-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HmhiTLeo5BbHvLgfYltlexNI4lqvmqo+ozFM4cooPbwf2FICUOQXfRcR1Tvh5b3U eENzfbiyCyK5Nti9amyS2w== /in/edgar/work/0000950129-00-005713/0000950129-00-005713.txt : 20001123 0000950129-00-005713.hdr.sgml : 20001123 ACCESSION NUMBER: 0000950129-00-005713 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 20001122 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STERLING CHEMICALS HOLDINGS INC /TX/ CENTRAL INDEX KEY: 0000795662 STANDARD INDUSTRIAL CLASSIFICATION: [2860 ] IRS NUMBER: 760502785 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 001-10059 FILM NUMBER: 775691 BUSINESS ADDRESS: STREET 1: 1200 SMITH ST, SUITE 1900 CITY: HOUSTON STATE: TX ZIP: 77002-4312 BUSINESS PHONE: 7136503700 MAIL ADDRESS: STREET 1: 1200 SMITH ST SUITE 1900 CITY: HOUSTON STATE: TX ZIP: 77002-4312 FORMER COMPANY: FORMER CONFORMED NAME: STERLING CHEMICALS INC /TX/ DATE OF NAME CHANGE: 19961218 FORMER COMPANY: FORMER CONFORMED NAME: STERLING CHEMICALS HOLDINGS INC DATE OF NAME CHANGE: 19960828 FORMER COMPANY: FORMER CONFORMED NAME: STERLING CHEMICALS INC DATE OF NAME CHANGE: 19920703 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STERLING CHEMICAL INC CENTRAL INDEX KEY: 0001014669 STANDARD INDUSTRIAL CLASSIFICATION: [2860 ] IRS NUMBER: 760502785 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 333-04343-01 FILM NUMBER: 775692 BUSINESS ADDRESS: STREET 1: 1200 SMITH STREET STREET 2: SUITE 1900 CITY: HOUSTON STATE: TX ZIP: 77002-4312 BUSINESS PHONE: 7136503700 MAIL ADDRESS: STREET 1: C/O STERLING GROUP INC STREET 2: EIGHT GREENWAY PLAZA, SUITE 702 CITY: HOUSTON STATE: TX ZIP: 77046 FORMER COMPANY: FORMER CONFORMED NAME: STX CHEMICALS CORP DATE OF NAME CHANGE: 19960516 10-K405/A 1 h82182ae10-k405a.txt STERLING CHEMICALS HOLDINGS, INC. - 09/30/1999 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A AMENDMENT NO. 1 ---------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 1999 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 1-10059 STERLING CHEMICALS HOLDINGS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0185186 (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 1200 SMITH STREET, SUITE 1900 HOUSTON, TEXAS 77002-4312 (713) 650-3700 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $.01 PER SHARE COMMISSION FILE NUMBER 333-04343-01 STERLING CHEMICALS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0502785 (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 1200 SMITH STREET SUITE 1900 HOUSTON, TEXAS 77002-4312 (713) 650-3700 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE STERLING CHEMICALS, INC. MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND (b) OF FORM 10-K, AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT PROVIDED FOR BY GENERAL INSTRUCTION I(2) OF FORM 10-K ---------- Indicate by check mark whether each of the registrants (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of each of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. X --- As of December 6, 1999, Sterling Chemicals Holdings, Inc. had 12,751,793 shares of common stock outstanding. As of such date, the aggregate market value of such common stock held by nonaffiliates, based upon the last sales price of these shares as reported on the OTC Electronic Bulletin Board maintained by the National Association of Securities Dealers, Inc., was approximately $36 million. As of December 6, 1999, all outstanding equity securities of Sterling Chemicals, Inc. were owned by Sterling Chemicals Holdings, Inc. Portions of the definitive Proxy Statement relating to the 2000 Annual Meeting of Stockholders of Sterling Chemicals Holdings, Inc. are incorporated by reference in Part III of this Form 10-K. ================================================================================ 2 EXPLANATORY NOTE TO AMENDMENT NO. 1 The undersigned registrant hereby amends its Annual Report on Form 10-K for the fiscal year ended September 30, 1999, for the sole purpose of filing the audited financial statements as of and for the year ended September 30, 1999 for Sterling Canada, Inc., Sterling Fibers, Inc. and Sterling Chemicals Energy, Inc., which are included in Item 8 "Financial Statements and Supplementary Data". PART II.--FINANCIAL INFORMATION ITEM 8. --FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 1 3 INDEX TO FINANCIAL STATEMENTS STERLING CHEMICALS HOLDINGS, INC. AND STERLING CHEMICALS, INC. Sterling Chemicals Holdings, Inc. Consolidated Statements of Operations for the years ended September 30, 1999, 1998, and 1997................................................................................. 5 Sterling Chemicals Holdings, Inc. Consolidated Balance Sheets as of September 30, 1999 and 1998............. 6 Sterling Chemicals Holdings, Inc. Consolidated Statements of Changes in Stockholders' Equity (Deficiency in Assets) for the years ended September 30, 1999, 1998, and 1997............................ 7 Sterling Chemicals Holdings, Inc. Consolidated Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997....................................................................... 8 Sterling Chemicals, Inc. Consolidated Statements of Operations for the years ended September 30, 1999, 1998, and 1997......................................................................................... 9 Sterling Chemicals, Inc. Consolidated Balance Sheets as of September 30, 1999 and 1998...................... 10 Sterling Chemicals, Inc. Consolidated Statements of Changes in Stockholder's Equity (Deficiency in Assets) for the years ended September 30, 1999, 1998, and 1997 .......................................... 11 Sterling Chemicals, Inc. Consolidated Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997.......................................................................................... 12 Notes to Consolidated Financial Statements.................................................................. 13 Independent Auditors' Reports............................................................................... 40 STERLING CHEMICALS U.S. SUBSIDIARIES Sterling Chemicals U.S. Subsidiaries Combined Statements of Operations for the years ended September 30, 1999, 1998, and 1997....................................................................... 42 Sterling Chemicals U.S. Subsidiaries Combined Balance Sheets as of September 30, 1999 and 1998.............. 43 Sterling Chemicals U.S. Subsidiaries Combined Statements of Changes in Stockholder's Equity for the years ended September 30, 1999, 1998, and 1997........................................................... 44 Sterling Chemicals U.S. Subsidiaries Combined Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997....................................................................... 45
2 4 Notes to Combined Financial Statements...................................................................... 46 Independent Auditors' Report................................................................................ 58 STERLING PULP CHEMICALS, LTD. Sterling Pulp Chemicals, Ltd. Statements of Operations for the years ended September 30, 1999, 1998, and 1997................................................................................................. 59 Sterling Pulp Chemicals, Ltd. Balance Sheets as of September 30, 1999 and 1998.............................. 60 Sterling Pulp Chemicals, Ltd. Statements of Changes in Stockholder's Equity for the years ended September 30, 1999, 1998, and 1997....................................................................... 61 Sterling Pulp Chemicals, Ltd. Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997................................................................................................. 62 Notes to Financial Statements............................................................................... 63 Independent Auditors' Report................................................................................ 72 STERLING CANADA, INC. Sterling Canada, Inc. Statements of Operations for the years ended September 30, 1999, 1998, and 1997................................................................................................. 74 Sterling Canada, Inc. Balance Sheets as of September 30, 1999 and 1998...................................... 75 Sterling Canada, Inc. Statements of Changes in Stockholder's Equity for the years ended September 30, 1999, 1998, and 1997....................................................................... 76 Sterling Canada, Inc. Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997................................................................................................. 77 Notes to Financial Statements............................................................................... 78 Independent Auditors' Report................................................................................ 89 STERLING FIBERS, INC. Sterling Fibers, Inc. Statements of Operations for the years ended September 30, 1999, 1998, and 1997................................................................................................. 90
3 5 Sterling Fibers, Inc. Balance Sheets as of September 30, 1999 and 1998...................................... 91 Sterling Fibers, Inc. Statements of Changes in Stockholder's Equity for the years ended September 30, 1999, 1998, and 1997....................................................................... 92 Sterling Fibers, Inc. Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997................................................................................................. 93 Notes to Financial Statements............................................................................... 94 Independent Auditors' Report................................................................................101 STERLING CHEMICALS ENERGY, INC. Sterling Chemicals Energy, Inc. Statements of Operations for the years ended September 30, 1999, 1998, and 1997.................................................................................................102 Sterling Chemicals Energy, Inc. Balance Sheets as of September 30, 1999 and 1998............................103 Sterling Chemicals Energy, Inc. Statements of Changes in Stockholder's Equity for the years ended September 30, 1999, 1998, and 1997.......................................................................104 Sterling Chemicals Energy, Inc. Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997.................................................................................................105 Notes to Financial Statements...............................................................................106 Independent Auditors' Report................................................................................110
4 6 STERLING CHEMICALS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED SEPTEMBER 30, ------------------------------------------------ 1999 1998 1997 ------------ ------------ ------------ Revenues ........................................................ $ 720,752 $ 822,590 $ 908,787 Cost of goods sold .............................................. 682,594 745,323 823,265 ------------ ------------ ------------ Gross profit .................................................... 38,158 77,267 85,522 Selling, general, and administrative expenses ................... 37,649 38,515 28,053 Impairment of assets ............................................ 26,369 -- -- Other expense ................................................... 10,832 5,962 -- Interest and debt related expenses, net of interest income ...... 104,061 104,455 88,901 ------------ ------------ ------------ Loss before taxes and extraordinary item ........................ (140,753) (71,665) (31,432) Benefit for income taxes ....................................... (34,936) (25,546) (7,296) ------------ ------------ ------------ Loss before extraordinary item .................................. (105,817) (46,119) (24,136) Extraordinary item, loss on early extinguishment of debt, net of tax .................................................. 4,212 -- 3,924 ------------ ------------ ------------ Net loss ........................................................ (110,029) (46,119) (28,060) Preferred stock dividends ....................................... 2,683 2,460 905 ------------ ------------ ------------ Net loss attributable to common stockholders .................... $ (112,712) $ (48,579) $ (28,965) ============ ============ ============ Per share data: Loss before extraordinary item .................................. $ (8.60) $ (3.99) $ (2.23) Extraordinary item .............................................. (0.34) -- (0.35) ------------ ------------ ------------ Loss per common share ........................................... $ (8.94) $ (3.99) $ (2.58) ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 5 7 STERLING CHEMICALS HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, ------------------------------ 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents ........................................................ $ 14,921 $ 11,168 Accounts receivable .............................................................. 141,059 114,571 Inventories ...................................................................... 70,464 73,225 Prepaid expenses ................................................................. 16,236 15,571 Deferred income tax benefit ...................................................... 16,888 5,140 ------------ ------------ Total current assets ........................................................... 259,568 219,675 Property, plant, and equipment, net ................................................. 402,723 450,315 Deferred income tax benefit ......................................................... 26,158 -- Other assets ........................................................................ 86,650 95,966 ------------ ------------ Total assets ................................................................... $ 775,099 $ 765,956 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY IN ASSETS) Current liabilities: Accounts payable ................................................................. $ 72,961 $ 46,983 Accrued liabilities .............................................................. 79,883 71,873 Current portion of long-term debt ................................................ 4,246 8,909 ------------ ------------ Total current liabilities ...................................................... 157,090 127,765 Long-term debt ...................................................................... 964,555 873,616 Deferred income tax liability ....................................................... 8,815 11,123 Deferred credits and other liabilities .............................................. 76,893 80,289 Common stock held by ESOP ........................................................... 2,946 5,938 Less: unearned compensation ........................................................ (745) (2,845) Redeemable preferred stock .......................................................... 20,932 18,249 Commitments and contingencies (Note 6) .............................................. -- -- Stockholders' equity (deficiency in assets): Common stock, $.01 par value, 20,000,000 shares authorized, 12,305,000 shares issued and 12,097,000 outstanding at September 30, 1999; and 12,273,000 shares issued and 12,073,000 outstanding at September 30, 1998 ................. 123 123 Additional paid-in capital ....................................................... (542,712) (542,701) Retained earnings ................................................................ 118,490 229,590 Accumulated other comprehensive income ........................................... (28,768) (32,680) Deferred compensation ............................................................ (58) (111) ------------ ------------ (452,925) (345,779) Treasury stock, at cost, 208,000 and 200,000 shares at September 30, 1999 and 1998, respectively ......................................................... (2,462) (2,400) ------------ ------------ Total stockholders' equity (deficiency in assets) ............................ (455,387) (348,179) ------------ ------------ Total liabilities and stockholders' equity (deficiency in assets) .......... $ 775,099 $ 765,956 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 6 8 STERLING CHEMICALS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY IN ASSETS) (AMOUNTS IN THOUSANDS)
ACCUMULATED ADDITIONAL OTHER COMMON STOCK PAID-IN RETAINED COMPREHENSIVE DEFERRED TREASURY SHARES AMOUNT CAPITAL EARNINGS INCOME COMPENSATION STOCK TOTAL ------ -------- ----------- ---------- ------------- ------------ --------- ---------- Balance, September 30, 1996 .. 10,599 $ 106 $ (560,077) $ 306,656 $ (19,124) $ -- $ -- $ (272,439) Comprehensive loss: Net loss ..................... -- -- -- (28,060) -- -- -- Other comprehensive loss, net of tax: Cumulative translation adjustments .............. -- -- -- -- (1,969) -- -- Pension adjustment ......... -- -- -- -- (31) -- -- Comprehensive loss ...... -- -- -- -- -- -- -- (30,060) Common stock issued in connection with AFB Acquisition, net ....... 778 8 9,331 -- -- -- -- 9,339 Preferred stock dividends .... -- -- -- (905) -- -- -- (905) Employee stock purchase ...... (44) -- (531) -- -- -- -- (531) Treasury stock purchases ..... (228) -- -- -- -- -- (2,730) (2,730) Common stock issued in connection with the Saskatoon Acquisition, net . 609 6 6,379 -- -- -- -- 6,385 Stock warrants .............. -- -- 2,413 -- -- -- -- 2,413 ------- -------- ---------- ---------- ---------- ---------- --------- ---------- Balance, September 30, 1997 .. 11,714 120 (542,485) 277,691 (21,124) -- (2,730) (288,528) Comprehensive loss: Net loss ..................... -- -- -- (46,119) -- -- -- Other comprehensive loss, net of tax: Cumulative translation adjustments .............. -- -- -- -- (11,466) -- -- Pension adjustment ......... -- -- -- -- (90) -- -- Comprehensive loss ...... -- -- -- -- -- -- -- (57,675) Common stock issued in connection with the exercise of warrants ....... 345 3 -- -- -- -- -- 3 Preferred stock dividends .... -- -- -- (2,460) -- -- -- (2,460) Treasury shares issued as restricted stock ........... 23 -- (48) -- -- (222) 270 -- Treasury shares issued -- -- 168 -- to ESOP .................... -- -- (168) -- Revaluation of ESOP shares to independently appraised -- -- -- 478 market value ................. -- -- -- 478 Amortization of deferred -- 111 -- 111 compensation ............... -- -- -- -- -- -- (108) (108) Treasury stock purchases ..... (9) -- -- -- ---------- ---------- --------- ---------- ------- -------- ---------- ---------- (32,680) (111) (2,400) (348,179) Balance, September 30, 1998 .. 12,073 123 (542,701) 229,590 Comprehensive loss: -- -- -- Net loss ..................... -- -- -- (110,029) Other comprehensive income (loss), net of tax: Cumulative translation adjustments .............. -- -- -- -- 3,972 -- -- Pension adjustment ......... -- -- -- -- (60) -- -- Comprehensive loss ...... -- -- -- -- -- -- -- (106,117) Common stock issued in c onnection with the exercise of warrants ................ 32 -- -- -- -- -- -- -- Preferred stock dividends .... -- -- -- (2,683) -- -- -- (2,683) Treasury shares issued as restricted stock ........ 1 -- (11) -- -- (7) 18 -- Revaluation of ESOP shares to independently appraised market value ............... -- -- -- 1,612 -- -- -- 1,612 Amortization of deferred compensation ............... -- -- -- -- -- 60 -- 60 Treasury stock purchases ..... (9) -- -- -- -- -- (80) (80) ------- -------- ---------- ---------- ---------- ---------- --------- ---------- Balance, September 30, 1999 .. 12,097 $ 123 $ (542,712) $ 118,490 $ (28,768) $ (58) $ (2,462) $ (455,387) ======= ======== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. 7 9 STERLING CHEMICALS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Cash flows from operating activities: Net loss ......................................................... $ (110,029) $ (46,119) $ (28,060) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization ............................... 57,677 55,963 49,849 Interest amortization ....................................... 3,105 4,376 4,163 Extraordinary item, loss on early extinguishment of debt .... 4,212 -- 3,924 Deferred tax benefit ........................................ (38,024) (19,722) (3,107) Early retirement programs and benefit changes ............... 6,781 -- -- Discount notes amortization ................................. 19,483 16,878 15,499 Impairment of assets ........................................ 26,369 -- -- Other ....................................................... 1,016 1,820 2,328 Change in assets/liabilities: Accounts receivable ......................................... (11,547) 44,419 (8,985) Inventories ................................................. 3,207 13,675 (6,674) Prepaid expenses ............................................ (10,760) (2,852) (7,767) Other assets ................................................ (1,477) 654 (1,754) Accounts payable ............................................ 19,137 (32,896) (1,424) Accrued liabilities ......................................... 4,619 (9,300) 27,305 Other liabilities ........................................... 12,341 18,988 2,017 ------------ ------------ ------------ Net cash provided by (used in) operating activities .............. (13,890) 45,884 47,314 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures ........................................ (29,540) (26,622) (43,428) Proceeds from sale of assets ................................ 3,583 -- -- Business acquisitions ....................................... -- -- (152,923) ------------ ------------ ------------ Net cash used in investing activities ............................ (25,957) (26,622) (196,351) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from long-term debt ................................ 814,105 59,862 375,260 Repayment of long-term debt ................................. (751,001) (75,152) (236,104) Issuance of common stock .................................... -- 3 18,721 Sale of warrants ............................................ -- -- 2,413 Debt issuance costs ......................................... (16,480) -- (9,684) Issuance of preferred stock ................................. -- -- 4,887 Purchase of treasury stock .................................. (80) (105) (3,256) Other ....................................................... (3,270) 154 (627) ------------ ------------ ------------ Net cash provided by (used in) financing activities .............. 43,274 (15,238) 151,610 Effect of United States /Canadian exchange rate on cash .......... 326 (814) (224) ------------ ------------ ------------ Net increase in cash and cash equivalents ........................ 3,753 3,210 2,349 Cash and cash equivalents - beginning of year .................... 11,168 7,958 5,609 ------------ ------------ ------------ Cash and cash equivalents - end of year .......................... $ 14,921 $ 11,168 $ 7,958 ============ ============ ============ Supplemental disclosures of cash flow information: Interest paid, net of interest income received .............. $ (83,167) $ (80,223) $ (60,387) Income taxes received ....................................... 4,750 6,653 3,116
The accompanying notes are an integral part of the consolidated financial statements. 8 10 STERLING CHEMICALS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Revenues ......................................... $ 720,752 $ 822,590 $ 908,787 Cost of goods sold ............................... 682,594 745,323 823,265 ------------ ------------ ------------ Gross profit ..................................... 38,158 77,267 85,522 Selling, general, and administrative expenses .... 36,980 37,319 27,358 Impairment of assets ............................. 26,369 -- -- Other expense .................................... 10,832 5,962 -- Interest and debt related expenses ............... 83,897 86,618 72,931 Interest income from parent ...................... -- -- (1,692) ------------ ------------ ------------ Loss before taxes and extraordinary item ......... (119,920) (52,632) (13,075) Benefit for income taxes ......................... (29,410) (18,963) (2,148) ------------ ------------ ------------ Loss before extraordinary item ................... (90,510) (33,669) (10,927) Extraordinary item, loss on early extinguishment of debt, net of tax ........................... 4,212 -- 3,924 ------------ ------------ ------------ Net loss ......................................... $ (94,722) $ (33,669) $ (14,851) ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 9 11 STERLING CHEMICALS, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, ---------------------------- 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents .......................................... $ 14,899 $ 11,159 Accounts receivable ................................................ 143,556 116,398 Inventories ........................................................ 70,464 73,225 Prepaid expenses ................................................... 15,059 13,632 Deferred income tax benefit ........................................ 16,888 5,140 ------------ ------------ Total current assets ............................................. 260,866 219,554 Property, plant and equipment, net .................................... 402,723 450,315 Deferred income tax benefit ........................................... 8,384 -- Other assets .......................................................... 80,133 92,634 ------------ ------------ Total assets ..................................................... $ 752,106 $ 762,503 ============ ============ LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIENCY IN ASSETS) Current liabilities: Accounts payable ................................................... $ 72,731 $ 46,775 Accrued liabilities ................................................ 79,883 71,873 Current portion of long-term debt .................................. 4,246 8,909 ------------ ------------ Total current liabilities .......................................... 156,860 127,557 Long-term debt ........................................................ 816,927 745,709 Deferred income tax liability ......................................... 8,815 23,301 Deferred credits and other liabilities ................................ 76,893 83,288 Common stock held by ESOP ............................................. 2,946 5,938 Less: unearned compensation .......................................... (745) (2,845) Commitments and contingencies ......................................... -- -- Stockholder's equity (deficiency in assets): Common stock, $.01 par value ....................................... -- -- Additional paid-in capital ......................................... (139,786) (139,786) Accumulated deficit ................................................ (140,978) (47,868) Accumulated other comprehensive income ............................. (28,768) (32,680) Deferred compensation .............................................. (58) (111) ------------ ------------ Total stockholder's equity (deficiency in assets) .................. (309,590) (220,445) ------------ ------------ Total liabilities and stockholder's equity (deficiency in assets) .. $ 752,106 $ 762,503 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 10 12 STERLING CHEMICALS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (DEFICIENCY IN ASSETS) (AMOUNTS IN THOUSANDS)
RETAINED ACCUMULATED ADDITIONAL EARNINGS OTHER COMMON STOCK PAID-IN (ACCUMULATED COMPREHENSIVE DEFERRED SHARES AMOUNT CAPITAL DEFICIT) INCOME COMPENSATION TOTAL --------- --------- ---------- ------------ ------------- ------------ ---------- Balance, September 30, 1996 ........ 1 $ -- $ (165,352) $ 174 $ (19,124) $ -- $ (184,302) Comprehensive loss: Net loss ........................... -- -- -- (14,851) -- Other comprehensive loss, net of tax: Cumulative translation adjustments .................... -- -- -- -- (1,969) Pension adjustment ............... -- -- -- -- (31) Comprehensive loss ............ -- -- -- -- -- -- (16,851) Earned ESOP shares ................. -- -- (2,118) -- -- -- (2,118) Contribution from parent ........... -- -- 27,684 -- -- -- 27,684 --------- --------- ---------- ---------- ---------- ---------- ---------- Balance, September 30, 1997 ........ 1 -- (139,786) (14,677) (21,124) -- (175,587) Comprehensive loss: Net loss ........................... -- -- -- (33,669) -- Other comprehensive loss, net of tax: Cumulative translation adjustments ........ -- -- -- -- (11,466) Pension adjustment ............... -- -- -- -- (90) Comprehensive loss ............ -- -- -- -- -- -- (45,225) Issuance of restricted stock ....... -- -- -- -- -- (222) (222) Revaluation of ESOP shares to independently appraised market value ..................... -- -- -- 478 -- -- 478 Amortization of deferred compensation ..................... -- -- -- -- -- 111 111 --------- --------- ---------- ---------- ---------- ---------- ---------- Balance, September 30, 1998 ........ 1 -- (139,786) (47,868) (32,680) (111) (220,445) Comprehensive loss: Net loss ........................... -- -- -- (94,722) -- Other comprehensive income (loss), net of tax: Cumulative translation adjustments ........ -- -- -- -- 3,972 Pension adjustment ............... -- -- -- -- (60) Comprehensive loss ............ -- -- -- -- -- -- (90,810) Issuance of restricted stock ....... -- -- -- -- -- (7) (7) Revaluation of ESOP shares to independently appraised market value ..................... -- -- -- 1,612 -- -- 1,612 Amortization of deferred compensation ..................... -- -- -- -- -- 60 60 --------- --------- ---------- ---------- ---------- ---------- ---------- Balance, September 30, 1999 ........ 1 $ -- $ (139,786) $ (140,978) $ (28,768) $ (58) $ (309,590) ========= ========= ========== ========== ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. 11 13 STERLING CHEMICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Cash flows from operating activities: Net loss ................................................... $ (94,722) $ (33,669) $ (14,851) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization ........................... 60,349 59,151 53,680 Deferred tax expense (benefit) .......................... (32,498) (13,139) 1,869 Extraordinary item ...................................... 4,212 -- 3,924 Early retirement and benefit charges .................... 6,781 -- -- Impairment of assets .................................... 26,368 -- -- Other ................................................... 1,016 2,020 2,173 Change in assets/liabilities: Accounts receivable ..................................... (10,877) 45,484 (13,510) Inventories ............................................. 3,207 13,675 (6,674) Prepaid expenses ........................................ (11,522) (1,838) (5,733) Other assets ............................................ 4,811 2,078 (2,271) Accounts payable ........................................ 17,797 (35,102) (1,288) Accrued liabilities ..................................... 4,619 (3,441) 27,218 Other liabilities ....................................... 6,556 10,654 2,037 ------------ ------------ ------------ Net cash provided by (used in) operating activities ........ (13,903) 45,873 46,574 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures .................................... (29,540) (26,622) (43,428) Business acquisitions ................................... -- -- (152,923) Proceeds from sale of assets ............................ 3,583 -- -- ------------ ------------ ------------ Net cash used in investing activities ...................... (25,957) (26,622) (196,351) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from long-term debt ............................ 814,105 59,862 375,260 Repayment of long-term debt ............................. (751,001) (75,153) (236,104) Debt issuance costs ..................................... (16,480) -- (9,684) Intercompany financing .................................. -- 1 3,000 Contribution from parent ................................ -- -- 22,286 Other ................................................... (3,350) 54 (2,380) ------------ ------------ ------------ Net cash provided by (used in) financing activities ........ 43,274 (15,236) 152,378 Effect of United States/Canadian exchange rate on ........ 326 (814) (224) cash ------------ ------------ ------------ Net increase in cash and cash equivalents .................. 3,740 3,201 2,377 Cash and cash equivalents - beginning of period ............ 11,159 7,958 5,581 ------------ ------------ ------------ Cash and cash equivalents - end of year .................... $ 14,899 $ 11,159 $ 7,958 ============ ============ ============ Supplement disclosures of cash flow information: Interest paid, net of interest income received .......... $ (83,180) $ (80,251) $ (60,402) Income taxes received ................................... 4,750 6,653 3,116
The accompanying notes are an integral part of the consolidated financial statements. 12 14 STERLING CHEMICALS HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Sterling Chemicals Holdings, Inc. ("Holdings" and, together with its subsidiaries, the "Company") manufactures seven commodity petrochemicals at its Texas City, Texas plant (the "Texas City Plant"). Additionally, the Company manufactures chemicals for use primarily in the pulp and paper industry at five plants in Canada and one plant in Valdosta, Georgia (the "Valdosta Plant"), and manufactures acrylic fibers in a plant near Pensacola, Florida (the "Santa Rosa Plant"). At its Texas City Plant, the Company produces styrene, acrylonitrile, acetic acid, plasticizers, methanol, tertiary butylamine ("TBA"), and sodium cyanide. The Company generally sells its petrochemicals products to customers for use in the manufacture of other chemicals and products, which in turn are used in the production of a wide array of consumer goods and industrial products. The Company produces regular textiles, specialty textiles, and technical fibers at the Santa Rosa Plant, as well as licensing its acrylic fibers manufacturing technology to producers worldwide. Sodium chlorate is produced at the Company's five plants in Canada and the Valdosta Plant. Sodium chlorite is produced at one of the Company's Canadian locations. In addition, chlor-alkali and calcium hypochlorite are produced at one of the Canadian locations. The Company licenses, engineers, and oversees construction of large-scale chlorine dioxide generators for the pulp and paper industry as part of the pulp chemicals business. These generators convert sodium chlorate into chlorine dioxide at pulp mills. Holdings is a holding company whose only material asset is its investment in Sterling Chemicals, Inc. ("Chemicals"). Chemicals and its subsidiaries are substantially all of the consolidated operating assets. The significant accounting policies of the Company are described below. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of all wholly owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The Company's investment in a cogeneration joint venture of a 50% equity interest and a 50/50 acrylonitrile marketing joint venture are accounted for under the equity method with the Company's share of the operating results of the joint ventures recorded in its Statement of Operations. CASH EQUIVALENTS The Company considers all investments purchased with a remaining maturity of three months or less to be cash equivalents. INVENTORIES Inventories are stated at the lower of cost or market; cost is primarily determined on the first-in, first-out basis except for stores and supplies, which are valued at average cost. The Company enters into agreements with other companies to exchange chemical inventories in order to minimize working capital requirements and to facilitate distribution logistics. Balances related to quantities due to or payable by the Company are included in inventory. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are recorded at cost. Major renewals and improvements, which extend the useful lives of the equipment, are capitalized. Major planned maintenance expenses are accrued for during the periods prior to the maintenance, while routine repair and maintenance expenses are charged to operations as incurred. Disposals are removed at carrying cost less accumulated depreciation with any resulting gain or loss reflected in operations. Depreciation is provided using the straight-line method over estimated useful lives ranging 13 15 from 5 to 25 years with the predominant life of the plant and equipment being 15 years. The Company capitalizes interest costs, which are incurred as part of the cost of constructing major facilities and equipment. The amount of interest capitalized for the fiscal years 1999, 1998, and 1997 was $1.4 million, $0.8 million, and $3.8 million, respectively. IMPAIRMENT OF LONG-LIVED ASSETS Impairment tests of long-lived assets are made when conditions indicate their carrying cost may not be recoverable. Such impairment tests are based on a comparison of undiscounted future cash flows or the market value of similar assets to the carrying cost of the asset. If an impairment is indicated, the asset value is written down to its estimated fair value. During fiscal 1999, the Company incurred an impairment loss of $26.4 million related to its methanol production assets. PATENTS AND ROYALTIES The cost of patents is amortized on a straight-line basis over their estimated useful lives which approximates ten years. The Company capitalized the value of the chlorine dioxide generator technology acquired in fiscal 1992 based on the net present value of all estimated remaining royalty payments associated with the technology. The resulting intangible amount is included in other assets and is amortized over the average life for these royalty payments of ten years. DEBT ISSUE COSTS Debt issue costs relating to long-term debt are amortized over the term of the related debt instrument using the effective interest method and are included in other assets. INCOME TAXES Deferred income taxes are recorded to reflect the tax effect of the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted rates. REVENUE RECOGNITION The Company generates revenues through sales in the open market, raw material conversion agreements, and long-term supply contracts. In addition, the Company has entered into shared profit arrangements with respect to certain petrochemicals products. The Company recognizes revenue from sales in the open market, raw material conversion agreements, and long-term supply contracts when the products are shipped. Revenues from shared profit arrangements are estimated and accrued monthly. Deferred credits are amortized over the life of the contract which gave rise to them. The Company also generates revenues from the construction and sale of chlorine dioxide generators, which are recognized using the percentage of completion method. The Company also receives prepaid royalties, which are recognized over a period, which is typically ten years. In addition, the Company generates revenues from the sale of acrylic fibers manufacturing technology to producers worldwide, which are recognized as earned. FOREIGN CURRENCY TRANSLATION AND FOREIGN EXCHANGE The Company's Canadian subsidiaries use the Canadian dollar as their functional currency. For financial reporting purposes, assets and liabilities of these subsidiaries denominated in Canadian dollars are translated into United States dollars at year-end exchange rates and revenues and expenses are translated at the average monthly exchange rates. Translation adjustments are reported as a separate component of stockholders' equity, while transaction gains and losses are included in operations when incurred. The Company's Canadian subsidiaries enter into forward foreign exchange contracts to minimize the short-term impact of Canadian dollar fluctuations on certain of its Canadian dollar denominated commitments. Gains or losses on these contracts are deferred and are included in operations in the same period in which the related transactions are settled. 14 16 HEDGING The Company periodically enters into contracts to hedge against the volatility in the price of natural gas, which is used in the production of styrene and methanol. These transactions generally take the form of price collars, and are placed with major financial institutions and industrial companies. The results of the hedging transactions are included in Cost of Goods Sold as the related production of styrene and methanol occurs. 15 17 EARNINGS PER SHARE For purposes of computing net income (loss) per common share, net income (loss) has been reduced by an amount equal to the fair market value of Released Shares (as hereinafter defined) at the end of the period, minus the sum of the amount previously recognized as compensation expense with respect to Released Shares and the amount of depreciation/appreciation in value of Released Shares in prior periods. This reduction results from the Company being required, under certain circumstances, to purchase for cash common stock distributed to participants by the Sterling Chemicals ESOP (the "ESOP"). "Released Shares" are shares held by the ESOP but allocated to employees. The weighted average number of outstanding shares and computation of the net income (loss) per common share is as follows (in thousands, except per share data):
YEAR ENDED SEPTEMBER 30, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Net loss attributable to common stockholders .................... $ (112,712) $ (48,579) $ (28,965) Plus depreciation in value of Released Shares ................... 1,048 298 -- ------------ ------------ ------------ Net loss for purpose of computing net income (loss) per share ... $ (111,664) $ (48,281) $ (28,965) ============ ============ ============ Net loss per common share ....................................... $ (8.94) $ (3.99) $ (2.58) ============ ============ ============ Weighted average shares outstanding ............................. 12,495 12,104 11,237 ============ ============ ============
As losses were incurred in fiscal 1999, 1998, and 1997, basic and diluted EPS are the same amount for these periods. COMPREHENSIVE INCOME (LOSS) As of October 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income". SFAS No. 130 establishes standards for the reporting and displaying of comprehensive net income and its components. Accumulated Other Comprehensive Income consists of the following (in thousands):
CUMULATIVE TRANSLATION ADJUSTMENT PENSION ADJUSTMENT TOTAL -------------- ------------------ -------------- Balance, September 30, 1996 ....... $ (19, 124) $ -- $ (19,124) Changes ........................... (1,969) (31) (2,000) -------------- -------------- -------------- Balance, September 30, 1997 ....... (21,093) (31) (21,124) Changes ........................... (11,466) (90) (11,556) -------------- -------------- -------------- Balance, September 30, 1998 ....... (32,559) (121) (32,680) Changes ........................... 3,972 (60) 3,912 -------------- -------------- -------------- Balance, September 30, 1999 ....... $ (28,587) $ (181) $ (28,768) ============== ============== ==============
There is no tax expense or benefit associated with the cumulative translation adjustment amounts above. The pension adjustment amounts are net of tax benefit of $32,000, $49,000, and $17,000 for the fiscal years ended September 30, 1999, 1998, and 1997, respectively. ENVIRONMENTAL COSTS Environmental costs are expensed unless the expenditures extend the economic useful life of the assets. Costs that extend the economic life of the assets are capitalized and depreciated over the remaining life of such assets. Liabilities are recorded when environmental assessments and/or remedial efforts are probable, and the cost can be reasonably estimated. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS In preparing disclosures about the fair value of financial instruments, the Company has assumed that the carrying amount approximates fair value for cash and cash equivalents, receivables, short-term borrowings, accounts 16 18 payable, and certain accrued expenses because of the short maturities of those instruments. The fair values of long-term debt instruments are estimated based upon quoted market values (if applicable) or on the current interest rates available to the Company for debt with similar terms and remaining maturities. Considerable judgment is required in developing these estimates and, accordingly, no assurance can be given that the estimated values presented herein are indicative of the amounts that would be realized in a free market exchange. ACCOUNTING ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Significant estimates include environmental reserves, litigation contingencies, maintenance costs related to shut downs, taxes, and revenues. Actual results could differ from these estimates. RECLASSIFICATION Certain amounts reported in the financial statements for the prior periods have been reclassified to conform with the current financial statement presentation with no effect on net income (loss) or stockholders' equity (deficiency in assets). 17 19 2. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS:
SEPTEMBER 30, ------------------------------ 1999 1998 ------------- ------------- (Dollars in Thousands) Inventories: Finished products ............................. $ 37,484 $ 42,436 Raw materials ................................. 10,355 8,089 ------------- ------------- Inventories at cost ............................. 47,839 50,525 ------------- ------------- Inventories under exchange agreements ......... 2,562 3,031 Stores and supplies ........................... 20,063 19,669 ------------- ------------- $ 70,464 $ 73,225 ============= ============= Property, plant, and equipment: Land .......................................... $ 10,274 $ 12,897 Buildings ..................................... 56,728 51,362 Plant and equipment ........................... 673,108 652,872 Construction in progress ...................... 39,388 30,506 Less: accumulated depreciation ............... (376,775) (297,322) ------------- ------------- $ 402,723 $ 450,315 ============= ============= Other assets: Patents and technology, net ................... $ 21,630 $ 26,821 Debt issue costs .............................. 34,055 28,248 Other ......................................... 30,965 40,897 ------------- ------------- $ 86,650 $ 95,966 ============= ============= Accrued liabilities: Repairs ....................................... $ 9,635 $ 16,890 Interest ...................................... 20,778 14,433 Compensation .................................. 18,174 5,489 Property taxes ................................ 8,243 7,754 Other ......................................... 23,053 27,307 ------------- ------------- $ 79,883 $ 71,873 ============= ============= Deferred credits and other liabilities: Deferred revenue .............................. $ 7,667 $ 15,168 Accrued postretirement benefits ............... 54,084 37,663 Other ......................................... 15,142 27,458 ------------- ------------- $ 76,893 $ 80,289 ============= =============
18 20 3. LONG-TERM DEBT: Long-term debt consisted of the following:
SEPTEMBER 30, ---------------------------------- 1999 1998 --------------- --------------- (Dollars in Thousands) Revolving credit facilities ...................... $ 54,643 $ -- Term loans ....................................... -- 274,000 Saskatoon term loans ............................. 44,045 49,552 ESOP term loan ................................... -- 3,250 11 1/4% notes .................................... 152,485 152,816 11 3/4% notes .................................... 275,000 275,000 12 3/8% notes .................................... 295,000 -- --------------- --------------- Total Chemicals' debt outstanding ............. 821,173 754,618 13 1/2% notes .................................... 147,628 127,907 --------------- --------------- Total Holdings' debt outstanding .............. 968,801 882,525 =============== =============== Less: Current maturities ............................ (4,246) (8,909) --------------- --------------- Total long-term debt ............................. $ 964,555 $ 873,616 =============== ===============
19 21 On July 23, 1999, Chemicals completed a private offering (the "12 3/8% Notes Offering") of $295,000,000 of its 12 3/8% Senior Secured Notes due 2006. On November 5, 1999, Chemicals completed a registered exchange offer, pursuant to which all of these notes were exchanged for publicly registered 12 3/8% Notes with substantially similar terms (the "12 3/8% Notes"). The 12 3/8% Notes are senior secured obligations of Chemicals and rank equally in right of payment with all other existing and future senior indebtedness of Chemicals and senior in right of payment to all existing and future subordinated indebtedness of Chemicals. The 12 3/8% Notes are guaranteed by all of Chemicals' existing direct and indirect United States subsidiaries (other than Sterling Chemicals Acquisitions, Inc.) on a joint and several basis. Each subsidiary's guarantee ranks equally in right of payment with all of such subsidiary's existing and future senior indebtedness and senior in right of payment to all existing and future subordinated indebtedness of such subsidiary. However, the 12 3/8% Notes, and each subsidiary's guarantee, is subordinated to the extent of the collateral securing Chemicals' new secured revolving credit facilities described below. The 12 3/8% Notes and the subsidiary guarantees are secured by (i) a second priority lien on all of Chemicals' and the subsidiary guarantors' United States production facilities and related assets, (ii) a second priority pledge of all of the capital stock of each subsidiary guarantor, and (iii) a first priority pledge of 65% of the stock of certain of the Company's subsidiaries incorporated outside of the United States. The 12 3/8% Notes bear interest at the annual rate of 12 3/8%, payable semi-annually on January 15 and July 15 of each year commencing January 15, 2000. Except as otherwise provided below, the 12 3/8% Notes may not be redeemed by Chemicals prior to July 15, 2003. From that date until July 15, 2004, the 12 3/8% Notes may be redeemed at a premium of the principal amount thereof at maturity of 106.188% and from July 15, 2004 until July 15, 2005, the 12 3/8% Notes may be redeemed at a premium of the principal amount thereof at maturity of 103.094%. Thereafter, Chemicals may redeem the 12 3/8% Notes at their face value plus accrued and unpaid interest. Prior to July 15, 2002, Chemicals may redeem in the aggregate up to 35% of the original principal amount of the 12 3/8% Notes with the proceeds of one or more Public Equity Offerings, as defined. Such redemptions may be made at a redemption price of 112.375 of the face value plus accrued and unpaid interest to the redemption date. After such redemption, at least $191.75 million aggregate principal amount of the 12 3/8% Notes must remain outstanding. In addition, on July 23, 1999, Chemicals established two new secured revolving credit facilities providing up to $155,000,000 in revolving credit loans (the "New Revolvers") under a single Revolving Credit Agreement (the "New Credit Agreement"). Under the New Credit Agreement, Chemicals and each of its direct and indirect United States subsidiaries (other than Sterling Chemicals Acquisitions, Inc.) are co-borrowers and are jointly and severally liable for any indebtedness thereunder. The New Revolvers consist of (i) a $70,000,000 revolving credit facility (the "Fixed Assets Revolver") secured by a first priority lien on all United States production facilities and related assets of Chemicals and the other co-borrowers, all of the capital stock of Chemicals and all of the capital stock of each co-borrower and a second priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers, and (ii) an $85,000,000 revolving credit facility (the "Current Assets Revolver") secured by a first priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers. Funding under the 12 3/8% Notes Offering and the New Revolvers occurred on July 23, 1999. The proceeds of the 12 3/8% Notes Offering and the initial borrowings under the New Revolvers were used to completely repay all outstanding indebtedness under Chemicals existing senior credit facility. Approximately $54.6 million was drawn under the Fixed Assets Revolver at September 30, 1999. Borrowings under the Fixed Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the "LIBOR Rate" (as defined in the New Credit Agreement) plus 3.75% or the Alternate Base Rate plus 2.25%. Borrowings under the Current Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the LIBOR Rate plus 3.00% or the Alternate Base Rate plus 1.50%. The "Alternate Base Rate" is equal to the greater of the Base Rate as announced from time to time by The Chase Manhattan Bank in New York, New York or the "Federal Funds Effective Rate" plus 1/2% (as such terms are defined in the New Credit Agreement.). At September 30, 1999, the weighted average interest rate in effect was 9.3%. The New Credit Agreement also requires Chemicals and the co-borrowers to pay an aggregate commitment fee ranging from 0.75% to 1.25% on the unused portion of the commitment for the Fixed Assets Revolver, depending on the amount drawn, and an aggregate commitment fee of 0.5% on the unused portion of the commitment for the Current Assets Revolver. Available credit under the Current Assets Revolver is subject to a monthly borrowing base consisting of 85% of eligible accounts receivable and 65% of eligible inventory with an inventory cap of $42,500,000. In addition, the borrowing base for the Current Assets Revolver must exceed outstanding borrowings thereunder by $12,000,000 at all times. 20 22 The Fixed Assets Revolver matures in five years, with quarterly commitment reductions totaling 28% of the total commitment in year four and the balance in year five. The Current Assets Revolver matures in five years, with no scheduled commitment reductions prior to that time. However, the commitments for each of the Fixed Assets Revolver and the Current Assets Revolver will be permanently reduced to the extent required under the New Credit Agreement upon prepayments made out of specific sources of funds, including asset sales and certain equity issuances by Holdings. On July 10, 1997, Sterling Pulp Chemicals (Sask) Ltd. ("Sterling Sask"), an indirect wholly owned subsidiary of Holdings and Chemicals, acquired substantially all of the assets of Saskatoon Chemicals Ltd. ("Saskatoon Chemicals"), a subsidiary of Weyerhaeuser Canada Ltd. (the "Saskatoon Acquisition"). In connection with the Saskatoon Acquisition, Sterling Sask entered into a credit agreement (the "Saskatoon Credit Agreement") with The Chase Manhattan Bank of Canada, individually and as administrative agent. Funding under the Saskatoon Credit Agreement occurred July 10, 1997, upon consummation of the Saskatoon Acquisition. The Saskatoon Credit Agreement provides for a revolving credit facility of Cdn. $8.0 million (the "Saskatoon Revolver"), and a term loan facility consisting of Cdn. $21.2 million Tranche A term loan due June 30, 2003, and $36.4 million Tranche B term loan due June 30, 2005 (the "Saskatoon Term Loans"). Advances under the Saskatoon Revolver are subject to a borrowing base consisting of 85% of eligible accounts receivable and 65% of eligible inventory with an inventory cap of 50% of the borrowing base. At September 30, 1999, the borrowing base did not limit such available credit and there were no borrowings outstanding under the Saskatoon Revolver. Sterling Sasks' obligations under the Saskatoon Credit Agreement are secured by substantially all of the assets of Sterling Sask. The Saskatoon Credit Agreement requires Sterling Sask to satisfy certain financial covenants and tests. In addition, the Saskatoon Credit Agreement requires that certain amounts of Excess Cash Flow (as defined therein) be used to prepay amounts outstanding under the Saskatoon Term Loans. A mandatory prepayment of Cdn. $2 million will be required in fiscal 2000. The Sterling Sask Tranche A term loan and the Saskatoon Revolver borrowings bear interest, at Sterling Sask's option, at an annual rate of either the Bankers Acceptance Rate or the Base Rate plus an Applicable Margin ranging from 1% to 2.5% depending upon Sterling Sask's Leverage Ratio (as defined in the Saskatoon Credit Agreement). The Tranche B term loan bears interest, at Sterling Sask's option, at an annual rate of either the Eurodollar Rate or the Base Rate plus an Applicable Margin ranging from 0% to 2.5% depending upon Sterling Sask's Leverage Ratio. The "Base Rate" for the Tranche A term loan and the Saskatoon Revolver is equal to the greater of the Prime Rate for Canadian Dollar commercial loans made in Canada, as announced from time to time by the agent bank, or the rate for Canadian Dollar Bankers Acceptances accepted by the agent with a term to maturity of 30 days plus 1% (as such terms are defined in the Saskatoon Credit Agreement). The "Base Rate" for the Tranche B term loan is equal to the greater of the Prime Rate as announced from time to time by the agent bank, the "Federal Funds Effective Rate" plus 1/2% or the "Base CD Rate" plus 1% (as such terms are defined in the Saskatoon Credit Agreement). At September 30, 1999, the interest rates in effect for the Tranche A and Tranche B term loans were 7.5% and 8.5%, respectively. The Saskatoon Credit Agreement also requires Sterling Sask to pay a commitment fee in the amount of 1/2% of the unused commitment under the Saskatoon Revolver. As part of the recapitalization of the Company in August of 1996, Chemicals also issued $275.0 million of its 11 3/4% Senior Subordinated Notes due 2006 (the "11 3/4% Notes") and Holdings issued $191.8 million of discount notes ($100 million initial proceeds) representing 191,751 Units, with each Unit consisting of one 13 1/2% Senior Secured Discount Note due 2008 (collectively, the "13 1/2% Notes") and one warrant to purchase three shares of the common stock, par value $0.01 per share, of Holdings ("Holdings Common Stock") for $0.01 per share. The 11 3/4% Notes are unsecured senior subordinated obligations of Chemicals, ranking subordinate in right of payment to all existing and future senior debt of Chemicals, but pari passu with the 11 1/4% Notes and all future senior subordinated indebtedness. The 11 3/4% Notes bear interest at the annual rate of 11 3/4%, payable semi-annually on February 15 and August 15 of each year commencing February 15, 1997. The 13 1/2% Notes are senior secured obligations of Holdings and rank equally in right of payment with all other senior indebtedness of Holdings and senior in right of payment to all subordinated indebtedness of Holdings. The 13 1/2% Notes will accrete interest until August 15, 2001, with no interest payable in cash until February 15, 2002, at an annual rate of 13 1/2%, compounded semi-annually. Commencing in 2002, interest will be payable semi-annually on February 15 and August 15 of each year until maturity. Except as otherwise provided below, the 11 3/4% Notes may not be redeemed by Chemicals prior to August 15, 2001. From that date through August 15, 2004, the 11 3/4% Notes may be redeemed at a premium of the principal 21 23 amount thereof at maturity varying between 105.875% and 101.958%. Subsequent to August 15, 2004, Chemicals may redeem the 11 3/4% Notes at their face value plus accrued and unpaid interest. Except as otherwise provided below, the 13 1/2% Notes may not be redeemed by Holdings prior to August 15, 2001. From that date through August 15, 2006, the 13 1/2% Notes may be redeemed at a premium of the principal amount thereof at maturity varying between 106.75% and 101.35%. Subsequent to August 15, 2006, Holdings may redeem the 13 1/2% Notes at their principal amount plus accrued interest. On April 7, 1997, Chemicals issued $150.0 million of its 11 1/4% Senior Subordinated Notes due 2007 (the "11 1/4% Notes"). The 11 1/4% Notes are unsecured senior subordinated obligations of Chemicals, ranking subordinate in right of payment to all existing and future senior debt of Chemicals, but pari passu with the 11 3/4 % Notes and all future senior subordinated indebtedness of Chemicals. The 11 1/4% Notes bear interest at the annual rate of 11 1/4%, payable semi-annually on April 1 and October 1 of each year commencing October 1, 1997. Except as otherwise provided below, the 11 1/4% Notes may not be redeemed by Chemicals prior to April 1, 2002. From that date through April 1, 2005, the 11 1/4% Notes may be redeemed at a premium of the principal amount thereof at maturity varying between 105.625% and 101.875%. Subsequent to April 1, 2005, Chemicals may redeem the 11 1/4% Notes at their face value plus accrued and unpaid interest. Prior to April 1, 2000, Chemicals may redeem in the aggregate up to 35% of the original principal amount of the 11 1/4% Notes with the proceeds of one or more public equity offerings, as defined. Such redemptions may be made at a redemption price of 111.25% of the face value plus accrued and unpaid interest to the redemption date. After such redemption, at least $97.5 million aggregate principal amount of the 11 1/4% Notes must remain outstanding. Under the terms of our New Credit Agreement, we cannot redeem all or any portion of Chemicals' 12 3/8% Notes, 11 3/4% Notes, or 11 1/4% Notes at any time unless expressly required to do so under the relevant indentures. In addition, our ability to redeem all of any portion of Chemicals' 11 3/4% Notes or 11 1/4% Notes is restricted under the indenture governing the 12 3/8% Notes. The indentures governing the 123/8% Notes, 11 1/4% Notes, 11 3/4% Notes, and 13 1/2% Notes (the "Indentures") contain numerous financial and operating covenants, including, but not limited to, restrictions on Chemicals' or Holdings' ability to incur indebtedness, pay dividends, create liens, sell assets, engage in mergers and acquisitions, and refinance existing indebtedness. In addition, the Indentures include various circumstances that will constitute, upon occurrence and subject in certain cases to notice and grace periods, an event of default thereunder. However, neither the Indentures nor the New Credit Agreement requires the Company or Chemicals to satisfy any financial ratios or maintenance tests. The indentures governing the 11 1/4 % Notes, the 11 3/4% Notes, and the 12 3/8% Notes and the New Credit Agreement contain provisions which restrict the payment of advances, loans and dividends from Chemicals to Holdings. The most restrictive of the covenants limits such payments during fiscal 2000 to approximately $2.0 million, plus any amounts due Holdings from Chemicals under the intercompany tax sharing agreement. The Saskatoon Credit Agreement contains provisions, which restrict the payment of advances, loans and dividends from Sterling Sask to Chemicals. The most restrictive of the covenants limits such payments during fiscal 2000 to approximately $1.0 million, plus any amounts due to Chemicals or Holdings from Sterling Sask under the intercompany tax sharing agreement. DEBT MATURITIES The estimated remaining principal payments on the outstanding debt follows:
YEAR ENDING PRINCIPAL SEPTEMBER 30, PAYMENTS ------------- (Dollars in Thousands) 2000 $ 4,246 2001 2,623 2002 4,726 2003 27,316 2004 52,827 Thereafter ............................................................. 877,063 ------------- Total Debt...................................................... $ 968,801
22 24 4. INCOME TAXES A reconciliation of federal statutory income taxes to the Company's effective tax benefit before extraordinary item follows:
YEAR ENDED SEPTEMBER 30, ----------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- (Dollars in Thousands) Benefit for income taxes at statutory rates ................ $ (51,526) $ (26,968) $ (11,001) Taxable foreign dividends .................................. 4,295 -- -- Change in valuation allowance .............................. 1,514 -- -- Non-deductible expenses .................................... 815 -- -- State and foreign income taxes ............................. 550 1,422 3,782 Other ...................................................... 9,416 -- (77) ------------- ------------- ------------- Effective tax benefit ...................................... $ (34,936) $ (25,546) $ (7,296) ============= ============= =============
The benefit for income taxes is composed of the following:
YEAR ENDED SEPTEMBER 30, ----------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- (Dollars in Thousands) From operations: Current federal ....................................... $ 2,246 $ (5,900) $ (6,131) Deferred federal ...................................... (36,724) (21,854) (9,211) Deferred foreign ...................................... (1,300) 2,132 6,104 Current state ......................................... 842 76 1,942 ------------- ------------- ------------- Total tax benefit .......................................... $ (34,936) $ (25,546) $ (7,296) ============= ============= =============
The components of the Company's deferred income tax assets and liabilities are summarized below:
YEAR ENDED SEPTEMBER 30, ------------------------------ 1999 1998 ------------- ------------- (Dollars in Thousands) Deferred tax assets: Accrued liabilities ........................................ $ 12,050 $ 12,074 Accrued postretirement cost ................................ 11,991 10,010 Tax loss and credit carry forwards ......................... 64,044 24,783 Discount note interest ..................................... 17,393 11,103 Other ...................................................... 1,628 17,980 ------------- ------------- Total deferred tax assets .................................. 107,106 75,950 ------------- ------------- Deferred tax liabilities: Property, plant and equipment .............................. $ (68,732) $ (78,113) Other ...................................................... (2,629) (3,820) ------------- ------------- Total deferred tax liabilities ............................. (71,361) (81,933) Valuation allowance ........................................ (1,514) -- ------------- ------------- Net deferred tax assets (liabilities) ...................... 34,231 (5,983) Less: current deferred tax assets .......................... (16,888) (5,140) ------------- ------------- Long-term deferred tax assets (liabilities) ................ $ 17,343 $ (11,123) ============= =============
The Company has approximately $155 million in United States net operating losses which will be carried forward and if not utilized in future years, will expire from fiscal 2018 to 2019. The Company also has approximately Cdn. $6.6 million in Canadian non-capital loss carryforwards and Cdn. $6.5 million of investment tax credits which will expire from 2000 through 2006. 23 25 5. EMPLOYEE BENEFITS The Company has established the following benefit plans: RETIREMENT BENEFIT PLANS The Company has non-contributory pension plans in the United States and employer and employee contributory plans in Canada which cover all salaried and wage employees. The benefits under these plans are based primarily on years of service and employees' pay near retirement. For those Company employees who were employed by the Company as of September 30, 1986, and were previously employed by Monsanto, the Company recognizes their Monsanto pension years of service for purposes of determining benefits under the Company's plans. For those Company employees who were employed by the Company on August 21, 1992, and were previously employed by Tenneco Inc., the Company recognizes their Tenneco Inc. pension years of service for purposes of determining benefits under the Company's plans. The Company's funding policy is consistent with the funding requirements of federal law and regulations. Plan assets consist principally of common stocks and government and corporate securities. For those Company employees as of January 31, 1997, who: (i) were previously employed by Cytec Industries Inc. and (ii) elect to retire from the Company on or before January 31, 1999, the Company supplements the standard pension payable such that the employee's total combined pension from the Company and from the Cytec Nonbargaining Employees' Retirement Plan equals the amount the employee would have received had he or she remained an employee of Cytec until retirement. The estimated liability for such supplements as of September 30, 1999 and 1998 is immaterial. The Company adopted SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits", which is effective for the Company for the year ended September 30, 1999 and revises the required disclosures about pensions and postretirement benefits other than pensions. 24 26 Information concerning the pension obligation, plan assets, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
AUGUST 31, ---------------------------- 1999 1998 ------------ ------------ (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year .................... $ 96,327 $ 82,971 Currency rate conversion ................................... 556 (1,314) Service cost ............................................... 5,198 5,093 Interest cost .............................................. 6,735 6,153 Plan amendments ............................................ 2,878 -- FAS 88 additional benefits ................................. 10,765 -- Actuarial loss (gain) ...................................... (1,205) 7,534 Benefits paid .............................................. (6,864) (4,110) ------------ ------------ Benefit obligation at end of year .......................... $ 114,390 $ 96,327 ============ ============ Change in plan assets: Fair value at beginning of year ............................ $ 86,187 $ 84,598 Currency rate conversion ................................... 498 (1,463) Actual return on plan assets ............................... 18,705 13 Employer contributions ..................................... 765 7,070 Participants' contributions ................................ -- 79 Benefits paid .............................................. (6,864) (4,110) ------------ ------------ Fair value at end of year .................................. $ 99,291 $ 86,187 ============ ============ Development of net amount recognized: Funded status .............................................. $ (15,100) $ (10,140) Unrecognized cost: Actuarial loss (gain) ................................... (4,197) 8,145 Prior service cost ...................................... 7,561 5,867 Transition liability .................................... 1,354 1,737 ------------ ------------ Net amount recognized ...................................... $ (10,382) $ 5,609 ============ ============ Amounts recognized in the statement of financial position: Prepaid pension cost ....................................... $ 529 $ 8,855 Accrued pension cost ....................................... (13,531) (3,620) Intangible asset ........................................... 2,341 189 Accumulated other comprehensive income (pre-tax) ........... 279 185 ------------ ------------ Net amount recognized ...................................... $ (10,382) $ 5,609 ============ ============
Net periodic pension costs (income) consist of the following components:
AUGUST 31, ---------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (Dollars in Thousands) Components of net pension costs: Service cost-benefits earned during the year ............ $ 5,198 $ 5,093 $ 4,857 Interest on prior year's projected benefit obligation ... 6,735 6,153 5,941 Expected return on plan assets .......................... (7,538) (7,411) (6,009) Net amortization: Actuarial loss (gain) ................................ 634 (130) (207) Prior service cost ................................... 73 658 660 Transition liability ................................. 376 378 378 Settlement/Curtailment loss ............................. 11,337 -- -- ------------ ------------ ------------ Net pension costs ....................................... $ 16,815 $ 4,741 $ 5,620 ============ ============ ============ Weighted-average assumptions: Discount Rate ........................................... 7.50% 7.00% 7.75% Rates of increase in salary compensation level .......... 5.38% 4.75% 5.25% Expected long-term rate of return on plan assets ........ 8.77% 8.00% 8.50%
25 27 POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company provides certain health care benefits and life insurance benefits for retired employees. Substantially all of the Company's employees become eligible for these benefits at normal retirement age. The Company accrues the cost of these benefits during the period in which the employee renders the necessary service. Health care benefits are provided to employees who retire from the Company with ten or more years of service credit except for Canadian employees covered by collective bargaining agreements. All of the Company's employees are eligible for postretirement life insurance. Postretirement health care benefits for United States plans are non-contributory. Benefit provisions for most hourly and some salaried employees are subject to collective bargaining. In general, the plans stipulate that retiree health care benefits are paid as covered expenses are incurred. For United States employees, postretirement medical plan deductibles are assumed to increase at the rate of the long-term consumer price index. As previously discussed, SFAS No. 132 revises the required disclosures about postretirement benefit plans. Information concerning the plan obligation, the funded status, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
AUGUST 31, ------------------------------ 1999 1998 ------------- ------------- (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year ........................... $ 43,131 $ 38,617 Service cost ...................................................... 1,200 1,466 Interest cost ..................................................... 3,005 2,818 Plan amendments, curtailments, and special termination benefit .... (2,472) -- Actuarial loss .................................................... 3,124 1,602 Benefits paid ..................................................... (2,314) (1,372) ------------- ------------- Benefit obligation at end of year ................................. $ 45,674 $ 43,131 ============= ============= Development of net amount recognized: Funded status ..................................................... $ (45,674) $ (43,131) Unrecognized cost: Actuarial loss ................................................. 11,380 3,578 Prior service cost ............................................. (5,943) 165 ------------- ------------- Net amount recognized ............................................. $ (40,237) $ (39,388) ============= =============
Net periodic plan costs (income) consist of the following components:
AUGUST 31, ---------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (Dollars in Thousands) Components of net plan costs: Service cost ........................................ $ 1,200 $ 1,466 $ 1,343 Interest cost ....................................... 3,005 2,818 2,494 Expected return on plan assets ...................... -- -- -- Net amortization: Actuarial loss (gain) ............................ 340 (3) 29 Prior service cost ............................... (233) 29 -- Curtailment and special termination benefit ......... (1,150) -- -- ------------ ------------ ------------ Net plan costs ...................................... $ 3,162 $ 4,310 $ 3,866 ============ ============ ============ Weighted-average assumptions: Discount Rate ....................................... 6.75% 7.50% 7.50%
26 28 The weighted average annual assumed health care trend rate is assumed to be 7.5% for 1999. The rate is assumed to decrease gradually to 5.8% in 2027 and remain level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one percentage point change in assumed health care trend rates would have the following effects:
1% Increase 1% Decrease ------------ ------------- (Dollars in Thousands) Effect on total of service and interest cost components .... $ 232 $ (201) Effect on post-retirement benefit obligation ............... 2,257 (1,959)
The Company recorded a $10.2 million charge, included in Other Expense, increasing its pension liability and other postretirement benefits liability in the second quarter of fiscal 1999 as a result of an early retirement program for employees at the Texas City, Texas plant and certain benefit changes for all U.S. employees. The early retirement program resulted in curtailment expense for the pension plan and special termination benefits expenses for both the pension and the other postretirement benefits plans, partially offset by the curtailment gain from the reduction of postretirement life insurance benefits for currently active U.S. employees. EMPLOYEE STOCK OWNERSHIP TRUST In connection with the recapitalization of the Company in August of 1996, an Employee Stock Ownership Trust (the "ESOT") was established which covers substantially all United States employees. Allocations of shares of common stock are made annually to participants. The ESOT primarily invests in shares of Holdings Common Stock and borrowed $6.5 million from Chemicals to purchase approximately 542,000 shares of Holdings Common Stock. This ESOP loan is payable in 16 quarterly installments during the period beginning December 31, 1996, and ending September 30, 2000. The shares of Holdings Common Stock purchased by the ESOT have been pledged as security for the ESOP loan and such shares are released and allocated to the ESOT participants' accounts as the ESOP Loan is discharged. Until the ESOP loan is paid in full, contributions to the ESOT will be used to pay the outstanding principal and interest on the ESOP loan. In addition, during fiscal 1998 and 1997, the ESOT purchased 14,000 and 99,000, respectively, shares of Holdings Common Stock. In fiscal 1999, 1998, and 1997, 160,000, 172,000, and 49,000, respectively, ESOT shares had been allocated to employees. The Company recorded $0.7 million, $1.4 million, and $1.6 million of expense related to the ESOT in fiscal 1999, 1998, and 1997, respectively. SAVINGS AND INVESTMENT PLAN The Company's Amended and Restated Savings and Investment Plan (the "Savings Plan") covers substantially all United States employees, including executive officers. The Savings Plan is qualified under Section 401(k) of the Internal Revenue Code (the "Code"). Each participant has the option to defer taxation of a portion of his or her earnings by directing the Company to contribute a percentage of such earnings to the Savings Plan. A participant may direct up to a maximum of 15% of eligible earnings to the Savings Plan, subject to certain limitations set forth in the Code for "highly compensated" participants. A participant's contributions become distributable upon the termination of his or her employment. The Company does not make any contribution to the Savings Plan. PROFIT SHARING AND BONUS PLANS In January 1997, the Board of Directors, upon recommendation of the Compensation Committee, approved the establishment of a Profit Sharing Plan that is designed to benefit all qualified employees, and a Bonus Plan that will provide for bonuses to certain exempt salaried employees based on the Company's annual financial performance. No expenses for profit sharing or bonuses were incurred in fiscal 1999, 1998, or 1997. OMNIBUS STOCK AWARDS AND INCENTIVE PLAN In April 1997, the Board of Directors approved the establishment of the Omnibus Stock Awards and Incentive Plan (as amended, the "Omnibus Plan"). Under the Omnibus Plan, the Company may grant to key employees 27 29 incentive and nonqualified stock options, SARs, restricted stock awards, performance awards, and phantom stock awards. One million shares of the Company's stock are reserved for issuance under the Omnibus Plan. The terms and amounts of the awards (including vesting schedule) are determined by the Compensation Committee of the Board of Directors. Generally, outstanding stock options become exercisable (vest) in equal annual installments beginning a year from date of grant and ending five years from date of grant. In the event of a specified change of control of the Company or a qualified public offering of Holdings Common Stock, all awards will immediately vest and become exercisable. During fiscal 1999 and 1998, the Company issued 1,500 and 23,000, respectively, restricted stock awards to certain employees. These restricted stock awards vested 25% immediately and 25% per year over the next three years. NONQUALIFIED STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS Also in April 1997, the Board of Directors approved the establishment of the Nonqualified Stock Option Plan for Non-Employee Directors (the "Nonqualified Plan"). Each non-employee director of the Company is eligible to participate in the Nonqualified Plan. Each eligible director on the date of adoption of the Nonqualified Plan was granted an option to acquire 2,000 shares of Holdings Common Stock (4,000 shares for the Vice-Chairman), and each eligible director who is serving on the Board of Directors on each subsequent October 1st is automatically granted an option to acquire 1,000 shares of Holdings Common Stock (2,000 shares for the Vice-Chairman). All options expire ten years from date of grant. All options are granted with an exercise price at or above the fair market value of a share of Holdings Common Stock on the date of grant (as determined by the Board of Directors) and vest and are exercisable immediately. A total of 160,000 shares of Holdings Common Stock are reserved for issuance under the Nonqualified Plan. OUTSTANDING STOCK OPTIONS A summary of the status of the Company's outstanding stock options as of September 30, 1999 and 1998, and changes during the years then ended is presented below:
1999 1998 1997 ----------------------------- ---------------------------- ---------------------------- SHARES WEIGHTED- SHARES WEIGHTED-AVERAGE SHARES WEIGHTED-AVERAGE (IN AVERAGE (IN AVERAGE (IN EXERCISE THOUSANDS) EXERCISE PRICE(1) THOUSANDS) EXERCISE PRICE THOUSANDS) EXERCISE PRICE ---------- ----------------- ---------- ---------------- ---------- ---------------- Outstanding at beginning of year ..... 692 $ 11.74 241 $ 12.00 -- -- Granted .............................. 95 $ 6.08 489 $ 11.62 274 $ 12.00 Exercised ............................ -- -- -- -- Forfeited ............................ (105) $ 6.00 (38) $ 11.94 (33) $ 12.00 ---------- ----------------- ---------- ---------------- ---------- ---------------- Outstanding at end of year ........... 682 $ 6.14 692 $ 11.74 241 $ 12.00 ========== ================= ========== ================ ========== ================ Options exercisable at end of year ... 178 86 14 ========== ========== ===========
(1) On December 14, 1998, the Company issued to all of its employees who held stock options on that date new options with an exercise price of $6.00 per share. The new options were issued in exchange for and cancellation of stock options previously issued to those employees for the same number of shares and with the same vesting schedules. The range of exercise prices for options outstanding at September 30, 1999, was $6.00 - $12.00, with all exercisable options having an exercise price range of $6.00 - $12.00. During fiscal 1998, Holdings granted certain employees rights to purchase an aggregate of 230,000 shares of Holdings Common Stock, at then current market prices. These rights expired without being exercised. All stock options are granted with an exercise price at or above fair market value of a share of Holdings Common Stock at the grant date. The weighted average fair value of the stock options granted during fiscal 1999, 1998, and 1997 was $0.6 million, $1.9 million, and $0.5 million, respectively. The fair value of each such stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following 28 30 weighted average assumptions used for the grants in fiscal 1999, 1998, and 1997: risk free interest rate of 5.9%, 4.4% and 6.1%, respectively; expected dividend yield of 0.0% for all years; expected life of ten years for all years; and expected volatility of 59%, 29%, and 44%, respectively. Stock options generally expire ten years from the date of grant and fully vest after five years. The outstanding stock options at September 30, 1999 have a weighted average contractual life of approximately 8 years. In accordance with SFAS 123, "Accounting for Stock-Based Compensation", the Company utilizes the intrinsic value method of accounting for stock-based compensation, and no compensation costs have been recognized for stock option awards described above. Had compensation cost for all option issuances been determined consistent with SFAS No. 123, it would not have had a material impact on the Company's pro forma net loss and loss per share for fiscal 1999, 1998, and 1997. 6. COMMITMENTS AND CONTINGENCIES PRODUCT CONTRACTS The Company has certain long-term agreements, which provide for the dedication of 100% of the Company's production of acetic acid, plasticizers, TBA, sodium cyanide, and calcium hypochlorite each to one customer. The Company also has various sales and conversion agreements, which dedicate significant portions of the Company's production of styrene, acrylonitrile, and methanol to various customers. Some of these agreements generally provide for cost recovery plus an agreed margin or element of profit based upon market price. LEASE COMMITMENTS The Company has entered into various long-term noncancellable operating leases. Future minimum lease commitments at September 30, 1999, are as follows: fiscal 2000 -- $5.3 million; fiscal 2001 -- $4.9 million; fiscal 2002 -- $4.8 million; fiscal 2003 -- $4.1 million; fiscal 2004 -- $3.7 million; and $7.6 million thereafter. ENVIRONMENTAL AND SAFETY MATTERS The Company's operations involve the handling, production, transportation, treatment, and disposal of materials that are classified as hazardous or toxic waste and that are extensively regulated by environmental and health and safety laws, regulations, and permit requirements. Environmental permits required for the Company's operations are subject to periodic renewal and can be revoked or modified for cause or when new or revised environmental requirements are implemented. Changing and increasingly strict environmental requirements can affect the manufacture, handling, processing, distribution, and use of the Company's chemical products and, if so, the Company's business and operations may be materially and adversely affected. In addition, changes in affected environmental requirements can cause the Company to incur substantial costs in upgrading or redesigning its facilities and processes, including waste treatment, storage, disposal, and other waste handling practices and equipment. The Company conducts environmental management programs designed to maintain compliance with applicable environmental requirements at all of its facilities. The Company routinely conducts inspection and surveillance programs designed to detect and respond to leaks or spills of regulated hazardous substances and to correct identified regulatory deficiencies. The Company believes that its procedures for waste handling are consistent with industry standards and applicable requirements. In addition, the Company believes that its operations are consistent with good industry practice through participation in the Responsible Care initiatives as a part of membership in the Chemical Manufacturers Association in the United States and the Canadian Chemical Producers Association. However, a business risk inherent in chemical operations is the potential for personal injury and property damage claims from employees, contractors and their employees, and nearby landowners and occupants. While the Company believes its business operations and facilities generally are operated in compliance in all material respects with all applicable environmental and health and safety requirements, it cannot be sure that past practices or future operations will not result in material claims or regulatory action, require material environmental expenditures, or result in exposure or injury claims by employees, contractors and their employees, and the public. Some risk of environmental costs and liabilities is inherent in the Company's operations and products, as it is with other companies engaged in similar businesses. The Company's operating expenditures for environmental matters, mostly waste management and compliance, were approximately $30 million, $52 million, and $50 million for fiscal 1999, 1998, and 1997, respectively. The 29 31 Company also spent approximately $6 million and $2 million for environmentally related capital projects in fiscal 1999 and 1998 respectively. Any significant ban on all chlorine containing compounds could have a materially adverse effect on the Company's financial condition and results of operations. British Columbia has a regulation in place requiring elimination of the use of all chlorine products, including chlorine dioxide, in the bleaching process by the year 2002. Chlorine dioxide is produced from sodium chlorate, which is one of the Company's pulp chemicals products. The pulp and paper industry believes that a ban of chlorine dioxide in the bleaching process will yield no measurable environmental or public health benefit and is working to change this regulation, but there can be no assurance that this regulation will be changed. In the event such a regulation is implemented, the Company would seek to sell the products it manufactures at its British Columbia facility to customers in other markets. The Company is not aware of any other laws or regulations in place in North America that would restrict the use of such products for other purposes. LEGAL PROCEEDINGS Ammonia Release On May 8, 1994, an ammonia release occurred at the Texas City Plant while a reactor in the acrylonitrile unit was being restarted after a shutdown for routine maintenance. Approximately 52 lawsuits and interventions involving approximately 6,000 plaintiffs were filed against the Company seeking an unspecified amount of money for alleged damages from the ammonia release. Approximately 2,600 of the plaintiffs agreed to submit their damage claims to binding arbitration. A two-week evidentiary hearing was conducted in July 1996 before a three-judge panel to determine the amount of damages. On May 1, 1997, the three-judge panel awarded the plaintiffs an amount of damages which was well within the limits of the Company's insurance coverage. Thirty-nine of the plaintiffs tried their cases to a jury in Harris County District Court. After approximately five months of trial, the jury returned a verdict on September 2, 1997. The total amount awarded for all 39 plaintiffs was well within the limits of the Company's insurance coverage. Approximately 5,980 of the claims in litigation have now been resolved or are pending final resolution and the Company continues to vigorously defend against the claims of the approximately 20 remaining plaintiffs. Nickel Carbonyl Release On July 30, 1997, as the Company's methanol unit at the Texas City Plant was being shut down for repair, nickel carbonyl was formed when carbon monoxide reacted with nickel catalyst in the unit's reformer. After isolating the nickel carbonyl within the methanol unit, the Company worked with the permission and guidance of the Texas Natural Resources Conservation Commission to destroy the nickel carbonyl by incineration on-site. Prior to its incineration, several Company employees and contractor employees may have been exposed to nickel carbonyl in the methanol unit. Two lawsuits and two interventions involving approximately 306 plaintiffs were filed against the Company seeking an unspecified amount for alleged damages from the nickel carbonyl release. Since the filing of the lawsuits, approximately 14 plaintiffs' claims (including one intervenor) have been resolved, some of which are subject to the completion of documentation. The Company continues to vigorously defend against the claims of the approximately 292 remaining plaintiffs. Additional claims and litigation against the Company relating to this incident may ensue. Ethylbenzene Release On April 1, 1998, a chemical leak occurred when a line failed in the ethylbenzene unit at the Texas City Plant. The released chemicals included ethylbenzene, benzene, polyethylbenzene, and hydrochloric acid. The Company does not believe any serious injuries were sustained, although a number of citizens sought medical examinations at local hospitals after a precautionary alert was given to neighboring communities. There is no lawsuit pending 30 32 against the Company based on this release, but the Company has received, and in some instances resolved, claims from individuals for alleged damage from this incident. Other Claims The Company is subject to various other claims and legal actions that arise in the ordinary course of its business. LITIGATION CONTINGENCY The Company has made estimates of the reasonably possible range of liability with regard to its outstanding litigation for which it may incur liability. These estimates are based on the Company's judgments using currently available information as well as consultation with the Company's insurance carriers and outside legal counsel. A number of the claims in these litigation matters are covered by the Company's insurance policies or by third-party indemnification of the Company. The Company, therefore, has also made estimates of its probable recoveries under insurance policies or from third-party indemnitors based on its understanding of its insurance policies and indemnifications, discussions with its insurers and indemnitors, and consultation with outside legal counsel, in addition to the Company's judgments. Based on the foregoing, as of September 30, 1999, the Company has accrued approximately $2.8 million as its estimate of aggregate contingent liability for these matters and has also recorded aggregate receivables from its insurers and third-party indemnitors of approximately $2.2 million. At September 30, 1999, management estimates that the aggregate reasonably possible range of loss for all litigation combined, in addition to the amount accrued, is from $0 to $5 million. The Company believes that this additional reasonably possible loss is substantially covered by insurance. While the Company has based its estimates on its evaluation of available information to date and the other matters described above, much of the litigation remains in the discovery stage and it is impossible to predict with certainty the ultimate outcome. The Company will adjust its estimates as necessary as additional information is developed and evaluated. However, the Company believes that the final resolution of these contingencies will not have a material adverse impact on the financial position, results of operations, or cash flows of the Company. In addition, the timing of probable insurance and indemnity recoveries, and payment of liabilities, if any, is not expected to have a material adverse effect on the financial position, results of operations, or cash flows of the Company. 7. BUSINESS ACQUISITIONS On January 31, 1997, the Company acquired the acrylic fibers business (the "AFB") from Cytec (the "AFB Acquisition"). The AFB, now owned by two wholly owned subsidiaries of the Company (collectively "Sterling Fibers"), recorded sales of approximately $92 million during the eight months of operations in fiscal 1997 and consists of an acrylic fibers plant located near Pensacola, Florida, and several associated marketing and research offices. Sterling Fibers is one of two acrylic fibers manufacturers in the United States. Cytec supplies acrylonitrile to Sterling Fibers through a five-year supply agreement ending in 2002. The acquisition was financed through the incurence of $81 million of term debt and the issuance of $10 million (liquidation value) of Series A "pay in kind" mandatory redeemable preferred stock ("Series A Preferred") to Cytec, and the sale of $10 million of Holdings Common Stock in a private placement. The Company used the purchase method to account for the acquisition, and operating results of Sterling Fibers, beginning February 1, 1997, are included with those of the Company. On July 10, 1997, Sterling Sask acquired substantially all of the assets of Saskatoon Chemicals (the "Saskatoon Acquisition"). The acquired assets include a manufacturing plant near Saskatoon, Saskatchewan, which manufactures sodium chlorate, caustic soda, calcium hypochlorite, chlorine, and hydrochloric acid. Total consideration of $69.2 million was financed with: (i) approximately $54.6 million under a new credit facility established by Sterling Sask with a group of lenders, (ii) approximately $7.3 million pursuant to a private placement of Holdings Common Stock, and (iii) approximately $7.3 million pursuant to a private placement of Units, each Unit consisting of shares of Holdings' Series B "pay in kind" mandatory Cumulative Redeemable Preferred Stock ("Series B Preferred") and warrants to purchase shares of Holdings Common Stock. The Saskatoon Acquisition was accounted for under the purchase method, and operating results of Sterling Sask, beginning July 10, 1997, are included with those of the Company. 31 33 The following table presents the unaudited pro forma results of operations of the Company as if the AFB Acquisition and the Saskatoon Acquisition had occurred on October 1, 1996. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the AFB Acquisition and the Saskatoon Acquisition been made at the beginning of the fiscal year 1997 or of results which may occur in the future (in thousands, except per share amounts).
Pro Forma Twelve Months Ended September 30, 1997 -------------- Revenues......................................................................... $ 988,000 Income (loss) before extraordinary items......................................... $ (27,300) Net income (loss) attributable to common stockholders............................ $ (34,200) Net income (loss) per common share............................................... $ (2.85)
32 34 8. SEGMENT AND GEOGRAPHIC INFORMATION: Effective October 1, 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" and has restated its segment disclosures for all reporting periods. The Company's operations are divided into two reportable segments: petrochemicals and pulp chemicals. The petrochemicals segment manufactures commodity petrochemicals and acrylic fibers. The pulp chemicals segment manufactures chemicals for use primarily in the pulp and paper industry. Operating segment information for 1999, 1998, and 1997 is presented below.
YEAR ENDED SEPTEMBER 30, ----------------------------------------------- 1999 1998 1997 ------------- ------------- ------------- (Dollars in Thousands) Segment Information (1) Revenues: Petrochemicals ..................... $ 530,927 $ 621,605 $ 728,215 Pulp chemicals ..................... 189,825 200,985 180,572 ------------- ------------- ------------- Total .................................. $ 720,752 $ 822,590 $ 908,787 Operating income (loss): Petrochemicals ..................... $ (63,710) $ (3,442) $ 11,524 Pulp chemicals ..................... 27,018 36,232 45,945 ------------- ------------- ------------- Total .................................. $ (36,692) $ 32,790 $ 57,469 Depreciation and amortization expenses: Petrochemicals ..................... $ 34,001 $ 31,894 $ 31,504 Pulp chemicals ..................... 23,676 24,069 18,345 ------------- ------------- ------------- Total .................................. $ 57,677 $ 55,963 $ 49,849 Interest expenses: Petrochemicals ..................... $ 65,426 $ 59,617 $ 53,814 Pulp chemicals ..................... 38,635 44,838 35,087 ------------- ------------- ------------- Total .................................. $ 104,061 $ 104,455 $ 88,901 Capital expenditures: Petrochemicals ..................... $ 21,252 $ 16,768 $ 22,664 Pulp chemicals ..................... 8,288 9,854 20,764 ------------- ------------- ------------- Total .................................. $ 29,540 $ 26,622 $ 43,428 Property, plant, and equipment, net: Petrochemicals ..................... $ 223,519 $ 263,692 $ 282,630 Pulp chemicals ..................... 179,204 186,623 209,406 ------------- ------------- ------------- Total .................................. $ 402,723 $ 450,315 $ 492,036
(1) The petrochemicals segment is based in the United States. The pulp chemicals segment is primarily based in Canada. Sales to individual customers constituting 10% or more of total revenues and sales by segment were as follows:
YEAR ENDED SEPTEMBER 30, ---------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (Dollars in Thousands) Major Customers: British Petroleum plc and subsidiaries $ 71,803 $ 100,610 * Export Sales: Export revenues $ 200,448 $ 233,165 $ 274,139 Percentage of total revenues 28% 28% 30%
*DOES NOT COMPRISE 10% OF TOTAL REVENUE FOR FISCAL 1997, THEREFORE NOT REPORTED. 33 35 9. FINANCIAL INSTRUMENTS FOREIGN EXCHANGE The Company enters into forward foreign exchange contracts to hedge Canadian dollar currency transactions on a continuing basis for periods consistent with its committed exposures. The forward foreign exchange contracts have varying maturities with none exceeding 18 months. The Company makes net settlements of United States dollars for Canadian dollars at rates agreed to at inception of the contracts. The Company enters into forward foreign exchange contracts to reduce risk due to Canadian dollar exchange rate movements. The Company does not engage in currency speculation. The Company had a notional amount of approximately $6 million and $54 million of forward foreign exchange contracts outstanding to buy Canadian dollars at September 30, 1999 and 1998, respectively. The deferred loss on these forward foreign exchange contracts at September 30, 1999 and 1998 was $0.3 million and $4.7 million, respectively. The last of the Company's existing forward exchange contracts expires in March of 2000, and it does not intend to enter into any additional forward exchange contracts. GAS HEDGE The Company hedged a portion of its natural gas to be used in the production of styrene and methanol during fiscal 1999, 1998, and 1997. At September 30, 1999, there were no outstanding natural gas hedges. The Company had a net loss of $1.5 million, $1.0 million, and $0.1 million due to natural gas hedging contracts in fiscal 1999, 1998, and 1997. INTEREST RATE SWAPS The Company has entered into a declining balance interest rate swap contract to hedge a portion of its interest rate risk that expires in January 2002. At September 30, 1999, the Company had a contractual notional amount of $49.1 million outstanding with a fixed rate of 6.66% and a floating rate based on LIBOR. The Company's interest rate swap is settled on a quarterly basis, with the interest rate differential received or paid by the Company recognized as adjustments to interest expense. CONCENTRATION OF RISK The Company sells its products primarily to companies involved in the petrochemicals, acrylic fibers, and pulp and paper manufacturing industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral for accounts receivable. However, letters of credit are required by the Company on many of its export sales. Historically, the Company's credit losses have been minimal. The Company maintains cash deposits with major banks, which from time to time may exceed federally insured limits. The Company periodically assesses the financial condition of the institutions and believes that the likelihood of any possible loss is minimal. Approximately 37% of the Company's employees are covered by union agreements. Approximately 5% of the Company's employees are covered by union agreements which could expire within one year. INVESTMENTS It is the policy of the Company to invest its excess cash in investment instruments or securities whose value is not subject to market fluctuations, such as certificates of deposit, repurchase agreements, or Eurodollar deposits with domestic or foreign banks or other financial institutions. Other permitted investments include commercial paper of major United States corporations with ratings of A1 by Standard & Poor's Ratings Group or P1 by Moody's Investor Services, Inc., loan participations of major United States corporations with a short term credit rating of A1/P1 and direct obligations of the United States Government or its agencies. In addition, not more than $5 million will be invested by the Company with any single bank, financial institution, or United States corporation. 34 36 FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reflected in the consolidated balance sheet for cash and cash equivalents, receivables, payables, and certain accrued expenses approximate fair value due to the short maturities. The following table presents the carrying values and fair values of the Company's long-term debt at September 30, 1999.
CARRYING VALUE FAIR VALUE -------------- ------------ (Dollars in Thousands) Revolving credit facilities $ 54,643 $ 54,643 Saskatoon Term Loans 44,045 44,045 11 1/4% Notes 152,485 85,500 11 3/4% Notes 275,000 170,500 12 3/8% Notes 295,000 295,000 13 1/2% Notes 147,628 32,598
The fair values of the 13 1/2% Notes, 11 1/4 % Notes, and 11 3/4% Notes are based on quoted market prices. Due to the 12 3/8% Notes being issued near the Company's September 30, 1999 fiscal year-end, the fair value approximates the carrying value. In addition, due to the New Revolvers and the Saskatoon Term Loans having variable interest rates, the fair value equals their carrying value. At September 30, 1999, the foreign exchange contracts had a fair value of $0.3 million loss based on then current exchange rates. In addition, the interest rate swaps had a fair market value of $0.5 million loss, based on the Company's estimate of what it would have to pay to terminate the swap at September 30, 1999. 10. RELATED PARTY TRANSACTIONS In May of 1999, the Company engaged Credit Suisse First Boston Corporation ("CSFB") and Donaldson Lufkin & Jenrette Securities Corporation ("DLJ") as Joint-Book Running Managers in connection with the issuance by Chemicals of the 12 3/8% Notes. CSFB and DLJ also underwrote the New Credit Agreement with The CIT Group/Business Credit, Inc. The Company paid CSFB a total of $5,218,750 under these arrangement in fiscal 1999. John L. Garcia, one of the Company's directors, was a Managing Director and the Head of the Global Chemical Investment Banking Group of CSFB from 1994 until April of 1999. Since October 1, 1991, the Company has had ongoing commercial relationships in the ordinary course of business with certain affiliates of Koch Industries, Inc., including agreements for the supply of raw materials, sales of petrochemicals, and transportation of natural gas. During the fiscal years of the Company ended September 30, 1999, 1998, and 1997: o the Company made product sales to and purchased raw materials from Koch Chemical, an indirect wholly owned subsidiary of Koch Industries, Inc.; o the Company made payments to John Zink Company, an indirect wholly owned subsidiary of Koch Industries, Inc., in consideration for certain contracting and construction services performed at the Texas City Plant; and o the Company made payments to Koch Gateway Pipeline Company for the transportation of natural gas to the Santa Rosa Plant through a pipeline in which it is a partner. Each of these relationships represented less than 5% of the Company's revenues in each of such fiscal years. In addition, in 1998 the Company filed a lawsuit against John Zink Company seeking recovery for certain types of damages sustained in connection with a release of nickel carbonyl from the Company's methanol unit on July 30, 1997. This lawsuit has been voluntarily dismissed but, under a tolling agreement between the parties, may be refiled at any time. Koch Capital Services, Inc., an affiliate of Koch Industries, Inc., is a significant stockholder of the 35 37 Company and, under the Voting Agreement described below, has the right to designate a member of the Board of Directors of the Company. In connection with the Saskatoon Acquisition, the Company paid a one-time fee of $100,000 to Clipper Capital Associates, Inc. ("Clipper") and Olympus Partners ("Olympus") to act as placement agents for the Series B Preferred Stock. Rolf H. Towe, a director of the Company, and Robert Calhoun, a former director of the Company, are officers of Clipper and affiliates of Clipper. Affiliates of Clipper and Olympus are significant stockholders of the Company. In addition, under the Voting Agreement described below, an affiliate of Clipper has the right to designate a member of the Board of Directors of the Company. The holders of 6,654,963 shares of Holdings Common Stock, representing approximately 52% of Holdings outstanding shares, are parties to a Third Amended and Restated Voting Agreement dated as of February 1, 1999 (the "Voting Agreement"). Four directors of the Company, Frank P. Diassi, Frank J. Hevrdejs, T. Hunter Nelson and William A. McMinn, are parties to the Voting Agreement. Other parties to the Voting Agreement include Koch Capital Services, Inc. (an affiliate of Koch Industries), affiliates of Clipper ("The Clipper Group"), affiliates of Olympus, CSFB, and Gordon A. Cain. The parties to the Voting Agreement are required to vote any shares of Holdings Common Stock owned by them in favor of three nominees to the Board of Directors of Holdings, one to be designated by each of Koch Capital Services, Inc., The Clipper Group, and Mr. Cain. George J. Damiris is the current designee of Koch Capital Services, Inc., Rolf H. Towe is the current designee of The Clipper Group, and William A. McMinn is the current designee of Mr. Cain. The rights of each of Koch Capital Services, Inc. and The Clipper Group to designate nominees under the Voting Agreement terminates on the earlier of August 21, 2006 or the time at which they beneficial own less than 5% of the outstanding shares of Holdings Common Stock, respectively. The right of Mr. Cain to designate a nominee terminates upon the earlier of (i) December 15, 2008 and (ii) the later of (a) the expiration of the Standby Purchase Agreement to which he is a party (described below) and (b) the time at which Mr. Cain beneficial owns less than 5% of the outstanding shares of Holdings Common Stock. The Company paid The Sterling Group, Inc. ("TSG") a one-time transaction fee of approximately $1.1 million in connection with the AFB Acquisition and a one-time fee of approximately $0.7 million in connection with the Saskatoon Acquisition. In addition, the Company paid TSG approximately $12,782 in fiscal 1999 in advisory fees and reimbursement of expenses. Two directors of the Company, Frank J. Hevrdejs and T. Hunter Nelson, are principals of TSG, with Mr. Hevrdejs also serving as the President of TSG. Frank P. Diassi, Chairman of the Board of the Company, Peter W. De Leeuw, President and Chief Executive Officer of the Company, Robert W. Roten, Vice Chairman of the Board of the Company and former President and Chief Executive Officer of the Company, William A. McMinn, a director of the Company, Gary M. Spitz, Chief Financial Officer and a Vice President of the Company, Richard K. Crump, Vice President--Strategic Planning of the Company, and David G. Elkins, Vice President, General Counsel and Secretary of the Company, have all previously co-invested with principals of TSG in various transactions unrelated to the Company. Under engagement letters dated April 15, 1998 and April 27, 1998, the Company engaged Chem Systems, an IBM company, to perform certain consulting services related to the Company's styrene monomer business. In addition, on August 10, 1998, the Company engaged Chem Systems to conduct a site study of the Texas City Plant and to benchmark the Company's best practices and organizational structures against top quartile performers in the industry. Finally, in connection with the refinancing in July of 1999, the Company paid Chem Systems amounts owed to them by DLJ related to the performance of an appraisal of some of the Company's assets required for the refinancing. During fiscal 1999, the Company paid Chem Systems an aggregate of $421,164 pursuant to these arrangements. Peter Spitz, who is the father of Gary M. Spitz (Chief Financial Officer and a Vice President of the Company), was the Director of Chem Systems until August of 1999. Peter Spitz did not personally perform any direct services under any of these arrangements. As of December 15, 1998, Holdings entered into separate Standby Purchase Agreements with each of Gordon A. Cain, William A. McMinn, James Crane, Frank P. Diassi, Frank J. Hevrdejs, and Koch Capital Services, Inc. as described below in Footnote 11. 11. CAPITAL STOCK On January 31, 1997, the Company issued 778,232 shares of Holdings Common Stock in connection with the AFB Acquisition. In addition, on July 10, 1997, the Company issued 608,334 shares of Holdings Common Stock in connection with the Saskatoon Acquisition. 36 38 In connection with the issuance of the 13 1/2% Notes (see Note 3), Holdings issued 191,751 warrants to purchase three shares of Holdings Common Stock for $0.01, exercisable beginning in August 1998 until August 2008. During fiscal 1999 and 1998, 32,460 and 345,123 shares, respectively, of Holdings Common Stock were issued as a result of 10,820 and 115,041, respectively, of these warrants being exercised. In connection with the Saskatoon Acquisition, Holdings also issued to holders of the Series B Preferred Stock warrants to purchase 201,048 shares of Holdings Common Stock for $0.01, exercisable beginning in July 1997 until December 2007. In December 1998, the Company entered into separate Standby Purchase Agreements (collectively, the "Purchase Agreements") with each of Gordon A. Cain, William A. McMinn, James Crane, Mr. Diassi, Mr. Hevrdejs, and Koch Capital Services, Inc. (collectively, the "Purchasers"). Pursuant to the terms of the Purchase Agreements, the Purchase committed to purchase up to 2.5 million shares of Common Stock, at a price of $6.00 per share, if, as, and when requested by the Company at any time or from time to time prior to December 15, 2001. Under each of the Purchase Agreements, the Company may only require the Purchasers to purchase such shares if it believes that such capital is necessary to maintain, reestablish, or enhance its borrowing ability under the Company's revolving credit facilities or to satisfy any requirement thereunder to raise additional equity. To induce the Purchasers to enter into the Purchase Agreements, the Company issued to them warrants to purchase an aggregate of 300,000 shares of Common Stock at an exercise price of $6.00 per share. Pursuant to the Purchase Agreements, the Company agreed to issue to the Purchasers additional warrants to purchase up to 300,000 additional shares of Common Stock if, as, and when they purchase shares of Common Stock under the Purchase Agreements. Any shares of Common Stock purchased under the Purchase Agreement and the warrants issued to the Purchasers as contemplated by the Purchase Agreements will be subject to the terms of the Third Amended and Restated Voting Agreement dated as of February 1, 1999, the Sterling Chemicals Holdings, Inc. Stockholders Agreement dated effective as of August 21, 1996, as amended, and the Tag-Along Agreement dated as of August 21, 1996. At September 30, 1999, warrants to purchase an aggregate of 698,718 shares Holdings Common Stock were outstanding. 12. MANDATORY REDEEMABLE PREFERRED STOCK In connection with the AFB Acquisition, the Company authorized 350,000 shares and issued 104,110 shares of non-voting Series A Preferred Stock with a fair value and carrying value of $10.0 million. The Series A Preferred Stock has a cumulative dividend rate of 10%, payable in kind semi-annually on January 1 and July 1 of each year commencing July 1, 1997. The Company may redeem all or any number of shares of Series A Preferred Stock at any time with proper written notice at a price of $100 per share plus accrued dividends. The holders of Series A Preferred Stock may elect to have the Company redeem shares on any dividend payment date after June 30, 2009 with proper written notice at a price of $100 per share plus accrued dividends. The carrying value of the Series A Preferred Stock at September 30, 1999 and 1998, was $13.0 million and $11.8 million, respectively (liquidation value of $100 per share). In connection with the Saskatoon Acquisition, the Company authorized 58,000 shares and issued approximately 7,532 shares of non-voting Series B Preferred Stock with a fair value of $4.9 million. The Series B Preferred Stock has a 14% dividend rate through July 10, 2002, and thereafter a variable rate between 14% and 18% depending on payment terms until redeemed. The dividend is payable in kind on January 1, April 1, July 1, and October 1 of each year, commencing October 1, 1997. The Company may redeem all or any number of shares of Series B Preferred Stock at any time with proper written notice at a price of $1,000 per share plus a premium ranging from 5% to 1% depending on the date of redemption plus accrued dividends. The holders of Series B Preferred Stock may elect to have the Company redeem shares on any dividend payment date after June 30, 2009, with proper written notice at a price of $1,000 per share plus accrued dividends. The carrying value of the Series B Preferred Stock at September 30, 1999 and 1998, was $7.9 million and $6.5 million, respectively (liquidation value of $1,000 per share). The difference in the carrying value and the redemption amount will be accreted as a charge to retained earnings over the holding period using the effective interest rate method. 13. NEW ACCOUNTING STANDARDS SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Management is currently evaluating the accounting impact and disclosures required when this statement is adopted in the first quarter of fiscal 2001. 37 39 STERLING CHEMICALS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Except as modified below, the Notes to the Company's Consolidated Financial Statements are incorporated herein by reference insofar as they relate to Chemicals. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES INCOME TAXES Chemicals is included in the consolidated federal tax return filed by its parent, Holdings. A tax sharing agreement between Holdings and Chemicals defines the computation of Chemicals' obligations to Holdings. Chemicals' provision for income taxes is computed as if Chemicals and its subsidiaries file their annual tax return on a separate company basis. Deferred income taxes are recorded to reflect the tax effect of the temporary differences between the financial reporting basis and the tax basis of Chemicals' assets and liabilities at enacted rates. EARNINGS PER SHARE All issued and outstanding shares of Chemicals are held by Holdings, and accordingly, earnings per share are not presented. 2. INCOME TAXES A reconciliation of federal statutory income taxes to Chemicals' effective tax benefit before extraordinary item follows:
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 1997 -------- -------- -------- (Dollars in Thousands) Benefit for income taxes at statutory rates .... $(44,235) $(20,385) $ (4,576) Taxable foreign dividends ...................... 4,295 -- -- Change in valuation allowance .................. 1,514 -- -- Non-deductible expenses ........................ 195 -- -- State and foreign income taxes ................. 550 1,422 3,782 Other .......................................... 8,271 -- (1,354) -------- -------- -------- Effective tax benefit .......................... $(29,410) $(18,963) $ (2,148) ======== ======== ========
The benefit for income taxes is composed of the following:
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 1997 -------- -------- -------- (Dollars in Thousands) From operations: Current federal ........................... $ 2,246 $ (5,900) $ (5,959) Deferred federal .......................... (31,198) (15,271) (4,235) Deferred foreign .......................... (1,300) 2,132 6,104 Current state ............................. 842 76 1,942 -------- -------- -------- Total tax provision (benefit) ............. $(29,410) $(18,963) $ (2,148) ======== ======== ========
38 40 The components of Chemicals' deferred income tax assets and liabilities are summarized below:
SEPTEMBER 30, ---------------------- 1999 1998 -------- -------- (Dollars in Thousands) Deferred tax assets: Accrued liabilities ................................. $ 12,050 $ 12,074 Accrued postretirement cost ......................... 11,991 10,010 Tax loss and credit carryforward and other .......... 63,663 24,783 Other ............................................... 1,628 17,980 -------- -------- Total deferred tax assets ........................... 89,332 64,847 -------- -------- Deferred tax liabilities: Property, plant and equipment ....................... $(68,732) $(78,113) Other ............................................... (2,629) (4,895) -------- -------- Total deferred tax liabilities ...................... (71,361) (83,008) Valuation allowance ................................. (1,514) -- -------- -------- Net deferred tax assets (liabilities) ............... 16,457 (18,161) Less current deferred tax assets .................... (16,888) (5,140) -------- -------- Long-term deferred tax liabilities .................. $ (431) $(23,301) ======== ========
39 41 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Sterling Chemicals Holdings, Inc. We have audited the accompanying consolidated balance sheets of Sterling Chemicals Holdings, Inc. and subsidiaries as of September 30, 1999 and 1998, and the related consolidated statements of operations, changes in stockholders' equity (deficiency in assets), and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sterling Chemicals Holdings, Inc. and subsidiaries as of September 30, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1999 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Houston, Texas December 9, 1999 40 42 INDEPENDENT AUDITORS' REPORT To the Stockholder of Sterling Chemicals, Inc. We have audited the accompanying consolidated balance sheets of Sterling Chemicals, Inc. and subsidiaries as of September 30, 1999 and 1998, and the related consolidated statements of operations, changes in stockholder's equity (deficiency in assets), and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sterling Chemicals, Inc. and subsidiaries as of September 30, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the period ended September 30, 1999 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Houston, Texas December 9, 1999 41 43 STERLING CHEMICALS UNITED STATES SUBSIDIARIES COMBINED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, --------------------------------------- 1999 1998 1997 --------- --------- --------- Revenues ......................................... $ 222,353 $ 261,990 $ 262,256 Cost of goods sold ............................... 188,296 209,883 197,555 --------- --------- --------- Gross profit ..................................... 34,057 52,107 64,701 Selling, general and administrative expenses ..... 19,280 22,098 15,637 Interest and debt related expenses ............... 38,877 36,366 35,165 --------- --------- --------- Net income (loss) before income taxes ............ (24,100) (6,357) 13,899 Provision (benefit) for income taxes ............. (3,727) (2,217) 6,290 --------- --------- --------- Net income (loss) ................................ $ (20,373) $ (4,140) $ 7,609 ========= ========= =========
The accompanying notes are an integral part of the combined financial statements. 42 44 STERLING CHEMICALS UNITED STATES SUBSIDIARIES COMBINED BALANCE SHEETS (DOLLARS IN THOUSANDS)
SEPTEMBER 30, ------------------------ 1999 1998 --------- --------- ASSETS Current assets: Cash and cash equivalents ...................................... $ 9,323 $ 4,093 Accounts receivable ............................................ 45,139 38,562 Inventories .................................................... 29,207 32,532 Prepaid expenses ............................................... 12,748 6,090 --------- --------- Total current assets ....................................... 96,417 81,277 Property, plant and equipment, net ................................. 196,877 207,177 Due from affiliates ................................................ 121,506 131,771 Other assets ....................................................... 40,275 51,635 --------- --------- Total assets ............................................... $ 455,075 $ 471,860 ========= ========= LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities: Accounts payable ............................................... $ 22,399 $ 20,432 Accrued liabilities ............................................ 16,515 16,277 --------- --------- Total current liabilities .................................. 38,914 36,709 Long-term debt due to parent ....................................... 325,402 323,303 Deferred income taxes .............................................. 7,272 6,509 Deferred credits and other liabilities ............................. 7,227 12,019 Commitments and contingencies (Note 7) ............................. -- -- Stockholder's equity: Common stock ................................................... -- -- Additional paid-in capital ..................................... 92,734 92,734 Retained earnings .............................................. 11,026 31,399 Accumulated other comprehensive income ......................... (27,500) (30,813) --------- --------- Total stockholder's equity ................................. 76,260 93,320 --------- --------- Total liabilities and stockholder's equity ............. $ 455,075 $ 471,860 ========= =========
The accompanying notes are an integral part of the combined financial statements. 43 45 STERLING CHEMICALS UNITED STATES SUBSIDIARIES COMBINED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (AMOUNTS IN THOUSANDS)
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED COMPREHENSIVE STOCK CAPITAL EARNINGS INCOME TOTAL ------- ---------- --------- ------------- --------- Balance, September 30, 1996 ............... -- $ 83,395 $ 27,930 $ (19,124) $ 92,201 Acquisition of acrylic fibers business .... -- 9,339 -- -- 9,339 Comprehensive income: Net income ............................ -- -- 7,609 -- Translation adjustment ................ -- -- -- (1,648) Comprehensive income ............. -- -- -- -- 5,961 ------- --------- --------- --------- --------- Balance, September 30, 1997 ............... -- 92,734 35,539 (20,772) 107,501 Comprehensive income: Net loss .............................. -- -- (4,140) -- Translation adjustment ................ -- -- -- (10,041) Comprehensive loss ............... -- -- -- -- (14,181) ------- --------- --------- --------- --------- Balance, September 30, 1998 ............... -- 92,734 31,399 (30,813) 93,320 Comprehensive income: Net loss .............................. -- -- (20,373) -- Translation adjustment ................ -- -- -- 3,313 Comprehensive loss ............... -- -- -- -- (17,060) ------- --------- --------- --------- --------- Balance, September 30, 1999 ............... -- $ 92,734 $ 11,026 $ (27,500) $ 76,260 ======= ========= ========= ========= =========
The accompanying notes are an integral part of the combined financial statements. 44 46 STERLING CHEMICALS UNITED STATES SUBSIDIARIES COMBINED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net income (loss) .......................................... $(20,373) $ (4,140) $ 7,609 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization .......................... 24,153 23,502 20,537 Deferred tax expense (benefit) ......................... (2,404) (2,479) 5,894 Other .................................................. (233) 447 74 Change in assets/liabilities: Accounts receivable .................................... (6,577) 14,331 10,824 Inventories ............................................ 3,325 (77) (24,897) Prepaid expenses ....................................... (6,658) (3,291) 570 Due from affiliates .................................... 14,135 1,174 66,042 Other assets ........................................... 5,189 (613) (11,909) Accounts payable ....................................... 1,966 665 6,509 Accrued liabilities .................................... 238 (531) 4,266 Other liabilities ...................................... (2,182) 298 (2,221) -------- -------- -------- Net cash flows provided by operating activities ............ 10,579 29,286 83,298 Cash flows from investing activities: Capital expenditures ................................... (7,682) (10,550) (24,065) -------- -------- -------- Net cash used in investing activities ...................... (7,682) (10,550) (24,065) -------- -------- -------- Cash flows from financing activities: Net change in long-term debt due to Parent ............. 2,099 (20,411) (57,156) -------- -------- -------- Net cash provided by (used in) financing activities ........ 2,099 (20,411) (57,156) Effect of United States/Canadian exchange rate on cash ..... 234 (447) (205) -------- -------- -------- Net increase (decrease) in cash and cash equivalents ....... 5,230 (2,122) 1,872 Cash and cash equivalents--beginning of year ............... 4,093 6,215 4,343 -------- -------- -------- Cash and cash equivalents--end of year ..................... $ 9,323 $ 4,093 $ 6,215 ======== ======== ======== Supplemental disclosures of cash flow information: Income taxes paid ...................................... $ (749) $ (541) $ (766)
The accompanying notes are an integral part of the combined financial statements. 45 47 STERLING CHEMICALS UNITED STATES SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS On July 23, 1999, Sterling Chemicals, Inc. ("Chemicals") completed a private offering of $295,000,000 of its 12 3/8% Senior Secured Notes due 2006. On November 5, 1999, Chemicals completed a registered exchange offer, pursuant to which all of these 12 3/8% Notes were exchanged for publicly registered 12 3/8% Notes with substantially similar terms (the "12 3/8% Notes"). The 12 3/8% Notes are guaranteed by all of Chemicals' existing direct and indirect United States ("United States") subsidiaries (other than Sterling Chemicals Acquisitions, Inc.) on a joint and several basis and are secured by, among other things, a second priority pledge of 100% of the stock of these same United States subsidiaries. These United States subsidiaries consist of Sterling Canada, Inc. and its United States subsidiaries, Sterling Chemicals Energy, Inc., Sterling Chemicals International, Inc., and Sterling Fibers, Inc. The financial statements of these companies (except for Sterling Chemicals Energy, Inc., whose securities do not constitute a substantial portion of the collateral) have been combined to present the accompanying financial statements of the Company. Sterling Canada, Inc. (including its United States and Canadian subsidiaries), Sterling Chemicals International, Inc., and Sterling Fibers, Inc. are hereinafter collectively referred to as "Sterling Chemicals United States Subsidiaries" or the "Company". The Company manufactures chemicals for use primarily in the pulp and paper industry at four plants in Canada and one plant in Valdosta, Georgia (the "Valdosta Plant"), and manufactures acrylic fibers in a plant near Pensacola, Florida (the "Santa Rosa Plant"). Sodium chlorate is produced at the four plants in Canada and the Valdosta Plant. Sodium chlorite is produced at one of the Canadian locations. The Company licenses, engineers, and overseas construction of large-scale chlorine dioxide generators for the pulp and paper industry as part of the pulp chemical business. These generators convert sodium chlorate into chlorine dioxide at pulp mills. The Company produces regular textiles, specialty textiles, and technical fibers at the Santa Rosa Plant, as well as licensing its acrylic fibers manufacturing technology to producers worldwide (collectively, the "acrylic fibers business" or "AFB"). 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies of the Company are described below. PRINCIPLES OF COMBINATION The combined financial statements include the accounts of all wholly owned and majority-owned subsidiaries of the combined entities. All significant intercompany accounts and transactions among entities included in the combined financial statements have been eliminated. CASH EQUIVALENTS The Company considers all investments purchased with a remaining maturity of three months or less to be cash equivalents. INVENTORIES Inventories are stated at the lower of cost or market; cost is primarily determined on the first-in, first-out basis except for stores and supplies, which are valued at average cost. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are recorded at cost. Major renewals and improvements, which extend the useful lives of the equipment, are capitalized. Major planned maintenance expenses are accrued for during the 46 48 periods prior to the maintenance, while routine repair and maintenance expenses are charged to operations as incurred. Disposals are removed at carrying cost less accumulated depreciation with any resulting gain or loss reflected in operations. Depreciation is provided using the straight-line method over estimated useful lives ranging from 5 to 25 years with the predominant life of the plant and equipment being 15 years. The Company capitalizes interest costs, which are incurred as part of the cost of constructing major facilities and equipment. The amount of interest capitalized for the fiscal years 1999, 1998, and 1997 was $0 million, $0 million, and $2.7 million, respectively. IMPAIRMENT OF LONG-LIVED ASSETS Impairment tests of long-lived assets are made when conditions indicate their carrying cost may not be recoverable. Such impairment tests are based on a comparison of undiscounted future cash flows or the market value of similar assets to the carrying cost of the asset. If an impairment is indicated, the asset value is written down to its estimated fair value. PATENTS AND ROYALTIES The cost of patents is amortized on a straight-line basis over their estimated useful lives which approximates ten years. The Company capitalized the value of the chlorine dioxide generator technology acquired in fiscal 1992 based on the net present value of all estimated remaining royalty payments associated with the technology. The resulting intangible amount is included in other assets and is amortized over an average life for these royalty payments of ten years. INCOME TAXES The Company is included in the consolidated United States federal income tax return filed by Chemicals' parent, Sterling Chemicals Holdings, Inc. ("Holdings"). The Company's provision (benefit) for United States income taxes has been allocated by Chemicals as if the Company filed their annual tax returns on a separate return basis. The Company's Canadian subsidiaries file separate federal Canadian tax returns as well as returns in the provinces in which they operate. For these Canadian subsidiaries, deferred income taxes are recorded to reflect the tax effect of the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. REVENUE RECOGNITION The Company generates revenues through sales in the open market and long-term supply contracts and recognizes these revenues as the products are shipped. Deferred credits are amortized over the life of the contract which gave rise to them. The Company also generates revenues from the construction and sale of chlorine dioxide generators, which are recognized using the percentage of completion method. The Company also receives prepaid royalties, which are typically recognized over a period of ten years. In addition, the Company generates revenues from the sale of acrylic fibers manufacturing technology to producers worldwide, which are recognized as earned. FOREIGN CURRENCY TRANSLATION AND FOREIGN EXCHANGE Assets and liabilities denominated in Canadian dollars are translated into United States dollars at year-end exchange rates and revenues and expenses are translated at the average monthly exchange rates. Translation adjustments are reported as a separate component of stockholders' equity, while transaction gains and losses are included in operations when incurred. The Company's Canadian subsidiaries enter into forward foreign exchange contracts to minimize the short-term impact of Canadian dollar fluctuations on certain of its Canadian dollar denominated commitments. Gains or 47 49 losses on these contracts are deferred and are included in operations in the same period in which the related transactions are settled. EARNINGS PER SHARE All issued and outstanding shares of the entities included in the Company's financial statements are held directly or indirectly by Chemicals, and accordingly, earnings per share information is not presented. ENVIRONMENTAL COSTS Environmental costs are expensed unless the expenditures extend the economic useful life of the assets. Costs that extend the economic life of the assets are capitalized and depreciated over the remaining life of such assets. Liabilities are recorded when environmental assessments and/or remedial efforts are probable, and the cost can be reasonably estimated. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS In preparing disclosures about the fair value of financial instruments, the Company has assumed that the carrying amount approximates fair value for cash and cash equivalents, receivables, short-term borrowings, accounts payable, and certain accrued expenses because of the short maturities of those instruments. The fair values of long-term debt instruments are estimated based upon quoted market values (if applicable) or on the current interest rates available for debt with similar terms and remaining maturities. Considerable judgment is required in developing these estimates and, accordingly, no assurance can be given that the estimated values presented herein are indicative of the amounts that would be realized in a free market exchange. ACCOUNTING ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Significant estimates include environmental reserves, litigation contingencies, maintenance costs related to shut downs, and taxes. Actual results could differ from these estimates. ALLOCATIONS The Company is wholly owned by Chemicals, which incurs certain direct and indirect expenses for the benefit and support of the Company. These services include, among others, tax planning, treasury, legal, risk management, and the maintenance of insurance coverage for the Company. Chemicals allocated $3.5 million, $4.1 million, and $2.7 million of such expenses to the Company in fiscal years 1999, 1998, and 1997, respectively, which are included in selling, general, and administrative expenses. Allocations are based on the Company's proportionate share of the respective amount and are determined using various criteria including headcount, payroll, number of vehicles, and revenue. In addition, the Company is dependent on Chemicals for financing. NEW ACCOUNTING STANDARDS Effective October 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and displaying of comprehensive income and its components and SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which establishes revisions to employers' disclosure about pension and other post retirement benefit plans. Adoption of these statements in fiscal 1999 had no effect on net income (loss). The only item of accumulated other comprehensive income is the Company's foreign currency translation adjustment. 48 50 SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Management is currently evaluating the accounting impact and disclosures required when this statement is adopted in the first quarter of fiscal 2001. RECLASSIFICATION Certain amounts reported in the financial statements for the prior periods have been reclassified to conform with the current financial statement presentation with no effect on net income (loss) or stockholder's equity (deficiency in assets). 3. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS:
SEPTEMBER 30, ------------------------ 1999 1998 --------- --------- (Dollars in Thousands) Inventories: Finished products ........................... $ 17,513 $ 20,198 Raw materials ............................... 2,235 2,784 --------- --------- Inventories at cost ................................. 19,748 22,982 --------- --------- Inventories under exchange agreements ....... 170 34 Stores and supplies ......................... 9,289 9,516 --------- --------- $ 29,207 $ 32,532 ========= ========= Property, plant and equipment: Land ........................................ $ 2,808 $ 5,440 Buildings ................................... 34,919 30,822 Plant and equipment ......................... 222,528 215,739 Construction in progress .................... 13,073 13,342 --------- --------- Property, plant and equipment at cost ....... 273,328 265,343 Less: accumulated depreciation .............. (76,451) (58,166) --------- --------- $ 196,877 $ 207,177 ========= ========= Other assets: Patents and technology, net ................. $ 20,718 $ 27,017 Other ....................................... 19,557 24,618 --------- --------- $ 40,275 $ 51,635 ========= ========= Accrued liabilities: Accrued compensation ........................ $ 4,988 $ 927 Billings in excess of costs incurred ........ 3,135 2,593 Other ....................................... 8,392 12,757 --------- --------- $ 16,515 $ 16,277 ========= =========
4. LONG-TERM DEBT In August 1996 in connection with a recapitalization transaction, Chemicals allocated $276.8 million of debt to the Company. In addition, debt of $81 million incurred at the time Chemicals acquired the acrylic fibers business (see Note 8) was allocated to the Company. Principal payments are allocated to the Company by Chemicals as scheduled principal payments are made on a basis consistent with the original allocation. In addition, the Company makes principal payments, from time to time, out of available cash. Interest expense is allocated based on the terms of Chemicals' debt agreements. At September 30, 1999, interest rates ranged from 11.25% to 12.375%. Debt issue costs relating to long-term debt have been allocated to the Company by Chemicals on a basis consistent with long-term debt and are included in other assets. On July 23, 1999, Chemicals completed a private offering of $295,000,000 of its 12 3/8% Notes due 2006 which were subsequently exchanged for the 12 3/8% Notes. The 12 3/8% Notes are guaranteed by all of Chemicals' existing direct and indirect United States subsidiaries (other than Sterling Chemicals Acquisitions, Inc.) on a joint and 49 51 several basis. Each subsidiary's guarantee ranks equally in right of payment with all of such subsidiary's existing and future senior indebtedness and senior in right of payment to all existing and future subordinated indebtedness of such subsidiary. However, the 12 3/8% Notes and each subsidiary's guarantee, is subordinated to the extent of the collateral securing Chemicals' new secured revolving credit facilities described below. The 12 3/8% Notes and the subsidiary guarantees are secured by (i) a second priority lien on all of Chemicals' and the subsidiary guarantors' United States production facilities and related assets, (ii) a second priority pledge of all of the capital stock of each subsidiary guarantor, and (iii) a first priority pledge of 65% of the stock of certain of the Chemicals' subsidiaries incorporated outside of the United States. The proceeds of the offering of the 12 3/8% Notes were used to fully repay and terminate Chemicals' three outstanding term loans. Upon consummation of the offering of the 12 3/8% Notes, the debt allocated to the Company by Chemicals increased to $325.4 million. In addition, on July 23, 1999, Chemicals established two new secured revolving credit facilities providing for up to $155,000,000 in revolving credit loans (the "New Revolvers") under a single Revolving Credit Agreement (the "New Credit Agreement"). Under the New Credit Agreement, Chemicals and the Company are co-borrowers and are jointly and severally liable for any indebtedness thereunder. The New Revolvers consist of (i) a $70,000,000 revolving credit facility (the "Fixed Assets Revolver") secured by a first priority lien on all United States production facilities and related assets of Chemicals and the Company, all of the capital stock of Chemicals and the Company and a second priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the Company, and (ii) an $85,000,000 revolving credit facility (the "Current Assets Revolver") secured by a first priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the Company. Funding under the 12 3/8% Notes and the New Revolvers occurred on July 23, 1999. The proceeds of the 12 3/8% Notes and the initial borrowings under the New Revolvers were used to completely repay all outstanding indebtedness under Chemicals then existing senior credit facility. Approximately $54.6 million was drawn by Chemicals under the Fixed Assets Revolver at September 30, 1999, of which no amounts were allocated to the Company. Borrowings under the Fixed Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the "LIBOR Rate" (as defined in the New Credit Agreement) plus 3.75% or the "Alternate Base Rate" plus 2.25%. Borrowings under the Current Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the LIBOR Rate plus 3.00% or the "Alternate Base Rate" plus 1.50%. The "Alternate Base Rate" is equal to the greater of the "Base Rate" as announced from time to time by The Chase Manhattan Bank in New York, New York or the "Federal Funds Effective Rate" plus 1/2% (as such terms are defined in the New Credit Agreement). The New Credit Agreement also requires Chemicals and the Company to pay an aggregate commitment fee ranging from 0.75% to 1.25% on the unused portion of the commitment for the Fixed Assets Revolver, depending on the amount drawn, and an aggregate commitment fee of 0.5% on the unused portion of the commitment for the Current Assets Revolver. Available credit under the Current Assets Revolver is subject to a monthly borrowing base consisting of 85% of eligible accounts receivable and 65% of eligible inventory with an inventory cap of $42,500,000. In addition, the borrowing base for the Current Assets Revolver must exceed outstanding borrowings thereunder by $12,000,000 at all times. The Fixed Assets Revolver matures in five years, with quarterly commitment reductions totaling 28% of the total commitment in year four and the balance in year five. The Current Assets Revolver matures in five years, with no scheduled commitment reductions prior to that time. However, the commitments for each of the Fixed Assets Revolver and the Current Assets Revolver will be permanently reduced to the extent required under the New Credit Agreement upon prepayments made out of specific sources of funds, including asset sales and certain equity issuances by Holdings. 5. INCOME TAXES The Company is included in the consolidated federal United States tax return filed by Holdings. The Company's provision (benefit) for United States income taxes has been allocated as if the Company filed their annual federal United States tax returns on a separate return basis. As of September 30, 1999 and 1998, $14.6 million and $10.5 million, respectively, of deferred income tax assets were included in Due from Affiliates. For the years ended September 30, 1999, 1998, and 1997 the Company recorded $4.0 million, $4.0 million, and $1.8 million, respectively, of United States income tax benefit in the provision (benefit) for income taxes. Canadian deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and the financial reporting amounts at each year-end (the liability method). 50 52 A reconciliation of the Canadian income taxes to the Canadian effective tax provision follows:
YEAR ENDED SEPTEMBER 30, ------------------------------- 1999 1998 1997 ----- ------- ------- (Dollars in Thousands) Provision for federal income tax at the statutory rate ............... $ 259 $ 1,367 $ 5,798 Provincial income taxes at the statutory rate ........................ 88 563 2,672 Federal and provincial manufacturing and processing tax credits ...... (50) (286) (889) Other ................................................................ 16 156 600 ----- ------- ------- Total Canadian tax provision ......................................... $ 313 $ 1,800 $ 8,181 ===== ======= =======
The provision for Canadian income taxes is composed of the following:
YEAR ENDED SEPTEMBER 30, -------------------------------- 1999 1998 1997 ------- ------- ------ (Dollars in Thousands) Current federal .................... $ 2,098 $ 2,852 $1,489 Deferred federal ................... (1,859) (1,611) 3,717 Current provincial ................. 619 1,427 798 Deferred provincial ................ (545) (868) 2,177 ------- ------- ------ Total Canadian tax provision ....... $ 313 $ 1,800 $8,181 ======= ======= ======
The components of the Company's Canadian deferred income tax assets and liabilities are summarized below:
SEPTEMBER 30, ---------------------- 1999 1998 -------- -------- (Dollars in Thousands) Deferred tax assets: Accrued liabilities ................... $ 318 $ 299 Accrued postretirement cost ........... 1,236 966 Investment tax credits ................ 4,767 6,806 -------- -------- 6,321 8,071 -------- -------- Deferred tax liabilities: Property, plant, and equipment ........ (13,593) (14,459) Other ................................. -- (121) -------- -------- (13,593) (14,580) -------- -------- Net deferred tax liabilities .............. $ (7,272) $ (6,509) ======== ========
6. EMPLOYEE BENEFITS The Company's United States employees participate in various employee benefit plans of Chemicals. Costs, assets, and liabilities associated with United States employees participating in these various plans are allocated to the Company by Chemicals based on the number of employees. In addition, the Company sponsors various employee benefit plans in Canada. RETIREMENT BENEFIT PLANS Chemicals has non-contributory pension plans in the United States which cover all salaried and wage employees. The benefits under these plans are based primarily on years of service and employees' pay near retirement. Chemicals' funding policy is consistent with the funding requirements of federal law and regulations. 51 53 Plan assets consist principally of common stocks and government and corporate securities. The liability relating to United States employees allocated to the Company by Chemicals for the retirement benefit plans and included in Due from Affiliates was $3.6 million and $2.5 million at September 30, 1999 and 1998, respectively. The total pension expense relating to United States employees allocated to the Company was $1.1 million, $1.1 million, and $0.9 million for the years ended September 30, 1999, 1998, and 1997, respectively. The Company has employer and employee contributor plans in Canada which cover all salaried and wage employees. Information for Canadian benefit plans concerning the pension obligation, plan assets, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
AUGUST 31, ---------------------- 1999 1998 -------- -------- (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year ................... $ 14,577 $ 13,348 Currency rate conversion .................................. 556 (1,314) Service cost .............................................. 919 748 Interest cost ............................................. 1,112 1,016 Actuarial loss (gain) ..................................... (124) 1,008 Benefits paid ............................................. (757) (229) -------- -------- Benefit obligation at end of year ......................... $ 16,283 $ 14,577 ======== ======== Change in plan assets: Fair value at beginning of year ........................... $ 13,062 $ 14,859 Currency rate conversion .................................. 498 (1,463) Actual return on plan assets .............................. 1,858 (882) Employer contributions .................................... 669 698 Participants' contributions ............................... -- 79 Benefits paid ............................................. (757) (229) -------- -------- Fair value at end of year ................................. $ 15,330 $ 13,062 ======== ======== Development of net amount recognized: Funded status ............................................. $ (953) $ (1,515) Unrecognized cost: Actuarial loss (gain) ................................ (22) 962 Prior service cost ................................... 333 348 -------- -------- Net amount recognized ..................................... $ (642) $ (205) ======== ======== Amounts recognized in the statement of financial position: Prepaid pension cost ...................................... $ 529 $ 655 Accrued pension cost ...................................... (1,198) (1,054) Intangible asset .......................................... 27 175 Accumulated other comprehensive income .................... -- 19 -------- -------- Net amount recognized ..................................... $ (642) $ (205) ======== ========
52 54 Net periodic pension costs (income) for the Canadian pension plan consist of the following components:
AUGUST 31, ----------------------------------- 1999 1998 1997 ------- ------- ------- (Dollars in Thousands) Components of net pension costs: Service cost-benefits earned during the year ................ $ 919 $ 748 $ 830 Interest on prior year's projected benefit obligation ....... 1,112 1,016 1,127 Expected return on plan assets .............................. (963) (1,092) (1,212) Net amortization: Actuarial loss (gain) .................................. 68 (130) (144) Prior service cost ..................................... 29 15 16 ------- ------- ------- Net pension costs ........................................... $ 1,165 $ 557 $ 617 ======= ======= ======= Weighted-average assumptions: Discount Rate ............................................... 7.50% 7.00% 8.00% Rates of increase in salary compensation level .............. 4.50% 4.00% 5.00% Expected long-term rate of return on plan assets ............ 7.50% 7.00% 8.00%
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Chemicals and the Company provide certain health care benefits and life insurance benefits for retired employees. Substantially all employees become eligible for these benefits at normal retirement age. The cost of these benefits are accrued during the period in which the employee renders the necessary service. Health care benefits are provided to employees who retire with ten or more years of service except for Canadian employees covered by collective bargaining agreements. All employees are eligible for postretirement life insurance. Postretirement health care benefits for United States. Plans are non-contributory. Benefit provisions for most hourly and some salaried employees are subject to collective bargaining. In general, the plans stipulate that retiree health care benefits are paid as covered expenses are incurred. The liability relating to United States employees allocated to the Company by Chemicals for the postretirement benefits other than pensions and included in Due from Affiliates was $7.3 million and $7.2 million at September 30, 1999 and 1998, respectively. The total postretirement benefits other than pensions expense for United States employees allocated to the Company was $0.8 million, $0.8 million, and $0.8 million for the years ended September 30, 1999, 1998, and 1997, respectively. In addition, a curtailment gain of $0.8 million was allocated during fiscal 1999 related to the reduction of postretirement life insurance benefits for currently active U.S. employees. Information for Canadian benefit plans concerning the plan obligation, the funded status, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
AUGUST 31, -------------------- 1999 1998 ------- ------- (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year ......... $ 4,306 $ 3,831 Service cost .................................... 307 264 Interest cost ................................... 299 286 Actuarial loss (gain) ........................... -- (50) Benefits paid ................................... (26) (25) ------- ------- Benefit obligation at end of year ............... $ 4,886 $ 4,306 ======= ======= Development of net amount recognized: Funded status ................................... $(4,886) $(4,306) Unrecognized cost: Actuarial loss (gain) ...................... 637 669 Prior service cost ......................... -- -- ------- ------- Net amount recognized ........................... $(4,249) $(3,637) ======= =======
53 55 Net periodic plan costs (income) for the Canadian postretirement benefit consist of the following components:
AUGUST 31, ------------------------ 1999 1998 1997 ---- ---- ---- (Dollars in Thousands) Components of net plan costs: Service cost ..................... $307 $264 $208 Interest cost .................... 299 286 202 Net amortization Actuarial loss (gain) ....... 32 -- -- ---- ---- ---- Net plan costs (income) .......... $638 $550 $410 ==== ==== ==== Weighted-average assumptions: Discount Rate .................... 6.75% 7.5% 7.5%
The weighted average annual assumed health care trend rate is assumed to be 7.5% for 1999. The rate is assumed to decrease gradually to 5.8% in 2027 and remain level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care trend rates would have the following effects:
1% INCREASE 1% DECREASE ----------- ----------- (Dollars in Thousands) Effect on total of service and interest cost components ......... $ 33 $ (29) Effect on post-retirement benefit obligation .................... 230 (200)
SAVINGS AND INVESTMENT PLAN Chemicals' Amended and Restated Savings and Investment Plan (the "Savings Plan") covers substantially all United States employees of the Company, including executive officers. The Savings Plan is qualified under Section 401(k) of the Internal Revenue Code (the "Code"). Each participant has the option to defer taxation of a portion of his or her earnings by directing the Company to contribute a percentage of such earnings to the Savings Plan. A participant may direct up to a maximum of 15% of eligible earnings to the Savings Plan, subject to certain limitations set forth in the Code for "highly compensated" participants. A participant's contributions become distributable upon the termination of his or her employment. The Company does not make any contributions to the Savings Plan. PROFIT SHARING AND BONUS PLANS In January 1997, the Board of Directors of Holdings, upon recommendation of its Compensation Committee, approved the establishment of a Profit Sharing Plan that is designed to benefit all qualified employees, and a Bonus Plan that will provide for bonuses to exempt salaried employees based on the annual financial performance of Holdings. No expenses for profit sharing or bonuses were incurred by Chemicals or allocated to the Company in fiscal 1999, 1998, or 1997. 54 56 PHANTOM STOCK PLAN The Company introduced a phantom stock plan to all eligible full-time Canadian employees. The effective date of the plan was August 21, 1996. At the end of each plan year, the plan administrator establishes a "determined percentage" for the preceding plan year. This percentage is then multiplied be each participant's compensation for the plan year to determine the award amount. The award amount is then divided be the fair market value of one share of the common stock of 'Holdings, as of December 31 of that plan year, to determine the number of rights to be credited to participants. Upon termination of employment, the benefit amount becomes payable to the participant. The benefit amount will be the number of vested rights in the participant's account, multiplied by the fair market value of one share of common stock of Holdings as of the most recent valuation date. The Company has recorded expense of $248,000, $238,000, and $346,000 related to the phantom stock plan for the years ended September 30, 1999, 1998, or 1997. 7. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company has entered into various long-term non-cancelable operating leases. Future minimum lease commitments at September 30, 1999, are as follows: fiscal 2000 -- $4.5 million; fiscal 2001 -- $4.2 million; fiscal 2002 -- $4.1 million; fiscal 2003 -- $3.9 million; fiscal 2004 -- $3.7 million; and $7.6 million thereafter. ENVIRONMENTAL AND SAFETY MATTERS The Company's operations involve the handling, production, transportation, treatment, and disposal of materials that are classified as hazardous or toxic waste and that are extensively regulated by environmental and health and safety laws and regulations. Environmental permits required for the Company's operations are subject to periodic renewal and can be revoked or modified for cause or when new or revised environmental laws or permit requirements are implemented. Changing and increasingly strict environmental laws, regulations, and permit requirements can affect the manufacturing, handling, processing, distribution, and use of the Company's products and, if so, the Company's business and operations may be materially and adversely affected. In addition, changes in the law, regulations, and permit requirements can cause the Company to incur substantial costs in upgrading or redesigning its facilities and processes, including waste treatment, storage, disposal, and other waste handling practices and equipment. While the Company believes that its business operations and facilities generally are operated in compliance with all material aspects of applicable environmental and health and safety laws, regulations, and disclosure requirements, there can be no assurance that past practices and future operations will not result in material claims or regulatory action, require material environmental expenditures, or result in exposure or injury claims by employees and the public. Some risk of environmental costs and liabilities is inherent in the operations and products of the Company, as it is with other companies engaged in similar businesses. In addition, a catastrophic event at any of the Company's facilities could result in liabilities to the Company substantially in excess of its insurance coverages. Any significant ban on all chlorine containing compounds could have a materially adverse effect on the Company's financial condition and results of operations. British Columbia has a regulation in place requiring elimination of the use of all chlorine products, including chlorine dioxide, in the bleaching process by the year 2002. Chlorine dioxide is produced from sodium chlorate, which is one of the Company's pulp chemicals products. The pulp and paper industry believes that a ban of chlorine dioxide in the bleaching process will yield no measurable environmental or public health benefit and is working to change this regulation but there can be no assurance that the regulation will be changed. In the event such a regulation is implemented, the Company would seek to sell the products it manufactures at its British Columbia facility to customers in other markets. The Company is not aware of any other laws or regulations in place in North America which would restrict the use of such products for other purposes. 55 57 LEGAL PROCEEDINGS The Company is subject to claims and legal actions that arise in the ordinary course of its business. The Company believes that the ultimate liability, if any, with respect to these claims and legal actions will not have a material effect on the financial position or results of operations of the Company. PLEDGE OF COMMON STOCK In order to secure the repayment of indebtedness under the Fixed Assets Revolver, a first priority pledge of 100% of the common stock of each of the United States entities included in these financial statements was granted by the holders of such stock. In order to secure the repayment of the 12 3/8% Notes, a second priority pledge of 100% of the common stock of each of the United States entities included in these financial statements was granted by the holders of such stock. In addition, a first priority pledge of 65% of the common stock of each of the Company's non-United States entities was given by the holders of such stock. 8. BUSINESS ACQUISITION On January 31, 1997, the Company acquired the AFB from Cytec Industries Inc. ("Cytec"). The AFB, or Sterling Fibers, recorded sales of approximately $92 million during the eight months of operations in fiscal 1997 and consists of an acrylic fibers plant located near Pensacola, Florida, and several associated marketing and research offices. Sterling Fibers is one of two acrylic fibers manufacturers in the United States. Cytec supplies acrylonitrile to Sterling Fibers through a five-year supply agreement ending in 2002. The acquisition was financed through the issuance of $81 million of debt by Chemicals, the issuance of $10 million (liquidation value) of Series A "pay in kind" mandatory redeemable preferred stock of Holdings ("Series A Preferred") to Cytec, and the sale of $10 million of Holdings' common stock in a private placement. At the acquisition date, the debt and amounts related to the Series A Preferred Stock were allocated to the Company as long-term debt due to Holdings and amounts related to Holdings' common stock were recorded as contributed capital. The Company used the purchase method to account for the acquisition, and operating results of Sterling Fibers beginning February 1, 1997, are included with those of the Company. 56 58 The following table presents the unaudited pro forma results of operations of the Company as if the AFB acquisition had occurred on October 1, 1996. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the AFB Acquisition been made at the beginning of the fiscal year 1996 or of results which may occur in the future (in thousands).
PRO FORMA TWELVE MONTHS ENDED SEPTEMBER 30, 1997 -------------- Revenues............................... $ 306,756 Net income............................. $ 5,408
9. FINANCIAL INSTRUMENTS FOREIGN EXCHANGE The Company enters into forward foreign exchange contracts to hedge Canadian dollar currency transactions on a continuing basis for periods consistent with its committed exposures. The forward foreign exchange contracts have varying maturities with none exceeding 18 months. The Company makes net settlements of United States dollars for Canadian dollars at rates agreed to at inception of the contracts. The Company enters into forward foreign exchange contracts to reduce risk due to Canadian dollar exchange rate movements. The Company does not engage in currency speculation. The Company had a notional amount of approximately $6 million and $54 million of forward foreign exchange contracts outstanding to buy Canadian dollars at September 30, 1999 and 1998, respectively. The deferred loss on these forward foreign exchange contracts at September 30, 1999 and 1998 was $0.3 million and $4.7 million, respectively. The last of the Company's existing forward exchange contracts expired in March of 2000, and it does not intend to enter into any additional forward exchange contracts. CONCENTRATION OF RISK The Company sells its products primarily to companies involved in the acrylic fiber and pulp and paper manufacturing industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral for accounts receivable. However, letters of credit are required by the Company on many of its export sales. Historically, the Company's credit losses have been minimal. The Company maintains cash deposits with major banks, which from time to time may exceed federally insured limits. The Company periodically assesses the financial condition of the institutions and believes that any possible loss is minimal. Approximately 36% of the Company's employees are covered by union agreements. Approximately 8% of the Company's employees are covered by union agreements which could expire within one year. INVESTMENTS It is the policy of the Company to invest its excess cash in investment instruments or securities whose value is not subject to market fluctuations such as certificates of deposit, repurchase agreements, or Eurodollar deposits with domestic or foreign banks or other financial institutions. Other permitted investments include commercial paper of major United States corporations with ratings of A1 by Standard & Poor's Ratings Group or P1 by Moody's Investor Services, Inc., loan participations of major United States corporations with a short term credit rating of A1/P1, and direct obligations of the United States Government or its agencies. In addition, not more than $5 million will be invested by the Company with any single bank, financial institution, or United States corporation. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reflected in the consolidated balance sheet for cash and cash equivalents, receivables, payables, and certain accrued expenses approximate fair value due to the short maturities. Based on the Company's allocated portion of Chemicals' debt at September 30, 1999, the carrying value is $325.4 million, and the fair value is $246.9 million. 57 59 INDEPENDENT AUDITORS' REPORT To the Stockholder of Sterling Canada, Inc. Sterling Fibers, Inc. Sterling Chemicals International, Inc. We have audited the accompanying combined balance sheets of Sterling Chemicals U.S. Subsidiaries (as defined in Note 1--the "Company") as of September 30, 1999 and 1998, and the related combined statements of operations, changes in stockholder's equity, and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such combined financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1999 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Houston, Texas December 9, 1999 58 60 STERLING PULP CHEMICALS, LTD. STATEMENTS OF OPERATIONS (U.S. DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, 1999 1998 1997 -------- -------- -------- Revenues ....................................... $109,510 $112,750 $130,114 Cost of goods sold ............................. 90,656 86,403 91,752 -------- -------- -------- Gross profit ................................... 18,854 26,347 38,362 Selling, general and administrative expenses ... 12,740 16,650 14,468 Interest and debt related expenses ............. 5,548 4,997 4,122 -------- -------- -------- Net income before income taxes ................. 566 4,700 19,772 Provision for income taxes (Note 5) ............ 313 1,800 8,181 -------- -------- -------- Net income ..................................... $ 253 $ 2,900 $ 11,591 ======== ======== ========
The accompanying notes are an integral part of these financial statements. 59 61 STERLING PULP CHEMICALS, LTD. BALANCE SHEETS (U.S. DOLLARS IN THOUSANDS)
SEPTEMBER 30, SEPTEMBER 30, 1999 1998 ------------- ------------- ASSETS Current Cash and cash equivalents ............................................ $ 8,481 $ 3,426 Accounts receivable (net of allowance for doubtful accounts of $205; 1998--$153) ....................................................... 16,840 14,015 Due from related parties (Note 8) .................................... 1,369 954 Other receivables .................................................... 2,254 1,744 Inventories (Note 2) ................................................. 5,146 6,660 Prepaid expenses ..................................................... 633 592 ---------- ---------- 34,723 27,391 Property, plant and equipment, net (Note 3) ............................... 75,531 80,038 Other assets .............................................................. 440 4,878 ---------- ---------- Total assets ......................................................... $ 110,694 $ 112,307 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY Current Accounts payable ..................................................... $ 8,978 $ 13,400 Accrued generator construction costs ................................. 2,967 1,175 Other accrued liabilities ............................................ 7,093 5,213 Due to related parties (Note 8) ...................................... 1,241 7,400 Current portion of long-term debt .................................... -- 4,527 ---------- ---------- 20,279 31,715 Note payable (Note 4) ..................................................... 56,667 54,095 Deferred income taxes (Note 5) ............................................ 7,272 6,509 Deferred credits and other liabilities .................................... 3,972 3,681 Commitments and contingencies (Note 7) .................................... -- -- Stockholder's equity: Common stock ......................................................... 1 1 Additional paid-in capital ........................................... 16,871 -- Retained earnings .................................................... 14,470 25,296 Accumulated other comprehensive income ............................... (8,838) (8,990) ---------- ---------- Total stockholder's equity ........................................ 22,504 16,307 ---------- ---------- Total liabilities and stockholder's equity ...................... $ 110,694 $ 112,307 ========== ==========
The accompanying notes are an integral part of these financial statements. 60 62 STERLING PULP CHEMICALS, LTD. STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (U.S. DOLLARS IN THOUSANDS)
ACCUMULATED COMMON STOCK ADDITIONAL OTHER -------------------- PAID-IN RETAINED COMPREHENSIVE SHARES AMOUNT CAPITAL EARNINGS INCOME TOTAL -------- -------- -------- -------- ------------- -------- Balance, September 30, 1996... 1 $ 1 $ 36,968 $ 21,471 $ (5,277) $ 53,163 Net capital distributions..... -- -- (29,630) -- -- (29,630) Comprehensive income: Net income ................ -- -- -- 11,591 -- Translation adjustment..... -- -- -- -- (715) Comprehensive income.... -- -- -- -- -- 10,876 -------- -------- -------- -------- -------- -------- Balance, September 30, 1997... 1 1 7,338 33,062 (5,992) 34,409 Net capital distributions..... -- -- (7,338) -- -- (7,338) Dividends .................... -- -- -- (10,666) -- (10,666) Comprehensive income: Net income ................ -- -- -- 2,900 -- Translation adjustment..... -- -- -- -- (2,998) Comprehensive loss...... -- -- -- -- -- (98) -------- -------- -------- -------- -------- -------- Balance, September 30, 1998... 1 1 -- 25,296 (8,990) 16,307 Net capital contributions..... -- -- 16,871 -- -- 16,871 Dividends .................... -- -- -- (11,079) -- (11,079) Comprehensive income: Net income ................ -- -- -- 253 -- Translation adjustment..... -- -- -- -- 152 Comprehensive income.... -- -- -- -- -- 405 -------- -------- -------- -------- -------- -------- Balance, September 30, 1999... 1 $ 1 $ 16,871 $ 14,470 $ (8,838) $ 22,504 ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these financial statements. 61 63 STERLING PULP CHEMICALS, LTD. STATEMENTS OF CASH FLOWS (U.S. DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net income ................................................... $ 253 $ 2,900 $ 11,591 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ........................... 7,757 7,700 8,359 Loss on disposal/write off of assets .................... 50 70 -- Deferred tax expense/(benefit) .......................... (539) (2,479) 5,894 Other ................................................... (31) 505 (170) Changes in assets/liabilities: Accounts receivable ..................................... (2,156) 6,036 3,803 Due from related parties ................................ (377) 2,216 1,482 Other receivables ....................................... (436) 4,136 1,504 Inventories ............................................. 1,791 (1,113) 434 Prepaid expenses ........................................ (21) 117 (1) Other assets--net ....................................... 4,530 846 1,339 Accounts payable ........................................ (607) 5,496 (1,336) Accrued generator construction costs .................... 2,450 (4,414) 1,298 Other accrued liabilities ............................... (2,467) (1,252) 869 Due to related parties .................................. (6,505) 3,702 2,133 Other liabilities ....................................... 299 (4,240) (814) -------- -------- -------- Net cash provided by operating activities ......................... 3,991 20,226 36,385 -------- -------- -------- Cash flows from investing activities: Proceeds on disposal of fixed assets ......................... 3,578 -- -- Capital expenditures ......................................... (3,465) (4,381) (3,336) -------- -------- -------- Net cash provided by (used in) investing activities ............... 113 (4,381) (3,336) -------- -------- -------- Cash flows from financing activities: Repayment of long term debt .................................. (4,527) -- -- Contribution from parent ..................................... 16,871 -- -- Distribution to parent ....................................... -- (7,338) (29,630) Dividends .................................................... (11,079) (10,666) -- -------- -------- -------- Net cash provided by (used in) financing activities ............... 1,265 (18,004) (29,630) Effect of exchange rate on cash ................................... (314) 405 (1,469) -------- -------- -------- Net increase (decrease) in cash and cash equivalents .............. 5,055 (1,754) 1,950 Cash and cash equivalents, beginning of year ...................... 3,426 5,180 3,230 -------- -------- -------- Cash and cash equivalents, end of year ............................ $ 8,481 $ 3,426 $ 5,180 ======== ======== ======== Supplemental disclosures of cash flow information: Interest paid, net of interest income received ............... $(11,608) $ (92) $ (1,076) Income taxes paid ............................................ (749) (541) (766)
The accompanying notes are an integral part of these financial statements. 62 64 STERLING PULP CHEMICALS, LTD. NOTES TO THE FINANCIAL STATEMENTS (U.S. DOLLARS) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND OPERATIONS Sterling Pulp Chemicals, Ltd. (the "Company") is a Canadian company which operates four pulp chemical facilities in Canada. These plants primarily produce sodium chlorate, a chemical used primarily to make chlorine dioxide, which in turn is used by pulp mills in the pulp bleaching process. The Company sells sodium chlorate to customers in Canada and the United States. The Company also oversees construction of large-scale chlorine dioxide generators for the pulp and paper industry. The Company is a wholly owned subsidiary of Sterling Canada, Inc. ("Parent"), which is a wholly-owned subsidiary of Sterling Chemicals, Inc. ("Chemicals"). The financial statements of the Company are presented in accordance with generally accepted accounting principles in the United States of America ("U.S.") and have been translated from Canadian dollars, the Company's functional currency to U.S. dollars, the reporting currency of the Parent, following the guidelines established by SFAS No. 52 "Foreign Currency Translation". CASH EQUIVALENTS The Company considers all investments purchased with a remaining maturity of three months or less to be cash equivalents. INVENTORIES Inventories are stated at the lower of cost and market; cost is primarily determined on the first-in, first-out basis except for stores and supplies, which are valued at average cost. The Company enters into agreements with other companies to exchange chemical inventories in order to minimize working capital requirements and to facilitate distribution logistics. Balances related to quantities due to or payable by the Company are included in inventory. IMPAIRMENT OF LONG-LIVED ASSETS Impairment tests of long-lived assets are made when conditions indicate their carrying costs may not be recoverable. Such impairment tests are based on a comparison of undiscounted future cash flows or the market value of similar assets to the carrying cost of the asset. If an impairment is indicated, the asset value is written down to its estimated fair value. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are recorded at cost. Major renewals and improvements which extend the useful lives of the equipment are capitalized, while repair and maintenance expenses are charged to operations as incurred. Disposals are removed at carrying costs less accumulated depreciation with any resulting gain or loss reflected in operations. Depreciation is provided using the straight-line method over estimated useful lives ranging from 5 to 25 years with the predominant life of the plant and equipment being 15 years. 63 65 INCOME TAXES The Company files a federal Canadian tax return as well as returns in the provinces in which it operates. Deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax bases of assets and liabilities and the financial reporting amounts at each year-end (the liability method). REVENUE RECOGNITION The Company generates revenues through sales in the open market pursuant to short-term and long-term contracts with its customers. The Company recognizes revenue from sales as the products are shipped. Revenues associated with the constructing of chlorine dioxide generators are recognized using the percentage of completion method based on cost incurred compared to total estimated cost. FOREIGN CURRENCY TRANSLATION AND FOREIGN EXCHANGE The Company's functional currency is the Canadian dollar. The Parent's reporting currency is the U.S. dollar. For financial reporting purposes, assets and liabilities denominated in Canadian dollars are translated into U.S. dollars at year-end rates of exchange and revenues and expenses are translated at the average monthly exchange rates. Translation adjustments are reported as a separate component of stockholder's equity while transaction gains and losses are included in operations. ENVIRONMENTAL COSTS Environmental costs are expensed unless the expenditures extend the economic useful life of the assets. Costs that extend the economic life of the assets are capitalized and depreciated over the remaining life of such assets. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the cost can be reasonably estimated. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS In preparing disclosures about the fair value of financial instruments, the Company has assumed that the carrying amount approximates fair value for cash and cash equivalents, receivables, short-term borrowings, accounts payable, and certain accrued expenses because of the short maturities of those instruments. The fair values of long-term debt instruments are estimated based upon quoted market values (if applicable) or on the current interest rates available to the Company for debt with similar terms and remaining maturities. Considerable judgement is required in developing these estimates and, accordingly, no assurances can be given that the estimated values presented herein are indicative of the amounts that would be realized in a free market exchange. ACCOUNTING ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. EARNINGS PER SHARE All issued and outstanding shares of the Company are held by the Parent. Accordingly, earnings per share information is not presented. 64 66 NEW ACCOUNTING STANDARDS Effective October 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and displaying of comprehensive income and its components and SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which establishes revisions to employers' disclosure about pension and other post retirement benefit plans. Adoption of these statements in fiscal 1999 had no effect on net income (loss). The only item of accumulated other comprehensive income is the Company's foreign currency translation adjustment. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Management is currently evaluating the accounting impact and disclosures required when this statement is adopted in the first quarter of fiscal 2001. 2. INVENTORIES
SEPTEMBER 30, ------------------------- 1999 1998 ---------- ---------- (Dollars in Thousands) Inventories: Finished products ..................................... $ 1,872 $ 3,455 Raw materials ......................................... 209 253 ---------- ---------- Inventories at cost ........................................ 2,081 3,708 Inventories under exchange agreements ...................... 77 78 Stores and supplies ........................................ 2,988 2,874 ---------- ---------- $ 5,146 $ 6,660 ========== ==========
3. PROPERTY, PLANT, AND EQUIPMENT
SEPTEMBER 30, -------------------------- 1999 1998 ---------- ---------- (Dollars in Thousands) Property, plant, and equipment: Land .................................................. $ 1,448 $ 4,079 Buildings ............................................. 13,808 11,864 Plant and equipment ................................... 110,711 106,408 ---------- ---------- Property, plant, and equipment at cost ................ 125,967 122,351 Less accumulated depreciation ......................... (50,436) (42,313) ---------- ---------- $ 75,531 $ 80,038 ========== ==========
4. NOTE PAYABLE On August 20, 1992, the Company entered into an agreement for a $109.1 million demand note facility with Sterling NRO, Ltd. ("Sterling NRO"). Sterling NRO is also owned by the Parent and is therefore related by virtue of common control. The note has no scheduled terms of repayment and interest is calculated and payable monthly in arrears at 1.5% above the Bank of Nova Scotia prime rate. Interest expensed for the years ended September 30, 1999, 1998, and 1997 were $5.5 million, $4.9 million and $4.2 million, respectively. Principal repayments for the years ended September 30, 1999 and 1998 were $4.5 million and nil, respectively. 5. INCOME TAXES A reconciliation of federal statutory income taxes to the Company's effective tax provision follows:
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 1997 -------- -------- -------- (Dollars in Thousands) Provision for federal income tax at the statutory rate ............ 259 $ 1,367 $ 5,798 Provincial income taxes at the statutory rate ..................... 88 563 2,672 Federal and provincial manufacturing and processing tax credits ... (50) (286) (889) Other ............................................................. 16 156 600 -------- -------- -------- $ 313 $ 1,800 $ 8,181 ======== ======== ========
65 67 The provision for income taxes is composed of the following:
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 1997 -------- -------- -------- (Dollars in Thousands) Current federal ................................................... $ 2,098 $ 2,852 $ 1,489 Deferred federal .................................................. (1,859) (1,611) 3,717 Current provincial ................................................ 619 1,427 798 Deferred provincial ............................................... (545) (868) 2,177 -------- -------- -------- Total tax provision .......................................... $ 313 $ 1,800 $ 8,181 ======== ======== ========
The components of the Company's deferred income tax assets and liabilities are summarized below:
SEPTEMBER 30, -------------------------- 1999 1998 ---------- ---------- (Dollars in Thousands) Deferred tax assets Accrued liabilities ............................................. $ 318 $ 299 Accrued postretirement cost ..................................... 1,236 966 Investment tax credits .......................................... 4,767 6,806 ---------- ---------- $ 6,321 $ 8,071 ---------- ---------- Deferred tax liabilities Property, plant and equipment ................................... (13,593) (14,459) Other ........................................................... -- (121) ---------- ---------- (13,593) (14,580) Net deferred tax liabilities ......................................... $ (7,272) $ (6,509) ========== ==========
6. EMPLOYEE BENEFITS The Company has established the following benefit plans: RETIREMENT BENEFIT PLANS The Company has employer and employee contributory plans which cover all salaried and wage employees. The benefits under these plans are based primarily on years of service and/or employee's pay near retirement. The Company's funding policy is consistent with the funding requirements of Canadian federal and provincial laws and regulations. Plan assets consist principally of common stocks and government and corporate securities. 66 68 Information concerning the pension obligation, plan assets, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
AUGUST 31, -------------------------- 1999 1998 ---------- ---------- (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year ................................ $ 14,577 $ 13,348 Currency rate conversion ............................................... 556 (1,314) Service cost ........................................................... 919 748 Interest cost .......................................................... 1,112 1,016 Actuarial loss (gain) .................................................. (124) 1,008 Benefits paid .......................................................... (757) (229) ---------- ---------- Benefit obligation at end of year ...................................... $ 16,283 $ 14,577 ========== ========== Change in plan assets: Fair value at beginning of year ........................................ $ 13,062 $ 14,859 Currency rate conversion ............................................... 498 (1,463) Actual return on plan assets ........................................... 1,858 (882) Employer contributions ................................................. 669 698 Participants' contributions ............................................ -- 79 Benefits paid .......................................................... (757) (229) ---------- ---------- Fair value at end of year .............................................. $ 15,330 $ 13,062 ========== ========== Development of net amount recognized: Funded status .......................................................... $ (953) $ (1,515) Unrecognized cost: Actuarial loss (gain) ............................................... (22) 962 Prior service cost .................................................. 333 348 ---------- ---------- Net amount recognized .................................................. $ (642) $ (205) ========== ========== Amounts recognized in the statement of financial position: Prepaid pension cost ................................................... $ 529 $ 655 Accrued pension cost ................................................... (1,198) (1,054) Intangible asset ....................................................... 27 175 Accumulated other comprehensive income ................................. -- 19 ---------- ---------- Net amount recognized .................................................. $ (642) $ (205) ========== ==========
Net periodic pension costs (income) consist of the following components:
AUGUST 31, ------------------------------------ 1999 1998 1997 -------- -------- -------- (Dollars in Thousands) Components of net pension costs: Service cost-benefits earned during the year ................... $ 919 $ 748 $ 830 Interest on prior year's projected benefit obligation .......... 1,112 1,016 1,127 Expected return on plan assets ................................. (963) (1,092) (1,212) Net amortization: Actuarial loss (gain) ....................................... 68 (130) (144) Prior service cost .......................................... 29 15 16 -------- -------- -------- Net pension costs .............................................. $ 1,165 $ 557 $ 617 ======== ======== ======== Weighted-average assumptions: Discount Rate .................................................. 7.50% 7.00% 8.00% Rates of increase in salary compensation level ................. 4.50% 4.00% 5.00% Expected long-term rate of return on plan assets ............... 7.50% 7.00% 8.00%
67 69 POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company provides certain health care and life insurance benefits for retired employees. Employees become eligible for these benefits at normal retirement age. Retiree insurance plans provide health and life insurance benefits to employees who retire from the Company with ten or more years of service. All of the Company's employees are eligible for postretirement life insurance and, except for collectively bargained employees, are eligible for postretirement medical insurance. Postretirement medical insurance is a non-contributory plan. Benefit provisions for most hourly and some salaried employees are subject to collective bargaining. Information concerning the plan obligation, the funded status, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
AUGUST 31, -------------------------- 1999 1998 ---------- ---------- (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year ................................ $ 4,306 $ 3,831 Service cost ........................................................... 307 264 Interest cost .......................................................... 299 286 Actuarial loss (gain) .................................................. -- (50) Benefits paid .......................................................... (26) (25) ---------- ---------- Benefit obligation at end of year ...................................... $ 4,886 $ 4,306 ========== ========== Development of net amount recognized: Funded status .......................................................... $ (4,886) $ (4,306) Unrecognized cost: Actuarial loss ...................................................... 637 669 ---------- ---------- Net amount recognized .................................................. $ (4,249) $ (3,637) ========== ==========
Net periodic plan costs (income) consist of the following components:
AUGUST 31, ------------------------------------ 1999 1998 1997 -------- -------- -------- (Dollars in Thousands) Components of net plan costs: Service cost ................................................... $ 307 $ 264 $ 208 Interest cost .................................................. 299 286 202 Net amortization: Actuarial loss .............................................. 32 -- -- -------- -------- -------- Net plan costs ................................................. $ 638 $ 550 $ 410 ======== ======== ======== Weighted-average assumptions: Discount Rate .................................................. 6.75% 7.50% 7.50%
The weighted average annual assumed health care trend rate is assumed to be 7.5% for 1999. The rate is assumed to decrease gradually to 5.8% in 2027 and remain level thereafter. Assumed health care cost trend rates 68 70 have a significant effect on the amounts reported for the health care plans. A one percentage point change in assumed health care trend rates would have the following effects:
1% INCREASE 1% DECREASE ----------- ----------- Dollars in Thousands) Effect on total of service and interest cost components............. $ 33 $ (29) Effect on post-retirement benefit obligation........................ 230 (200)
PROFIT SHARING PLANS The Company established profit sharing plans for the benefit of salaried and hourly employees meeting certain eligibility requirements. The Company distributes a specified percentage of its earnings before interest, taxes, depreciation, and amortization above a specified level to eligible employees on a yearly basis. The amount of each eligible employee's quarterly distribution is related to a specified percentage of each such employee's base salary or wages, with the percentage determined by the employee's position in the Company. The profit sharing for each of the fiscal years ended September 30, 1999, 1998, and 1997 was nil. PHANTOM STOCK PLAN The Company introduced a phantom stock plan to all eligible full-time Canadian employees effective August 21, 1996. At the end of each plan year, the plan administrator establishes a "determined percentage" for the preceding plan year. This percentage is then multiplied by each participant's compensation for the plan year to determine the award amount. The award amount is then divided by the fair market value of one share of the common stock of Sterling Chemicals Holdings, Inc. ("Holdings"), as of December 31 of that plan year, to determine the number of rights to be credited to participants. Upon termination of employment, the benefit amount becomes payable to the participant. The benefit amount will be the number of vested rights in the participant's account, multiplied by the fair market value of one share of common stock of Holdings as of the most recent valuation date. The Company has recorded expense of $0.2 million, $0.2 million, and $0.3 million related to the phantom stock plan for the years ended September 30, 1999, 1998, and 1997, respectively. 7. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company has entered into various long-term noncancellable rail car and other operating leases. Future minimum lease commitments are as follows: fiscal 2000--$4.4 million, fiscal 2001--$4.1 million, fiscal 2002--$4.1 million, fiscal 2003--$3.9 million, fiscal 2004--$3.7 million, and thereafter--$7.6 million. ENVIRONMENTAL AND SAFETY MATTERS The Company's operations involve the handling, production, transportation, treatment, and disposal of materials that are classified as hazardous or toxic waste and that are extensively regulated by environmental and health and safety laws and regulations. Environmental permits required for the Company's operations are subject to periodic renewal and can be revoked or modified for cause or when new or revised environmental laws or permit requirements are implemented. Changing and increasingly strict environmental laws, regulations, and permit requirements can affect the manufacturing, handling, processing, distribution, and use of the Company's products and, if so, the Company's business and operations may be materially and adversely affected. In addition, changes in the law, regulations, and permit requirements can cause the Company to incur substantial costs in upgrading or redesigning its facilities and processes, including waste treatment, storage, disposal, and other waste handling practices and equipment. 69 71 While the Company believes that its business operations and facilities generally are operated in compliance with all material aspects of applicable environmental and health and safety laws, regulations, and disclosure requirements, there can be no assurance that past practices and future operations will not result in material claims or regulatory action, require material environmental expenditures, or result in exposure or injury claims by employees and the public. Some risk of environmental costs and liabilities is inherent in the operations and products of the Company, as it is with other companies engaged in similar businesses. In addition, a catastrophic event at any of the Company's facilities could result in liabilities to the Company substantially in excess of its insurance coverages. Any significant ban on all chlorine containing compounds could have a materially adverse effect on the Company's financial condition and results of operations. British Columbia has a regulation in place requiring elimination of the use of all chlorine products, including chlorine dioxide, in the bleaching process by the year 2002. Chlorine dioxide is produced from sodium chlorate, which is the Company's primary pulp chemicals product. The pulp and paper industry believes that a ban of chlorine dioxide in the bleaching process will yield no measurable environmental or public health benefit and is working to change this regulation but there can be no assurance that the regulation will be changed. In the event such a regulation is implemented, the Company would seek to sell the products it manufactures at its British Columbia facility to customers in other markets. The Company is not aware of any other laws or regulations in place in North America which would restrict the use of such products for other purposes. LEGAL PROCEEDINGS The Company is subject to claims and legal actions that arise in the ordinary course of its business. The Company believes that the ultimate liability, if any, with respect to these claims and legal actions will not have a material effect on the financial position or results of operations of the Company. PLEDGE OF COMMON STOCK In order to secure the repayment of a 1999 issuance of $295,000,000 of 12 3/8% Senior Secured Notes due 2006 by Chemicals, Parent granted the note holders a first priority pledge of 65% of the Company's common stock. 8. RELATED PARTY TRANSACTIONS In the normal course of operations of the Company, the following represents significant transactions with related parties for the fiscal years ended September 30, 1999, 1998, and 1997:
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 1997 -------- -------- -------- (Dollars in Thousands) Chemicals: Management fees .............................................. $ 869 $ 795 $ 848 Parent: Services, marketing and R&D revenue .......................... $ 921 $ 833 $ 617 Commonly controlled companies: Sale of goods ................................................ $ 9,295 $ 4,867 $ 347 Purchase of goods ............................................ 6,401 4,580 -- Supply agreement revenue ..................................... -- -- 585 Administration fee revenue ................................... 335 323 361 Interest expense ............................................. 5,630 4,860 4,199
The amounts due from and to related parties for the years ended September 30, 1999 and 1998 are as follows:
SEPTEMBER 30, 1999 1998 ------------ ------------ (Dollars in Thousands) Due from related parties: Parent ............................ $ 12 $ 305 Commonly controlled companies ..... 1,357 649 ------------ ------------ $ 1,369 $ 954 ============ ============ Due to related parties: Parent ............................ $ 132 $ 128 Commonly controlled companies ..... 1,109 7,272 ------------ ------------ $ 1,241 $ 7,400 ============ ============
70 72 9. EXPORT SALES The Company is engaged in the sale of products for export into the United States. These were primarily sodium chlorate sales and represented 47%, 46%, and 41% of revenues for fiscal 1999, 1998, and 1997, respectively. 10. FINANCIAL INSTRUMENTS FORWARD EXCHANGE CONTRACTS The Company enters into forward exchange contracts to hedge foreign currency transactions on a continuing basis for periods consistent with its committed exposures. The Company does not engage in currency speculation. The effect of this practice is to minimize the impact of foreign exchange rate movements on the Company's operating results. As of September 30, 1999 and 1998, the Company had a notional amount of approximately $6.0 million and $54.0 million, respectively, of forward foreign exchange contracts outstanding to buy Canadian dollars. The Company makes net settlements of Canadian dollars for U.S. dollars at maturity, at rates agreed to at inception of the contracts. The deferred loss on these forward foreign exchange contracts at September 30, 1999 and 1998 were $0.3 million and $4.7 million, respectively. The last of the Company's existing forward exchange contracts expires in March of 2000, and it does not intend to enter into any additional forward exchange contracts. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value approximated the carrying value of financial instruments included in current assets and current liabilities on the balance sheet at September 30, 1999 due to the short maturities. The fair value of the notes payable on the balance sheet at September 30, 1999 approximated their carrying value, as the interest rate fluctuates with changes in market rates. CONCENTRATIONS OF CREDIT RISK The Company sells its products primarily to companies involved in the pulp and paper industry. The Company performs ongoing credit evaluations of its customers and generally does not require collateral for accounts receivable. The Company maintains cash deposits with major banks which from time to time may exceed federally insured limits. Management periodically assesses the financial condition of the institutions and believes that any possible credit loss is minimal. Approximately 50% of the Company's employees are covered by union agreements. 71 73 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholder of Sterling Pulp Chemicals, Ltd. We have audited the accompanying balance sheets of Sterling Pulp Chemicals, Ltd. (an indirect wholly-owned subsidiary of Sterling Chemicals, Inc.) as at September 30, 1999 and 1998 and the related statements of operations, changes in stockholder's equity and cash flows for each of the years ended September 30, 1999, 1998 and 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards in Canada. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the accompanying financial statements present fairly, in all material respects, the financial positions of Sterling Pulp Chemicals, Ltd. as at September 30, 1999 and 1998, and the results of its operations and its cash flows for each of the three years ended September 30, 1999, 1998 and 1997, in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Chartered Accountants Mississauga, Canada December 9, 1999 72 74 REPORT OF MANAGEMENT Management is responsible for the preparation and content of the financial statements and other information included in this annual report. The financial statements have been prepared in conformity with generally accepted accounting principles appropriate under the circumstances to reflect, in all material respects, the substance of events and transactions that should be included. The financial statements reflect management's judgments and estimates as to the effects of events and transactions that are accounted for or disclosed. Management maintains accounting systems which are supported by internal accounting controls that provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with management's authorization and recorded properly to permit the preparation of financial statements in accordance with generally accepted accounting principles. The concept of reasonable assurance is based on the recognition that the cost of a system of internal accounting controls should not exceed the benefits. Deloitte & Touche LLP performed an independent audit of the Company's financial statements for fiscal years 1999, 1998, and 1997, for the purpose of determining that the statements are presented fairly and in accordance with generally accepted accounting principles. The independent auditors are appointed by the Board of Directors and meet regularly with the Audit and Compliance Committee of the Board of Directors, which is comprised solely of outside directors. The Audit and Compliance Committee meets periodically with the Company's senior officers and independent accountants to review the adequacy and reliability of the Company's accounting, financial reporting, and internal controls. Peter W. De Leeuw President and Chief Executive Officer Paul G. Vanderhoven Controller - Principal Accounting Officer December 16, 1999 73 75 STERLING CANADA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Revenues ......................................... $ 155,673 $ 162,066 $ 170,723 Cost of goods sold ............................... 125,812 124,887 120,584 ------------ ------------ ------------ Gross profit ..................................... 29,861 37,179 50,139 Selling, general, and administrative expenses .... 9,839 9,941 7,086 Interest and debt related expenses ............... 29,463 28,484 29,228 ------------ ------------ ------------ Net income (loss) before income taxes ............ (9,441) (1,246) 13,825 Provision (benefit) for income taxes ............. 487 (534) 6,047 ------------ ------------ ------------ Net income (loss) ................................ $ (9,928) $ (712) $ 7,778 ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 74 76 STERLING CANADA, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
SEPTEMBER 30, ---------------------------- 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents ........................... $ 8,588 $ 3,572 Accounts receivable ................................. 33,342 26,399 Inventories ......................................... 6,288 7,866 Prepaid expenses .................................... 12,947 6,590 ------------ ------------ Total current assets .............................. 61,165 44,427 Property, plant, and equipment, net .................... 127,658 135,952 Due from affiliates .................................... 139,868 149,650 Other assets ........................................... 34,389 45,947 ------------ ------------ Total assets ...................................... $ 363,080 $ 375,976 ============ ============ LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities: Accounts payable .................................... $ 14,680 $ 13,538 Accrued liabilities ................................ 11,238 12,867 ------------ ------------ Total current liabilities ......................... 25,918 26,405 Long-term debt due to parent ........................... 243,999 245,764 Deferred income taxes .................................. 7,272 6,509 Deferred credits and other liabilities ................. 4,927 9,719 Commitments and contingencies (Note 7) ................. -- -- Stockholder's equity: Common stock ........................................ -- -- Additional paid-in capital .......................... 83,396 83,396 Retained earnings ................................... 25,068 34,996 Accumulated other comprehensive income .............. (27,500) (30,813) ------------ ------------ Total stockholder's equity ........................ 80,964 87,579 ------------ ------------ Total liabilities and stockholder's equity ..... $ 363,080 $ 375,976 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 75 77 STERLING CANADA, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (DOLLARS IN THOUSANDS)
ACCUMULATED ADDITIONAL OTHER COMMON PAID-IN RETAINED COMPREHENSIVE STOCK CAPITAL EARNINGS INCOME TOTAL ------------- ------------- ------------- ------------- ------------- Balance, September 30, 1996 ............ $ -- $ 83,396 $ 27,930 $ (19,124) $ 92,202 Comprehensive income: Net income .......................... -- -- 7,778 -- Translation adjustment .............. -- -- -- (1,648) Comprehensive income ............. 6,130 ------------- ------------- ------------- ------------- ------------- Balance, September 30, 1997 ............ -- 83,396 35,708 (20,772) 98,332 Comprehensive income: Net loss ............................ -- -- (712) -- Translation adjustment .............. -- -- -- (10,041) Comprehensive loss ............... (10,753) ------------- ------------- ------------- ------------- ------------- Balance, September 30, 1998 ............ -- 83,396 34,996 (30,813) 87,579 Comprehensive income: Net loss ............................ -- -- (9,928) -- Translation adjustment .............. -- -- -- 3,313 Comprehensive loss ............... (6,615) ------------- ------------- ------------- ------------- ------------- Balance, September 30, 1999 ............ $ -- $ 83,396 $ 25,068 (27,500) $ 80,964 ============= ============= ============= ============= =============
The accompanying notes are an integral part of the consolidated financial statements. 76 78 STERLING CANADA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------------- 1999 1998 1997 ---------- ---------- ---------- Cash flows from operating activities: Net income (loss).................................................................... $ (9,928) $ (712) $ 7,778 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization .................................................... 18,328 18,140 11,702 Deferred tax expense (benefit) ................................................... 763 (361) (5,146) Other ............................................................................ (234) 448 205 Change in assets/liabilities: Accounts receivable .............................................................. (6,943) 6,863 6,369 Inventories ...................................................................... 1,578 (1,718) (166) Prepaid expenses ................................................................. (6,357) (2,846) (375) Due from affiliates .............................................................. 13,095 (3,796) 26,374 Other assets ..................................................................... 5,881 (1,062) (5,591) Accounts payable ................................................................. 1,142 5,208 (4,864) Accrued liabilities .............................................................. (1,629) 1,606 (1,281) Other liabilities ................................................................ (4,792) 298 3,209 ---------- ---------- ---------- Net cash flows provided by operating activities ..................................... 10,904 22,068 38,214 ---------- ---------- ---------- Cash flows from investing activities- Capital expenditures ............................................................. (4,357) (6,154) (18,782) ---------- ---------- ---------- Cash flows from financing activities - Net change in long-term debt due to Parent ....................................... (1,765) (17,806) (17,659) ---------- ---------- ---------- Effect of United States/Canadian exchange rate on cash .............................. 234 (447) (205) ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents ................................ 5,016 (2,339) 1,568 Cash and cash equivalents--beginning of year ........................................ 3,572 5,911 4,343 ---------- ---------- ---------- Cash and cash equivalents--end of year............................................... $ 8,588 $ 3,572 $ 5,911 ========== ========== ========== Supplemental disclosures of cash flow information: Income taxes paid................................................................. $ (749) $ (541) $ (766)
The accompanying notes are an integral part of the consolidated financial statements. 77 79 STERLING CANADA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. DOLLARS) 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS Sterling Canada, Inc., through its subsidiaries (Sterling Canada, Inc. and its subsidiaries collectively, the "Company") manufactures chemicals for use primarily in the pulp and paper industry at four plants in Canada and one plant in Valdosta, Georgia. These plants primarily produce sodium chlorate, a chemical used primarily to make chlorine dioxide, which in turn is used by pulp mills in the pulp bleaching process. The Company also produces sodium chlorite at one of its Canadian locations and oversees construction of large-scale chlorine dioxide generators for the pulp and paper industry. Sterling Canada, Inc. is a wholly-owned subsidiary of Sterling Chemicals, Inc. ("Chemicals"), which is a wholly owned subsidiary of Sterling Chemicals Holdings, Inc. ("Holdings"). Under SEC rules, specified information is required to be provided with respect to subsidiaries of an issuer of debt securities whose capital stock is pledged to secure the repayment of those debt securities. On July 23, 1999, Chemicals completed a private offering of $295,000,000 of its 12 3/8% Senior Secured Notes due 2006. On November 5, 1999, Chemicals completed a registered exchange offer, pursuant to which all of these 12 3/8% Notes were exchanged for publicly registered 12 3/8% Notes with substantially similar terms (the "12 3/8% Notes"). The 12 3/8% Notes are guaranteed by Sterling Canada, Inc. and all of Chemicals' other existing direct and indirect subsidiaries incorporated in the United States (other than Sterling Chemicals Acquisitions, Inc.) on a joint and several basis and are secured by, among other things, a second priority pledge of 100% of the stock of these subsidiaries. The 12 3/8% Notes are also secured by 65% of the stock of Sterling Pulp Chemicals, Ltd. ("Sterling Pulp") and Sterling NRO, Ltd., each of which is a subsidiary of Sterling Canada, Inc. incorporated in Canada. In order to comply with these SEC rules, the financial statements and footnotes of Sterling Canada, Inc. are presented. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies of the Company are described below. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Sterling Canada, Inc. and all of its direct and indirect wholly owned subsidiaries, which include Sterling Pulp, Sterling Pulp Chemicals, Inc., Sterling Pulp Chemicals US, Inc., and Sterling NRO, Ltd. All significant intercompany accounts and transactions have been eliminated. CASH EQUIVALENTS The Company considers all investments purchased with a remaining maturity of three months or less to be cash equivalents. INVENTORIES Inventories are stated at the lower of cost or market; cost is determined on the first-in, first-out basis except for raw materials and stores and supplies, which are valued at average cost. The Company enters into agreements with other companies to exchange chemical inventories in order to minimize working capital requirements and to facilitate distribution logistics. Balances related to quantities due to or payable by the Company are included in inventory. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are recorded at cost. Major renewals and improvements which extend the useful lives of the equipment are capitalized, while repair and maintenance expenses are charged to operations as incurred. 78 80 Disposals are removed at carrying costs less accumulated depreciation with any resulting gain or loss reflected in operations. Depreciation is provided using the straight-line method over estimated useful lives ranging from five to 25 years with the predominant life of the plant and equipment being 15 years. IMPAIRMENT OF LONG-LIVED ASSETS Impairment tests of long-lived assets are made when conditions indicate their carrying costs may not be recoverable. Such impairment tests are based on a comparison of undiscounted future cash flows or the market value of similar assets to the carrying cost of the asset. If an impairment is indicated, the asset value is written down to its estimated fair value. PATENTS AND ROYALTIES The cost of patents is amortized on a straight-line basis over their estimated useful lives, which approximates ten years. The Company capitalized the value of the chlorine dioxide generator technology acquired in fiscal 1992 based on the net present value of all estimated remaining royalty payments associated with the technology. The resulting intangible amount is included in other assets and is amortized over the average life for these royalty payments of ten years. INCOME TAXES The Company is included in the consolidated United States federal income tax return filed by Holdings. The Company's provision (benefit) for United States income taxes has been allocated by Holdings as if the Company filed its annual tax returns on a separate return basis. The Company's Canadian subsidiaries file separate federal Canadian tax returns, as well as returns in the provinces in which they operate. For these Canadian subsidiaries, deferred income taxes are recorded to reflect the tax effect of the temporary differences between the financial reporting basis and the tax basis of the subsidiary's assets and liabilities. REVENUE RECOGNITION The Company generates revenues through sales in the open market pursuant to short-term and long-term contracts with its customers. The Company recognizes revenue from sales as the products are shipped. Revenues associated with the constructing of chlorine dioxide generators are recognized using the percentage of completion method based on cost incurred compared to total estimated cost. The Company also receives prepaid royalties for use of the chlorine dioxide generator technology; such royalties are typically recognized as revenues over a period of ten years. FOREIGN CURRENCY TRANSLATION AND FOREIGN EXCHANGE Assets and liabilities denominated in Canadian dollars are translated into United States dollars at year-end exchange rates and revenues and expenses are translated at the average monthly exchange rates. Translation adjustments are reported as a separate component of stockholder's equity, while transaction gains and losses are included in operations when incurred. The Company's Canadian subsidiaries enter into forward foreign exchange contracts to minimize the short-term impact of Canadian dollar fluctuations on certain of its Canadian dollar denominated commitments. Gains or losses on these contracts are deferred and are included in operations in the same period in which the related transactions are settled. ENVIRONMENTAL COSTS Environmental costs are expensed unless the expenditures extend the economic useful life of the assets. Costs that extend the economic life of the assets are capitalized and depreciated over the remaining life of such assets. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the cost can be reasonably estimated. 79 81 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS In preparing disclosures about the fair value of financial instruments, the Company has assumed that the carrying amount approximates fair value for cash and cash equivalents, receivables, accounts payable, and certain accrued expenses because of the short maturities of those instruments. The fair values of long-term debt instruments are estimated based upon quoted market values (if applicable) of the debt allocated to the Company by Chemicals or on the current interest rates available for debt with similar terms and remaining maturities. Considerable judgement is required in developing these estimates and, accordingly, no assurances can be given that the estimated values presented herein are indicative of the amounts that would be realized in a free market exchange. ACCOUNTING ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. ALLOCATIONS Sterling Canada, Inc. and each of its subsidiaries is directly or indirectly wholly owned by Chemicals, which incurs certain direct and indirect expenses for the benefit and support of the Company. These services include, among others, tax planning, treasury, legal, risk management, and the maintenance of insurance coverage for the Company. Chemicals allocated $2.5 million, $2.5 million, and $1.7 million of such expenses to the Company in fiscal years 1999, 1998, and 1997, respectively, which are included in selling, general, and administrative expenses. Allocations are based on the Company's proportionate share of the respective amounts and are determined primarily on revenue. In addition, the Company is dependent on Chemicals for financing. EARNINGS PER SHARE All issued and outstanding shares of the Company are held directly or indirectly by Chemicals, and accordingly, earnings per share information is not presented. NEW ACCOUNTING STANDARDS Effective October 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which established standards for reporting and displaying of comprehensive income and its components and SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which established revisions to employers' disclosure about pension and other postretirement benefit plans. Adoption of these statements in fiscal 1999 had no effect on net income. The only item of accumulated other comprehensive income is the Company's foreign currency translation adjustment. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company is currently evaluating the accounting impact and disclosures that will be required when these statements are adopted in the first quarter of fiscal 2001. 80 82 3. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS:
September 30, ---------------------------- 1999 1998 ------------ ------------ (Dollars in Thousands) Inventories: Finished products ........................ $ 2,512 $ 4,226 Raw materials ............................ 270 302 ------------ ------------ Inventories, at cost ........................ 2,782 4,528 Inventories under exchange agreements ....... 170 35 Stores and supplies ......................... 3,336 3,303 ------------ ------------ $ 6,288 $ 7,866 ============ ============ Property, plant, and equipment: Land ..................................... $ 1,465 $ 4,097 Buildings ................................ 27,040 26,820 Plant and equipment ...................... 161,824 154,916 ------------ ------------ Property, plant, and equipment, at cost ..... 190,329 185,833 Less accumulated depreciation ............... (62,671) (49,881) ------------ ------------ $ 127,658 $ 135,952 ============ ============ Accrued liabilities: Accrued compensation ..................... $ 2,169 $ 927 Billings in excess of costs incurred ..... 3,135 2,593 Other .................................... 5,934 9,347 ------------ ------------ $ 11,238 $ 12,867 ============ ============
4. LONG TERM DEBT In August 1996, in connection with a recapitalization transaction, Chemicals allocated $276.8 million of debt to the Company. Principal payments were allocated to the Company by Chemicals as scheduled principal payments were made on a basis consistent with the original allocation. In addition, the Company made payments to Chemicals for application towards the intercompany allocation of principal, from time to time, out of available cash. Interest expense is allocated based on the terms of Chemicals' debt agreements. At September 30, 1999, interest rates ranged from 11.25% to 12.375%. Debt issue costs relating to long-term debt have been allocated to the Company by Chemicals on a basis consistent with long-term debt and are included in other assets. On July 23, 1999, Chemicals completed a private offering of $295,000,000 of its 12 3/8% Notes due 2006 which were subsequently exchanged for the 12 3/8% Notes. The 12 3/8% Notes are guaranteed by most of Chemicals' existing direct and indirect subsidiaries incorporated in the United States, including Sterling Canada, Inc., Sterling Pulp Chemicals, Inc., and Sterling Pulp Chemicals US, Inc., on a joint and several basis. Each subsidiary's guarantee ranks equally in right of payment with all of such subsidiary's existing and future senior indebtedness and senior in right of payment to all existing and future subordinated indebtedness of such subsidiary. However, the 12 3/8% Notes and each subsidiary's guarantee are subordinated to the extent of the collateral securing Chemicals' new secured revolving credit facilities described below. The 12 3/8% Notes and the subsidiary guarantees are secured by (i) a second priority lien on all of Chemicals' and the subsidiary guarantors' United States production facilities and related assets, (ii) a second priority pledge of all of the capital stock of each subsidiary guarantor, and (iii) a first 81 83 priority pledge of 65% of the stock of certain of the Chemicals' subsidiaries incorporated outside of the United States, including Sterling Pulp and Sterling NRO, Ltd. The proceeds of the offering of the 12 3/8% Notes were used to fully repay and terminate Chemicals' three outstanding term loans. Upon consummation of the offering of the 12 3/8% Notes, the debt allocated to the Company by Chemicals increased to $244.0 million. In addition, on July 23, 1999, Chemicals established two new secured revolving credit facilities providing for up to $155,000,000 in revolving credit loans (the "New Revolvers") under a single Revolving Credit Agreement (the "New Credit Agreement"). Under the New Credit Agreement, Chemicals and most of its direct and indirect subsidiaries incorporated in the United States are co-borrowers and are jointly and severally liable for any indebtedness thereunder. The New Revolvers consist of (i) a $70,000,000 revolving credit facility (the "Fixed Assets Revolver") secured by a first priority lien on all United States production facilities and related assets of Chemicals and the other co-borrowers, all of the capital stock of Chemicals and the other co-borrowers and a second priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers, and (ii) an $85,000,000 revolving credit facility (the "Current Assets Revolver") secured by a first priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers. Funding under the 12 3/8% Notes and the New Revolvers occurred on July 23, 1999. The proceeds of the 12 3/8% Notes and the initial borrowings under the New Revolvers were used to completely repay all outstanding indebtedness under Chemicals' then existing senior credit facilities. Approximately $54.6 million was drawn by Chemicals under the Fixed Assets Revolver at September 30, 1999, of which no amounts were allocated to the Company. Borrowings under the Fixed Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the "LIBOR Rate" (as defined in the New Credit Agreement) plus 3.75% or the "Alternate Base Rate" plus 2.25%. Borrowings under the Current Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the LIBOR Rate plus 3.00% or the "Alternate Base Rate" plus 1.50%. The "Alternate Base Rate" is equal to the greater of the "Base Rate" as announced from time to time by The Chase Manhattan Bank in New York, New York or the "Federal Funds Effective Rate" plus 1/2% (as defined in the New Credit Agreement). The New Credit Agreement also requires Chemicals and the other co-borrowers to pay an aggregate commitment fee ranging from 0.75% to 1.25% on the unused portion of the commitment for the Fixed Assets Revolver, depending on the amount drawn, and an aggregate commitment fee of 0.5% on the unused portion of the commitment for the Current Assets Revolver. Available credit under the Current Assets Revolver is subject to a monthly borrowing base consisting of 85% of eligible accounts receivable and 65% of eligible inventory with an inventory cap of $42,500,000. In addition, the borrowing base for the Current Assets Revolver must exceed outstanding borrowings thereunder by $12,000,000 at all times. The Fixed Assets Revolver matures on July 23, 2004, with quarterly commitment reductions totaling 28% of the total commitment in year four and the balance in year five. The Current Assets Revolver matures on July 23, 2004, with no scheduled commitment reductions prior to that time. However, the commitments for each of the Fixed Assets Revolver and the Current Assets Revolver will be permanently reduced to the extent required under the New Credit Agreement upon prepayments made out of specific sources of funds, including certain equity issuances by Holdings and asset sales. 5. INCOME TAXES The Company is included in the consolidated federal United States tax return filed by Holdings. The Company's provision (benefit) for United States income taxes has been allocated as if the Company filed their annual federal United States tax returns on a separate return basis. As of September 30, 1999 and 1998, $13.1 million and $13.3 million, respectively, of deferred income tax assets were included in "Due from Affiliates". For the years ended September 30, 1999, 1998, and 1997, the Company recorded $0.2 million, $(2.3) million, and $(2.1) million, respectively, of United States income tax provision (benefit) in its provision (benefit) for income taxes. Canadian deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and the financial reporting amounts at each year-end. 82 84 A reconciliation of the Canadian income taxes to the Canadian effective tax provision follows:
Year Ended September 30, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (Dollars in Thousands) Provision for federal income tax at the statutory rate ............... $ 259 $ 1,367 $ 5,798 Provincial income taxes at the statutory rate ........................ 88 563 2,672 Federal and provincial manufacturing and processing tax credits ...... (50) (286) (889) Other ................................................................ 16 156 600 ------------ ------------ ------------ Total Canadian tax provision ......................................... $ 313 $ 1,800 $ 8,181 ============ ============ ============
The provision for Canadian income taxes is composed of the following:
Year Ended September 30, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (Dollars in Thousands) Current federal ...................................................... $ 2,098 $ 2,852 $ 1,489 Deferred federal ..................................................... (1,859) (1,611) 3,717 Current provincial ................................................... 619 1,427 798 Deferred provincial .................................................. (545) (868) 2,177 ------------ ------------ ------------ Total Canadian tax provision ......................................... $ 313 $ 1,800 $ 8,181 ============ ============ ============
The components of the Company's Canadian deferred income tax assets and liabilities are summarized below:
September 30, ---------------------------- 1999 1998 ------------ ------------ (Dollars in Thousands) Deferred tax assets: Accrued liabilities ................. $ 318 $ 299 Accrued postretirement cost ......... 1,236 966 Investment tax credits .............. 4,767 6,806 ------------ ------------ 6,321 8,071 ------------ ------------ Deferred tax liabilities: Property, plant, and equipment ...... (13,593) (14,459) Other ............................... -- (121) ------------ ------------ (13,593) (14,580) ------------ ------------ Net deferred tax liabilities ........... $ (7,272) $ (6,509) ============ ============
6. EMPLOYEE BENEFITS The Company's United States employees participate in various employee benefit plans of Chemicals. Costs, assets, and liabilities associated with United States employees participating in these various plans are allocated to the Company by Chemicals based on the number of employees. In addition, the Company sponsors various employee benefit plans in Canada. RETIREMENT BENEFIT PLANS Chemicals has non-contributory pension plans in the United States which cover all salaried and wage employees. The benefits under these plans are based primarily on years of service and employees' pay near retirement. Chemicals' funding policy is consistent with the funding requirements of federal law and regulations. Plan assets consist principally of government and corporate securities. The liability relating to United States employees allocated to the Company by Chemicals for the retirement benefit plans and included in Due from Affiliates was $0.4 million and $0.3 million at September 30, 1999 and 1998, respectively. The total pension expense relating to United States employees allocated to the Company was $0.1 million, $0.1 million, and $0.2 million for the years ended September 30, 1999, 1998, and 1997, respectively. 83 85 The Company has employer and employee contributor plans in Canada which cover all salaried and wage employees. Information for Canadian benefit plans concerning the pension obligation, plan assets, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
August 31, ---------------------------- 1999 1998 ------------ ------------ (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year ................. $ 14,577 $ 13,348 Currency rate conversion ................................ 556 (1,314) Service cost ............................................ 919 748 Interest cost ........................................... 1,112 1,016 Actuarial loss (gain) ................................... (124) 1,008 Benefits paid ........................................... (757) (229) ------------ ------------ Benefit obligation at end of year ....................... $ 16,283 $ 14,577 ============ ============ Change in plan assets: Fair value at beginning of year ......................... $ 13,062 $ 14,859 Currency rate conversion ................................ 498 (1,463) Actual return on plan assets ............................ 1,858 (882) Employer contributions .................................. 669 698 Participants' contributions ............................. -- 79 Benefits paid ........................................... (757) (229) ------------ ------------ Fair value at end of year ............................... $ 15,330 $ 13,062 ============ ============ Development of net amount recognized: Funded status ........................................... $ (953) $ (1,515) Unrecognized cost: Actuarial loss (gain) ................................ (22) 962 Prior service cost ................................... 333 348 ------------ ------------ Net amount recognized ................................... $ (642) $ (205) ============ ============ Amounts recognized in the statement of financial position: Prepaid pension cost .................................... $ 529 $ 655 Accrued pension cost .................................... (1,198) (1,054) Intangible asset ........................................ 27 175 Accumulated other comprehensive income .................. -- 19 ------------ ------------ Net amount recognized ................................... $ (642) $ (205) ============ ============
Net periodic pension costs for the Canadian pension plan consist of the following components:
August 31, ---------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (Dollars in Thousands) Components of net pension costs: Service cost-benefits earned during the year ................. $ 919 $ 748 $ 830 Interest on prior year's projected benefit obligation ........ 1,112 1,016 1,127 Expected return on plan assets ............................... (963) (1,092) (1,212) Net amortization: Actuarial loss (gain) ..................................... 68 (130) (144) Prior service cost ........................................ 29 15 16 ------------ ------------ ------------ Net pension costs ............................................ $ 1,165 $ 557 $ 617 ============ ============ ============ Weighted-average assumptions: Discount Rate ................................................ 7.5% 7.0% 8.0% Rates of increase in salary compensation level ............... 4.5% 4.0% 5.0% Expected long-term rate of return on plan assets ............. 7.5% 7.0% 8.0%
84 86 POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Chemicals and the Company provide certain health care benefits and life insurance benefits for retired employees. Substantially all employees become eligible for these benefits at normal retirement age. The cost of these benefits are accrued during the period in which the employee renders the necessary service. Health care benefits are provided to employees who retire with ten or more years of service, excluding Canadian employees covered by collective bargaining agreements. All employees are eligible for postretirement life insurance. Postretirement health care benefits for United States plans are non-contributory. Benefit provisions for most hourly and some salaried employees are subject to collective bargaining agreements. In general, the plans stipulate that retiree health care benefits are paid as covered expenses are incurred. The liability relating to United States employees allocated to the Company by Chemicals for the postretirement benefits other than pensions and included in Due from Affiliates was $0.4 million and $0.2 million at September 30, 1999 and 1998, respectively. The total postretirement benefits other than pensions expense for United States employees allocated to the Company was $0.1 million, $0.1 million, and $0.1 million for the years ended September 30, 1999, 1998, and 1997, respectively. Information for Canadian benefit plans concerning the plan obligation, the funded status, amounts recognized in the Company's financial statements, and underlying actuarial assumptions is stated below.
August 31, ---------------------------- 1999 1998 ------------ ------------ (Dollars in Thousands) Change in benefit obligation: Benefit obligation at beginning of year ....... $ 4,306 $ 3,831 Service cost .................................. 307 264 Interest cost ................................. 299 286 Actuarial loss (gain) ......................... -- (50) Benefits paid ................................. (26) (25) ------------ ------------ Benefit obligation at end of year ............. $ 4,886 $ 4,306 ============ ============ Development of net amount recognized: Funded status ................................. $ (4,886) $ (4,306) Unrecognized cost: Actuarial loss (gain) ...................... 637 669 Prior service cost ......................... -- -- ------------ ------------ Net amount recognized ......................... $ (4,249) $ (3,637) ============ ============
Net periodic plan costs for the Canadian postretirement benefit consist of the following components:
August 31, -------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ (Dollars in Thousands) Components of net plan costs: Service cost ............................. $ 307 $ 264 $ 208 Interest cost ............................ 299 286 202 Net amortization of actuarial loss .......... 32 -- -- ------------ ------------ ------------ Net plan costs ........................... $ 638 $ 550 $ 410 ============ ============ ============ Weighted-average assumptions: Discount rate ............................ 6.75% 7.5% 7.5%
The weighted average annual assumed health care trend rate is assumed to be 7.5% for 1999. The rate is assumed to decrease gradually to 5.8% in 2027 and remain level thereafter. Assumed health care cost trend rates 85 87 have a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care trend rates would have the following effects:
1% 1% Increase Decrease --------- --------- (Dollars in Thousands) Effect on total of service and interest cost components ......... $ 33 $ (29) Effect on post-retirement benefit obligation .................... 230 (200)
SAVINGS AND INVESTMENT PLAN Chemicals' Fifth Amended and Restated Savings and Investment Plan (the "Savings Plan") covers substantially all United States employees of the Company, including executive officers. The Savings Plan is qualified under Section 401(k) of the Internal Revenue Code (the "Code"). Each participant has the option to defer taxation of a portion of his or her earnings by directing the Company to contribute a percentage of such earnings to the Savings Plan. A participant may direct up to a maximum of 15% of eligible earnings to the Savings Plan, subject to certain limitations set forth in the Code for "highly compensated" participants. A participant's contributions become distributable upon the termination of his or her employment. The Company does not make any contributions to the Savings Plan. PROFIT SHARING PLANS In January 1997, the Board of Directors of Holdings, upon recommendation of its Compensation Committee, approved the establishment of a Profit Sharing Plan that is designed to benefit all qualified employees, and a Bonus Plan that will provide bonuses to exempt salaried employees depending on the annual financial performance of Holdings. No expenses for profit sharing or bonuses were incurred by Holdings or allocated to the Company in fiscal 1999, 1998, or 1997. PHANTOM STOCK PLAN The Company introduced a phantom stock plan to all eligible full-time Canadian employees. The effective date of the plan was August 21, 1996. At the end of each plan year, the plan administrator establishes a "determined percentage" for the preceding plan year. This percentage is then multiplied be each participant's compensation for the plan year to determine the award amount. The award amount is then divided be the fair market value of one share of the common stock of Holdings, as of December 31 of that plan year, to determine the number of rights to be credited to participants. Upon termination of employment, the benefit amount becomes payable to the participant. The benefit amount will be the number of vested rights in the participant's account, multiplied by the fair market value of one share of common stock of Holdings as of the most recent valuation date. The Company has recorded expense of $248,000, $238,000, and $346,000 related to the phantom stock plan for the years ended September 30, 1999, 1998, or 1997. 7. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company has entered into various long-term non-cancelable operating leases. Future minimum lease commitments at September 30, 1999 are as follows: fiscal 2000 - $4.4 million; fiscal 2001 - $4.1 million; fiscal 2002 - $4.1 million; fiscal 2003 - $3.9 million; fiscal 2004 - $3.7 million; and - $7.6 million thereafter. 86 88 ENVIRONMENTAL AND SAFETY MATTERS The Company's operations involve the handling, production, transportation, treatment, and disposal of materials that are classified as hazardous or toxic waste and that are extensively regulated by environmental and health and safety laws and regulations. Environmental permits required for the Company's operations are subject to periodic renewal and can be revoked or modified for cause or when new or revised environmental requirements are implemented. Changing and increasingly strict environmental requirements can affect the manufacturing, handling, processing, distribution, and use of the Company's products and, if so, the Company's business and operations may be materially and adversely affected. In addition, changes in affected environmental requirements can cause the Company to incur substantial costs in upgrading or redesigning its facilities and processes, including waste treatment, storage, disposal, and other waste handling practices and equipment. The Company conducts environmental management programs designed to maintain compliance with applicable environmental requirements at all of its facilities. The Company routinely conducts inspection and surveillance programs designed to detect and respond to leaks or spills of regulated hazardous substances and to correct identified regulatory deficiencies. The Company believes that its procedures for waste handling are consistent with industry standards and applicable requirements. In addition, the Company believes that its operations are consistent with good industry practice through participation in the Responsible Care initiatives as a part of membership in the Chemical Manufacturers Association in the United States and the Canadian Chemical Producers Association. However, a business risk inherent in chemical operations is the potential for personal injury and property damage claims from employees, contractors and their employees, and nearby landowners and occupants. While the Company believes that its business operations and facilities generally are operated in compliance in all material respects with applicable environmental and health and safety requirements, there can be no assurance that past practices and future operations will not result in material claims or regulatory action, require material environmental expenditures, or result in exposure or injury claims by employees, contractors and their employees, or the public. Some risk of environmental costs and liabilities is inherent in the operations and products of the Company, as it is with other companies engaged in similar businesses. In addition, a catastrophic event at any of the Company's facilities could result in liabilities to the Company substantially in excess of its insurance coverages. Any significant ban on all chlorine containing compounds could have a materially adverse effect on the Company's financial condition and results of operations. British Columbia has a regulation in place requiring elimination of the use of all chlorine products, including chlorine dioxide, in the bleaching process by the year 2002. Chlorine dioxide is produced from sodium chlorate, which is the Company's primary pulp chemical product. The pulp and paper industry believes that a ban of chlorine dioxide in the bleaching process will yield no measurable environmental or public health benefit and is working to change this regulation but there can be no assurance that the regulation will be changed. In the event such a regulation is implemented, the Company would seek to sell the products it manufactures at its British Columbia facility to customers in other markets. The Company is not aware of any other laws or regulations in place in North America which would restrict the use of such products for other purposes. LEGAL PROCEEDINGS The Company is subject to claims and legal actions that arise in the ordinary course of its business. The Company believes that the ultimate liability, if any, with respect to these claims and legal actions will not have a material adverse effect on the financial position or results of operations of the Company. PLEDGE OF COMMON STOCK In order to secure the repayment of indebtedness under the Fixed Assets Revolver, a first priority pledge of 100% of the common stock of each of the United States entities included in these financial statements was granted by the holders of such stock. In order to secure the repayment of the 12 3/8% Notes, a second priority pledge of 100% of the common stock of each of the United States entities included in these financial statements was granted by the holders of such stock. In addition, a first priority pledge of 65% of the common stock of each of the non-United States entities included in these financial statements was given by the holders of such stock. 87 89 8. FINANCIAL INSTRUMENTS FOREIGN EXCHANGE The Company may enter into forward foreign exchange contracts to hedge Canadian dollar currency transactions on a continuing basis for periods consistent with its committed exposures. The forward foreign exchange contracts have varying maturities with none exceeding 18 months. The Company makes net settlements of United States dollars for Canadian dollars at rates agreed to at inception of the contracts. The Company may also enter into forward foreign exchange contracts to reduce risk due to Canadian dollar exchange rate movements. The Company does not engage in currency speculation. The Company had a notional amount of approximately $6 million and $54 million of forward foreign exchange contracts outstanding to buy Canadian dollars at September 30, 1999 and 1998, respectively. The deferred loss on these forward foreign exchange contracts at September 30, 1999 and 1998 was $0.3 million and $4.7 million, respectively. The last of the Company's existing forward exchange contracts expires in March of 2000, and it does not currently intend to enter into any additional forward exchange contracts. CONCENTRATION OF RISK The Company sells its products primarily to companies involved in the pulp and paper manufacturing industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral for accounts receivable. However, letters of credit are required by the Company on many of its export sales. Historically, the Company's credit losses have been minimal. The Company maintains cash deposits with major banks, which from time to time may exceed federally insured limits. The Company periodically assesses the financial condition of these institutions and believes that the possibility of any loss is minimal. Approximately 36% of the Company's employees are covered by union agreements. Approximately 23% of the Company's employees are covered by union agreements which could expire within one year. INVESTMENTS Not more than $5 million may be invested by the Company with any single bank, financial institution, or United States corporation. It is the policy of the Company to invest its excess cash in investment instruments or securities whose value is not subject to market fluctuations, such as certificates of deposit, repurchase agreements, or Eurodollar deposits with domestic or foreign banks or other financial institutions. Other permitted investments include commercial paper of major United States corporations with ratings of A1 by Standard & Poor's Ratings Group or P1 by Moody's Investor Services, Inc., loan participations of major United States corporations with a short term credit rating of A1/P1, and direct obligations of the United States Government or its agencies. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reflected in the consolidated balance sheet for cash and cash equivalents, receivables, payables, and certain accrued expenses approximate fair value due to short maturities. Based on the Company's allocated portion of Chemicals' debt at September 30, 1999, the carrying value was $244.0 million and the fair value was $174.3 million. 88 90 INDEPENDENT AUDITORS' REPORT To the Stockholder of Sterling Canada, Inc. We have audited the accompanying consolidated balance sheets of Sterling Canada, Inc. (the "Company") as of September 30, 1999 and 1998, and the related consolidated statements of operations, changes in stockholder's equity, and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1999, in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Houston, Texas December 9, 1999 89 91 STERLING FIBERS, INC. STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------------- 1999 1998 1997 ---------- ---------- ---------- Revenues ............................................... $ 66,580 $ 99,424 $ 90,905 Cost of goods sold ..................................... 62,650 85,441 77,354 ---------- ---------- ---------- Gross profit ........................................... 3,930 13,983 13,551 Selling, general, and administrative expenses .......... 9,209 11,939 8,391 Interest and debt related expenses ..................... 9,070 7,556 5,710 ---------- ---------- ---------- Net loss before income taxes ........................... (14,349) (5,512) (550) Benefit for income taxes ............................... (4,018) (1,984) (176) ---------- ---------- ---------- Net loss ............................................... $ (10,331) $ (3,528) $ (374) ========== ========== ==========
The accompanying notes are an integral part of these financial statements. 90 92 STERLING FIBERS, INC. BALANCE SHEETS (DOLLARS IN THOUSANDS)
SEPTEMBER 30, ---------------------------- 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents ................................................... $ 735 $ 521 Accounts receivable ......................................................... 11,796 10,891 Inventories ................................................................. 22,919 24,666 Prepaid expenses ............................................................ 78 -- ------------ ------------ Total current assets ...................................................... 35,528 36,078 Property, plant, and equipment, net ............................................ 69,219 71,225 Other assets ................................................................... 2,582 2,110 ------------ ------------ Total assets .............................................................. $ 107,329 $ 109,413 ============ ============ LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIENCY IN ASSETS) Current liabilities: Accounts payable ............................................................ $ 8,912 $ 6,794 Accrued liabilities ......................................................... 5,870 3,524 Total current liabilities ................................................. 14,782 10,318 Long-term debt due to parent ................................................... 77,751 73,846 Due to affiliates .............................................................. 17,390 17,512 Deferred credits and other liabilities ......................................... 2,300 2,300 Commitments and contingencies (Note 7) ......................................... -- -- Stockholder's equity (deficiency in assets): Common stock ................................................................ -- -- Additional paid-in capital .................................................. 9,339 9,339 Accumulated deficit ......................................................... (14,233) (3,902) ------------ ------------ Total stockholder's equity (deficiency in assets) ......................... (4,894) 5,437 ------------ ------------ Total liabilities and stockholder's equity (deficiency in assets) ...... $ 107,329 $ 109,413 ============ ============
The accompanying notes are an integral part of these financial statements. 91 93 STERLING FIBERS, INC. STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (DEFICIENCY IN ASSETS) (DOLLARS IN THOUSANDS)
ADDITIONAL COMMON PAID-IN ACCUMULATED STOCK CAPITAL DEFICIT ---------- ---------- ----------- Balance, September 30, 1996 ................. $ -- $ -- $ -- Acquisition of acrylic fibers business ...... -- 9,339 -- Net loss .................................... -- -- (374) ---------- ---------- ---------- Balance, September 30, 1997 ................. -- 9,339 (374) Net loss .................................... -- -- (3,528) ---------- ---------- ---------- Balance, September 30, 1998 ................. -- 9,339 (3,902) Net loss .................................... -- -- (10,331) ---------- ---------- ---------- Balance, September 30, 1999 ................. $ -- $ 9,339 $ (14,233) ========== ========== ==========
The accompanying notes are an integral part of these financial statements. 92 94 STERLING FIBERS, INC. STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------------- 1999 1998 1997 ---------- ---------- ---------- Cash flows from operating activities: Net loss............................................................................. $ (10,331) $ (3,528) $ (374) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization .................................................... 5,793 5,431 3,303 Change in assets/liabilities: Accounts receivable .............................................................. (905) 8,740 2,756 Inventories ...................................................................... 1,747 1,641 (2,949) Prepaid expenses ................................................................. (192) (589) 790 Due to affiliates ................................................................ (122) 2,686 8,703 Other assets ..................................................................... (743) 227 711 Accounts payable ................................................................. 2,118 (5,201) (1,806) Accrued liabilities .............................................................. 2,460 (2,110) 358 Other liabilities ................................................................ -- -- (5,430) ---------- ---------- ---------- Net cash flows provided by (used in) operating activities ........................... (175) 7,297 6,062 ---------- ---------- ---------- Cash flows used in investing activities - Capital expenditures ............................................................. (3,516) (4,510) (5,174) ---------- ---------- ---------- Cash flows from financing activities - Net change in long-term debt due to Parent ....................................... 3,905 (2,570) (584) ---------- ---------- ---------- Net increase in cash and cash equivalents ........................................... 214 217 304 Cash and cash equivalents--beginning of year ........................................ 521 304 0 ---------- ---------- ---------- Cash and cash equivalents--end of year............................................... $ 735 $ 521 $ 304 ========== ========== ==========
The accompanying notes are an integral part of these financial statements. 93 95 STERLING FIBERS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS Sterling Fibers, Inc. (the "Company") manufactures acrylic fibers in a plant near Pensacola, Florida (the "Santa Rosa Plant"). The Company produces regular textiles, specialty textiles, and technical fibers at the Santa Rosa Plant. The Company is a wholly-owned subsidiary of Sterling Chemicals, Inc. ("Chemicals"), which is a wholly owned subsidiary of Sterling Chemicals Holdings, Inc. ("Holdings"). On January 31, 1997, the Company acquired its business, including the Santa Rosa plant and several associated marketing and research offices, from Cytec Industries Inc. and certain of its affiliates (collectively, "Cytec"). On the same day, Sterling Chemicals International, Inc., an affiliate of the Company, acquired all of Cytec's intellectual property related to this business. The Company recorded sales of approximately $91 million during the eight months of operations in fiscal 1997. The Company is one of two acrylic fibers manufacturers in the United States. Cytec supplies acrylonitrile to the Company through a five-year supply agreement ending in 2002. The acquisition was financed through borrowings under a new $81 million term loan bank facility by Chemicals, the issuance of $10 million (liquidation value) of Series A "pay in kind" preferred stock of Holdings ("Series A Preferred") to Cytec, and the sale of $10 million of Holdings' common stock in a private placement. At the acquisition date, $72 million of the bank was allocated to the Company as long-term debt due to Chemicals and amounts raised from the issuance of Holdings' common stock was recorded as contributed capital. Chemicals used the purchase method to account for the acquisition and operating results of the Company began on February 1, 1997. The following table presents the unaudited pro forma results of operations of the Company as if the Company had acquired its business from Cytec on October 1, 1996. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition been made at the beginning of fiscal 1997 or of results which may occur in the future (in thousands).
PRO FORMA TWELVE MONTHS ENDED SEPTEMBER 30, 1997 -------------- Revenues............................... $ 135,405 Net loss............................... $ (2,337)
Under SEC rules, specified information is required to be provided with respect to subsidiaries of an issuer of debt securities whose capital stock is pledged to secure the repayment of those debt securities. On July 23, 1999, Chemicals completed a private offering of $295,000,000 of its 12 3/8% Senior Secured Notes due 2006. On November 5, 1999, Chemicals completed a registered exchange offer, pursuant to which all of these 12 3/8% Notes were exchanged for publicly registered 12 3/8% Notes with substantially similar terms (the "12 3/8% Notes"). The 12 3/8% Notes are guaranteed by the Company and all of Chemicals' other existing direct and indirect subsidiaries incorporated in the United States (other than Sterling Chemicals Acquisitions, Inc.) on a joint and several basis and are secured by, among other things, a second priority pledge of 100% of the stock of these subsidiaries. In order to comply with these SEC rules, the financial statements and footnotes of Sterling Fibers, Inc. are presented. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies of the Company are described below. CASH EQUIVALENTS The Company considers all investments purchased with a remaining maturity of three months or less to be cash equivalents. 94 96 INVENTORIES Inventories are stated at the lower of cost or market. Cost is primarily determined on the first-in, first-out basis, except for stores and supplies, which are valued at average cost. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are recorded at cost. Major renewals and improvements, which extend the useful lives of the equipment, are capitalized. Major planned maintenance expenses are accrued for during the periods prior to the maintenance, while routine repair and maintenance expenses are charged to operations as incurred. Disposals are removed at carrying cost less accumulated depreciation with any resulting gain or loss reflected in operations. Depreciation is provided using the straight-line method over estimated useful lives ranging from 5 to 25 years with the predominant life of the plant and equipment being 15 years. IMPAIRMENT OF LONG-LIVED ASSETS Impairment tests of long-lived assets are made when conditions indicate their carrying cost may not be recoverable. Such impairment tests are based on a comparison of undiscounted future cash flows or the market value of similar assets to the carrying cost of the asset. If an impairment is indicated, the asset value is written down to its estimated fair value. INCOME TAXES The Company is included in the consolidated United States federal income tax return filed by Holdings. The Company's provision (benefit) for income taxes has been allocated by Holdings as if the Company filed its annual tax returns on a separate return basis. REVENUE RECOGNITION The Company generates revenues through sales in the open market and recognizes these revenues as the products are shipped. EARNINGS PER SHARE All issued and outstanding shares are held directly by Chemicals and, accordingly, earnings per share information is not presented. ENVIRONMENTAL COSTS Environmental costs are expensed unless the expenditures extend the economic useful life of the assets. Costs that extend the economic life of the assets are capitalized and depreciated over the remaining life of such assets. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the cost can be reasonably estimated. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS In preparing disclosures about the fair value of financial instruments, the Company has assumed that the carrying amount approximates fair value for cash and cash equivalents, receivables, accounts payable, and certain accrued expenses due to the short maturities of those instruments. The fair values of long-term debt instruments due to Chemicals are estimated based upon quoted market values (if applicable) of debt allocated to the Company by Chemicals or on the current interest rates available for debt with similar terms and remaining maturities. Considerable judgment is required in developing these estimates and, accordingly, no assurance can be given that the estimated values presented herein are indicative of the amounts that would be realized in a free market exchange. 95 97 ACCOUNTING ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Significant estimates include environmental reserves and taxes. Actual results could differ from these estimates. ALLOCATIONS The Company is wholly owned by Chemicals, which incurs certain direct and indirect expenses for the benefit and support of the Company. These services include, among others, tax planning, treasury, legal, risk management, and the maintenance of insurance coverage for the Company. Chemicals allocated $1.3 million, $1.6 million, and $1.0 million of such expenses to the Company in fiscal years 1999, 1998, and 1997, respectively, which are included in selling, general, and administrative expenses. Allocations are based on the Company's proportionate share of the respective amount and are determined primarily on revenue. In addition, the Company is dependent on Chemicals for financing. NEW ACCOUNTING STANDARDS Effective October 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which established standards for reporting and displaying of comprehensive income and its components. There were no differences between comprehensive loss and net loss for the Company for the years ended September 30, 1999, 1998, and 1997. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company is currently evaluating the accounting impact and disclosures that will be required when these statements are adopted in the first quarter of fiscal 2001. 3. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS:
SEPTEMBER 30, -------------------- 1999 1998 -------- -------- (Dollars in Thousands) Inventories: Finished products ......................... $ 15,000 $ 16,338 Raw materials ............................. 1,965 2,545 -------- -------- Inventories at cost ............................ 16,965 18,883 Stores and supplies ....................... 5,954 5,783 -------- -------- $ 22,919 $ 24,666 ======== ======== Property, plant, and equipment: Land ...................................... $ 1,343 $ 1,343 Buildings ................................. 7,878 7,800 Plant and equipment ....................... 66,491 65,070 Construction in progress .................. 7,287 5,296 -------- -------- Property, plant, and equipment at cost .... 82,999 79,509 Less: accumulated depreciation ............ (13,780) (8,284) -------- -------- $ 69,219 $ 71,225 ======== ======== Accrued liabilities: Accrued compensation ...................... $ 2,819 $ 1,890 Accrued property taxes .................... 569 652 Accrued insurance ......................... 945 982 Other ..................................... 1,537 -- -------- -------- $ 5,870 $ 3,524 ======== ========
96 98 4. LONG-TERM DEBT Chemicals incurred $81 million in bank debt to finance, in part, the acquisition of the acrylic fibers business from Cytec and allocated $77 million of this amount to the Company. Principal payments were allocated to the Company by Chemicals as scheduled principal payments were made on a basis consistent with the original allocation. Interest expense was allocated based on the terms of Chemicals' credit agreement. At September 30, 1999, interest rates ranged from 11.25% to 12.375% in connection with the refinancing of Chemicals' debt. Debt issue costs relating to long-term debt have been allocated to the Company by Chemicals on a basis consistent with long-term debt and are included in other assets. On July 23, 1999, Chemicals completed a private offering of $295,000,000 of its 12 3/8% Notes due 2006 which were subsequently exchanged for the 12 3/8% Notes. The 123/8% Notes are guaranteed by the Company and all of Chemicals' other existing direct and indirect subsidiaries incorporated in the United States (other than Sterling Chemicals Acquisitions, Inc.) on a joint and several basis. Each subsidiary's guarantee ranks equally in right of payment with all of such subsidiary's existing and future senior indebtedness and senior in right of payment to all existing and future subordinated indebtedness of such subsidiary. However, the 12 3/8% Notes and each subsidiary's guarantee are subordinated to the extent of the collateral securing Chemicals' new secured revolving credit facilities described below. The 12 3/8% Notes and the subsidiary guarantees are secured by (i) a second priority lien on all of Chemicals' and the subsidiary guarantors' United States production facilities and related assets, (ii) a second priority pledge of all of the capital stock of each subsidiary guarantor, and (iii) a first priority pledge of 65% of the stock of certain of the Chemicals' subsidiaries incorporated outside of the United States. The proceeds of the offering of the 12 3/8% Notes were used to fully repay and terminate Chemicals' then outstanding term loans. Upon consummation of the offering of the 12 3/8% Notes, the debt allocated to the Company by Chemicals increased to $77.8 million. In addition, on July 23, 1999, Chemicals established two new secured revolving credit facilities providing for up to $155,000,000 in revolving credit loans (the "New Revolvers") under a single Revolving Credit Agreement (the "New Credit Agreement"). Under the New Credit Agreement, Chemicals and most of its direct and indirect subsidiaries incorporated in the United States, including the Company, are co-borrowers and are jointly and severally liable for any indebtedness thereunder. The New Revolvers consist of (i) a $70,000,000 revolving credit facility (the "Fixed Assets Revolver") secured by a first priority lien on all United States production facilities and related assets of Chemicals and the other co-borrowers, all of the capital stock of Chemicals and the other co-borrowers and a second priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers, and (ii) an $85,000,000 revolving credit facility (the "Current Assets Revolver") secured by a first priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers. Funding under the 12 3/8% Notes and the New Revolvers occurred on July 23, 1999. The proceeds of the 12 3/8% Notes and the initial borrowings under the New Revolvers were used to completely repay all outstanding indebtedness under Chemicals then existing senior credit facilities. Approximately $54.6 million was drawn by Chemicals under the Fixed Assets Revolver at September 30, 1999, of which no amounts were allocated to the Company. Borrowings under the Fixed Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the "LIBOR Rate" (as defined in the New Credit Agreement) plus 3.75% or the "Alternate Base Rate" plus 2.25%. Borrowings under the Current Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the LIBOR Rate plus 3.00% or the "Alternate Base Rate" plus 1.50%. The "Alternate Base Rate" is equal to the greater of the "Base Rate" as announced from time to time by The Chase Manhattan Bank in New York, New York or the "Federal Funds Effective Rate" plus 1/2% (as defined in the New Credit Agreement). The New Credit Agreement also requires Chemicals and the other co-borrowers to pay an aggregate commitment fee ranging from 0.75% to 1.25% on the unused portion of the commitment for the Fixed Assets Revolver, depending on the amount drawn, and an aggregate commitment fee of 0.5% on the unused portion of the commitment for the Current Assets Revolver. Available credit under the Current Assets Revolver is subject to a monthly borrowing base consisting of 85% of eligible accounts receivable and 65% of eligible inventory with an inventory cap of $42,500,000. In addition, the borrowing base for the Current Assets Revolver must exceed outstanding borrowings thereunder by $12,000,000 at all times. 97 99 The Fixed Assets Revolver matures on July 23, 2004, with quarterly commitment reductions totaling 28% of the total commitment in year four and the balance in year five. The Current Assets Revolver matures on July 23, 2004, with no scheduled commitment reductions prior to that time. However, the commitments for each of the Fixed Assets Revolver and the Current Assets Revolver will be permanently reduced to the extent required under the New Credit Agreement upon prepayments made out of specific sources of funds, including certain equity issuances by Holdings and asset sales. 5. INCOME TAXES The Company is included in the consolidated federal tax return filed by Holdings. The Company's provision (benefit) for income taxes has been allocated as if the Company filed their annual federal tax returns on a separate return basis. As of September 30, 1999 and 1998, $1.2 million and $(2.8) million, respectively, of deferred income tax assets (liabilities) were included in "Due to Affiliates". For the years ended September 30, 1999, 1998, and 1997, the Company recorded $4.0 million, $2.0 million, and $0.2 million, respectively, of income tax benefit in its provision (benefit) for income taxes. 6. EMPLOYEE BENEFITS The Company's employees participate in various employee benefit plans of Chemicals. Costs, assets, and liabilities associated with employees participating in these various plans are allocated to the Company by Chemicals based on the number of employees. RETIREMENT BENEFIT PLANS Chemicals has non-contributory pension plans which cover all salaried and wage employees. The benefits under these plans are based primarily on years of service and employees' pay near retirement. Chemicals' funding policy is consistent with the funding requirements of federal law and regulations. Plan assets consist principally of government and corporate securities. The liability allocated to the Company by Chemicals for the retirement benefit plans and included in Due to Affiliates was $3.2 million and $2.2 million at September 30, 1999 and 1998, respectively. The total pension expense allocated to the Company was $1.0 million, $1.0 million, and $0.8 million for the years ended September 30, 1999, 1998, and 1997, respectively. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Chemicals and the Company provide certain health care benefits and life insurance benefits for retired employees. Substantially all employees become eligible for these benefits at normal retirement age. The cost of these benefits are accrued during the period in which the employee renders the necessary service. All employees are eligible for postretirement life insurance. Postretirement health care benefits are non-contributory. In general, the plans stipulate that retiree health care benefits are paid as covered expenses are incurred. The liability allocated to the Company by Chemicals for the postretirement benefits other than pensions and included in Due to Affiliates was $6.9 million and $7.0 million at September 30, 1999 and 1998, respectively. The total postretirement benefits other than pensions expense allocated to the Company was $0.7 million, $0.7 million, and $0.7 million for the years ended September 30, 1999, 1998, and 1997, respectively. In addition, a curtailment gain of $0.8 million was allocated during fiscal 1999 related to the reduction of postretirement life insurance benefits for currently active employees. SAVINGS AND INVESTMENT PLAN Chemicals' Fifth Amended and Restated Savings and Investment Plan (the "Savings Plan") covers substantially all employees of the Company, including executive officers. The Savings Plan is qualified under Section 401(k) of the Internal Revenue Code (the "Code"). Each participant has the option to defer taxation of a portion of his or her earnings by directing the Company to contribute a percentage of such earnings to the Savings Plan. A participant may direct up to a maximum of 15% of eligible earnings to the Savings Plan, subject to certain limitations set forth in the Code for "highly compensated" participants. A participant's contributions become distributable upon the termination of his or her employment. The Company does not make any contributions to the Savings Plan. 98 100 PROFIT SHARING AND BONUS PLANS In January 1997, the Board of Directors of Holdings, upon recommendation of its Compensation Committee, approved the establishment of a Profit Sharing Plan that is designed to benefit all qualified employees, and a Bonus Plan that will provide bonuses to exempt salaried employees depending on the annual financial performance of Holdings. No expenses for profit sharing or bonuses were incurred by Chemicals or allocated to the Company in fiscal 1999, 1998, or 1997. 7. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company has entered into various long-term non-cancelable operating leases. Future minimum lease commitments at September 30, 1999 are as follows: fiscal 2000 -- $0.1 million; fiscal 2001 -- $0.1 million; and thereafter $0. ENVIRONMENTAL AND SAFETY MATTERS The Company's operations involve the handling, production, transportation, treatment, and disposal of materials that are classified as hazardous or toxic waste and that are extensively regulated by environmental and health and safety laws and regulations. Environmental permits required for the Company's operations are subject to periodic renewal and can be revoked or modified for cause or when new or revised environmental requirements are implemented. Changing and increasingly strict environmental requirements can affect the manufacturing, handling, processing, distribution, and use of the Company's products and, if so, the Company's business and operations may be materially and adversely affected. In addition, changes in the affected environmental requirements can cause the Company to incur substantial costs in upgrading or redesigning its facilities and processes, including waste treatment, storage, disposal, and other waste handling practices and equipment. The Company conducts environmental management programs designed to maintain compliance with applicable environmental requirements at all of its facilities. The Company routinely conducts inspection and surveillance programs designed to detect and respond to leaks or spills of regulated hazardous substances and to correct identified regulatory deficiencies. The Company believes that its procedures for waste handling are consistent with industry standards and applicable requirements. In addition, the Company believes that its operations are consistent with good industry practice through participation in the Responsible Care initiatives as a part of membership in the Chemical Manufacturers Association. However, a business risk inherent in chemical operations is the potential for personal injury and property damage claims from employees, contractors and their employees, and nearby landowners and occupants. While the Company believes that its business operations and facilities generally are operated in compliance in all material respects with applicable environmental and health and safety requirements, there can be no assurance that past practices and future operations will not result in material claims or regulatory action, require material environmental expenditures, or result in exposure or injury claims by employees, contractors and their employees, or the public. Some risk of environmental costs and liabilities is inherent in the operations and products of the Company, as it is with other companies engaged in similar businesses. In addition, a catastrophic event at the Company's facility could result in liabilities to the Company substantially in excess of its insurance coverages. LEGAL PROCEEDINGS The Company is subject to claims and legal actions that arise in the ordinary course of its business. The Company believes that the ultimate liability, if any, with respect to these claims and legal actions will not have a material adverse effect on the financial position or results of operations of the Company. 99 101 PLEDGE OF COMMON STOCK In order to secure the repayment of indebtedness under the Fixed Assets Revolver, a first priority pledge of 100% of the common stock of the Company was granted by the holders of such stock. In order to secure the repayment of the 12 3/8% Notes, a second priority pledge of 100% of the common stock of the Company was granted by the holders of such stock. 8. FINANCIAL INSTRUMENTS CONCENTRATION OF RISK The Company sells its products primarily to companies involved in the textiles industry. The Company performs ongoing credit evaluations of its customers and generally does not require collateral for accounts receivable. However, letters of credit are required by the Company on many of its export sales. Historically, the Company's credit losses have been minimal. The Company maintains cash deposits with major banks, which from time to time may exceed federally insured limits. The Company periodically assesses the financial condition of these institutions and believes that the possibility of any loss is minimal. None of the Company's employees are covered by union agreements. INVESTMENTS Not more than $5 million may be invested by the Company with any single bank, financial institution, or United States corporation. It is the policy of the Company to invest its excess cash in investment instruments or securities whose value is not subject to market fluctuations, such as certificates of deposit, repurchase agreements, or Eurodollar deposits with domestic or foreign banks or other financial institutions. Other permitted investments include commercial paper of major United States corporations with ratings of A1 by Standard & Poor's Ratings Group or P1 by Moody's Investor Services, Inc., loan participations of major United States corporations with a short term credit rating of A1/P1, and direct obligations of the United States Government or its agencies. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reflected in the consolidated balance sheet for cash and cash equivalents, receivables, payables, and certain accrued expenses approximate fair value due to short maturities. Based on the Company's allocated portion of Chemicals' debt at September 30, 1999, the carrying value was $77.8 million and the fair value was $69.0 million. 100 102 INDEPENDENT AUDITORS' REPORT To the Stockholder of Sterling Fibers, Inc. We have audited the accompanying balance sheets of Sterling Fibers, Inc. (the "Company") as of September 30, 1999 and 1998, and the related statements of operations, changes in stockholder's equity (deficiency in assets), and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1999, in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Houston, Texas December 9, 1999 101 103 STERLING CHEMICALS ENERGY, INC. STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------- 1999 1998 1997 -------- -------- -------- Revenues .............................. $ 1,763 $ 1,894 $ 1,806 Cost of goods sold .................... 1,763 1,894 1,806 -------- -------- -------- Gross profit .......................... -- -- -- Interest and debt related expenses .... 2,866 2,708 2,622 -------- -------- -------- Loss before income taxes .............. (2,866) (2,708) (2,622) Benefit for income taxes .............. 803 976 840 Equity in earnings of joint venture ... 2,549 1,871 2,217 -------- -------- -------- Net income ............................ $ 486 $ 139 $ 435 ======== ======== ========
The accompanying notes are an integral part of these financial statements. 102 104 STERLING CHEMICALS ENERGY, INC. BALANCE SHEETS (DOLLARS IN THOUSANDS)
SEPTEMBER 30, ------------------- 1999 1998 -------- -------- ASSETS Current assets: Cash and cash equivalents .......................... $ -- $ -- Accounts receivable ................................ 101 179 -------- -------- Total current assets ............................. 101 179 Property, plant, and equipment, net ................... 4,815 5,568 Due from affiliates ................................... 24,721 23,937 Investment in joint venture ........................... 3,539 3,021 -------- -------- Total assets ..................................... $ 33,176 $ 32,705 ======== ======== LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities: Accounts payable ................................... $ 1,535 $ 1,550 -------- -------- Total current liabilities ........................ 1,535 1,550 Long-term debt due to parent .......................... 25,934 25,934 Commitments and contingencies (Note 6) ................ -- -- Stockholder's equity: Common stock ....................................... 1 1 Retained earnings .................................. 5,706 5,220 -------- -------- Total stockholder's equity ....................... 5,707 5,221 -------- -------- Total liabilities and stockholder's equity .... $ 33,176 $ 32,705 ======== ========
The accompanying notes are an integral part of these financial statements. 103 105 STERLING CHEMICALS ENERGY, INC. STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (DOLLARS IN THOUSANDS)
COMMON RETAINED STOCK EARNINGS -------- ---------- Balance, September 30, 1996.............. $ 1 $ 4,646 Net income............................ -- 435 -------- ---------- Balance, September 30, 1997.............. 1 5,081 Net income............................ -- 139 -------- ---------- Balance, September 30, 1998.............. 1 5,220 Net income............................ -- 486 -------- ---------- Balance, September 30, 1999.............. $ 1 $ 5,706 ======== ==========
The accompanying notes are an integral part of these financial statements. 104 106 STERLING CHEMICALS ENERGY, INC. STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, -------------------------------- 1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net income ............................................................... $ 486 $ 139 $ 435 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ......................................... 698 698 698 Undistributed earnings from joint venture ............................. (204) (668) (21) Change in assets/liabilities: Accounts receivable ................................................... 78 91 (99) Due from affiliates ................................................... (784) (119) (1,165) Other assets .......................................................... (259) 127 149 Accounts payable ...................................................... (15) (268) 3 -------- -------- -------- Net cash flows provided by operating activities .......................... -- -- -- -------- -------- -------- Net increase (decrease) in cash and cash equivalents ..................... -- -- -- Cash and cash equivalents--beginning of year ............................. -- -- -- -------- -------- -------- Cash and cash equivalents--end of year ................................... $ -- $ -- $ -- ======== ======== ========
The accompanying notes are an integral part of these financial statements. 105 107 STERLING CHEMICALS ENERGY, INC. NOTES TO FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS Sterling Chemicals Energy, Inc. (the "Company") owns and operates a turbo generator that produces electricity which is sold to the Company's parent, Sterling Chemicals, Inc. ("Chemicals"). The Company also owns a 50% general partnership interest in a joint venture cogeneration facility ("S&L Cogeneration Company") with Praxair Energy Resources, Inc. owning the other 50% interest. The cogeneration facility produces electricity and steam which is sold to Chemicals. The assets of the Company and S&L Cogeneration Company are located in Texas City, Texas on leased property adjacent to Chemicals' production facility. On July 23, 1999, Chemicals completed a private offering of $295,000,000 of its 12 3/8% Senior Secured Notes due 2006. On November 5, 1999, Chemicals completed a registered exchange offer, pursuant to which all of these 12 3/8% Notes were exchanged for publicly registered 12 3/8% Notes with substantially similar terms (the "12 3/8% Notes"). The 12 3/8% Notes are guaranteed by the Company and all of Chemicals' other existing direct and indirect subsidiaries incorporated in the United States (other than Sterling Chemicals Acquisitions, Inc.) on a joint and several basis and are secured by, among other things, a second priority pledge of 100% of the stock of these subsidiaries. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies of the Company are described below. INVESTMENT IN JOINT VENTURE The Company's investment in the cogeneration joint venture is accounted for under the equity method with the Company's share of operating results of the joint venture recorded in its Statement of Operations. CASH EQUIVALENTS The Company considers all investments purchased with a remaining maturity of three months or less to be cash equivalents. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment are recorded at cost. Major renewals and improvements, which extend the useful lives of the equipment, are capitalized. Depreciation is provided using the straight-line method over estimated useful lives with the predominant life of the plant and equipment being 15 years. INCOME TAXES The Company is included in the consolidated federal income tax return filed by Holdings. The Company's provision (benefit) for income taxes has been allocated by Holdings as if the Company filed its annual tax returns on a separate return basis. REVENUE RECOGNITION The Company recognizes revenues from sales of electricity and steam to Chemicals as they are delivered. EARNINGS PER SHARE All issued and outstanding shares of the Company are held directly by Chemicals and, accordingly, earnings per share information is not presented. 106 108 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS In preparing disclosures about the fair value of financial instruments, the Company has assumed that the carrying amount approximates fair value for receivables and accounts payable due to the short maturities of those instruments. The fair values of long-term debt instruments are estimated based upon quoted market values (if applicable) of the debt allocated to the Company by Chemicals or on the current interest rates available for debt with similar terms and remaining maturities. Considerable judgment is required in developing these estimates and, accordingly, no assurance can be given that the estimated values presented herein are indicative of the amounts that would be realized in a free market exchange. ACCOUNTING ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from these estimates. NEW ACCOUNTING STANDARDS Effective October 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which established standards for reporting and displaying of comprehensive income. There were no differences between comprehensive income and net income for the Company for the years ended September 30, 1999, 1998, and 1997. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities", establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company is currently evaluating the accounting impact and disclosures that will be required when these statements are adopted in the first quarter of fiscal 2001. 3. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
SEPTEMBER 30, ------------------------ 1999 1998 ---------- ---------- (Dollars in Thousands) Property, plant, and equipment: Plant and equipment at cost .................. $ 7,529 $ 7,252 Less: accumulated depreciation ............... (2,714) (1,684) ---------- ---------- $ 4,815 $ 5,568 ========== ==========
4. LONG-TERM DEBT In August 1996, in connection with a recapitalization transaction, Chemicals allocated $25.9 million of debt to the Company. Principal payments were allocated to the Company by Chemicals as scheduled principal payments were made on a basis consistent with the original allocation. In addition, the Company makes principal payments, from time to time, out of available cash. Interest expense is allocated based on the terms of Chemicals' debt agreements. At September 30, 1999, the weighted average interest rate on long-term debt was 11.7%. On July 23, 1999, Chemicals completed a private offering of $295,000,000 of its 12 3/8% Notes due 2006 which were subsequently exchanged for the 12 3/8% Notes. The 12 3/8% Notes are guaranteed by the Company and all of Chemicals' other existing direct and indirect subsidiaries incorporated in the United States (other than Sterling Chemicals Acquisitions, Inc.) on a joint and several basis. Each subsidiary's guarantee ranks equally in right of payment with all of such subsidiary's existing and future senior indebtedness and senior in right of payment to all existing and future subordinated indebtedness of such subsidiary. However, the 12 3/8% Notes and each subsidiary's guarantee are subordinated to the extent of the collateral securing Chemicals' new secured revolving credit facilities described below. The 12 3/8% Notes and the subsidiary guarantees are secured by (i) a second priority lien on all of Chemicals' and the subsidiary guarantors' United States production facilities and related assets, (ii) a second 107 109 priority pledge of all of the capital stock of each subsidiary guarantor, and (iii) a first priority pledge of 65% of the stock of certain of the Chemicals' subsidiaries incorporated outside of the United States. The proceeds of the offering of the 12 3/8% Notes were used to fully repay and terminate Chemicals' then outstanding term loans. In addition, on July 23, 1999, Chemicals established two new secured revolving credit facilities providing for up to $155,000,000 in revolving credit loans (the "New Revolvers") under a single Revolving Credit Agreement (the "New Credit Agreement"). Under the New Credit Agreement, Chemicals and most of its direct and indirect subsidiaries incorporated in the United States, including the Company, are co-borrowers and are jointly and severally liable for any indebtedness thereunder. The New Revolvers consist of (i) a $70,000,000 revolving credit facility (the "Fixed Assets Revolver") secured by a first priority lien on all United States production facilities and related assets of Chemicals and other co-borrowers, all of the capital stock of Chemicals and the other co-borrowers and a second priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers, and (ii) an $85,000,000 revolving credit facility (the "Current Assets Revolver") secured by a first priority lien on all accounts receivable, inventory, and other specified assets of Chemicals and the other co-borrowers. Funding under the 12 3/8% Notes and the New Revolvers occurred on July 23, 1999. The proceeds of the 12 3/8% Notes and the initial borrowings under the New Revolvers were used to completely repay all outstanding indebtedness under Chemicals then existing senior credit facilities. Approximately $54.6 million was drawn by Chemicals under the Fixed Assets Revolver at September 30, 1999, of which no amounts were allocated to the Company. Borrowings under the Fixed Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the "LIBOR Rate" (as defined in the New Credit Agreement) plus 3.75% or the "Alternate Base Rate" plus 2.25%. Borrowings under the Current Assets Revolver bear interest, at Chemicals' option, at an annual rate of either the LIBOR Rate plus 3.00% or the "Alternate Base Rate" plus 1.50%. The "Alternate Base Rate" is equal to the greater of the "Base Rate" as announced from time to time by The Chase Manhattan Bank in New York, New York or the "Federal Funds Effective Rate" plus 1/2% (as defined in the New Credit Agreement). The New Credit Agreement also requires Chemicals and the other co-borrowers to pay an aggregate commitment fee ranging from 0.75% to 1.25% on the unused portion of the commitment for the Fixed Assets Revolver, depending on the amount drawn, and an aggregate commitment fee of 0.5% on the unused portion of the commitment for the Current Assets Revolver. Available credit under the Current Assets Revolver is subject to a monthly borrowing base consisting of 85% of eligible accounts receivable and 65% of eligible inventory with an inventory cap of $42,500,000. In addition, the borrowing base for the Current Assets Revolver must exceed outstanding borrowings thereunder by $12,000,000 at all times. The Fixed Assets Revolver matures on July 23, 2004, with quarterly commitment reductions totaling 28% of the total commitment in year four and the balance in year five. The Current Assets Revolver matures on July 23, 2004, with no scheduled commitment reductions prior to that time. However, the commitments for each of the Fixed Assets Revolver and the Current Assets Revolver will be permanently reduced to the extent required under the New Credit Agreement upon prepayments made out of specific sources of funds, including certain equity issuances by Holdings and asset sales. 5. INCOME TAXES The Company is included in the consolidated federal tax return filed by Holdings. The Company's provision (benefit) for income taxes has been allocated as if the Company filed its annual federal tax returns on a separate return basis. As of September 30, 1999 and 1998, $ 2.6 million and $2.4 million, respectively, of deferred income tax liabilities were included in "Due from Affiliates". For the years ended September 30, 1999, 1998, and 1997, the Company recorded $0.1 million, $(0.1) million, and $0.2 million, respectively, of income tax provision (benefit). 108 110 6. COMMITMENTS AND CONTINGENCIES LEGAL PROCEEDINGS The Company is subject to claims and legal actions that arise in the ordinary course of its business. The Company believes that the ultimate liability, if any, with respect to these claims and legal actions will not have a material adverse effect on the financial position or results of operations of the Company. PLEDGE OF COMMON STOCK In order to secure the repayment of indebtedness under the Fixed Assets Revolver, a first priority pledge of 100% of the common stock of the Company was granted by the holders of such stock. In order to secure the repayment of the 12 3/8% Notes, a second priority pledge of 100% of the common stock of the Company was granted by the holders of such stock. 7. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reflected in the balance sheet for receivables and payables approximate fair value due to short maturities. Based on the Company's allocated portion of Chemicals' debt at September 30, 1999, the carrying value was $25.9 million and the fair value was $19.7 million. 8. INVESTMENT IN JOINT VENTURE The amounts included in the Company's financial statements for S&L Cogeneration Company represent amounts reported by S&L Cogeneration Company for periods end three months later. Accordingly, amounts included in the Company's financial statements represent the amounts reported by S&L Cogeneration Company for the twelve-month periods end December 31, 1999, 1998, and 1997. Summarized financial information reported by S&L Cogeneration Company for such periods is:
YEAR ENDED DECEMBER 31, ---------------------------------- 1999 1998 1997 ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Revenues........................................ $ 21,227 $ 20,016 $ 21,801 Net income...................................... 4,910 5,751 4,604
DECEMBER 31, ---------------------- 1999 1998 ---------- ---------- (DOLLARS IN THOUSANDS) Total assets $ 17,307 $ 18,504
109 111 INDEPENDENT AUDITORS' REPORT To the Stockholder of Sterling Chemicals Energy, Inc. We have audited the accompanying balance sheets of Sterling Chemicals Energy, Inc. (the "Company") as of September 30, 1999 and 1998, and the related statements of operations, changes in stockholder's equity, and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1999, in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP Houston, Texas December 9, 1999 (September 29, 2000 as to Note 8) 110 112 STERLING CHEMICALS HOLDINGS, INC. SUPPLEMENTAL FINANCIAL INFORMATION (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) QUARTERLY FINANCIAL DATA (UNAUDITED)
FISCAL FIRST SECOND THIRD FOURTH YEAR QUARTER QUARTER QUARTER QUARTER ------ --------- --------- --------- --------- Revenues 1999 $ 171,929 $ 152,472 $ 181,729 $ 214,622 1998 230,236 204,504 205,414 182,436 Gross Profit 1999 16,717 4,312 12,198 4,931 1998 19,299 11,359 22,528 24,081 Loss before extraordinary item(1) 1999 (13,100) (24,820) (16,415) (51,482) 1998 (10,145) (16,288) (13,118) (6,568) Net loss(1) 1999 (13,100) (24,820) (16,415) (55,694) 1998 (10,145) (16,288) (13,118) (6,568) Per Share Data: Loss before extraordinary item 1999 $ (1.11) $ (1.96) $ (1.37) $ (4.15) 1998 (0.91) (1.37) (1.13) (0.60) Net loss attributable to common stockholders 1999 (1.11) (1.96) (1.37) (4.49) 1998 (0.91) (1.37) (1.13) (0.60)
(1) During the first and third quarters of fiscal 1999, the Company recorded $2.3 million and $1.7 million, respectively, of expense related to workforce reductions in the petrochemicals and pulp chemicals businesses. In addition, during the second quarter of fiscal 1999, the Company recorded a one-time non-cash pretax charge of $6.8 million related to early retirement programs and benefit changes. During the fourth quarter of fiscal 1999, the Company recorded a $4.2 million after-tax ($6.5 million pre-tax) extraordinary item related to unamortized debt issue costs as a result of the prepayment of certain term loans. The Company also recorded non-cash expense related to the impairment of its methanol production assets of $26.4 million in the fourth quarter of fiscal 1999. During the second and third quarters of fiscal 1998, the Company recorded $3.0 million and $3.0 million, respectively, of expense related to voluntary severance programs offered by the Company at the Company's Texas City plant. 111 113 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized. STERLING CHEMICALS HOLDINGS, INC. STERLING CHEMICALS, INC. (Registrants) Date: November 22, 2000 /s/ FRANK P. DIASSI ---------------------------------------- Frank P. Diassi Chairman of the Board of Directors (Principal Executive Officer) Date: November 22, 2000 /s/ GARY M. SPITZ ---------------------------------------- Gary M. Spitz Executive Vice President-Finance and Chief Financial Officer (Principal Financial Officer) 114 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 23.1 Consent of Independent Auditors
EX-23.1 2 h82182aex23-1.txt CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-30917 of Sterling Chemicals Holdings, Inc. on Form S-3 and Registration Statement No. 333-52795 of Sterling Chemicals Holdings, Inc. on Form S-8 of our report dated December 9, 1999 appearing in this Annual Report on Form 10-K/A of Sterling Chemicals Holdings, Inc. for the year ended September 30, 1999. DELOITTE & TOUCHE LLP Houston, Texas November 21, 2000 -----END PRIVACY-ENHANCED MESSAGE-----