**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **ý**                                              |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|---------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
|                                                    |   |                                                                                                |
| **For the quarterly period ended  March 31, 2004** |
|                                                    |   |                                                                                                |
| **or**                                                  |
|                                                    |
| **o**                                                   |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**Commission filenumber    33-109686**

 

**Rockwood Specialties Group, Inc.**

(Exact name of Registrant as specified in itscharter)

 
| **Delaware**                                                    |   | **52-2277390**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**100 Overlook Center, Princeton, New Jersey08540**

(Address of principal executive offices) (ZipCode)

 

**(609)-514-0300**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.    ýYes  oNo

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Act).   o Yes  ý No

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

As of May 14, 2004, there were outstanding 382,000 shares ofcommon stock, par value $0.01 per share, of the Registrant.

 

 

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**TABLE OF CONTENTS**

**FORM 10-Q**

 
| PART I-  FINANCIAL INFORMATION |                                                                                                     |
|--------------------------------|----------------------------------------------------------------------------------------------------------|
| Item 1                         | Financial Statements (Unaudited)                                                                         |   |
|                           | Condensed Consolidated Statements of  Operations for the three months ended March 31, 2004 and 2003 |   |
|                           | Condensed Consolidated Balance Sheets as of  March 31, 2004 and December 31, 2003              |   |
|                           | Condensed Consolidated Statements of Cash  Flows for the three months ended March 31, 2004 and 2003 |   |
|                           | Notes to Condensed Consolidated Financial  Statements                                                    |   |
| Item 2                         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations              |   |
| Item 3                         | Quantitative  and Qualitative Disclosures about Market Risk                                              |   |
| Item 4                         | Controls  and Procedures                                                                                 |   |
| PART  II- OTHER INFORMATION    |                                                                                                     |
| Item 1                         | Legal Proceedings                                                                                        |   |
| Item  2                        | Changes  in Securities and Use of Proceeds                                                               |   |
| Item 3                         | Defaults Upon Senior Securities                                                                          |   |
| Item 4                         | Submission of Matters to a Vote of Security  Holders                                                     |   |
| Item 5                         | Other Information                                                                                        |   |
| Item 6                         | Exhibits and Reports on Form 8-K                                                                         |   |
|                           |                                                                                                     |   |
|                           | Signatures                                                                                               |   |

 

2

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## **PART I** – FINANCIAL INFORMATION

## ** **

**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Dollars in thousands)**

**(Unaudited)**

 
|                                          |   | **Three  months ended March 31,** |    |
|-----------------------------------------------|--------|----------------------------------------|---------|
|                                          |   | **2004**                               |    | **2003** | ** ** |
| NET SALES                                     |   | $                                      | 227,370 |   | $ | 180,155 |   |
| COST OF PRODUCTS SOLD                         |   | 164,982                                |    | 134,108 |   |
| GROSS PROFIT                                  |   | 62,388                                 |    | 46,047 |   |
|                                          |   |                                   |    |   |   |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |   | 35,179                                 |    | 30,372 |   |
| RESTRUCTURING CHARGE, net                     |   | —                                 |    | 295 |   |
| OPERATING INCOME                              |   | 27,209                                 |    | 15,380 |   |
| OTHER INCOME (EXPENSES):                      |   |                                   |    |   |   |
| Interest, net                                 |   | (16,646                                | )       | (20,773 | ) |
| Foreign exchange gain (loss), net             |   | 12,257                                 |    | (13,572 | ) |
| Net                                           |   | (4,389                                 | )       | (34,345 | ) |
| INCOME (LOSS) BEFORE TAXES                    |   | 22,820                                 |    | (18,965 | ) |
| INCOME TAX PROVISION (BENEFIT)                |   | 7,808                                  |    | (5,690 | ) |
| NET INCOME (LOSS)                             |   | $                                      | 15,012  |   | $ | (13,275 | ) |

 

See accompanying notes to condensedconsolidated financial statements.

 

3

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Dollars in thousands, except per shareamounts)**

**(Unaudited)**

 
|                                                                                               |   | **March 31,  2004** |      | **December 31,  2003** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------------------|-----------|-----------------------------|--------|
|                                                                                               |   |                     |      |                        |   |
| **ASSETS**                                                                                         |   |                     |      |                        |   |
| CURRENT ASSETS:                                                                                    |   |                     |      |                        |   |
| Cash and cash equivalents                                                                          |   | $                        | 32,350    |                        | $      | 42,697 |   |
| Accounts receivable, net                                                                           |   | 161,674                  |      | 138,277                     |   |
| Inventories                                                                                        |   | 92,463                   |      | 87,779                      |   |
| Deferred income taxes                                                                              |   | 2,821                    |      | 2,788                       |   |
| Prepaid expenses and other                                                                         |   | 15,160                   |      | 12,514                      |   |
| Total current assets                                                                               |   | 304,468                  |      | 284,055                     |   |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                 |   | 414,014                  |      | 418,629                     |   |
| GOODWILL                                                                                           |   | 687,162                  |      | 683,888                     |   |
| OTHER INTANGIBLE ASSETS, net                                                                       |   | 23,593                   |      | 25,672                      |   |
| DEFERRED DEBT ISSUANCE COSTS                                                                       |   | 13,637                   |      | 14,085                      |   |
| OTHER ASSETS                                                                                       |   | 7,106                    |      | 6,679                       |   |
| TOTAL ASSETS                                                                                       |   | $                        | 1,449,980 |                        | $      | 1,433,008 |   |
|                                                                                               |   |                     |      |                        |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                     |   |                     |      |                        |   |
| CURRENT LIABILITIES:                                                                               |   |                     |      |                        |   |
| Accounts payable                                                                                   |   | $                        | 97,623    |                        | $      | 98,596 |   |
| Income taxes payable                                                                               |   | 14,636                   |      | 12,006                      |   |
| Accrued expenses and other current  liabilities                                                    |   | 62,793                   |      | 51,214                      |   |
| Long-term debt, current portion                                                                    |   | 11,579                   |      | 9,027                       |   |
| Total current liabilities                                                                          |   | 186,631                  |      | 170,843                     |   |
| LONG-TERM DEBT                                                                                     |   | 812,626                  |      | 823,928                     |   |
| DEFERRED INCOME TAXES                                                                              |   | 10,655                   |      | 7,299                       |   |
| OTHER LIABILITIES                                                                                  |   | 76,138                   |      | 77,295                      |   |
| Total liabilities                                                                                  |   | 1,086,050                |      | 1,079,365                   |   |
| STOCKHOLDERS’ EQUITY:                                                                         |   |                     |      |                        |   |
| Common stock ($.01 par value, 1,000,000  shares authorized; 382,000 shares issued and outstanding) |   | 4                        |      | 4                           |   |
| Paid-in capital                                                                                    |   | 467,749                  |      | 468,365                     |   |
| Accumulated other comprehensive income                                                             |   | 82,278                   |      | 86,387                      |   |
| Accumulated deficit                                                                                |   | (186,101                 | )         | (201,113                    | )      |
| Total stockholders’ equity                                                                    |   | 363,930                  |      | 353,643                     |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                    |   | $                        | 1,449,980 |                        | $      | 1,433,008 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

4

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
|                                                                                                          |   | **For the  Three Months ended  March 31,** |   |
|---------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                                                          |   | **2004**                                        |   | **2003** |   |
|                                                                                                          |   |                                            |   |   |   |
| **CASH FLOWS FROM  OPERATING ACTIVITIES:**                                                                    |   |                                            |   |   |   |
| Net income (loss)                                                                                             |   | $                                               | 15,012 |   | $ | (13,275 | ) |
|  Adjustments to reconcile net income (loss) to net cash provided  by (used in) operating activities:     |   |                                            |   |   |   |
| Depreciation and amortization                                                                                 |   | 13,787                                          |   | 12,062 |   |
| Deferred financing costs amortization                                                                         |   | 469                                             |   | 1,538 |   |
| Foreign exchange gain (loss)                                                                                  |   | (12,257                                         | )      | 13,554 |   |
| Fair value adjustment of derivatives                                                                          |   | (2,272                                          | )      | 1,026 |   |
| Bad debt provision                                                                                            |   | 664                                             |   | (202 | ) |
| Deferred income taxes                                                                                         |   | 3,786                                           |   | — |   |
|  Changes in assets and liabilities, net of the effect of foreign  currency translation and acquisitions: |   |                                            |   |   |   |
| Accounts receivable                                                                                           |   | (23,700                                         | )      | (19,659 | ) |
| Inventories                                                                                                   |   | (4,702                                          | )      | (3,183 | ) |
| Prepaid expenses and other assets                                                                             |   | (3,130                                          | )      | (2,589 | ) |
| Accounts payable                                                                                              |   | (920                                            | )      | 917 |   |
| Income taxes payable                                                                                          |   | 2,794                                           |   | (5,690 | ) |
| Accrued expenses and other liabilities                                                                        |   | 11,802                                          |   | (10,316 | ) |
| Net cash provided by (used in) operating activities                                                           |   | 1,333                                           |   | (25,817 | ) |
| **CASH FLOWS FROM  INVESTING ACTIVITIES:**                                                                    |   |                                            |   |   |   |
| Acquisitions, net of cash acquired                                                                            |   | —                                          |   | (11,961 | ) |
| Capital expenditures                                                                                          |   | (6,741                                          | )      | (7,488 | ) |
| Proceeds on sale of property, plant and  equipment                                                            |   | 33                                              |   | 195 |   |
| Insurance proceeds from fire damage, net                                                                      |   | —                                          |   | 3,257 |   |
| Net cash used in investing activities                                                                         |   | (6,708                                          | )      | (15,997 | ) |
| **CASH FLOWS FROM  FINANCING ACTIVITIES:**                                                                    |   |                                            |   |   |   |
| Payments on long-term debt                                                                                    |   | (4,527                                          | )      | — |   |
| Proceeds from long-term debt                                                                                  |   | —                                          |   | 20,000 |   |
| Net cash (used in) provided by financing  activities                                                          |   | (4,527                                          | )      | 20,000 |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                       |   | (445                                            | )      | 3,242 |   |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                                                                     |   | (10,347                                         | )      | (18,572 | ) |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD                                                               |   | 42,697                                          |   | 42,896 |   |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                      |   | $                                               | 32,350 |   | $ | 24,324 |   |
|                                                                                                          |   |                                            |   |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                                                           |   |                                            |   |   |   |
| Interest paid, net                                                                                            |   | $                                               | 8,006  |   | $ | 18,337 |   |
| Income taxes paid, net of refunds                                                                             |   | $                                               | 1,170  |   | $ | 542 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

5

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**Notes To Condensed Consolidated Financial****Statements (Unaudited)**

**(Dollars and euros in thousands, except pershare amounts)**

 

**1.****                                      DESCRIPTIONOF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:**

 

***BusinessDescription, Background and Basis of Presentation***—RockwoodSpecialties Group, Inc. and Subsidiaries (“Rockwood” or the “Company”) isa worldwide manufacturer and distributor of specialty chemicals and performancematerials used for industrial and commercial purposes.

 

The Company is an indirect wholly-owned subsidiary ofRockwood Holdings, Inc., (“Holdings”), an entity controlled by Kohlberg,Kravis Roberts & Co. L.P. (“KKR”) through an acquisition of certainassets, stock and businesses from Laporte plc (the “Seller”) onNovember 20, 2000. The cost of the acquisition (the “Acquisition”), alongwith related fees and expenses, was financed using aggregate proceeds of$1,227,000 consisting of $382,000 in equity contributed by entities controlledby KKR and $845,000 of borrowings under a Credit Agreement, datedNovember 20, 2000 (the “Credit Agreement”), with certain lendinginstitutions (the “Lenders). The borrowings under this Credit Agreement wererefinanced in July 2003. KKR provides consulting and management advisoryservices to us for an annual fee of $600.

 

The accompanying condensed consolidated balance sheets of Rockwood andthe related condensed consolidated statements of operations and cash flows arepresented on a consolidated basis. All significant intercompany accounts andtransactions have been eliminated.

 

The interim financial statements included herein are unaudited. Thecondensed consolidated financial statements are presented based upon accountingprinciples generally accepted in the United States of America (“US GAAP”),except that certain information and footnote disclosures, normally included infinancial statements prepared in accordance with US GAAP, have been condensed oromitted. The accompanying consolidated financial statements should be read inconjunction with the consolidated financial statements and the notes theretocontained in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2003 (the “2003 10-K”). Management believes the disclosuresherein are adequate and the financial statements reflect adjustments consistingonly of normal recurring adjustments necessary to present fairly the financialposition of the Company as of March 31, 2004 and December 31, 2003and the results of its operations and its cash flows for the quarters endedMarch 31, 2004 and 2003. The results of operations for the interim periodsare not necessarily indicative of the results of operations for the full year.

 

***Revenue Recognition***—TheCompany recognizes revenue when the earnings process is complete. Thisgenerally occurs when products are shipped to the customer in accordance withthe terms of the contract of sale, title and risk of loss have beentransferred, collectibility is reasonably assured, and pricing is fixed ordeterminable. Accruals are made for sales returns and other allowances based onthe Company’s experience.

 

***Stock-BasedCompensation***—The Company accounts for its Amendedand Restated 2003 Stock Purchase and Option Plan (the “Plan”) under therecognition and measurement principles of APB Opinion 25, *Accounting for Stock Issued to Employees*,and related Interpretations. No stock-based employee compensation is reflectedin net income (loss) for this Plan, as all options granted had an exerciseprice at least equal to the market value of the underlying common stock on thedate of the grant. The following table illustrates the effect on net income(loss) if the Company had applied the fair value recognition provisions ofSFAS 123, *Accounting for Stock-BasedCompensation*, to stock-based employee compensation.

 
|                                                                                            |   | **Three  months ended  March 31,** |   |
|-------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                            |   | **2004**                                |   | **2003** |   |
| Net income (loss), as reported                                                                  |   | $                                       | 15,012 |   | $ | (13,275 | ) |
| Stock-based employee compensation expense  determined under fair value based method, net of tax |   | (116                                    | )      | (105 | ) |
| Pro forma net income (loss)                                                                     |   | $                                       | 14,896 |   | $ | (13,380 | ) |

 

6

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***Comprehensive income(loss)***—Comprehensive income (loss) includes netincome (loss) and other comprehensive income (loss), summarized as follows:

 
|                         |   | **Three  months ended  March 31,** |   |
|------------------------------|--------|-----------------------------------------|--------|
|                         |   | **2004**                                |   | **2003** |   |
| Net income (loss)            |   | $                                       | 15,012 |   | $ | (13,275 | ) |
| Foreign currency translation |   | (4,109                                  | )      | 7,947 |   |
| Comprehensive income (loss)  |   | $                                       | 10,903 |   | $ | (5,328 | ) |

 

***Reclassifications***—Certainprior year amounts have been reclassified to conform to current yearclassification.

 

***Recent AccountingPronouncements***—No new accounting pronouncementshave been adopted nor issued during 2004 that would have a significant impacton the Company’s financial position, results of operations or cash flows.

 

**2.****                                      SEGMENTINFORMATION:**

 

Rockwood operates in three reportable segments according to the natureand economic characteristics of its products and services as well as the mannerin which the information is used internally by its key decision makers. Thethree segments, each of which includes various business lines, are:(1) Performance Additives, which consists of pigments, timber treatmentchemicals, clay-based additives and water treatment chemicals;(2) Specialty Compounds, which consists of plastic compounds; and(3) Electronics, which consists of electronic chemicals, wafer reclaim andphotomasks.

 

The accounting policies of the segments are the same as those describedin Note 1.

 

Summarized financial information for each of the reportable segments isprovided in the following table.

 
|                                        |   | **Performance  Additives** |    | **Specialty  Compounds** |   | **Electronics** |   | **Corporate  and  Eliminations** |   | **Consolidated** |   |
|---------------------------------------------|--------|----------------------------|---------|--------------------------|--------|-----------------|--------|----------------------------------|--------|------------------|--------|
| **Three Months Ended March 31, 2004**  |   |                       |    |                     |   |            |   |                             |   |             |   |
| Net sales                                   |   | $                          | 139,078 |                     | $      | 47,880          |   | $                                | 40,412 |             | $      | — |   | $ | 227,370 |   |
| Operating income (loss)                     |   | 24,946                     |    | 5,400                    |   | 1,590           |   | (4,727                           | )      | 27,209           |   |
| Adjusted EBITDA                             |   | 32,054                     |    | 6,776                    |   | 6,640           |   | (4,390                           | )      | 41,080           |   |
|                                        |   |                       |    |                     |   |            |   |                             |   |             |   |
| **Three Months Ended  March 31, 2003** |   |                       |    |                     |   |            |   |                             |   |             |   |
| Net sales                                   |   | $                          | 100,775 |                     | $      | 43,990          |   | $                                | 35,390 |             | $      | — |   | $ | 180,155 |   |
| Operating income (loss)                     |   | 13,004                     |    | 4,787                    |   | 1,962           |   | (4,373                           | )      | 15,380           |   |
| Adjusted EBITDA                             |   | 19,550                     |    | 6,023                    |   | 6,195           |   | (3,427                           | )      | 28,341           |   |

 

The summary of segment information above includes “Adjusted EBITDA”, afinancial measure used by senior management to evaluate the operatingperformance of each segment. We define Adjusted EBITDA as operating incomeexcluding depreciation and amortization, certain non-cash gains and charges,certain non-recurring gains and charges and certain items deemed by our seniormanagement to have little or no bearing on the day-to-day operating performanceof our business segments and reporting units. In addition, management uses Adjusted EBITDA as the most significantcriterion in the calculation of performance-based cash bonuses.

 

7

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Below is segment information reconciling net income (loss) to AdjustedEBITDA: 

 
|                                        |   | **Performance  Additives** |   | **Specialty  Compounds** |   | **Electronics** |   | **Corporate  and  Eliminations** |   | **Consolidated** |   |
|---------------------------------------------|--------|----------------------------|--------|--------------------------|--------|-----------------|--------|----------------------------------|--------|------------------|--------|
| **Three Months Ended March 31, 2004**  |   |                       |   |                     |   |            |   |                             |   |             |   |
| Net income                                  |   | $                          | 10,351 |                     | $      | 3,734           |   | $                                | 671    |             | $      | 256 |   | $ | 15,012 |   |
| Income tax (benefit) provision              |   | 8,429                      |   | 1,725                    |   | 1,220           |   | (3,566                           | )      | 7,808            |   |
| Interest expense, net                       |   | 7,560                      |   | (59                      | )      | 1,518           |   | 7,627                            |   | 16,646           |   |
| Depreciation and amortization               |   | 7,108                      |   | 1,376                    |   | 5,050           |   | 253                              |   | 13,787           |   |
| Systems/organization establishment expenses |   | —                     |   | —                   |   | —          |   | 84                               |   | 84               |   |
| Foreign exchange loss (gain)                |   | (1,394                     | )      | —                   |   | (1,819          | )      | (9,044                           | )      | (12,257          | )      |
| Total Adjusted EBITDA                       |   | $                          | 32,054 |                     | $      | 6,776           |   | $                                | 6,640  |             | $      | (4,390 | ) | $ | 41,080 |   |
|                                        |   |                       |   |                     |   |            |   |                             |   |             |   |
| **Three Months Ended  March 31, 2003** |   |                       |   |                     |   |            |   |                             |   |             |   |
| Net income (loss)                           |   | $                          | 4,043  |                     | $      | 3,470           |   | $                                | 159    |             | $      | (20,947 | ) | $ | (13,275 | ) |
| Income tax (benefit) provision              |   | 1,733                      |   | 1,487                    |   | 68              |   | (8,978                           | )      | (5,690           | )      |
| Interest expense, net                       |   | 7,220                      |   | (73                      | )      | 1,626           |   | 12,000                           |   | 20,773           |   |
| Depreciation and amortization               |   | 6,223                      |   | 1,220                    |   | 4,099           |   | 520                              |   | 12,062           |   |
| Restructuring and related charges           |   | 180                        |   | 16                       |   | 99              |   | —                           |   | 295              |   |
| Systems/organization establishment expenses |   | —                     |   | —                   |   | —          |   | 372                              |   | 372              |   |
| Acquisition and disposal costs              |   | —                     |   | —                   |   | 35              |   | 54                               |   | 89               |   |
| Inventory write-up reversal                 |   | 143                        |   | —                   |   | —          |   | —                           |   | 143              |   |
| Foreign exchange loss (gain)                |   | 8                          |   | (97                      | )      | 109             |   | 13,552                           |   | 13,572           |   |
| Total Adjusted EBITDA                       |   | $                          | 19,550 |                     | $      | 6,023           |   | $                                | 6,195  |             | $      | (3,427 | ) | $ | 28,341 |   |

 

A significant component of Adjusted EBITDA is foreignexchange (gain) loss.  The Company hasrecorded foreign exchange (gains) and losses reflecting the non-cash impact ofremeasuring its euro-denominated debt. Such (gains) losses resulted from the strengthening (weakening) euroagainst the U.S. dollar during the applicable periods.

 

**3.****                                      INVENTORIES:**

 

Inventories are comprised of the following:

 
|                |   | **March 31,  2004** |   | **December 31,  2003** |   |
|---------------------|--------|--------------------------|--------|-----------------------------|--------|
| Raw materials       |   | $                        | 30,237 |                        | $      | 26,821 |   |
| Work-in-process     |   | 3,045                    |   | 3,203                       |   |
| Finished goods      |   | 51,033                   |   | 49,967                      |   |
| Packaging materials |   | 8,148                    |   | 7,788                       |   |
|                |   | $                        | 92,463 |                        | $      | 87,779 |   |

 

**4.****                                      GOODWILL:**

 

Below are goodwill balances and activity by segment:

 
|                            |   | **Performance  Additives** |    | **Specialty  Compounds** |   | **Electronics** |   | **Total** |    |
|---------------------------------|--------|----------------------------|---------|--------------------------|--------|-----------------|--------|-----------|---------|
| Balance, December 31, 2003 |   | $                          | 450,923 |                     | $      | 110,302         |   | $         | 122,663 |   | $ | 683,888 |   |
| Foreign exchange                |   | 466                        |    | 565                      |   | 2,088           |   | 3,119     |    |
| Other                           |   | 7                          |    | —                   |   | 148             |   | 155       |    |
| Balance, March 31, 2004    |   | $                          | 451,396 |                     | $      | 110,867         |   | $         | 124,899 |   | $ | 687,162 |   |

 

8

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**5.****                                      OTHERINTANGIBLE ASSETS:**

 

Other intangible assets, net consist of:

 
|                                     |   | **March 31,  2004** |   | **December 31,  2003** |   |
|------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Patents                                  |   | $                        | 40,548 |                        | $      | 41,388 |   |
| Less accumulated amortization            |   | (18,630                  | )      | (17,571                     | )      |
| Patents, net                             |   | 21,918                   |   | 23,817                      |   |
| Internally developed software costs      |   | 2,122                    |   | 2,083                       |   |
| Less accumulated amortization            |   | (1,005                   | )      | (870                        | )      |
| Internally developed software costs, net |   | 1,117                    |   | 1,213                       |   |
| Other, net                               |   | 558                      |   | 642                         |   |
| Other intangible assets, net             |   | $                        | 23,593 |                        | $      | 25,672 |   |

 

Amortization of other intangible assets was $1,646 and $1,396 for thethree months ended March 31, 2004 and 2003, respectively.

 

**6.****                                      EMPLOYEEBENEFIT PLANS:**

 

The following represents the net periodic pension benefit costs andrelated components in accordance with SFAS 132:

 
|                                        |   | **Three  Months ended March 31,** |   |
|---------------------------------------------|--------|----------------------------------------|--------|
|                                        |   | **2004**                               |   | **2003** |   |
|                                        |   |                                   |   |   |   |
| Service cost                                |   | $                                      | 318    |   | $ | 285 |   |
| Interest cost                               |   | 645                                    |   | 494 |   |
| Expected return on plan assets              |   | (473                                   | )      | (377 | ) |
| Net amortization of prior experience losses |   | 150                                    |   | 59 |   |
| Net periodic benefit cost                   |   | $                                      | 640    |   | $ | 461 |   |

 

**7.****                                      CONTINGENCIES:**

 

The Company is involved in various legal proceedings, including productliability and environmental matters of a nature considered normal to itsbusiness. It is the Company’s policy to accrue for amounts related to thesematters, in accordance with SFAS 5, *Accountingfor Contingencies*, if it is probable that a liability has beenincurred and an amount can be reasonably estimated. It is the Company’s policyto disclose such matters when there is at least a reasonable possibility that amaterial loss may have been incurred.

 

The Seller is obligated to indemnify the Company for certain legal, taxand environmental liabilities and obligations that relate to the period priorto the closing of the Acquisition. In the opinion of management, and based uponinformation currently available, the ultimate resolution of any indemnificationclaims will not have a material effect on the Company’s financial condition orresults of operations.

 

***EnvironmentalMatters***—In the ordinary course of business, likemost other industrial companies, the Company’s operations are subject toextensive and evolving federal, state, local and foreign environmental laws andregulations. Governmental authorities may resort to a variety of civil andcriminal enforcement measures, including monetary penalties and remediationrequirements, for violation of such laws. The Company is currently involved inthe assessment and remediation of some sites, which include Company-owned sitesand sites owned by third parties. The Seller has assumed responsibility for theobligations in connection with the third party sites.

 

9

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**8.****                                      SUBSEQUENTEVENT:**

 

In April 2004, the Company entered into an agreement to acquireDynamit Nobel AG (other than its plastics division) (“DN”), a German-basedspecialty chemical company, from mg technologies, ag pursuant to a Sale andPurchase Agreement, dated April 19, 2004 (the “DN Agreement”). Thepurchase price is €1,975,000 (€2,250,000 less the minimum deduction per the DNAgreement for pensions and other benefit obligations of €275,000) or $2,355,000based on exchange rates on the date of the DN Agreement, subject to adjustmentsbased on the closing balance sheet. Rockwood expects to complete thetransaction during the third quarter of 2004.

 

The DN businesses that will be acquired consist of Advanced Ceramics,Pigments (titanium dioxide and other barium and zinc-based additives),Specialty Chemicals (surface treatment and lithium chemicals) and CustomSynthesis (pharmaceutical intermediates).

 

Based on the exchange rates at the date of the DN Agreement, theacquisition will be financed by approximately $475,000 of new equitycontributions from an affiliate of KKR and DLJ Merchant Banking Partners.  The balance will be supplied by a newdebt-financing package expected to include a new senior secured creditagreement with comparable terms to the Company’s existing senior secured creditagreement of approximately $1,850,000, including a new revolving creditfacility of up to $250,000, and a new senior subordinated term loan facility ofapproximately $850,000.  The seniorsubordinated term loan will be due ten years from the closing of theacquisition; provided however, in the event the existing senior subordinatednotes have not been refinanced or repaid, the senior subordinated term loanwill be due February 2011.  The seniorsubordinated loan will be *pari passu*to Rockwood’s existing senior subordinated notes, with initial interest at afloating, LIBOR-based rate ranging from 9 to 12% annually.  If this senior subordinated term loan is notrefinanced within 18 months, the interest rate would be 14.5% (12.0 to 12.5% ofwhich would be payable in cash).  Allother terms would be comparable to the Company’s existing senior subordinatednotes. A portion of both elements of the debt-financing package are expected tobe denominated in Euros.

 

Inorder to mitigate the effect of any exchange rate changes which may take placeprior to the closing of the acquisition (and its related financing components),the Company has entered into call options, exercisable on July 28, 2004,permitting it to purchase up to €750,000 at a price of $1.225 per Euro. Theoption premium of $10,960 is due on the exercise date. If the acquisition isnot consummated the Company will share any losses or gains on the call optionswith KKR and DLJ Merchant Banking Partners with the Company’s share being37.0%. TheCompany believes that the counterparty to these agreements is a financiallysound institution and the credit risk for non-performance of these contracts isnot significant. Changes in the fair value of these options will be recognizedcurrently in earnings over the contract life.

 

10

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**9.****                                      CONSOLIDATINGFINANCIAL INFORMATION:**

 

As described in the Company’s 2003 10-K, the Company issued seniorsubordinated notes in July 2003. The following unaudited consolidating financial statements present theresults of operation, financial condition and cash flows, in separate columns,of the Parent Company (Rockwood Specialties Group, Inc.) which is theissuer of the senior subordinated debt, guarantor subsidiaries, non-guarantorsubsidiaries, elimination adjustments, and consolidated totals.

 

**ROCKWOOD SPECIALTIES GROUP INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF OPERATIONS**

**THREE MONTHS ENDED MARCH 31, 2004**

 
|                                          |   | **Parent  Company** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidated** |   |
|-----------------------------------------------|--------|---------------------|--------|-----------------------------|--------|---------------------------------|--------|------------------|--------|
| NET SALES                                     |   | $                   | — |                        | $      | 148,326                         |   | $                | 79,044 |   | $ | 227,370 |   |
| COST OF PRODUCTS SOLD                         |   | —              |   | 103,126                     |   | 61,856                          |   | 164,982          |   |
| GROSS PROFIT                                  |   | —              |   | 45,200                      |   | 17,188                          |   | 62,388           |   |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |   | 50                  |   | 23,519                      |   | 11,610                          |   | 35,179           |   |
| RESTRUCTURING CHARGE, net                     |   | —              |   | —                      |   | —                          |   | —           |   |
| OPERATING INCOME (LOSS)                       |   | (50                 | )      | 21,681                      |   | 5,578                           |   | 27,209           |   |
| OTHER INCOME (EXPENSES):                      |   |                |   |                        |   |                            |   |             |   |
| Intergroup interest, net                      |   | 14,352              |   | (13,463                     | )      | (889                            | )      | —           |   |
| Interest, net                                 |   | (13,467             | )      | (227                        | )      | (2,952                          | )      | (16,646          | )      |
| Intergroup other, net                         |   | —              |   | (143                        | )      | 143                             |   | —           |   |
| Foreign exchange gain (loss), net             |   | (141                | )      | 7                           |   | 12,391                          |   | 12,257           |   |
| Net                                           |   | 744                 |   | (13,826                     | )      | 8,693                           |   | (4,389           | )      |
| INCOME (LOSS) BEFORE TAXES                    |   | 694                 |   | 7,855                       |   | 14,271                          |   | 22,820           |   |
| INCOME TAX PROVISION (BENEFIT)                |   | 278                 |   | 3,535                       |   | 3,995                           |   | 7,808            |   |
| NET INCOME (LOSS)                             |   | $                   | 416    |                        | $      | 4,320                           |   | $                | 10,276 |   | $ | 15,012 |   |

 

**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF OPERATIONS**

**THREE MONTHS ENDED MARCH 31, 2003**

 
|                                          |   | **Parent  Company** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidated** |   |
|-----------------------------------------------|--------|---------------------|--------|-----------------------------|--------|---------------------------------|--------|------------------|--------|
| NET SALES                                     |   | $                   | — |                        | $      | 114,175                         |   | $                | 65,980 |   | $ | 180,155 |   |
| COST OF PRODUCTS SOLD                         |   | —              |   | 83,283                      |   | 50,825                          |   | 134,108          |   |
| GROSS PROFIT                                  |   | —              |   | 30,892                      |   | 15,155                          |   | 46,047           |   |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |   | 60                  |   | 20,645                      |   | 9,667                           |   | 30,372           |   |
| RESTRUCTURING CHARGE, net                     |   | —              |   | 295                         |   | —                          |   | 295              |   |
| OPERATING INCOME (LOSS)                       |   | (60                 | )      | 9,952                       |   | 5,488                           |   | 15,380           |   |
| OTHER INCOME (EXPENSES):                      |   |                |   |                        |   |                            |   |             |   |
| Intergroup interest, net                      |   | 14,069              |   | (13,262                     | )      | (807                            | )      | —           |   |
| Interest, net                                 |   | (16,660             | )      | (1                          | )      | (4,112                          | )      | (20,773          | )      |
| Intergroup other, net                         |   | —              |   | (624                        | )      | 624                             |   | —           |   |
| Foreign exchange (loss) gain, net             |   | (3,886              | )      | 294                         |   | (9,980                          | )      | (13,572          | )      |
| Net                                           |   | (6,477              | )      | (13,593                     | )      | (14,275                         | )      | (34,345          | )      |
| (LOSS) INCOME BEFORE TAXES                    |   | (6,537              | )      | (3,641                      | )      | (8,787                          | )      | (18,965          | )      |
| INCOME TAX (BENEFIT) PROVISION                |   | (1,961              | )      | (1,092                      | )      | (2,637                          | )      | (5,690           | )      |
| NET (LOSS) INCOME                             |   | $                   | (4,576 | )                           | $      | (2,549                          | )      | $                | (6,150 | ) | $ | (13,275 | ) |

 

11

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING BALANCE SHEET**

**MARCH 31, 2004**

 
|                                            |   | **Parent  Company** |      | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |    | **Consolidated** |   |
|-------------------------------------------------|--------|---------------------|-----------|-----------------------------|--------|---------------------------------|--------|------------------|---------|------------------|--------|
| **ASSETS**                                      |   |                |      |                        |   |                            |   |             |    |             |   |
| CURRENT ASSETS:                                 |   |                |      |                        |   |                            |   |             |    |             |   |
| Cash and cash equivalents                       |   | $                   | (2,513    | )                           | $      | 30,311                          |   | $                | 4,552   |             | $      | — |   | $ | 32,350 |   |
| Accounts receivable, net                        |   | —              |      | 97,417                      |   | 64,257                          |   | —           |    | 161,674          |   |
| Inventories                                     |   | —              |      | 50,574                      |   | 41,889                          |   | —           |    | 92,463           |   |
| Deferred income taxes                           |   | (388                | )         | 1,993                       |   | 1,216                           |   | —           |    | 2,821            |   |
| Prepaid expenses and other                      |   | —              |      | 10,547                      |   | 4,613                           |   | —           |    | 15,160           |   |
| Total current assets                            |   | (2,901              | )         | 190,842                     |   | 116,527                         |   | —           |    | 304,468          |   |
| PROPERTY, PLANT AND EQUIPMENT, net              |   | 2                   |      | 188,810                     |   | 225,202                         |   | —           |    | 414,014          |   |
| INVESTMENT IN SUBSIDIARIES                      |   | 660,412             |      | —                      |   | —                          |   | (660,412         | )       | —           |   |
| GOODWILL                                        |   | —              |      | 362,448                     |   | 324,714                         |   | —           |    | 687,162          |   |
| INTERGROUP RECEIVABLE                           |   | 575,042             |      | 571,226                     |   | 73,910                          |   | (1,220,178       | )       | —           |   |
| OTHER INTANGIBLE ASSETS, net                    |   | —              |      | 5,133                       |   | 18,460                          |   | —           |    | 23,593           |   |
| DEFERRED DEBT ISSUANCE COSTS, net               |   | 2,045               |      | 9,282                       |   | 2,310                           |   | —           |    | 13,637           |   |
| OTHER ASSETS                                    |   | —              |      | 6,854                       |   | 252                             |   | —           |    | 7,106            |   |
| TOTAL ASSETS                                    |   | $                   | 1,234,600 |                        | $      | 1,334,595                       |   | $                | 761,375 |             | $      | (1,880,590 | ) | $ | 1,449,980 |   |
|                                            |   |                |      |                        |   |                            |   |             |    |             |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**  |   |                |      |                        |   |                            |   |             |    |             |   |
| CURRENT LIABILITIES:                            |   |                |      |                        |   |                            |   |             |    |             |   |
| Accounts payable                                |   | $                   | —    |                        | $      | 50,978                          |   | $                | 46,645  |             | $      | — |   | $ | 97,623 |   |
| Income taxes payable                            |   | (578                | )         | (229                        | )      | 15,443                          |   | —           |    | 14,636           |   |
| Accrued expenses and other liabilities          |   | 17,839              |      | 28,207                      |   | 16,747                          |   | —           |    | 62,793           |   |
| Long-term debt, current portion                 |   | 2,697               |      | —                      |   | 8,882                           |   | —           |    | 11,579           |   |
| Total current liabilities                       |   | 19,958              |      | 78,956                      |   | 87,717                          |   | —           |    | 186,631          |   |
| LONG-TERM DEBT                                  |   | 640,685             |      | —                      |   | 171,941                         |   | —           |    | 812,626          |   |
| INTERGROUP PAYABLE                              |   | 14,784              |      | 1,063,719                   |   | 141,675                         |   | (1,220,178       | )       | —           |   |
| DEFERRED INCOME TAXES                           |   | (29,332             | )         | 22,504                      |   | 17,483                          |   | —           |    | 10,655           |   |
| OTHER LIABILITIES                               |   | 23,089              |      | 27,932                      |   | 25,023                          |   | 94               |    | 76,138           |   |
| Total liabilities                               |   | 669,184             |      | 1,193,111                   |   | 443,839                         |   | (1,220,084       | )       | 1,086,050        |   |
| STOCKHOLDERS’ EQUITY:                      |   |                |      |                        |   |                            |   |             |    |             |   |
| Common stock                                    |   | 4                   |      | 190,606                     |   | 70,037                          |   | (260,643         | )       | 4                |   |
| Paid-in capital                                 |   | 478,331             |      | 134,157                     |   | 255,124                         |   | (399,863         | )       | 467,749          |   |
| Accumulated other comprehensive income  (loss)  |   | 17,102              |      | (2,991                      | )      | 68,167                          |   | —           |    | 82,278           |   |
| Accumulated deficit                             |   | 69,979              |      | (180,288                    | )      | (75,792                         | )      | —           |    | (186,101         | )      |
| Total stockholders’ equity                 |   | 565,416             |      | 141,484                     |   | 317,536                         |   | (660,506         | )       | 363,930          |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                   | 1,234,600 |                        | $      | 1,334,595                       |   | $                | 761,375 |             | $      | (1,880,590 | ) | $ | 1,449,980 |   |

 

12

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING BALANCE SHEET**

**DECEMBER 31, 2003**

 
|                                            |   | **Parent  Company** |      | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |    | **Consolidated** |   |
|-------------------------------------------------|--------|---------------------|-----------|-----------------------------|--------|---------------------------------|--------|------------------|---------|------------------|--------|
| **ASSETS**                                      |   |                |      |                        |   |                            |   |             |    |             |   |
| CURRENT ASSETS:                                 |   |                |      |                        |   |                            |   |             |    |             |   |
| Cash and cash equivalents                       |   | $                   | (43,150   | )                           | $      | 79,213                          |   | $                | 6,634   |             | $      | — |   | $ | 42,697 |   |
| Accounts receivable, net                        |   | —              |      | 78,892                      |   | 59,385                          |   | —           |    | 138,277          |   |
| Inventories                                     |   | —              |      | 47,597                      |   | 40,182                          |   | —           |    | 87,779           |   |
| Deferred income taxes                           |   | (388                | )         | 1,993                       |   | 1,183                           |   | —           |    | 2,788            |   |
| Prepaid expenses and other                      |   | —              |      | 8,099                       |   | 4,415                           |   | —           |    | 12,514           |   |
| Total current assets                            |   | (43,538             | )         | 215,794                     |   | 111,799                         |   | —           |    | 284,055          |   |
| PROPERTY, PLANT AND EQUIPMENT, net              |   | 2                   |      | 190,083                     |   | 228,544                         |   |             |    | 418,629          |   |
| INVESTMENT IN SUBSIDIARIES                      |   | 660,412             |      | —                      |   | —                          |   | (660,412         | )       | —           |   |
| GOODWILL                                        |   | —              |      | 362,441                     |   | 321,447                         |   | —           |    | 683,888          |   |
| INTERGROUP RECEIVABLE                           |   | 609,061             |      | 602,176                     |   | 90,968                          |   | (1,302,205       | )       | —           |   |
| OTHER INTANGIBLE ASSETS, net                    |   | —              |      | 5,703                       |   | 19,969                          |   | —           |    | 25,672           |   |
| DEFERRED DEBT ISSUANCE COSTS, net               |   | 2,257               |      | 9,600                       |   | 2,228                           |   | —           |    | 14,085           |   |
| OTHER ASSETS                                    |   | —              |      | 6,429                       |   | 250                             |   | —           |    | 6,679            |   |
| TOTAL ASSETS                                    |   | $                   | 1,228,194 |                        | $      | 1,392,226                       |   | $                | 775,205 |             | $      | (1,962,617 | ) | $ | 1,433,008 |   |
|                                            |   |                |      |                        |   |                            |   |             |    |             |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**  |   |                |      |                        |   |                            |   |             |    |             |   |
| CURRENT LIABILITIES:                            |   |                |      |                        |   |                            |   |             |    |             |   |
| Accounts payable                                |   | $                   | —    |                        | $      | 52,611                          |   | $                | 45,985  |             | $      | — |   | $ | 98,596 |   |
| Income taxes payable                            |   | (578                | )         | 88                          |   | 12,496                          |   | —           |    | 12,006           |   |
| Accrued expenses and other liabilities          |   | 7,802               |      | 25,349                      |   | 18,063                          |   | —           |    | 51,214           |   |
| Long-term debt, current portion                 |   | 2,697               |      | —                      |   | 6,330                           |   | —           |    | 9,027            |   |
| Total current liabilities                       |   | 9,921               |      | 78,048                      |   | 82,874                          |   | —           |    | 170,843          |   |
| LONG-TERM DEBT                                  |   | 642,033             |      | —                      |   | 181,895                         |   | —           |    | 823,928          |   |
| INTERGROUP PAYABLE                              |   | 14,663              |      | 1,129,939                   |   | 157,603                         |   | (1,302,205       | )       | —           |   |
| DEFERRED INCOME TAXES                           |   | (29,610             | )         | 18,996                      |   | 17,913                          |   | —           |    | 7,299            |   |
| OTHER LIABILITIES                               |   | 24,702              |      | 28,046                      |   | 24,453                          |   | 94               |    | 77,295           |   |
| Total liabilities                               |   | 661,709             |      | 1,255,029                   |   | 464,738                         |   | (1,302,111       | )       | 1,079,365        |   |
| STOCKHOLDERS’ EQUITY:                      |   |                |      |                        |   |                            |   |             |    |             |   |
| Common stock                                    |   | 4                   |      | 190,606                     |   | 70,037                          |   | (260,643         | )       | 4                |   |
| Paid-in capital                                 |   | 478,331             |      | 134,412                     |   | 255,485                         |   | (399,863         | )       | 468,365          |   |
| Accumulated other comprehensive income  (loss)  |   | 18,587              |      | (3,213                      | )      | 71,013                          |   | —           |    | 86,387           |   |
| Accumulated deficit                             |   | 69,563              |      | (184,608                    | )      | (86,068                         | )      | —           |    | (201,113         | )      |
| Total stockholders’ equity                 |   | 566,485             |      | 137,197                     |   | 310,467                         |   | (660,506         | )       | 353,643          |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                   | 1,228,194 |                        | $      | 1,392,226                       |   | $                | 775,205 |             | $      | (1,962,617 | ) | $ | 1,433,008 |   |

 

13

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF CASH FLOWS**

**THREE MONTHS ENDED MARCH 31, 2004**

 
|                                                                                                    |   | **Parent  Company** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidated** |   |
|---------------------------------------------------------------------------------------------------------|--------|---------------------|--------|-----------------------------|--------|---------------------------------|--------|------------------|--------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                   |   |                |   |                        |   |                            |   |             |   |
| Net income (loss)                                                                                       |   | $                   | 416    |                        | $      | 4,320                           |   | $                | 10,276 |   | $ | 15,012 |   |
| Adjustments to reconcile net income (loss)  to net cash (used in) provided by operating activities:     |   |                |   |                        |   |                            |   |             |   |
| Depreciation and amortization                                                                           |   | —              |   | 5,643                       |   | 8,144                           |   | 13,787           |   |
| Deferred financing costs amortization                                                                   |   | 71                  |   | 320                         |   | 78                              |   | 469              |   |
| Foreign exchange gain (loss)                                                                            |   | 141                 |   | (7                          | )      | (12,391                         | )      | (12,257          | )      |
| Fair value adjustments of derivatives                                                                   |   | (1,542              | )      | —                      |   | (730                            | )      | (2,272           | )      |
| Bad debt provision                                                                                      |   | —              |   | 604                         |   | 60                              |   | 664              |   |
| Deferred income taxes                                                                                   |   | 278                 |   | 3,508                       |   | —                          |   | 3,786            |   |
| Changes in assets and liabilities, net of  the effect of foreign currency translation and acquisitions: |   |                |   |                        |   |                            |   |             |   |
| Accounts receivable                                                                                     |   | —              |   | (19,129                     | )      | (4,571                          | )      | (23,700          | )      |
| Inventories                                                                                             |   | —              |   | (2,977                      | )      | (1,725                          | )      | (4,702           | )      |
| Prepaid expenses and other assets                                                                       |   | —              |   | (2,448                      | )      | (682                            | )      | (3,130           | )      |
| Accounts payable                                                                                        |   | —              |   | (1,492                      | )      | 572                             |   | (920             | )      |
| Income taxes payable                                                                                    |   | —              |   | (317                        | )      | 3,111                           |   | 2,794            |   |
| Accrued expenses and other liabilities                                                                  |   | 42,762              |   | (33,024                     | )      | 2,064                           |   | 11,802           |   |
| Net cash provided by (used in) operating  activities                                                    |   | 42,126              |   | (44,999                     | )      | 4,206                           |   | 1,333            |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   |   |                |   |                        |   |                            |   |             |   |
| Capital expenditures                                                                                    |   | —              |   | (3,916                      | )      | (2,825                          | )      | (6,741           | )      |
| Sale of property, plant and equipment                                                                   |   | —              |   | 6                           |   | 27                              |   | 33               |   |
| Net cash used in investing activities                                                                   |   | —              |   | (3,910                      | )      | (2,798                          | )      | (6,708           | )      |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                   |   |                |   |                        |   |                            |   |             |   |
| Payments on long-term debt                                                                              |   | (1,348              | )      | —                      |   | (3,179                          | )      | (4,527           | )      |
| Net cash used in financing activities                                                                   |   | (1,348              | )      | —                      |   | (3,179                          | )      | (4,527           | )      |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                 |   | (141                | )      | 7                           |   | (311                            | )      | (445             | )      |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                                   |   | 40,637              |   | (48,902                     | )      | (2,082                          | )      | (10,347          | )      |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD                                                         |   | (43,150             | )      | 79,213                      |   | 6,634                           |   | 42,697           |   |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                |   | $                   | (2,513 | )                           | $      | 30,311                          |   | $                | 4,552  |   | $ | 32,350 |   |

 

14

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF CASH FLOWS**

**THREE MONTHS ENDED MARCH 31, 2003**

 
|                                                                                                    |   | **Parent Company** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidated** |   |
|---------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-----------------------------|--------|---------------------------------|--------|------------------|--------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                   |   |               |   |                        |   |                            |   |             |   |
| Net (loss) income                                                                                       |   | $                  | (4,576 | )                           | $      | (2,549                          | )      | $                | (6,150 | ) | $ | (13,275 | ) |
| Adjustments to reconcile net (loss) income  to net cash (used in) provided by operating activities:     |   |               |   |                        |   |                            |   |             |   |
| Depreciation and amortization                                                                           |   | —             |   | 5,499                       |   | 6,563                           |   | 12,062           |   |
| Deferred financing costs amortization                                                                   |   | 1,268              |   | —                      |   | 271                             |   | 1,538            |   |
| Foreign exchange loss                                                                                   |   | 3,900              |   | —                      |   | 9,654                           |   | 13,554           |   |
| Fair value adjustments of derivatives                                                                   |   | 712                |   | —                      |   | 313                             |   | 1,026            |   |
| Bad debt provision                                                                                      |   | —             |   | (205                        | )      | 3                               |   | (202             | )      |
| Changes in assets and liabilities, net of  the effect of foreign currency translation and acquisitions: |   |               |   |                        |   |                            |   |             |   |
| Accounts receivable                                                                                     |   | —             |   | (13,522                     | )      | (6,137                          | )      | (19,659          | )      |
| Inventories                                                                                             |   | —             |   | (1,669                      | )      | (1,514                          | )      | (3,183           | )      |
| Prepaid expenses and other assets                                                                       |   | —             |   | (3,007                      | )      | 418                             |   | (2,589           | )      |
| Accounts payable                                                                                        |   | —             |   | 2,059                       |   | (1,142                          | )      | 917              |   |
| Income taxes payable                                                                                    |   | (1,961             | )      | (1,092                      | )      | (2,637                          | )      | (5,690           | )      |
| Accrued expenses and other liabilities                                                                  |   | (52,596            | )      | 40,618                      |   | 1,662                           |   | (10,316          | )      |
| Net cash (used in) provided by operating  activities                                                    |   | (53,253            | )      | 26,132                      |   | 1,304                           |   | (25,817          | )      |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   |   |               |   |                        |   |                            |   |             |   |
| Acquisitions, net of cash acquired                                                                      |   | —             |   | (11,961                     | )      | —                          |   | (11,961          | )      |
| Capital expenditures                                                                                    |   | —             |   | (3,437                      | )      | (4,051                          | )      | (7,488           | )      |
| Sale of property, plant and equipment                                                                   |   | —             |   | 171                         |   | 24                              |   | 195              |   |
| Net insurance proceeds from fire damage                                                                 |   | —             |   | —                      |   | 3,257                           |   | 3,257            |   |
| Net cash used in investing activities                                                                   |   | —             |   | (15,227                     | )      | (770                            | )      | (15,997          | )      |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                   |   |               |   |                        |   |                            |   |             |   |
| Proceeds from long-term debt                                                                            |   | 20,000             |   | —                      |   | —                          |   | 20,000           |   |
| Net cash provided by financing activities                                                               |   | 20,000             |   | —                      |   | —                          |   | 20,000           |   |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                 |   | —             |   | —                      |   | 3,242                           |   | 3,242            |   |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                                                   |   | (33,253            | )      | 10,905                      |   | 3,776                           |   | (18,572          | )      |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD                                                         |   | 42,392             |   | (1,738                      | )      | 2,242                           |   | 42,896           |   |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                |   | $                  | 9,139  |                        | $      | 9,167                           |   | $                | 6,018  |   | $ | 24,324 |   |

 

15

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**Item 2.****           Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

*The following should be read in conjunctionwith the Condensed Consolidated Financial Statements and the related notes thatappear elsewhere in this document.*

 

**General**

 

We are a global developer, manufacturer and marketerof high value-added specialty chemicals and performance materials in ourspecific markets. We serve customers across a wide variety of industries andgeographic areas. We operate through three business segments:(i) Performance Additives; (ii) Specialty Compounds; and(iii) Electronics, which generated approximately 61.3%, 21.1% and 17.6%,respectively, of our first quarter 2004 net sales, and 78.0%, 16.5% and 16.2%,respectively, of our first quarter 2004 Adjusted EBITDA, with corporate costsand eliminations representing (10.7%) of our first quarter 2004 AdjustedEBITDA, and 91.8%, 19.8% and 5.8%, respectively, of our first quarter 2004operating income, with corporate costs and eliminations representing (17.4%) ofour first quarter 2004 operating income. Our senior management uses AdjustedEBITDA as the primary measure to evaluate our ongoing financial performance. Inaddition, management uses Adjusted EBITDA on a consolidated basis as the mostsignificant criterion in the calculation of performance-based cash bonuses. Webelieve this financial measure on a consolidated basis is helpful inhighlighting trends in our overall business because Adjusted EBITDA excludesthose items that have little or no bearing on our day-to-day operatingperformance. See Components of Adjusted EBITDA below for a detailed discussionof this measure as well as a reconciliation of such measure to net income(loss).

 

**Factors Which Affect our Results ofOperations**

 

**Economic and Market Conditions**

 

Economic and market conditions in our business segments and regions inwhich we operate vary from period to period. The principal factors that impactour results of operations in these periods included the following:

 

***PerformanceAdditives***

 

•                                          Thecontinued growth in the North American construction market contributed to anincrease in sales of our products into this end-use market, specifically ourPigments and Timber Treatment Chemicals businesses. Timber Treatment Chemicalsalso benefited from high levels of activity in home improvement areas such asnew and replacement decks. Both of these factors have resulted in an increasein demand for treated wood construction products.

 

•                                          Theincreasing market for environmentally advanced chemical products has had apositive impact on our Timber Treatment Chemicals business, which is a leadingsupplier of such products. This trend has helped our Timber Treatment Chemicalsbusiness increase its portion of sales of higher margin ACQ products, and weexpect this trend to continue as ACQ products are transitioned into the NorthAmerican residential market.

 

•                                          Acontinuing trend towards the increased use of colored concrete products in theNorth American construction market, particularly paving stones, has had apositive effect on our Pigments business line.

 

***Specialty Compounds***

 

•                                          Wehave significantly rationalized our cost structure in this segment throughplant consolidation, headcount reductions and other cost cutting measures.

 

***Electronics***

 

•                                          Demandfor our Electronic Chemicals products generally follows the activity levels ofsemiconductor and printed circuit board manufacturers, while the price of ourproducts is insulated to some degree from the effect of changes in the price ofsemiconductors and printed circuit boards due to the fact that the cost ofthese products is generally a small component of the cost of the end product.The global semiconductor and printed circuit board markets are cyclical innature. Market conditions have generally improved during 2004 as compared to2003.

 

•                                          Demandfor the services performed by our Wafer Reclaim business have risen in thecurrent year due to the

 

16

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improved market conditions. However, pricing pressure still exists dueto competitive factors.

 

•                                          Demandin our Photomasks business is affected by the number of new electronic productsrather than production levels of existing products, and thus is not affected asmuch by the demand levels for semiconductors, but rather follows the rate ofnew products being developed. The consolidation in our competitive basecontinues to cause downward pricing pressure in this business.

 

**Currency Fluctuations**

 

We operate a geographically diverse business. We estimate that we soldto customers in more than 60 countries during the first quarter of 2004. Weserve our diverse and extensive customer base with 40 manufacturing facilitiesin nine countries. Although we sell and manufacture our products in manycountries, our sales and production costs are mainly denominated in U.S.dollars, euros and pounds sterling. Our results of operations and financialcondition are therefore impacted by the fluctuation of the euro and the poundsterling against our reporting currency, the U.S. dollar. No other currency issignificant to our results of operations. Unless otherwise noted, allreferences below to currency exchange rate changes primarily relate to thestrengthening of the euro and the pound against the U.S. dollar in the periodscompared.

 

Our financial results are subject to the impact of gains and losses oncurrency translations, which occur when balance sheet accounts of foreignoperations are translated into U.S. dollars at period-end exchange rates andincome and expense accounts are translated at average exchange rates over thecourse of that period. Gains and losses on currency translations are recordedin our financial statements as a component of “other comprehensive income(loss)” and do not impact our operating margins. The increase in the value ofthe euro has had a positive impact on our net sales, gross profit and operatingincome reported in our consolidated statements of operations for the quarterended March 31, 2004.

 

Our balance sheet is also subject to the effect of currencyfluctuations on the translation of our euro-denominated debt. Gains and losseson the translation of debt denominated in a currency other than the functionalcurrency of the borrower are included as a component of “other income and expenses.”

 

In addition, our financial results are subject to the impact of gainsand losses on currency transactions, which occur when the currency structure ofour costs and liabilities deviates from the currency structure of salesproceeds and assets. Gains and losses on currency transactions are included inoperating income and impact our operating margins. We have entered into certaincontracts in 2004 in connection with a small portion of our currencytransaction risk. Although our historic operating margins have not beensignificantly impacted by currency transaction risk, our currency structure maychange in the future and, as a result, currency fluctuations could have amaterial impact on our future operating income and operating margins.

 

**Raw Materials**

 

Our most significant raw materials are iron oxide, used in Pigments,copper, amine and quat used in ACQ wood preservation chemicals in our TimberTreatment Chemicals business, quaternary amines used in Clay-based Additivesand polyvinyl chloride resin and plasticizers used in Specialty Compounds.

 

Most of our raw materials are readily available. We generally purchaseraw materials based on supply agreements linked to market prices and thereforeour operating results are subject to short-term fluctuations in raw materialsprices. Our Specialty Compounds segment is subject to price fluctuationsrelated to its primary raw material, polyvinyl chloride, or PVC resin. PVCresin is a commodity product, and its pricing is directly related to the priceof ethylene and chlorine, as well as PVC industry operating rates. Our supplycontracts for PVC resin do not specify a fixed price, and most contain marketprice and volume rebate adjustments. When PVC resin prices increase, we areable to pass only a portion of that increase through to our customers.

 

With the exception of PVC resin, our raw materials generally have notdisplayed significant price fluctuations. PVC prices have increased in2004.  In addition, other than inconnection with energy costs, we do not have any significant exposure topetroleum price fluctuations.

 

**Acquisitions and Dispositions**

 

Our Pigments business within our Performance Additives segmentpurchased the assets of Southern Color for approximately $12.0 million inMarch 2003. As a result, we have expanded our position as a leadingsupplier of pigments, packaged mortar products and masonry coloring services tothe construction industry. In addition, we acquired blending and packagingservices for major cement producers, as well as color and specialty productsfor the brick and ready-mix markets and decorative concrete surface treatments

 

17

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including stains, sealers and overlay products. We financed thisacquisition using a combination of existing cash flows from operations andborrowings under our revolving credit facility. Results of operations forSouthern Color were included in our results of operations effective as of theacquisition date.

 

See also “–Liquidity and Capital Resources” below for discussion of ourmajor acquisition expected to be consummated in the third quarter of 2004.

 

**Components of Adjusted EBITDA**

 

Certain items are added to or subtracted from netincome (loss) to arrive at Adjusted EBITDA. One significant item is foreignexchange (gain)/loss.  We have recordedforeign exchange (gains) and losses related to our long-term debt. Theseamounts reflect the non-cash impact on our euro-denominated debt resulting fromthe strengthening or weakening of the euro against the U.S. dollar during theapplicable periods.

 

On a segment basis, we define Adjusted EBITDA as operating incomeexcluding depreciation and amortization, certain non-cash gains and charges,certain non-recurring gains and charges and certain items deemed by our seniormanagement to have little or no bearing on the day-to-day operating performanceof our business segments and reporting units. Our senior management usesAdjusted EBITDA as the primary measure to evaluate the ongoing performance ofour business segments and reporting units. We also use Adjusted EBITDA on aconsolidated basis to assess our operating performance. In addition, managementuses Adjusted EBITDA on a consolidated basis as the most significant criterionin the calculation of performance-based cash bonuses. We believe this financialmeasure on a consolidated basis is helpful in highlighting trends in ouroverall business because Adjusted EBITDA excludes those items that have littleor no bearing on our day-to-day operating performance.

 

We view Adjusted EBITDA on both a segment basis and consolidated basisas an operating performance measure and therefore use net income (loss) as themost comparable GAAP measure.

 

The following table sets forth the applicable components of AdjustedEBITDA and also serves as a reconciliation to net income (loss) on a GAAPbasis:

 
|                                        |   | **Three  Months Ended March 31,** |   |
|---------------------------------------------|--------|----------------------------------------|--------|
|                                        |   | **2004**                               |   | **2003** |   |
|                                        |   |                                   |   |   |   |
| Net income (loss)                           |   | $                                      | 15,012 |   | $ | (13,275 | ) |
| Income tax (benefit) provision              |   | 7,808                                  |   | (5,690 | ) |
| Interest expense, net                       |   | 16,646                                 |   | 20,773 |   |
| Depreciation and amortization               |   | 13,787                                 |   | 12,062 |   |
| Restructuring and related charges           |   | —                                 |   | 295 |   |
| Systems/organization establishment expenses |   | 84                                     |   | 372 |   |
| Acquisition and disposal costs              |   | —                                 |   | 89 |   |
| Inventory write-up reversal                 |   | —                                 |   | 143 |   |
| Foreign exchange (gain) loss                |   | (12,257                                | )      | 13,572 |   |
| Total Adjusted EBITDA                       |   | $                                      | 41,080 |   | $ | 28,341 |   |

 

On a consolidated basis, Adjusted EBITDA is also a key component usedin the calculation of financial ratios used in certain long-term debt financialcovenants, including the ratio of Adjusted EBITDA to cash interest expense, netand the ratio of net debt (debt, net of cash) to Adjusted EBITDA.

 

Particularly given our leverage, Adjusted EBITDA and ratios tied to itare critical to evaluating our liquidity position. Adjusted EBITDA, which isreferred to under the indenture governing our existing senior subordinatednotes as “EBITDA,” is defined therein as consolidated net income (which, asdefined in the indenture, excludes gains and losses on disposed operations andgoodwill impairment charges) plus (i) income tax expense,(ii) interest expense, (iii) depreciation and amortization expense,(iv) expenses related to any equity offerings, permitted investments,acquisitions, dispositions, recapitalizations or debt permitted to be incurredthereunder, (v) any restructuring charges, including any one-time costsincurred in connection with acquisitions, (vi) other non-cash charges,(vii) minority interest, (viii) systems/organization establishmentexpenses and, prior to the end of 2001, unusual patent

 

18

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litigation expenses, less (ix) non-cash items that increaseconsolidated net income. We include this measure because certain of ourlong-term debt financial covenants are tied to ratios based on this measure andthe analogous covenants in our old credit facilities, which was refinanced bythe new credit facilities, were tied to ratios based on this measure. Forexample, our ability to incur additional indebtedness, including to finance theDN acquisition (see “--Liquidity and Capital Resources”) and make restrictedpayments under the indenture governing the notes is tied to an Adjusted EBITDAto cash interest expense ratio of 2 to 1.

 

The key financial ratios in our senior secured credit agreement are netdebt to Adjusted EBITDA, currently required to be less than 5.95 to 1, andAdjusted EBITDA to cash interest expense (interest expense, net excludingdeferred debt issuance cost amortization and the movements in themark-to-market value of our interest rate and cross-currency interest ratederivatives), currently required to be at least 1.65 to 1. Adjusted EBITDA inour senior secured credit agreement is calculated in a manner consistent withthe definition of such measure in the indenture governing the notes.

 

As such, we believe Adjusted EBITDA is the most relevant financialmeasure for readers to evaluate our compliance with our financial covenants.Given this additional use of Adjusted EBITDA as a liquidity measure, below is areconciliation of net cash provided by (used in) operating activities toAdjusted EBITDA:

 
|                                                                                                            |   | **Three  Months Ended March 31,** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                            |   | **2004**                               |   | **2003** |   |
| Net cash provided by (used in) operating  activities                                                            |   | $                                      | 1,333  |   | $ | (25,817 | ) |
| Changes in assets and liabilities net of  the effect of foreign currency translation and acquisitions           |   | 17,856                                 |   | 40,520 |   |
| Current portion of income tax (benefit)  provision                                                              |   | 4,022                                  |   | (5,690 | ) |
| Interest expense, net, excluding  amortization of deferred financing costs and unrealized losses on derivatives |   | 18,449                                 |   | 18,209 |   |
| Restructuring and related charges                                                                               |   | —                                 |   | 295 |   |
| Systems/organization establishment expenses                                                                     |   | 84                                     |   | 372 |   |
| Acquisition and disposal costs                                                                                  |   | —                                 |   | 89 |   |
| Inventory write—up reversal                                                                                |   | —                                 |   | 143 |   |
| Bad debt provision                                                                                              |   | (664                                   | )      | 202 |   |
| Foreign currency loss                                                                                           |   | —                                 |   | 18 |   |
| Total Adjusted EBITDA                                                                                           |   | $                                      | 41,080 |   | $ | 28,341 |   |

 

Adjusted EBITDA is not an alternative to net income (loss), operatingincome or cash flows from operating activities as calculated and presented inaccordance with GAAP. Readers should not rely on Adjusted EBITDA as asubstitute for any GAAP financial measure. In addition, our calculations ofAdjusted EBITDA may or may not be consistent with that of other companies. Westrongly urge you to review the reconciliations of Adjusted EBITDA contained inthis section, including the related explanations, the limitations of theseexclusions described below and the other financial information containedherein. We also strongly urge you not to rely on any single financial measureto evaluate our business.

 

Management compensates for the limitations of using non-GAAP financialmeasures by using them only to supplement our GAAP results to provide a morecomplete understanding of the factors and trends affecting our business. Whenviewed with our GAAP results and the reconciliation of Adjusted EBITDAdiscussed above and contained in the notes to our financial statements, webelieve Adjusted EBITDA provides a more complete understanding of factors andtrends affecting our business than GAAP results alone.

 

There are material limitations associated with excluding thereconciling items listed in the previous tables from our earnings to calculateAdjusted EBITDA and using this non-GAAP financial measure as compared to theuse of the most directly comparable GAAP financial measure. For example, thecash portion of: income tax (benefit) provision, interest expense—net, andrestructuring as well as non-recurring charges related to areas such assecurities issuance, acquisition activities, and systems/organizationestablishment, generally represent (gains) charges which may significantlyaffect funds available to use in our operating, financing, and investmentactivities. Non-operating foreign exchange gains (losses), although notimmediately affecting cash, may affect the amount of funds needed to serviceour debt if those currency impacts remain in place as we meet our futureprincipal repayment obligations. Depreciation, amortization, non cash (gains)charges, inventory write-up reversal, and impairment charges, though notdirectly affecting our current cash position, represent the wear and tearand/or reduction in value of the plant, equipment, inventory, and intangibleassets which permit us to manufacture and/or market our products. These itemsmay be indicative of future needs for capital expenditures, for development oracquisition of intangible assets or relevant trends causing asset valuechanges. An investor or potential investor may find any one or all of theseitems important in evaluating our performance, results of operations, financial

 

19

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position and liquidity.

 

**Off-Balance Sheet Arrangements**

 

None.

 

**Critical Accounting Policies**

 

Our discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and the related disclosure of contingentassets and liabilities. We evaluate our estimates on an ongoing basis, based onhistorical experience and various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

 

We believe the following to be the most critical accounting policiesand estimates affecting preparation of our consolidated financial statements.

 

*Revenue Recognition.*  We recognize revenue when the earningsprocess is complete. This generally occurs when products are shipped to thecustomer in accordance with the terms of the contract of sale, title and riskof loss have been transferred, collectibility is reasonably assured, andpricing is fixed or determinable. Accruals are made for sales returns and otherallowances based on our experience.

 

*Impairment Accounting.*  The recoverability of goodwill is reviewedon an annual basis during the fourth quarter. Additionally, the recoverabilityof goodwill, long-lived tangible, and certain intangible assets is reviewedwhen events or changes in circumstances occur indicating that the carryingvalue of the assets may not be recoverable. The measurement of possibleimpairment for assets other than goodwill is based upon the ability to recoverthe carrying value of the asset through the expected future undiscounted cashflows from the use of the asset and its eventual disposition. An impairmentloss, equal to the difference between the asset’s fair value and its carryingvalue, is recognized when the estimated future undiscounted cash flows are lessthan its carrying amount.

 

*Legal Matters.*  We are involved in various legalproceedings, including product liability and environmental matters, of a natureconsidered normal to our business. It is our policy to accrue for amountsrelated to these matters in accordance with SFAS No. 5, “Accounting forContingencies,” if it is probable that a liability has been incurred and anamount can be reasonably estimated. It is our policy to disclose such matterswhen there is at least a reasonable possibility that a loss may have beenincurred.

 

*Environmental Matters.*  We accrue costs of a non-capital naturerelated to environmental clean-up when those costs are believed to be probableand can be reasonably estimated. Expenditures that extend the life of therelated property or mitigate or prevent future environmental contamination arecapitalized, and expenditures related to existing conditions resulting frompast or present operations and from which no current or future benefit isdiscernible are immediately expensed. The quantification of environmentalexposures requires an assessment of many factors, including changing laws andregulations, advancements in environmental technologies, the quality ofinformation available related to specific sites, the assessment stage of eachsite investigation and the length of time involved in remediation orsettlement. We do not include anticipated recoveries from insurance carriers orother third parties in our accruals for environmental liabilities.

 

We have evaluated our total environmental exposure based on currentlyavailable data and believe that such environmental matters will not have amaterial adverse impact on our financial position or results of operations. Ifmatters previously identified by management are resolved in a manner differentfrom original estimates, there is the potential for a material adverse effecton operating results or cash flows in any one accounting period.

 

*Restructuring.*  We record restructuring charges from time totime that represent expenses incurred in connection with consolidations andcessations of certain of our operations as well as headcount reductionprograms. These charges consist primarily of write-offs of surplus assets andseverance costs. These charges are based on various factors including theemployee’s length of service, contract provisions, salary levels and localgovernmental legislation. At the time a related charge is recorded, wecalculate our best estimate based upon detailed analysis. Although significantchanges are not expected, actual costs may differ from these estimates.

 

*Deferred Taxes.*  We have in the past recorded valuationallowances to reduce our deferred tax assets to the amount that is

 

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more likely than not to be realized. While we have considered futuretaxable income and ongoing prudent and feasible tax planning strategies inassessing the need for valuation allowances, if we were to determine that wewould be able to realize deferred tax assets in the future in excess of our netrecorded amount, an adjustment to the deferred tax asset would increase incomein the period such determination was made. Likewise, should we determine thatwe would not be able to realize all or part of our recorded net deferred taxassets in the future, an adjustment to the deferred tax asset would decreaseincome in the period such determination was made.

 

**Results of Operations**

 

Net sales consist of sales of our products in our threesegments, net of sales discounts, product returns and allowances. Sales areprimarily made on a purchase order basis. Revenues are recognized when theearnings process is complete which is generally when products are shipped andtitle and risk of loss has been transferred to the customer.

 

Cost of products sold consists of raw material costs, manufacturingvariable and fixed costs, including headcount-related costs, manufacturingoverhead, including depreciation, energy costs and periodic maintenance costs.

 

Selling, general and administrative expenses include research anddevelopment costs, sales and marketing, divisional management expenses andcorporate services including cash management, legal, benefit planadministration and other administrative and professional services.

 

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The following tables present the major components of our operationsincluding changes therein on a historical basis and as a percentage of netsales.

 
|                                          |   | **Three  Months Ended March 31,** |    |
|-----------------------------------------------|--------|----------------------------------------|---------|
|                                          |   | **2004**                               |    | **2003** |   |
|                                          |   | **(dollars  in thousands)**            |    |
| **Statement of  operations data:**            |   |                                   |    |   |   |
| Net sales:                                    |   |                                   |    |   |   |
| Performance Additives                         |   | $                                      | 139,078 |   | $ | 100,775 |   |
| Specialty Compounds                           |   | 47,880                                 |    | 43,990 |   |
| Electronics                                   |   | 40,412                                 |    | 35,390 |   |
| Total                                         |   | 227,370                                |    | 180,155 |   |
| Gross profit:                                 |   |                                   |    |   |   |
| Performance Additives                         |   | 44,733                                 |    | 29,488 |   |
|                                          |   | 32.2                                   | %       | 29.3 | % |
| Specialty Compounds                           |   | 9,072                                  |    | 8,316 |   |
|                                          |   | 18.9                                   | %       | 18.9 | % |
| Electronics                                   |   | 8,583                                  |    | 8,243 |   |
|                                          |   | 21.2                                   | %       | 23.3 | % |
| Corporate costs and eliminations              |   | —                                 |    | — |   |
| Total                                         |   | 62,388                                 |    | 46,047 |   |
|                                          |   | 27.5                                   | %       | 25.6 | % |
| Selling, general and administrative  expenses |   | 35,179                                 |    | 30,372 |   |
|                                          |   | 15.5                                   | %       | 16.9 | % |
| Restructuring charges                         |   | —                                 |    | 295 |   |
| Operating (loss) income:                      |   |                                   |    |   |   |
| Performance Additives                         |   | 24,946                                 |    | 13,004 |   |
|                                          |   | 17.9                                   | %       | 12.9 | % |
| Specialty Compounds                           |   | 5,400                                  |    | 4,787 |   |
|                                          |   | 11.3                                   | %       | 10.9 | % |
| Electronics                                   |   | 1,590                                  |    | 1,962 |   |
|                                          |   | 3.9                                    | %       | 5.5 | % |
| Corporate costs and eliminations              |   | (4,727                                 | )       | (4,373 | ) |
| Total                                         |   | 27,209                                 |    | 15,380 |   |
|                                          |   | 12.0                                   | %       | 8.5 | % |
| Other income (expenses):                      |   |                                   |    |   |   |
| Interest expense, net                         |   | (16,646                                | )       | (20,773 | ) |
| Foreign exchange (loss) gain                  |   | 12,257                                 |    | (13,572 | ) |
| Income (loss) before taxes                    |   | 22,820                                 |    | (18,965 | ) |
| Income tax (benefit) provision                |   | 7,808                                  |    | (5,690 | ) |
| Net income (loss)                             |   | $                                      | 15,012  |   | $ | (13,275 | ) |
| Adjusted EBITDA:                              |   |                                   |    |   |   |
| Performance Additives                         |   | $                                      | 32,054  |   | $ | 19,550 |   |
| Specialty Compounds                           |   | 6,776                                  |    | 6,023 |   |
| Electronics                                   |   | 6,640                                  |    | 6,195 |   |
| Corporate costs and eliminations              |   | (4,390                                 | )       | (3,427 | ) |
| Total                                         |   | $                                      | 41,080  |   | $ | 28,341 |   |

 

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|                                               |   | **Change:  Three Month Ended March 31, 2004 versus 2003** |   |
|----------------------------------------------------|--------|----------------------------------------------------------------|--------|
|                                               |   | **Total**                                                      |   | **%  Change** |   | **FX Effect** |   | **Acquisition &  Divestitures, net** |   | **Other** |   |
| **Statement of  operations data:**                 |   |                                                           |   |   |   |   |   |   |   |   |   |
| **Net sales:**                                     |   |                                                           |   |   |   |   |   |   |   |   |   |
| Performance Additives                              |   | $                                                              | 38,303 |   | 38.0 | % | $ | 4,565 |   | $ | 4,519 |   | $ | 29,219 |   |
| Specialty Compounds                                |   | 3,890                                                          |   | 8.8 | % | 1,971 |   | — |   | 1,919 |   |
| Electronics                                        |   | 5,022                                                          |   | 14.2 | % | 2,289 |   | 1,114 |   | 1,619 |   |
| Total                                              |   | 47,215                                                         |   | 26.2 | % | 8,825 |   | 5,633 |   | 32,757 |   |
| Gross Profit:                                      |   |                                                           |   |   |   |   |   |   |   |   |   |
| Performance Additives                              |   | 15,245                                                         |   | 51.7 | % | 1,173 |   | 711 |   | 13,361 |   |
| Specialty Compounds                                |   | 756                                                            |   | 9.1 | % | 300 |   | — |   | 456 |   |
| Electronics                                        |   | 340                                                            |   | 4.1 | % | (92 | ) | 27 |   | 405 |   |
| Total                                              |   | 16,341                                                         |   | 35.5 | % | 1,381 |   | 738 |   | 14,222 |   |
| **Selling, general  and administrative expenses:** |   | 4,807                                                          |   | 15.8 | % | 1,728 |   | 625 |   | 2,454 |   |
| Restructuring charges                              |   | (295                                                           | )      |   |   |   |   |   |   |   |   |
| **Operating income  (loss):**                      |   |                                                           |   |   |   |   |   |   |   |   |   |
| Performance Additives                              |   | 11,942                                                         |   | 91.8 | % | 161 |   | 126 |   | 11,655 |   |
| Specialty Compounds                                |   | 613                                                            |   | 12.8 | % | 95 |   | — |   | 518 |   |
| Electronics                                        |   | (372                                                           | )      | -19.0 | % | (569 | ) | (13 | ) | 210 |   |
| Corporate costs and eliminations                   |   | (354                                                           | )      | 8.1 | % | (34 | ) | — |   | (320 | ) |
| Total                                              |   | 11,829                                                         |   | 76.9 | % | (347 | ) | 113 |   | 12,063 |   |
| **Other income  (expenses):**                      |   |                                                           |   |   |   |   |   |   |   |   |   |
| Interest expense, net                              |   | 4,127                                                          |   | -19.9 | % | (438 | ) | — |   | 4,565 |   |
| Foreign exchange (loss) gain, net                  |   | 25,829                                                         |   |   |   |   |   |   |   |   |   |
| Income (Loss) before taxes                         |   | 41,785                                                         |   |   |   |   |   |   |   |   |   |
| Income tax (benefit) provision                     |   | 13,498                                                         |   |   |   |   |   |   |   |   |   |
| **Net (loss) income:**                             |   |                                                           |   |   |   |   |   |   |   |   |   |
| Performance Additives                              |   | 12,504                                                         |   |   |   |   |   |   |   |   |   |
| Specialty Compounds                                |   | 753                                                            |   |   |   |   |   |   |   |   |   |
| Electronics                                        |   | 512                                                            |   |   |   |   |   |   |   |   |   |
| Corporate costs and eliminations                   |   | (21,203                                                        | )      |   |   |   |   |   |   |   |   |
| Total                                              |   | 28,287                                                         |   |   |   |   |   |   |   |   |   |
|                                               |   |                                                           |   |   |   |   |   |   |   |   |   |
| **Adjusted EBITDA:**                               |   |                                                           |   |   |   |   |   |   |   |   |   |
| Performance Additives                              |   | 12,504                                                         |   | 64.0 | % | 681 |   | 275 |   | 11,548 |   |
| Specialty Compounds                                |   | 753                                                            |   | 12.5 | % | 204 |   | — |   | 549 |   |
| Electronics                                        |   | 445                                                            |   | 7.2 | % | (131 | ) | 25 |   | 551 |   |
| Corporate costs and eliminations                   |   | (963                                                           | )      | 28.1 | % | (34 | ) | — |   | (929 | ) |
| Total                                              |   | $                                                              | 12,739 |   | 44.9 | % | $ | 720 |   | $ | 300 |   | $ | 11,719 |   |

 

***Three months ended March 31, 2004 compared with threemonths ended March 31, 2003***

*** ***

**Net sales**

 

Net sales were $227.4 million for the first quarter of2004 as compared to $180.2 million for the first quarter of 2003. The 26.2%increase is principally due to strong demand in our Performance Additivessegment, primarily within our Timber Treatment Chemicals and Pigmentsbusinesses. Included in this increase were first quarter 2004 sales fromacquisitions, primarily a full quarter’s sales in 2004 from Southern Color,within our Pigments business in the Performance Additives segment versus onemonth of net sales in the first quarter of 2003. Currency positively impactednet sales in the first quarter of 2004 by approximately $8.8 million.

 

*Performance Additives.*  Net sales for our Performance Additivessegment increased 38.0% over the prior year period

 

23

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primarily due to higher sales of our Timber Treatment Chemicals andPigments businesses, as well as acquisitions (primarily Southern Color) andfavorable currency exchange rates. The increase in Timber Treatment Chemicalswas primarily due to a greater mix of ACQ products versus CCA products withinthe Timber Treatment Chemicals business line, due to the ACQ conversion. OurPigments business had stronger volume due to an increase in demand forconstruction products.

 

*Specialty Compounds.*  Net sales for our Specialty Compoundssegment increased in part due to currency exchange rate changes with theremaining increase in net sales of $1.9 million primarily due to increasedsales volumes and more favorable pricing of certain products in our wire andcable compounds business.

 

***Electronics.*** Net sales for our Electronics segment increased primarily due to highersales volumes, offset in part by pricing pressure in certain businesses.Conditions in certain of our Electronic Chemicals business continued to improvein the first quarter of 2004 due to improvement in general market conditions inthe industries served.

*** ***

**Gross profit**

 

Gross profit margin was 27.5% in the first quarter of 2004 as comparedto 25.6% in the first quarter of 2003. Gross profit increased$14.2 million primarily due to increased sales discussed above.

 

*Performance Additives.*  Gross profit margin was 32.2% in the firstquarter of 2004 as compared to 29.3% in the first quarter of 2003 due tofavorable mix in our Timber Treatment Chemicals and higher sales volume in thePigments business.

 

*Specialty Compounds.*  Gross profit margin was 18.9% in both thefirst quarter of 2004 and the first quarter of 2003. The increase of$0.5 million was due to increased sales volumes, pricing and favorablecurrency changes offset by higher PVC raw material costs.

 

*Electronics.*  Gross profit margin was 21.2% in the firstquarter of 2004 as compared to 23.3% in the first quarter of 2003, althoughactual gross profit increased primarily due to increased sales volume. Higherproduction costs and selling price pressure caused the gross margin percentagedecrease.

 

**Selling, general and administrative expenses**

 

Selling, general and administrative expenses, or “SG&A” increaseddue to higher bonus accruals consistent with the improved overall operatingperformance, and bad debt expense consistent with higher sales levels. Currencyexchange rate changes unfavorably affected SG&A.

 

**Operating income**

 

Operating income increased for the same reasons as gross profit, offsetin part by the SG&A increase described above. The operating income increaseof $12.1 million was comprised of increases of $11.7 million in ourPerformance Additives segment, $0.5 million in our Specialty Compoundssegment, $0.2 million in our Electronics segment and increases of $0.3million of corporate costs and eliminations.

 

**Adjusted EBITDA**

 

*Performance Additives.*  Adjusted EBITDA for our PerformanceAdditives segment increased primarily due to the increase in sales andfavorable currency exchange rate changes.

 

*Specialty Compounds.*  Adjusted EBITDA for our Specialty Compoundssegment increased primarily due to the higher sales volumes discussed above andby currency exchange rate changes.

 

*Electronics.*  Adjusted EBITDA for our Electronics segmentincreased primarily due to higher sales volumes.

 

*Corporate.*  Adjusted EBITDA loss at Corporate decreasedprimarily due to lower discretionary spending including certain professionalfees offset in part by higher bonus accruals consistent with improved operatingperformance.

 

**Other income (expenses)**

 

*Interest expense, net.*  For the first quarter of 2004 and 2003,interest expense, net, included a gain of $2.2 million and a loss

 

24

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of $1.0 million, respectively, representing the movement in themark to market valuation of our interest rate and cross currency hedginginstruments as well as $0.5 million and $1.5 million, respectively,of amortization expense related to deferred financing costs. This amortizationdecreased in 2004 due to the effect of the July and December 2003refinancings, or Refinancing, (see “--Liquidity and Capital Resources” below),which substantially reduced our deferred financing cost balance. Currencyexchange rate changes increased interest expense, net by $0.4 million. Theremaining decrease of $0.5 million was due to the lower interest rates from theRefinancing.

 

*Foreign exchange loss.*  In the first quarter of 2004, the foreignexchange gains reflected the non-cash currency impact on our euro-denominateddebt of the strengthening of the pound against the euro. In the first quarterof 2003, the foreign exchange losses reflected the non-cash currency impact onour euro-denominated debt of the strengthening of the euro against the U.S.dollar.

 

*Provision for income taxes.*  An income tax provision of $7.8 millionon income before taxes of $22.8 million in the first quarter of 2004resulted in an effective income tax rate of 34.2%. This compared to an incometax benefit of $5.7 million on a loss before taxes of $19.0 millionin the first quarter of 2003, which resulted in an effective income tax rate of30.0%. The 2003 effective tax rate was lower due to valuation allowances inconnection with a portion of the pre-tax loss for that period.

 

**Net income (loss)**

 

Net income for the first quarter of 2004 was $15.0 million versusthe first quarter of 2003 net loss of $13.3 million due to the reasonsdiscussed above.

 

**Liquidity and Capital Resources**

 

Net cash provided by operating activities was $1.3 million in thefirst quarter of 2004 and net cash used in operating activities was$25.8 million in the first quarter of 2003. The change in cash flows fromoperating activities for the first quarter of 2004 as compared to the firstquarter of 2003 was primarily due to the stronger operating results discussedabove as well as the smaller increase in working capital accounts in 2004compared to 2003, including the impact of lower interest payments in 2004primarily due to the scheduled timing of these payments.

 

Net cash used for investing activities was $6.5 million in thefirst quarter of 2004 and $16.0 million in the first quarter of 2003. Thedecrease in 2004 as compared to 2003 was primarily due to the 2003 acquisitionof Southern Color, partially offset by insurance proceeds from fire damagereceived in 2003.

 

Net cash used for financing activities was $4.5 million in thefirst quarter of 2004 and net cash provided by financing activities was$20.0 million in the first quarter of 2003. 

 

In connection with the Acquisition, we incurred substantial amounts ofdebt, including amounts outstanding under our old senior credit facilities andour old senior subordinated loan facility. Interest payments on thisindebtedness and the current debt resulting from the Refinancing aresignificant. As part of the Refinancing, we repaid the borrowings under ourthen-existing senior subordinated loan facility and repaid all amountsoutstanding under our old senior credit facilities with the borrowings underthe new senior credit facilities, the private offering of the outstanding notesand new equity contributions of $95.0 million from our parent companies.Subject to restrictions in our new senior credit facilities and the indenturegoverning the notes, the pay-in-kind obligations of Rockwood SpecialtiesConsolidated, Inc. and the new senior discount notes of RockwoodSpecialties International, Inc., we may incur more debt for workingcapital, capital expenditures, acquisitions and for other purposes.

 

As part of the Refinancing, our immediate parentcompany, Rockwood Specialties International, Inc. issued 12% seniordiscount notes due 2011 resulting in gross proceeds of $70.0 million($111.6 million aggregate principal amount at maturity) and contributedthe proceeds to us. The senior discount notes do not require RockwoodSpecialties International to pay cash interest on these notes until 2007, atwhich point interest will accrue on the notes at a rate of 12% per annum.Rockwood Specialties International, Inc. will rely on income generated byour operations (as available after providing for cash flows used in investingand financing activities), paid to it as dividends, to make these interestpayments. The indenture relating to our notes allows such dividends to be madein accordance with the terms of the senior discount notes of our parentcompany, Rockwood Specialties International, Inc. commencing in 2007. Inaddition, our ultimate parent company, Rockwood Holdings, Inc., issuedshares of Series A Participating Preferred Stock and warrants to purchase sharesof common stock to an affiliate of KKR resulting in proceeds of$25.0 million which was contributed to us through our parent companies.

 

As a result of the Refinancing, the new senior credit facilitiesconsisted of new tranche A term loans and new tranche B term loans. InDecember 2003, we refinanced all of the U.S. dollar borrowings under ourterm loan B facilities with the proceeds of a term

 

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loan C facility in order to reduce our interest expense. The tranche A termloans and the revolving credit facility mature in July 2009 and each ofthe tranche B term loans and tranche C term loans mature in July 2010. Asof March 31, 2004, we had aggregate borrowings under the term loan portionof our senior credit facilities of $449.2 million, no outstandingborrowings under our $100.0 million revolving credit facility, and$14.2 million of letters of credit, which reduced our availability underour revolving credit facility.

 

For the periods ended March 31, 2004 and 2003, our capitalexpenditures amounted to $6.7 million and $7.5 million, respectively. Ourcapital expenditures have averaged $34.9 million per year for the threeyears ended December 31, 2003, which consisted primarily of replacementsof worn, obsolete or damaged equipment as well as investments in new equipment,mostly for our Pigments and Timber Treatment Chemicals business lines. Weanticipate comparable or slightly higher capital expenditures in 2004 afteradjusting for the effect of foreign exchange rate changes. From 2001 through2003, we made significant investments in new facilities to expand capacityacross our business lines including expenditures made in connection with theexpansion of our ACQ production capabilities in our Timber Treatment Chemicals businessline and expansion and refurbishment of two wafer reclaim facilities andproduction equipment—the newly acquired ASP facility in Providence, RhodeIsland and the Greasque, France facility.

 

Apart from obligations in connection with the planned acquisitiondetailed below, there have been no material changes in our contractualobligations since December 31, 2003.

 

In April 2004, the Company entered into an agreement to acquireDynamit Nobel AG (other than its plastics division) (“DN”), a German-basedspecialty chemical company, from mg technologies, ag pursuant to a Sale andPurchase Agreement, dated April 19, 2004 (the “DN Agreement”). Thepurchase price is €1.975 billion (€2.250 billion less the minimum deduction perthe DN Agreement for pensions and other benefit obligations of €275.0 million)or $2.355 billion based on exchange rates on the date of the DN Agreement,subject to adjustments based on the closing balance sheet. Rockwood expects tocomplete the transaction during the third quarter of 2004.

 

Based on exchange rates at the date of the DN Agreement, theacquisition will be financed by approximately $475.0 million of new equitycontributions from an affiliate of KKR and DLJ Merchant Banking Partners.  The balance will be supplied by a new debt-financingpackage expected to include a new senior secured credit agreement withcomparable terms to the Company’s existing senior secured credit agreement ofapproximately $1.850 billion, including a new revolving credit facility of upto $250.0 million, and a new senior subordinated term loan facility ofapproximately $850.0 million.  Thesenior subordinated term loan will be due ten years from the closing of theacquisition; provided however, in the event the existing senior subordinatednotes have not been refinanced or repaid, the senior subordinated term loanwill be due February 2011.  The seniorsubordinated loan and will be *pari passu*to Rockwood’s existing senior subordinated notes, with initial interest at afloating, LIBOR-based rate ranging from 9 to 12% annually.  If this senior subordinated term loan is notrefinanced within 18 months, the interest rate would be 14.5% (12.0 to 12.5% ofwhich would be payable in cash).  Allother terms would be comparable to the Company’s existing senior subordinatednotes. A portion of both elements of the debt-financing package are expected tobe denominated in Euros.

 

In order to mitigate the effect of any exchange rate changes which maytake place prior to the closing of the acquisition (and its related financingcomponents), the Company has entered into call options, exercisable onJuly 28, 2004, permitting it to purchase up to €750.0 million at a priceof $1.225. The option premium of $11.0 million is due on the exercise date. Ifthe acquisition is not consummated the Company will share any losses or gainson the call options with KKR and DLJ Merchant Banking Partners with theCompany’s share being 37.0%. We believe that the counterparty to theseagreements is a financially sound institution and the credit risk fornon-performance of these contracts is not significant.  Changes in the fair value of these optionswill be recognized currently in earnings over the contract life.

 

We believe that this transaction will ultimately enhance our access tocapital markets (and thereby enhance our liquidity and capital resources) dueto the significantly increased size of the combined entity and increased endmarket and geographic diversification. However, in the short term, the proposed capital structure described abovemay result in less favorable financial ratios, measures commonly used in debtcovenants such as those governing our existing long-term debt.  Our annual capital expenditures willincrease in amount, but we do not believe they will change significantly fromcurrent levels in proportion to the expected size of the combined entity.

 

Our ability to pay principal and interest on our debt(including our notes), fund working capital and make anticipated capitalexpenditures depends on our future performance, which is subject to generaleconomic conditions and other factors, some of which are beyond our control. Webelieve that based on current and anticipated levels of operations andconditions in our industry and markets, cash flows from operations and borrowingsavailable under our revolving credit facility will be adequate for theforeseeable future to make required payments of principal and interest on ourdebt, including our notes, and fund our working capital and capital expenditurerequirements. There can be no assurance, however, that our business willgenerate sufficient cash flow from operations or that future borrowings will beavailable under our revolving credit facility in an amount sufficient to enableus to service our debt, including our notes, or to fund our other liquidityneeds. Furthermore, any future acquisitions, business combinations or similartransactions will likely require additional capital, and there can be noassurance that this capital will be available to us.

 

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**Information Concerning Forward LookingStatements**

 

We have included in this document forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended, that stateour intentions, beliefs, expectations or predictions for the future. Theseforward-looking statements are subject to certain risks and uncertainties thatcould cause actual results to differ materially from historical results orthose anticipated, depending on a variety of factors, including the statementsunder “Risk Factors” detailed in our annual report on Form 10-K for the yearended December 31, 2003 and other reports filed with the Securities andExchange Commission, such as:

 

•                                          changesin our business strategy;

 

•                                          changesin demand for our products;

 

•                                          fluctuationsin interest rates, exchange rates and currency values;

 

•                                          availabilityand pricing of raw materials;

 

•                                          fluctuationsin energy prices;

 

•                                          changesin the end-use markets in which our products are sold;

 

•                                          changesin the general economic conditions in North America and Europe and in otherlocations in which we currently do business;

 

•                                          technologicalchanges affecting production of our materials;

 

•                                          governmentaland environmental regulations and changes in those regulations;

 

•                                          hazardsassociated with chemicals manufacturing;

 

•                                          risksassociated with acquisitions;

 

•                                          risksassociated with competition and the introduction of new competing products,especially in the Asia-Pacific region; and

 

•                                          risksassociated with international sales and operations.

 

Although we believe that the expectations reflected inforward-looking statements are reasonable, we can give no assurance that thoseexpectations will prove to have been correct. All forward-looking statementscontained in this document are qualified by reference to this cautionarystatement.

 

**Item 3****.****           Quantitative and Qualitative DisclosuresAbout Market Risk.**

 

We are exposed to market risk from changes in interest rates, foreigncurrency exchange rates and commodity prices. We manage our exposure to thesemarket risks through regular operating and financing activities and, on alimited basis, through the use of derivatives. When used, derivatives are employedas risk management tools and not for trading purposes.

 

**Interest Rate Risk.**

 

We have $449.2 million of variable rate debt outstanding as ofMarch 31, 2004 under our senior credit facilities. Any borrowings underour revolving credit facility will also be at a variable rate. Under the seniorcredit facilities, we are not required to hedge, or otherwise protect againstinterest rate fluctuation, a significant portion of our variable rate debt.However, in February 2001, we entered into six derivative contracts tohedge interest rate risk which currently cover notional amounts of $166.2million and €123.5 million. The maturity date of all six contracts isFebruary 2006. We may in the future consider adjusting the amounts coveredby these derivative contracts to better suit our capital structure. A 0.125%increase or decrease in the assumed weighted average interest rate would changeannual interest expense by $0.1 million.

 

In connection with the DN Agreement we plan to increase our net debt byapproximately $2.0 billion, all of which is expected to be variable rate debt(tentatively subject to certain floors and caps).  We have not yet determined the extent to which we will attempt toprotect against potential interest rate fluctuation arising from these proposedborrowings.

 

27

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**Foreign Currency Risk**

 

We conduct operations in many countries around the world. Our resultsof operations are subject to both currency transaction risk and currencytranslation risk. We operate a geographically diverse business, with 66.9% ofour net sales generated from customers in North America, 27.3% in Europe and5.8% from Asia in 2003. Our diverse and extensive customer base is served by 40manufacturing facilities in 9 countries. Although we sell and manufacture ourproducts in many countries, our sales and production costs are mainlydenominated in U.S. dollars, euros and pounds sterling. Our results ofoperations and financial condition are therefore impacted by the fluctuation ofthe euro and the pound sterling against our reporting currency, the U.S.dollar.

 

Upon consummation of the DN acquisition, our geographical diversitywould change, with a significantly larger share of sales and production costsdenominated in euros. This would increase the impact of the fluctuation of theeuro against the U.S. dollar.

 

We incur currency transaction risk whenever we enter into either apurchase or sale transaction using a currency other than the local currency ofthe transacting entity. With respect to currency translation risk, ourfinancial condition and results of operations are measured and recorded in therelevant domestic currency and then translated into U.S. dollars for inclusionin our historical combined and consolidated financial statements. Exchangerates between these currencies and U.S. dollars in recent years have fluctuatedsignificantly and may do so in the future.

 

Our financial results are subject to the effect ofcurrency fluctuations on the translation of our euro-denominated debt. Oursenior credit facilities currently include $160.7 million of eurodenominated debt. Also, we have entered into $75.7 million ofcross-currency interest rate swaps that effectively convert U.S. dollar LIBORbased debt into euro LIBOR based debt. Gains and losses on the translation ofdebt denominated in a currency other than the functional currency of theborrower are included as a separate component of “other income and expenses.”Gains and losses on the cross-currency interest rate swaps are included ininterest expense.

 

We expect that the future net debt increase described above will bedenominated in a combination of euros and U.S. dollars, but the specificamounts have not been determined, and we have not determined whether we willenter into any additional interest rate derivative transactions in connectionwith such debt.

 

**Commodity Price Risk**

 

We are subject to commodity price risk for certain of our rawmaterials. We have not materially hedged this commodity price exposure to date,but expect to do so in the future.

 

**Item 4****.****           Controls and Procedures**

 

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our reports under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate, to allowtimely decisions regarding required disclosures. Any controls and procedures,no matter how well designed and operated, can provide only reasonable assuranceof achieving the desired control objectives. Our management, with theparticipation of our chief executive officer and chief financial officer, hasevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures as of March 31, 2004. Based upon that evaluationand subject to the foregoing, our chief executive officer and chief financialofficer concluded that the design and operation of our disclosure controls andprocedures are effective to accomplish their objectives.

 

In addition, there was no change in our internal control over financialreporting that occurred during the quarter ended March 31, 2004 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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## **PART II** – OTHER INFORMATION

## ** **

**Item 1. Legal Proceedings.**

 

We are involved in litigation from time to time in the ordinary courseof our business. However, we do not believe that there is any such litigation,either individually or in the aggregate, that is likely to have a materialadverse effect on our business or financial condition. In addition, thefollowing updates previously disclosed legal proceedings:

 

**CCA Litigation**

 

In March 2004, in the action entitled *Ardoin, et. al. v. Stine Lumber, et. al.,* the federaldistrict court ruled that the plaintiffs have not met the requirements forproceeding as a class action and denied class action certification.  See our annual report for the year endedDecember 31, 2003 on Form 10-K for a description of this proceeding aswell as other actions we are a party to.

 

**Item2.  Changes****in Securities and Use of Proceeds.**

 

None.

 

**Item3.  Defaults****upon Senior Securities.**

 

None.

 

**Item4.  Submission****of Matters to a Vote of Security Holders.**

 

None.

 

**Item5.  Other Information****.**

 

None.

 

**Item6.  Exhibits and Reports****on Form 8-K.**

 

(a)                                  Exhibits

 
| **Exhibit No.** |   | **Description  of Exhibit**                                                                                                                          |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1            |   | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a).                                                                                 |
| 31.2            |   | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a).                                                                                 |
| 32.1            |   | Certification of Chief Executive Officer Pursuant to 18 U.S.C  Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act  of 2002. |
| 32.2            |   | Certification of Chief Financial Officer Pursuant to 18 U.S.C  Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act  of 2002. |

 

(b)                                 Reports onForm 8-K:

 

On March 4, 2004, the Company furnished (not filed) a currentreport on Form 8-K pursuant to Item 12 containing one exhibit: a transcript ofthe Company’s conference call announcing its financial results for the quarterand year ended December 31, 2003 and the conference call materials.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|   |   | ROCKWOOD SPECIALTIES GROUP, INC.             |
|--------|--------|---------------------------------------------------|
|   |   |                                              |
|   |   |                                              |
|   | By:    | /s/ SEIFI GHASEMI                                 |
|   |   | Seifi Ghasemi                                     |
|   |   | Chairman of the Board and Chief Executive Officer |
|   |   | Date: May 17, 2004                                |

 

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