See accompanying notes to condensed consolidated financial statements.
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CROMPTON CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
ACCOUNTING POLICIES
Presentation of Condensed Consolidated Financial Statements
The information in the foregoing condensed consolidated financial statements for the second quarter and six months ended June 30, 2004 and June 30, 2003 is unaudited, but reflects all adjustments, which in the opinion of management, are necessary for a fair presentation of the results of operations for the interim periods presented. The foregoing condensed consolidated financial statements include the accounts of Crompton Corporation and its wholly-owned and majority owned subsidiaries, which are collectively referred to as "the Company." Other affiliates in which the Company has a 20% to 50% ownership are accounted for in accordance with the equity method.
On April 24, 2003, the Company entered into an agreement to sell certain assets and assign certain liabilities of the OrganoSilicones business unit to the Specialty Materials division of General Electric Company (GE) and to acquire GE's Specialty Chemicals business. The transaction closed on July 31, 2003. As a result, the accompanying financial statements reflect the OrganoSilicones business unit as a discontinued operation for the periods ending prior to July 31, 2003. The operations of the OrganoSilicones business unit have been classified as earnings from discontinued operations (net of tax) in the condensed consolidated statements of operations. The condensed consolidated statements of cash flows have not been adjusted to reflect the discontinued operations and thus include the cash flows of the OrganoSilicones business for the six months ended June 30, 2003. Refer to the Discontinued Operations footnote for further information.
Certain financial information and footnote disclosures included in the annual financial statements have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. It is suggested that the interim consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in the Company's 2003 Annual Report on Form 10-K. The consolidated results of operations for the six months ended June 30, 2004 are not necessarily indicative of the results expected for the full year.
Operating Costs and Expenses
Cost of products sold includes all costs incurred in manufacturing products, including raw materials, direct manufacturing costs and manufacturing overhead. Cost of products sold also includes warehousing, distribution, customer service, engineering (other than polymer processing equipment design engineering), purchasing, and environmental, health and safety functions. Selling, general and administrative expenses (SG&A) include costs and expenses related to the following functions and activities: selling, advertising, polymer processing equipment design engineering, shipping costs for out-bound product shipments, information technology, legal, provision for doubtful accounts, corporate facilities and corporate administration. SG&A also includes accounting, finance and human resources, excluding direct support in manufacturing operations, which is included as cost of products sold. Research and development expenses (R&D) include basic and applied research and development activities of a techni
cal and non-routine nature. R&D costs are expensed as incurred. Costs of products sold, SG&A, and R&D expenses exclude depreciation and amortization expenses, which are presented on a separate line in the condensed consolidated statements of operations.
Included in SG&A are shipping costs of $22.8 million and $21.6 million for the second quarters ended June 30, 2004 and June 30, 2003, respectively, and $45.3 million and $40.0 million for the six months ended June 30, 2004 and June 30, 2003, respectively.
Equity Investments
Included among the Company's equity investments at December 31, 2003 were a 50 percent ownership in Gustafson LLC and a 50 percent ownership in Gustafson Partnership, which were sold on March 31, 2004. Refer to the Divestitures footnote for further information. The Company accounted for these investments in accordance with the equity method. The combined assets and liabilities of these two investments were $93.4 million and $38.3 million, respectively, as of December 31, 2003. The combined pre-tax income of the two investments for the first quarter ended March 31, 2004 and six months ended June 30, 2003 were $18 million and $15.2 million, respectively, of which the Company's 50 percent share is $9 million and $7.6 million, respectively.
Other
Included in the Company's condensed consolidated balance sheets at June 30, 2004 and December 31, 2003, is approximately $18 million and $13 million, respectively, of restricted cash that is required to be on deposit to support certain letters of credit and performance guarantees, the majority of which will be settled within one year.
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Included in accounts receivable are allowances for doubtful accounts of $18.6 million at June 30, 2004 and $17.8 million at December 31, 2003.
Accumulated depreciation amounted to $833.6 million at June 30, 2004 and $828.0 million at December 31, 2003.
INDEBTEDNESS AND REFINANCING
The Company had a five-year credit facility of $300 million, which is scheduled to mature in October 2004. There were no outstanding borrowings under this facility at June 30, 2004. Effective July 1, 2004, the Company reduced borrowings available under this facility to $250 million. During the first quarter of 2004, the Company reclassified the carrying value of its outstanding $350 million of 8.5% Senior Notes to short-term due to a scheduled maturity date of March 2005. As a result, the Company had a working capital deficit of $136.7 million as of June 30, 2004. The Company does not anticipate that its operating cash flows during the nine months following June 30, 2004 will be sufficient to repay the amounts outstanding under the $350 million of 8.5% Senior Notes due in March 2005.
As a result, on July 21, 2004, the Company announced that it is planning to offer approximately $600 million aggregate principal amount of new senior notes (the "New Senior Notes"), which will be offered in a combination of three series with various interest rates and maturity dates. The offering of the New Senior Notes is part of a refinancing that includes the replacement of the Company's existing domestic credit facility with a new domestic revolving credit facility with a principal amount of at least $200 million and up to $250 million and a three year extension of the Company's domestic accounts receivable securitization program with the ability to sell up to $125 million of domestic receivables.
In addition, on July 19, 2004, the Company announced that it has commenced a cash tender offer to purchase and consent solicitation for all of its outstanding $350 million aggregate principal amount of 8.5% Senior Notes due 2005 and all of its outstanding $150 million aggregate principal amount of 6.125% Senior Notes due 2006 (collectively the "Notes"). The purchase price for the 8.5% Senior Notes is $1,025.88 per $1,000 principal amount, and the purchase price for the 6.125% Senior Notes is $1,038.35 per $1,000 principal amount of the 6.125% Senior Notes, payable in cash. In addition, Crompton will pay accrued and unpaid interest on validly tendered Notes up to but excluding the settlement date. Furthermore, under certain circumstances, Crompton will pay a consent payment of $10.00 per $1,000 principal amount of each series of Notes to tendering holders of the Notes.
The closing of the new domestic revolving credit facility, the offering of the New Senior Notes, the consent solicitation and tender offer for the Notes and the amendment of the Company's domestic accounts receivable securitization program are conditioned on the completion of one another (collectively referred to as the "Refinancing Transaction") and are subject to market and other customary conditions. The Company expects the Refinancing Transaction to be completed during the third quarter of 2004.
The Company intends to use the net proceeds from the sale of the New Senior Notes to (i) repay outstanding borrowings under its existing domestic revolving credit facility, (ii) fund its concurrent tender offer and consent solicitation for its 8.5% Senior Notes due 2005 and 6.125% Senior Notes due 2006, including tender premiums, consent payments, and accrued and unpaid interest, and (iii) fund working capital and general corporate purposes.
STOCK-BASED COMPENSATION
As permitted under Financial Accounting Standards Board (FASB) Statements No. 123, "Accounting for Stock-Based Compensation" and No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," the Company elected to continue its historical method of accounting for stock-based compensation in accordance with APB 25, "Accounting for Stock Issued to Employees." Under APB 25, compensation expense for fixed plans is recognized based on the difference between the exercise price and the stock price on the date of grant. Since the Company's fixed plan awards have been granted with an exercise price equal to the stock price on the date of grant, no compensation expense has been recognized in the statement of operations for these awards. However, compensation expense has been recognized for the restricted stock awards under the Company's long-term incentive programs in accordance with the provisions of APB 25, which would be unchanged under FASB Statements No. 123 and No. 148. The following table i
llustrates the effect on net earnings and related per share amounts as if the Company had applied the fair value recognition provisions of Statements No. 123 and No. 148 to all stock-based employee compensation awards.
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During the first quarter of 2004, the Company appointed a new President and CEO, and the former President and CEO, Senior Vice President and CFO, and certain other executives elected to retire. As a result of this reorganization, during the second quarter of 2004, the Company completed the separation agreements for the former Chairman, President and CEO, Senior Vice President and CFO, and other executives and recorded a pre-tax charge of $2.6 million for severance and related costs. Such costs are included in facility closures, severance and related costs in the condensed consolidated statements of operations. Payments related to this charge will begin during the third quarter of 2004.
In July 2003, the Company announced a cost reduction program to further eliminate overhead expenses. In order to achieve this goal, the Company expects to reduce its global workforce by approximately 375 positions, of which approximately 345 positions had been eliminated as of June 30, 2004. During the first six months of 2004, the Company recorded an additional pre-tax charge of $0.2 million for facility closures, severance and related costs relating to the July 2003 program in the condensed consolidated statements of operations. A summary of this charge is as follows:
