certain limitations. In
addition, for incidents occurring after the closing date of the recapitalization
transaction, management believes that we maintain adequate insurance coverage,
subject to deductibles, for environmental remediation activities.
As mentioned above, we have substantial continuing financial
commitments for compliance of environmental matters. During the nine months
ended September 30, 2003, we expended a gross total of $10 million related
mandatory EHS capital projects and we recovered $5 million from the Deferred
Credit balance. The Deferred Credit balance resulted from the 2002 settlement
with Shell. As of September 30, 2003, the Deferred Credit balance is zero. We
expect a similar operating environmental commitment to continue in future years;
however, the level of financial commitment may increase if the environmental
laws and regulations become more stringent.
23
EFFECTS OF CURRENCY FLUCTUATIONS
We conduct operations in countries around the world. Therefore, our
results of operations are subject to both currency transaction risk and currency
translation risk. We incur currency transaction risk whenever we enter into
either a purchase or sales transaction using a currency other than the local
currency of the transacting entity. With respect to currency translation risk,
our financial condition and results of operations are measured and recorded in
the relevant domestic currency and then translated into U.S. dollars for
inclusion in our consolidated and combined financial statements. Exchange rates
between these currencies and U.S. dollars in recent years have fluctuated
significantly and may do so in the future. The majority of our revenues and
costs are denominated in Euros, with the U. S. dollar also being significant.
For the nine months ended September 30, 2003, 55% of our total revenues and 57%
of our total expenses were from companies incorporated outside the United
States. For the nine months ended September 30, 2002, 51% of our total revenues
and 60% of our total expenses were from companies incorporated outside the
United States. A substantial amount of assets and liabilities outside the United
States are denominated in the Euro. The average exchange rate of the U. S.
dollar to the Euro was approximately 0.8623 to 1.0193 for the nine months ended
September 30, 2003 and 2002, respectively. Historically, we have not undertaken
hedging strategies to minimize the effect of currency fluctuations. Significant
changes in the value of the euro relative to the U.S. dollar could also have an
adverse effect on our financial condition and results of operations and our
ability to meet interest and principal payments on Euro-denominated debt,
including certain borrowings under the credit agreement, and U.S. dollar
denominated debt, including the notes and certain borrowings under the credit
agreement.
CAUTIONARY STATEMENTS FOR FORWARD-LOOKING INFORMATION
Certain information set forth in this report contains "forward-looking
statements" within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. Forward-looking statements include statements
concerning our plans, objectives, goals, strategies, future events, future
revenues or performance, capital expenditures, financing needs, plans or
intentions relating to acquisitions, business trends, and other information that
is not historical information in particular, appear under the heading "Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations". When used in this report, the words "estimates," "expects,"
"anticipates," "forecasts," "plans," "intends," "believes" and variations of
such words or similar expressions are intended to identify forward-looking
statements. We may also make additional forward-looking statements from time to
time. All such subsequent forward-looking statements, whether written or oral,
by us or on our behalf, are also expressly qualified by these cautionary
statements.
All forward-looking statements, including, without limitation,
management's examination of historical operating trends, are based upon our
current expectations and various assumptions. Our expectations, beliefs and
projections are expressed in good faith and we believe there is a reasonable
basis for them. However, there can be no assurance that management's
expectations, beliefs and projections will result or be achieved. All
forward-looking statements apply only as of the date made. We undertake no
obligation to publicly update or revise forward-looking statements, which may be
made to reflect events or circumstances after the date made or to reflect the
occurrence of unanticipated events.
There are a number of risks and uncertainties that could cause our
actual results to differ materially from the forward-looking statements
contained in or contemplated by this report. Such risks, uncertainties and other
important factors include, among others:
- general economic and business conditions; including those influenced
by international and geopolitical events such as the situation in
Iraq and any future terrorist attacks;
- the continuing decrease in our annual revenues over the past five
years and net income over the last three years;
- industry trends;
- increases in our leverage;
24
- changes in our ownership structure;
- restrictions contained in our debt agreements;
- the continuity or replacement of systems and services being provided
to us by Shell or its affiliates;
- changes in business strategy, development plans or cost savings
plans;
- competition;
- changes in distribution channels or competitive conditions in the
markets or countries where we operate;
- the highly cyclical nature of the end-use markets in which we
participate;
- the loss of any of our major customers;
- raw material costs and availability;
- ability to attain and maintain any price increases for our products;
- changes in demand for our products;
- availability of qualified personnel;
- foreign currency fluctuations and devaluations and political
instability in our foreign markets;
- the loss of our intellectual property rights;
- availability, terms and deployment of capital;
- changes in, or the failure or inability to comply with, government
regulation, including environmental regulations; and
- increases in the cost of compliance with laws and regulations,
including environmental laws and regulations.
These risks and certain other uncertainties are discussed in
more detail in our Registration Statement on Form S-4, as amended (File No.
333-106331), which was declared effective by the SEC on July 2, 2003. There may
be other factors, including those discussed elsewhere in this report that may
cause our actual results to differ materially from the forward-looking
statements. Any forward-looking statements should be considered in light of
these factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are engaged in manufacturing and marketing resins in the U.
S. and internationally. As a result, the Company is exposed to certain market
risks that include financial instruments such as foreign currency, short-term
investments, trade receivables, and long-term debt. The Company does not enter
into derivative instruments for trading purposes; however, an interest rate cap
for a notional amount of $150 million has been previously executed in connection
with the Company's credit facility. The interest rate cap protects the Company
against rising interest rates fluctuation by capping the floating portion of
credit facility interest rate. At September 30, 2003, the credit facility
balance does not include any amounts outstanding that are subject to variable
interest rates except within the limit of the interest rate cap.
25
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we
evaluated the effectiveness of the design and operation of our "disclosure
controls and procedures" ("Disclosure Controls"). This evaluation ("Controls
Evaluation") was done under the supervision and with the participation of
management, including the Chief Executive Officer ("CEO") and Chief Financial
Officer ("CFO").
Our management, including the CEO and CFO, does not expect
that our Disclosure Controls or our "internal controls and procedures for
financial reporting" ("Internal Controls") will prevent all error and all fraud.
A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Management is aware that certain internal controls continue to
be refined and improved. For example, we have implemented an internal control
steering committee and commenced the implementation of an internal control
software tool to enhance internal controls that will continue to provide us with
reasonable assurance that the identified controls are operating as intended.
Based upon the Controls Evaluation, the CEO and CFO have
concluded that, to the best of their knowledge and subject to the limitations
noted above, the Disclosure Controls are effective to timely alert management to
material information relating to us during the period when our periodic reports
are being prepared. There have been no significant changes in our internal
controls or in other factors that could significantly affect internal controls
subsequent to the date we carried out this evaluation. In addition, there have
been no changes in the Company's internal control over financial reporting that
have occurred during the most recent fiscal quarter that have materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
26
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.5 Share Purchase Agreement dated November 14, 2003 by
and between Resolution Holdings B.V., a Dutch
corporation and Mitsubishi Chemical Corporation, a
Japanese corporation.
31.1 CFO Section 302 certification
31.2 CEO Section 302 certification
32 CEO and CFO Section 906 certification
(b) Reports on Form 8-K.
On August 14, 2003, the Registrants filed a Current
Report on Form 8-K to disclose the first quarter 2003
earnings press release under "Item 7. Financial
Statements and Exhibits" and "Item 12. Results of
Operations and Financial Condition.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
each Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RESOLUTION PERFORMANCE PRODUCTS LLC
Date: November 14, 2003 By: /s/ J. Travis Spoede
--------------------
J. Travis Spoede, Executive Vice
President and Chief Financial
Officer
(Principal Financial and
Accounting Officer)
RPP CAPITAL CORPORATION
Date: November 14, 2003 By: /s/ J. Travis Spoede
--------------------
J. Travis Spoede, Executive Vice
President and Chief Financial
Officer
(Principal Financial and
Accounting Officer)
28
EXHIBIT INDEX
Exhibits
10.5 Share Purchase Agreement dated November 14, 2003 by
and between Resolution Holdings B.V., a Dutch
corporation and Mitsubishi Chemical Corporation, a
Japanese corporation.
31.1 CFO Section 302 certification
31.2 CEO Section 302 certification
32 CEO and CFO Section 906 certification
29