**UNITED STATESSECURITIES 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  June 30, 2004** |
| ** **                                             |
| **or**                                                 |
| ** **                                             |
| **o**                                                  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number   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 all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days.       ýYes  oNo

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Act).      oYes  ýNo

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 

As of August 13, 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 and six months ended June 30, 2004 and 2003 |   |
|    | Condensed Consolidated Balance Sheets as of  June 30, 2004 and December 31, 2003                           |   |
|    | Condensed Consolidated Statements of Cash  Flows for the six months ended June 30, 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  | Unregistered Sales of Equity 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 June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| NET SALES                                     |       | $                               | 266,969    |                          | $          | 212,697 |   | $ | 494,339 |   | $ | 392,852 |   |
| COST OF PRODUCTS SOLD                         |       | 188,384                         |       | 152,731                       |       | 353,366 |   | 286,839 |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| GROSS PROFIT                                  |       | 78,585                          |       | 59,966                        |       | 140,973 |   | 106,013 |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |       | 35,877                          |       | 26,980                        |       | 71,056 |   | 57,352 |   |
| RESTRUCTURING CHARGE, net                     |       | 55                              |       | 740                           |       | 55 |   | 1,035 |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| OPERATING INCOME                              |       | 42,653                          |       | 32,246                        |       | 69,862 |   | 47,626 |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| OTHER INCOME (EXPENSES):                      |       |                            |       |                          |       |   |   |   |   |
| Interest, net                                 |       | (12,441                         | )          | (22,383                       | )          | (29,087 | ) | (43,156 | ) |
| Foreign exchange gain (loss), net             |       | (3,625                          | )          | (6,644                        | )          | 8,632 |   | (20,216 | ) |
| Other, net                                    |       | (3,980                          | )          | —                        |       | (3,980 | ) | — |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Net                                           |       | (20,046                         | )          | (29,027                       | )          | (24,435 | ) | (63,372 | ) |
|                                          |       |                            |       |                          |       |   |   |   |   |
| INCOME (LOSS) BEFORE TAXES                    |       | 22,607                          |       | 3,219                         |       | 45,427 |   | (15,746 | ) |
| INCOME TAX PROVISION (BENEFIT)                |       | 11,785                          |       | 967                           |       | 19,593 |   | (4,723 | ) |
|                                          |       |                            |       |                          |       |   |   |   |   |
| NET INCOME (LOSS)                             |       | $                               | 10,822     |                          | $          | 2,252 |   | $ | 25,834 |   | $ | (11,023 | ) |

 

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)**

 
| ** **                                                                                         | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
|                                                                                               |       |               |       |                   |       |
| **ASSETS**                                                                                         |       |               |       |                   |       |
| CURRENT ASSETS:                                                                                    |       |               |       |                   |       |
| Cash and cash equivalents                                                                          |       | $                  | 68,278     |                   | $          | 42,697 |   |
| Accounts receivable, net                                                                           |       | 160,490            |       | 138,277                |       |
| Inventories                                                                                        |       | 87,462             |       | 87,779                 |       |
| Deferred income taxes                                                                              |       | 3,760              |       | 2,788                  |       |
| Prepaid expenses and other                                                                         |       | 16,286             |       | 12,514                 |       |
| Total current assets                                                                               |       | 336,276            |       | 284,055                |       |
|                                                                                               |       |               |       |                   |       |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                 |       | 404,619            |       | 418,629                |       |
| GOODWILL                                                                                           |       | 682,485            |       | 683,888                |       |
| OTHER INTANGIBLE ASSETS, net                                                                       |       | 21,813             |       | 25,672                 |       |
| DEFERRED DEBT ISSUANCE COSTS                                                                       |       | 13,146             |       | 14,085                 |       |
| OTHER ASSETS                                                                                       |       | 10,753             |       | 6,679                  |       |
| TOTAL ASSETS                                                                                       |       | $                  | 1,469,092  |                   | $          | 1,433,008 |   |
|                                                                                               |       |               |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                      |       |               |       |                   |       |
| CURRENT LIABILITIES:                                                                               |       |               |       |                   |       |
| Accounts payable                                                                                   |       | $                  | 109,719    |                   | $          | 98,596 |   |
| Income taxes payable                                                                               |       | 13,418             |       | 12,006                 |       |
| Accrued expenses and other current  liabilities                                                    |       | 69,779             |       | 51,214                 |       |
| Long-term debt, current portion                                                                    |       | 11,492             |       | 9,027                  |       |
| Total current liabilities                                                                          |       | 204,408            |       | 170,843                |       |
| LONG-TERM DEBT                                                                                     |       | 811,107            |       | 823,928                |       |
| DEFERRED INCOME TAXES                                                                              |       | 19,889             |       | 7,299                  |       |
| OTHER LIABILITIES                                                                                  |       | 64,049             |       | 77,295                 |       |
| Total liabilities                                                                                  |       | 1,099,453          |       | 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                                                                                    |       | 467,863            |       | 468,365                |       |
| Accumulated other comprehensive income                                                             |       | 77,051             |       | 86,387                 |       |
| Accumulated deficit                                                                                |       | (175,279           | )          | (201,113               | )          |
| Total stockholders’ equity                                                                    |       | 369,639            |       | 353,643                |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                    |       | $                  | 1,469,092  |                   | $          | 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 Six Months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                              | ** ** | **2004**                               | ** ** | **2003** | ** ** |
|                                                                                                    |       |                                   |       |   |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                               |       |                                   |       |   |   |
| Net income (loss)                                                                                       |       | $                                      | 25,834     |   | $ | (11,023 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities:               |       |                                   |       |   |   |
| Depreciation and amortization                                                                           |       | 28,171                                 |       | 24,726 |   |
| Deferred financing costs amortization                                                                   |       | 936                                    |       | 3,098 |   |
| Foreign exchange (gain) loss                                                                            |       | (8,632                                 | )          | 20,549 |   |
| Fair value adjustment of derivatives                                                                    |       | (8,636                                 | )          | 2,252 |   |
| Bad debt provision                                                                                      |       | 935                                    |       | 196 |   |
| Deferred income taxes                                                                                   |       | 12,277                                 |       | — |   |
| Changes in assets and liabilities, net of  the effect of foreign currency translation and acquisitions: |       |                                   |       |   |   |
| Accounts receivable                                                                                     |       | (23,592                                | )          | (14,108 | ) |
| Inventories                                                                                             |       | (232                                   | )          | (388 | ) |
| Prepaid expenses and other assets                                                                       |       | (361                                   | )          | (1,955 | ) |
| Accounts payable                                                                                        |       | 11,754                                 |       | 9,356 |   |
| Income taxes payable                                                                                    |       | 1,789                                  |       | (11,757 | ) |
| Accrued expenses and other liabilities                                                                  |       | 4,463                                  |       | (17,550 | ) |
| Net cash provided by operating activities                                                               |       | 44,706                                 |       | 3,396 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                               |       |                                   |       |   |   |
| Acquisitions, net of cash acquired                                                                      |       | —                                 |       | (12,465 | ) |
| Capital expenditures                                                                                    |       | (13,317                                | )          | (16,060 | ) |
| Proceeds on sale of property, plant and  equipment                                                      |       | 33                                     |       | 195 |   |
| Insurance proceeds from fire damage, net                                                                |       | —                                 |       | 3,257 |   |
| Net cash used in investing activities                                                                   |       | (13,284                                | )          | (25,073 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                               |       |                                   |       |   |   |
| Payments on long-term debt                                                                              |       | (4,527                                 | )          | (14,306 | ) |
| Proceeds from long-term debt                                                                            |       | —                                 |       | 8,000 |   |
| Net cash used in financing activities                                                                   |       | (4,527                                 | )          | (6,306 | ) |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                 |       | (1,314                                 | )          | 3,532 |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                                   |       | 25,581                                 |       | (24,451 | ) |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD                                                         |       | 42,697                                 |       | 42,896 |   |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                |       | $                                      | 68,278     |   | $ | 18,445 |   |
|                                                                                                    |       |                                   |       |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                                      |       |                                   |       |   |   |
| Interest paid, net                                                                                      |       | $                                      | 36,322     |   | $ | 48,350 |   |
| Income taxes paid, net of refunds                                                                       |       | $                                      | 5,472      |   | $ | 7,225 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

5

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**Notes To Condensed Consolidated FinancialStatements (Unaudited)**

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

 

**1. DESCRIPTION OF BUSINESS AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES:**

 

***Business Description,Background***—Rockwood Specialties Group, Inc.and Subsidiaries (“Rockwood” or the “Company”) is a worldwide manufacturer anddistributor of specialty chemicals and performance materials used forindustrial and commercial purposes.

 

The Company is an indirect wholly-owned subsidiary of RockwoodHoldings, Inc. (“Holdings”), an entity controlled by Kohlberg KravisRoberts & Co. L.P. (“KKR”), and formed in connection with anacquisition of certain assets, stock and businesses from Laporte plc (“Laporte”)on November 20, 2000. The cost of the acquisition (the “KKR Acquisition”),along with related fees and expenses, was financed using aggregate proceeds of$1,227,000, consisting of a $382,000 equity contribution made to the Company byits parent companies with $100,000 in borrowings by Rockwood SpecialtiesConsolidated, Inc. under a payment-in-kind subordinated loan facility (“RSCIPIK Notes”) and $282,000 equity investment in Holdings by affiliates of KKR and$845,000 of borrowings under senior secured credit facilities and seniorsubordinated loan facility. These borrowings were refinanced in July 2003 (the“2003 Refinancing”). Since the KKR Acquisition, KKR has provided consulting andmanagement advisory services to Rockwood for an annual fee of $600.

 

On July 31, 2004, the Company completed the acquisition of fourbusinesses of Dynamit Nobel from mg technologies ag. The businesses acquiredare focused on highly specialized markets and consist of: white pigments;surface treatment and lithium chemicals; ceramics; and pharmaceuticalintermediates.  The cost of theacquisition (the “DN Acquisition”), along with related fees and expenses, aswell as the repayment of the borrowings under the Company’s then existingsenior secured facilities (the “2003 Senior Credit Facilities”) and $20,000 ofthe pay-in-kind notes issued by Rockwood Specialties Consolidated, Inc., wasfinanced using new equity contributions from affiliates of KKR and affiliatesof CSFB Private Equity (“CSFB”), and borrowing under the new senior securedcredit facilities (the “2004 Senior Credit Facilities”) and the new seniorsubordinated loan facility (the “2004 Senior Subordinated Loan Facility”)(collectively, the “2004 Financing”) from certain lending institutions (the “DNLenders”) including CSFB. See Note 8 for a more complete description of the DNAcquisition and the 2004 Financing.

 

***Basis ofPresentation*** — The accompanying condensed consolidatedbalance sheets of Rockwood and the related condensed consolidated statements ofoperations and cash flows are presented on a consolidated basis. Allsignificant intercompany accounts and transactions 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 condensedor omitted. The accompanying condensed consolidated financial statements shouldbe read in conjunction with the consolidated financial statements and the notesthereto contained in the Company’s Annual Report on Form 10-K for the yearended December 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 June 30, 2004 and December 31, 2003 and theresults of its operations for the three and six months ended June 30, 2004 and2003 and its cash flows for the six months ended June 30, 2004 and 2003. Theresults of operations for the interim periods are not necessarily indicative ofthe 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.

 

6

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***Stock-BasedCompensation***—The Company accounts for the RockwoodHoldings, Inc. Amended and Restated 2003 Stock Purchase and Option Plan (the“Plan”) under the recognition 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  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                      | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                            |       |                             |       |                           |       |   |   |   |   |
| Net income (loss), as reported                                                                  |       | $                                | 10,822     |                           | $          | 2,252 |   | $ | 25,834 |   | $ | (11,023 | ) |
| Stock-based employee compensation expense  determined under fair value based method, net of tax |       | (116                             | )          | (159                           | )          | (232 | ) | (264 | ) |
|                                                                                            |       |                             |       |                           |       |   |   |   |   |
| Pro forma net income (loss)                                                                     |       | $                                | 10,706     |                           | $          | 2,093 |   | $ | 25,602 |   | $ | (11,287 | ) |

 

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

 
| ** **                   | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                   | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                         |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)            |       | $                                | 10,822     |                           | $          | 2,252 |   | $ | 25,834 |   | $ | (11,023 | ) |
| Foreign currency translation |       | (5,227                           | )          | 16,810                         |       | (9,336 | ) | 24,757 |   |
|                         |       |                             |       |                           |       |   |   |   |   |
| Comprehensive income         |       | $                                | 5,595      |                           | $          | 19,062 |   | $ | 16,498 |   | $ | 13,734 |   |

 

***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.

 

7

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**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 the Company’s key decisionmakers. The three segments are: (1) Performance Additives, which consistsof pigments, timber treatment chemicals, clay-based additives and watertreatment chemicals business lines; (2) Specialty Compounds; and(3) Electronics, which consists of electronic chemicals, wafer reclaim andphotomasks business lines.

 

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 June 30, 2004** |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net sales                            |       | $                          | 173,204    |                     | $          | 52,584          |       | $                                | 41,181     |             | $          | — |   | $ | 266,969 |   |
| Operating income (loss)              |       | 39,609                     |       | 6,828                    |       | 2,104           |       | (5,888                           | )          | 42,653           |       |
| Adjusted EBITDA                      |       | 46,630                     |       | 8,221                    |       | 7,392           |       | (4,102                           | )          | 58,141           |       |
|                                 |       |                       |       |                     |       |            |       |                             |       |             |       |
| **Three months ended June 30, 2003** |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net sales                            |       | $                          | 131,422    |                     | $          | 46,146          |       | $                                | 35,129     |             | $          | — |   | $ | 212,697 |   |
| Operating income (loss)              |       | 26,696                     |       | 4,795                    |       | 5,191           |       | (4,436                           | )          | 32,246           |       |
| Adjusted EBITDA                      |       | 33,366                     |       | 6,451                    |       | 5,588           |       | (3,402                           | )          | 42,003           |       |
|                                 |       |                       |       |                     |       |            |       |                             |       |             |       |
| **Six months ended June 30, 2004**   |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net sales                            |       | $                          | 312,282    |                     | $          | 100,464         |       | $                                | 81,593     |             | $          | — |   | $ | 494,339 |   |
| Operating income (loss)              |       | 64,555                     |       | 12,228                   |       | 3,694           |       | (10,615                          | )          | 69,862           |       |
| Adjusted EBITDA                      |       | 78,684                     |       | 14,997                   |       | 14,032          |       | (8,492                           | )          | 99,221           |       |
|                                 |       |                       |       |                     |       |            |       |                             |       |             |       |
| **Six months ended June 30, 2003**   |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net sales                            |       | $                          | 232,197    |                     | $          | 90,136          |       | $                                | 70,519     |             | $          | — |   | $ | 392,852 |   |
| Operating income (loss)              |       | 39,700                     |       | 9,582                    |       | 7,153           |       | (8,809                           | )          | 47,626           |       |
| Adjusted EBITDA                      |       | 52,916                     |       | 12,474                   |       | 11,783          |       | (6,829                           | )          | 70,344           |       |

 

The summary of segment information above includes “Adjusted EBITDA”, afinancial measure used by senior management to evaluate the operatingperformance of each segment. Rockwood defines Adjusted EBITDA as operatingincome excluding depreciation and amortization, certain non-cash gains andcharges, certain non-recurring gains and charges and certain items deemed byRockwood’s senior management to have little or no bearing on the day-to-dayoperating performance of its business segments and reporting units.  In addition, management uses Adjusted EBITDAas the most significant criterion in the calculation of performance-based cashbonuses.

 

8

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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 June 30, 2004**                |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net income (loss)                                   |       | $                          | 21,464     |                     | $          | 4,649           |       | $                                | 953        |             | $          | (16,244 | ) | $ | 10,822 |   |
| Income tax (benefit) provision                      |       | 11,000                     |       | 2,274                    |       | (24             | )          | (1,465                           | )          | 11,785           |       |
| Interest, net                                       |       | 7,015                      |       | (95                      | )          | 1,330           |       | 4,191                            |       | 12,441           |       |
| Depreciation and amortization                       |       | 7,021                      |       | 1,379                    |       | 5,247           |       | 737                              |       | 14,384           |       |
| Restructuring and related charges                   |       | —                     |       | 14                       |       | 41              |       | —                           |       | 55               |       |
| Systems/organization establishment expenses         |       | —                     |       | —                   |       | —          |       | 984                              |       | 984              |       |
| Cancelled acquisition and disposal costs            |       | —                     |       | —                   |       | —          |       | 65                               |       | 65               |       |
| Stamp duty tax                                      |       | —                     |       | —                   |       | —          |       | 3,980                            |       | 3,980            |       |
| Foreign exchange loss (gain)                        |       | 130                        |       | —                   |       | (155            | )          | 3,650                            |       | 3,625            |       |
| Total Adjusted EBITDA                               |       | $                          | 46,630     |                     | $          | 8,221           |       | $                                | 7,392      |             | $          | (4,102 | ) | $ | 58,141 |   |
|                                                |       |                       |       |                     |       |            |       |                             |       |             |       |
| **Three months ended June 30, 2003**                |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net income (loss)                                   |       | $                          | 19,797     |                     | $          | 5,958           |       | $                                | 2,788      |             | $          | (26,291 | ) | $ | 2,252 |   |
| Income tax (benefit) provision                      |       | (1,042                     | )          | (1,172                   | )          | 662             |       | 2,519                            |       | 967              |       |
| Interest, net                                       |       | 7,936                      |       | (70                      | )          | 1,730           |       | 12,787                           |       | 22,383           |       |
| Depreciation and amortization                       |       | 6,522                      |       | 1,257                    |       | 4,365           |       | 520                              |       | 12,664           |       |
| Restructuring and related charges                   |       | 148                        |       | 399                      |       | 193             |       | —                           |       | 740              |       |
| Systems/organization establishment expenses         |       | —                     |       | —                   |       | —          |       | 372                              |       | 372              |       |
| Cancelled acquisition and disposal costs            |       | —                     |       | —                   |       | 371             |       | 142                              |       | 513              |       |
| Business interruption costs and insurance  recovery |       | —                     |       | —                   |       | (4,532          | )          | —                           |       | (4,532           | )          |
| Foreign exchange loss (gain)                        |       | 5                          |       | 79                       |       | 11              |       | 6,549                            |       | 6,644            |       |
| Total Adjusted EBITDA                               |       | $                          | 33,366     |                     | $          | 6,451           |       | $                                | 5,588      |             | $          | (3,402 | ) | $ | 42,003 |   |
|                                                |       |                       |       |                     |       |            |       |                             |       |             |       |
| **Six months ended June 30, 2004**                  |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net income (loss)                                   |       | $                          | 31,845     |                     | $          | 8,383           |       | $                                | 1,624      |             | $          | (16,018 | ) | $ | 25,834 |   |
| Income tax (benefit) provision                      |       | 19,429                     |       | 3,999                    |       | 1,196           |       | (5,031                           | )          | 19,593           |       |
| Interest, net                                       |       | 14,575                     |       | (154                     | )          | 2,848           |       | 11,818                           |       | 29,087           |       |
| Depreciation and amortization                       |       | 14,129                     |       | 2,755                    |       | 10,297          |       | 990                              |       | 28,171           |       |
| Restructuring and related charges                   |       | —                     |       | 14                       |       | 41              |       | —                           |       | 55               |       |
| Systems/organization establishment expenses         |       | —                     |       | —                   |       | —          |       | 1,068                            |       | 1,068            |       |
| Cancelled acquisition and disposal costs            |       | —                     |       | —                   |       | —          |       | 65                               |       | 65               |       |
| Stamp duty tax                                      |       | —                     |       | —                   |       | —          |       | 3,980                            |       | 3,980            |       |
| Foreign exchange loss (gain)                        |       | (1,294                     | )          | —                   |       | (1,974          | )          | (5,364                           | )          | (8,632           | )          |
| Total Adjusted EBITDA                               |       | $                          | 78,684     |                     | $          | 14,997          |       | $                                | 14,032     |             | $          | (8,492 | ) | $ | 99,221 |   |
|                                                |       |                       |       |                     |       |            |       |                             |       |             |       |
| **Six months ended June 30, 2003**                  |       |                       |       |                     |       |            |       |                             |       |             |       |
| Net income (loss)                                   |       | $                          | 23,840     |                     | $          | 9,428           |       | $                                | 2,947      |             | $          | (47,238 | ) | $ | (11,023 | ) |
| Income tax (benefit) provision                      |       | 691                        |       | 315                      |       | 730             |       | (6,459                           | )          | (4,723           | )          |
| Interest, net                                       |       | 15,156                     |       | (143                     | )          | 3,356           |       | 24,787                           |       | 43,156           |       |
| Depreciation and amortization                       |       | 12,745                     |       | 2,477                    |       | 8,464           |       | 1,040                            |       | 24,726           |       |
| Restructuring and related charges                   |       | 328                        |       | 415                      |       | 292             |       | —                           |       | 1,035            |       |
| Systems/organization establishment expenses         |       | —                     |       | —                   |       | —          |       | 744                              |       | 744              |       |
| Cancelled acquisition and disposal costs            |       | —                     |       | —                   |       | 406             |       | 196                              |       | 602              |       |
| Business interruption costs and insurance  recovery |       | —                     |       | —                   |       | (4,532          | )          | —                           |       | (4,532           | )          |
| Inventory write-up reversal                         |       | 143                        |       | —                   |       | —          |       | —                           |       | 143              |       |
| Foreign exchange loss (gain)                        |       | 13                         |       | (18                      | )          | 120             |       | 20,101                           |       | 20,216           |       |
| Total Adjusted EBITDA                               |       | $                          | 52,916     |                     | $          | 12,474          |       | $                                | 11,783     |             | $          | (6,829 | ) | $ | 70,344 |   |

 

A significant adjustment in arriving at Adjusted EBITDA is foreignexchange loss (gain).  The Company hasrecorded foreign exchange losses and (gains) reflecting the non-cash impact ofremeasuring its euro-denominated debt. Such losses (gains) resulted from the(weakening) strengthening euro against the U.S. dollar during the applicableperiods. The current year amount also includes the impact of currencyfluctuations on cash balances denominated in a currency different than theapplicable local currency and a mark-to-market loss of $2,878 during thequarter ended June 30, 2004 on the call options related to the DN Acquisition.See Note 8 for a more complete description of the DN Acquisition and relatedcall options.

 

Systems/organization establishment expenses include costs that arose inconnection with the KKR Acquisition and

 

9

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Rockwood’s resulting organization as a stand-alone company andprimarily relate to the amortization of sign-on compensation arrangements forkey executives. These are reflected in the “corporate costs and eliminations”column when the Company’s results are presented on a segment basis. For thethree and six months ended June 30, 2004, systems/organization establishmentexpenses also include certain costs in connection with the integration of theDN Acquisition (See Note 8) as well as professional fees incurred regardingsystems and internal control documentation in connection with theSarbanes-Oxley Act of 2002.

 

The Stamp Duty tax is a tax on certain assets transferred in the UnitedKingdom in connection with the KKR Acquisition.

 

**3. INVENTORIES:**

 

Inventories are comprised of the following:

 

| ** **          | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------|------------|--------------------|------------|------------------------|------------|
|                |       |               |       |                   |       |
| Raw materials       |       | $                  | 26,506     |                   | $          | 26,821 |   |
| Work-in-process     |       | 2,951              |       | 3,203                  |       |
| Finished goods      |       | 50,405             |       | 49,967                 |       |
| Packaging materials |       | 7,600              |       | 7,788                  |       |
|                |       | $                  | 87,462     |                   | $          | 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           |       | (1,594                     | )          | (408                     | )          | 444             |       | (1,558    | )          |
| Other                      |       | 7                          |       | —                   |       | 148             |       | 155       |       |
| Balance, June 30, 2004     |       | $                          | 449,336    |                     | $          | 109,894         |       | $         | 123,255    |   | $ | 682,485 |   |

 

**5. OTHER INTANGIBLE ASSETS:**

 

Other intangible assets, net consist of:

 
| ** **                               | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------|------------|--------------------|------------|------------------------|------------|
| Patents                                  |       | $                  | 40,229     |                   | $          | 41,388 |   |
| Less accumulated amortization            |       | (19,871            | )          | (17,571                | )          |
| Patents, net                             |       | 20,358             |       | 23,817                 |       |
| Internally developed software costs      |       | 2,122              |       | 2,083                  |       |
| Less accumulated amortization            |       | (1,140             | )          | (870                   | )          |
| Internally developed software costs, net |       | 982                |       | 1,213                  |       |
| Other, net                               |       | 473                |       | 642                    |       |
| Other intangible assets, net             |       | $                  | 21,813     |                   | $          | 25,672 |   |

 

Amortization of other intangible assets was $1,616 and $1,702 for the threemonths ended June 30, 2004 and 2003, respectively, and  $3,262 and $3,098 for the six months endedJune 30, 2004 and 2003, respectively.

 

10

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

 

The following represents the net periodicpension benefit costs and related components in accordance with SFAS 132:

 
| ** **                                  | ** ** | **Three months  ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Service cost                                |       | $                                | 426        |                           | $          | 285 |   | $ | 744 |   | $ | 570 |   |
| Interest cost                               |       | 674                              |       | 494                            |       | 1,319 |   | 988 |   |
| Expected return on plan assets              |       | (478                             | )          | (377                           | )          | (951 | ) | (754 | ) |
| Net amortization of prior experience losses |       | 150                              |       | 59                             |       | 300 |   | 118 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Net periodic benefit cost                   |       | $                                | 772        |                           | $          | 461 |   | $ | 1,412 |   | $ | 922 |   |

 

**7.             CONTINGENCIES:**

 

***Legal Proceedings***—TheCompany is involved in various legal proceedings, including product liabilityand environmental matters of a nature considered normal to its business. It isthe Company’s policy to accrue for amounts related to these matters, inaccordance with SFAS 5, *Accounting forContingencies*, if it is probable that a liability has been incurredand an amount can be reasonably estimated. It is the Company’s policy todisclose such matters when there is at least a reasonable possibility that amaterial loss may have been incurred.

 

***Indemnity Matters***—Underthe terms of the Business and Share Sale and Purchase Agreement, the Deed ofTax Covenant and the Environmental Deed entered into in connection with the KKRAcquisition, Degussa UK Holdings Ltd., as successor to the Seller, is obligatedto indemnify the Company for certain legal, tax and environmental liabilitiesand obligations that relate to the period prior to the closing of the KKRAcquisition. In the opinion of management, and based upon information currentlyavailable, the ultimate resolution of any indemnification claims will not havea material effect on the Company’s financial condition or results ofoperations.

 

***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.

 

11

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**8.             SUBSEQUENTEVENTS:**

 

***DN Acquisition***—OnJuly 31, 2004, the Company completed the acquisition of four businesses ofDynamit Nobel from mg technologies ag. The businesses are focused on highlyspecialized markets and consist of: white pigments; surface treatment andlithium chemicals; ceramics; and pharmaceutical intermediates. At the sametime, the Company refinanced all outstanding borrowings under its then existingsenior secured credit facilities.

 

Approximatesources and uses of funds are as follows:

 
| **SOURCES:**                                                                                                                  |   |      |      |
|-------------------------------------------------------------------------------------------------------------------------------|--------|-----------|-----------|
| ***Stockholders’  equity***                                                                                              |   |      |      |
| Capital contributions from affiliates of  KKR and affiliates of CSFB to Holdings                                              |   | $         | 425,000   |   |
| Less repayment of RSCI PIK Notes                                                                                              |   | (21,000   | )         |
| Net capital contributed to Rockwood                                                                                           |   | 404,000   |      |
|                                                                                                                          |   |      |      |
| ***Long term debt  (excludes assumed DN debt of $162,000)***                                                                  |   |      |      |
| 2004 Senior Credit Facilities (excludes  $50,000 Term Loan and $250,000 revolving credit facility undrawn at July 31,  2004): |   |      |      |
| Term Loan A                                                                                                                   |   | $         | 202,000   |   |
| Term Loan B                                                                                                                   |   | 985,000   |      |
| Term Loan C                                                                                                                   |   | 267,000   |      |
| 2004 Senior Subordinated Loan Facility                                                                                        |   | 855,000   |      |
|                                                                                                                          |   | 2,309,000 |      |
|                                                                                                                          |   |      |      |
| ***Existing Cash  utilized***                                                                                                 |   | 49,000    |      |
|                                                                                                                          |   |      |      |
|                                                                                                                          |   | $         | 2,762,000 |   |
|                                                                                                                          |   |      |      |
| **USES:**                                                                                                                     |   |      |      |
| Repayment of 2003 Senior Credit Facilities                                                                                    |   | $         | 442,000   |   |
| Purchase price (subject to adjustment) of  net assets of DN businesses                                                        |   | 1,969,000 |      |
| Assumed DN debt to be repaid at or shortly  after closing                                                                     |   | 191,000   |      |
| Cash settlement of derivative transactions  related to DN Acquisition                                                         |   | 20,000    |      |
| Estimated transaction costs                                                                                                   |   | 70,000    |      |
| Estimated financing costs                                                                                                     |   | 70,000    |      |
|                                                                                                                          |   |      |      |
|                                                                                                                          |   | $         | 2,762,000 |   |

 

Under the 2004 Senior Credit Facilities, Term Loans A and B as well asthe revolving credit facility generally bear interest at an annual rate ofLIBOR + 2.5%.  Term Loan C generally hasan annual interest rate of LIBOR + 3.0%. Term Loan A is payable in January and July of each year at escalatingpercentages of the original principal amount with a final maturity date of July2011. Term Loans B and C are payable in January and July of each year atamounts equal to 0.5% of the original principal balance, with the remainder dueat the final maturity date of July 2012. At July 31, 2004 the Company hadno principal outstanding and approximately $15,000 of standby letters of creditoutstanding under the revolving credit facility, which has a final maturitydate of July 2010. In connection with the DN Acquisition, the Company assumed certainstandby letters of credit and comparable obligations. Many of these obligationswill have to be renewed upon expiration and will then reduce availability underthe revolving credit facility.

 

Similar to the 2003 Senior Credit Facilities, the 2004 Senior CreditFacilities are subject to certain financial covenants including the requirementof a maximum debt to earnings before interest, taxes, depreciation, andamortization and other items, as defined (“EBITDA”), ratio, and a minimumEBITDA to interest expense ratio, all as defined therein. The 2004 SeniorCredit Facilities also contains certain restrictions on the ability of theCompany to, among other things: incur indebtedness; merge or consolidate;dispose of assets; make investments or capital expenditures; pay dividends andmake payments to shareholders; make payments on certain indebtedness; and enterinto sale leaseback transactions. In addition, the term loans have been andwill continue to be subject to

 

12

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mandatory prepayment upon certain conditions as defined therein. The2004 Senior Credit Facilities borrowings are collateralized by substantiallyall of the assets and equity of Rockwood and its US subsidiaries as well as byassets and a portion of equity of certain non-US subsidiaries. Additionally,these borrowings are guaranteed by Rockwood SpecialtiesInternational, Inc., Rockwood’s immediate parent.

 

The 2004 SeniorSubordinated Loan Facility is due in 2014; provided however, in the event theexisting 10 5/8% senior subordinated notes (the “10 5/8% Notes”) have not beenrefinanced or repaid in full, the 2004 Senior Subordinated Loan Facility willbe due February 2011. The 2004 Senior Subordinated Loan is *pari passu* to Rockwood’s existing 10 5/8%Notes, with initial interest at a rate equal to the greater of 9.0% and LIBOR +7% (in the case of euro borrowings) or LIBOR + 8% (in the case of dollarborrowings) annually with a 75 basis point increase every six months for thefirst 18 months. If the 2004 Senior Subordinated Loan Facility is notrefinanced within 18 months, the interest rate will be 14.5%, of which 12.0%(12.5% under certain circumstances) is payable in cash with the remainderpayable in-kind at the Company’s option. All other terms are comparable to the Company’s 10 5/8% Notes.

 

$974,000 ofthe debt outstanding as a result of the 2004 Financing are denominated ineuros, using exchange rates in effect on July 31, 2004. In order to mitigatethe effect of any exchange rate changes which may have taken place prior to theclosing of the DN Acquisition (and its related 2004 Financing), the Companyentered into call options, permitting it to purchase up to €750,000 at a priceof $1.225 per euro. Rockwood recorded a mark-to-market loss of $2,878 duringthe quarter ended June 30, 2004 on the call options. The options expired unexercisedand the Company recorded an additional loss of $8,082 in the third quarter of2004. The Company also entered into a forward contract in July to purchase€1,057,000 at a fixed U.S. dollar rate related to the 2004 Financing, which wasutilized to pay for a portion of the purchase price at closing. The Companywill record a charge of approximately $4,000 in the third quarter on thiscontract.

 

Financing costs will becapitalized and amortized using the effective interest rate method over theterm of the debt outstanding under the 2004 Financing. Acquisition costs willbe capitalized into the overall cost of the DN Acquisition. Rockwood willrecord a write-off in the third quarter of 2004 of $1,831 of unamortized feesthat had been capitalized as part of the 2003 Refinancing for loans repaidunder the 2004 Financing.

 

Approximately $21,500 ofthe transaction and financing fees were paid to KKR or its affiliates andapproximately $34,500 to CSFB or its affiliates. Effective with the DNAcquisition, KKR and CSFB have agreed to provide Rockwood consulting andmanagement advisory services for an aggregate annual fee of $2,000, whichamount will be increased by 5% each year.

 

In July 2004, Rockwood agreed to acquire the Pigments and Dispersionsbusiness of Johnson Matthey Plc (“JM”) for approximately $48,000 (subject topost-closing adjustment).  Subject toregulatory clearance, Rockwood expects to complete this acquisition during thethird quarter of 2004.  Rockwood willutilize the remaining $50,000 of undrawn funds from the term loan portion ofthe 2004 Senior Credit Facilities to finance this transaction.

 

13

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**9.             CONSOLIDATINGFINANCIAL INFORMATION:**

 

As described in the Company’s 2003 10-K, the Company issued the 10 5/8%Notes in July 2003.  The followingunaudited consolidating financial statements present the results of operations,financial condition and cash flows, in separate columns, of the parent company(Rockwood Specialties Group, Inc.) which is the issuer of the 10 5/8%Notes, guarantor subsidiaries, non-guarantor subsidiaries, eliminationadjustments, and consolidated totals.

 

**ROCKWOOD SPECIALTIES GROUP INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF OPERATIONS**

**THREE MONTHS ENDED JUNE 30, 2004**

 
| ** **                                    | ** ** | **Parent Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| NET SALES                                     |       | $                  | —     |                        | $          | 183,084                         |       | $                | 83,885     |   | $ | 266,969 |   |
| COST OF PRODUCTS SOLD                         |       | —             |       | 124,508                     |       | 63,876                          |       | 188,384          |       |
| GROSS PROFIT                                  |       | —             |       | 58,576                      |       | 20,009                          |       | 78,585           |       |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |       | 50                 |       | 24,442                      |       | 11,385                          |       | 35,877           |       |
| RESTRUCTURING CHARGE, net                     |       | —             |       | 14                          |       | 41                              |       | 55               |       |
| OPERATING (LOSS) INCOME                       |       | (50                | )          | 34,120                      |       | 8,583                           |       | 42,653           |       |
| OTHER INCOME (EXPENSES):                      |       |               |       |                        |       |                            |       |             |       |
| Intergroup interest, net                      |       | 13,418             |       | (12,557                     | )          | (861                            | )          | —           |       |
| Interest, net                                 |       | (9,829             | )          | (412                        | )          | (2,200                          | )          | (12,441          | )          |
| Intergroup other, net                         |       | —             |       | (770                        | )          | 770                             |       | —           |       |
| Foreign exchange gain (loss), net             |       | (2,871             | )          | (19                         | )          | (735                            | )          | (3,625           | )          |
| Other, net                                    |       | —             |       | —                      |       | (3,980                          | )          | (3,980           | )          |
| Net                                           |       | 718                |       | (13,758                     | )          | (7,006                          | )          | (20,046          | )          |
| INCOME BEFORE TAXES                           |       | 668                |       | 20,362                      |       | 1,577                           |       | 22,607           |       |
| INCOME TAX PROVISION                          |       | 267                |       | 8,197                       |       | 3,321                           |       | 11,785           |       |
| NET INCOME (LOSS)                             |       | $                  | 401        |                        | $          | 12,165                          |       | $                | (1,744     | ) | $ | 10,822 |   |

 

**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF OPERATIONS**

**THREE MONTHS ENDED JUNE 30, 2003**

 
| ** **                                    | ** ** | **Parent Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| NET SALES                                     |       | $                  | —     |                        | $          | 141,178                         |       | $                | 71,519     |   | $ | 212,697 |   |
| COST OF PRODUCTS SOLD                         |       | —             |       | 98,577                      |       | 54,154                          |       | 152,731          |       |
| GROSS PROFIT                                  |       | —             |       | 42,601                      |       | 17,365                          |       | 59,966           |       |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |       | 50                 |       | 21,385                      |       | 5,545                           |       | 26,980           |       |
| RESTRUCTURING CHARGE, net                     |       | —             |       | 740                         |       | —                          |       | 740              |       |
| OPERATING (LOSS) INCOME                       |       | (50                | )          | 20,476                      |       | 11,820                          |       | 32,246           |       |
| OTHER INCOME (EXPENSES):                      |       |               |       |                        |       |                            |       |             |       |
| Intergroup interest, net                      |       | 14,456             |       | (13,633                     | )          | (823                            | )          | —           |       |
| Interest, net                                 |       | (17,995            | )          | 18                          |       | (4,406                          | )          | (22,383          | )          |
| Intergroup other, net                         |       | —             |       | (522                        | )          | 522                             |       | —           |       |
| Foreign exchange gain (loss), net             |       | (5,254             | )          | (300                        | )          | (1,090                          | )          | (6,644           | )          |
| Net                                           |       | (8,793             | )          | (14,437                     | )          | (5,797                          | )          | (29,027          | )          |
| (LOSS) INCOME BEFORE TAXES                    |       | (8,843             | )          | 6,039                       |       | 6,023                           |       | 3,219            |       |
| INCOME TAX (BENEFIT) PROVISION                |       | (2,653             | )          | 1,812                       |       | 1,808                           |       | 967              |       |
| NET (LOSS) INCOME                             |       | $                  | (6,190     | )                           | $          | 4,227                           |       | $                | 4,215      |   | $ | 2,252 |   |

 

14

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**ROCKWOOD SPECIALTIES GROUP INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF OPERATIONS**

**SIX MONTHS ENDED JUNE 30, 2004**

 
| ** **                                    | ** ** | **Parent Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| NET SALES                                     |       | $                  | —     |                        | $          | 331,410                         |       | $                | 162,929    |   | $ | 494,339 |   |
| COST OF PRODUCTS SOLD                         |       | —             |       | 227,634                     |       | 125,732                         |       | 353,366          |       |
| GROSS PROFIT                                  |       | —             |       | 103,776                     |       | 37,197                          |       | 140,973          |       |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |       | 100                |       | 47,961                      |       | 22,995                          |       | 71,056           |       |
| RESTRUCTURING CHARGE, net                     |       | —             |       | 14                          |       | 41                              |       | 55               |       |
| OPERATING (LOSS) INCOME                       |       | (100               | )          | 55,801                      |       | 14,161                          |       | 69,862           |       |
| OTHER INCOME (EXPENSES):                      |       |               |       |                        |       |                            |       |             |       |
| Intergroup interest, net                      |       | 27,770             |       | (26,020                     | )          | (1,750                          | )          | —           |       |
| Interest, net                                 |       | (23,296            | )          | (639                        | )          | (5,152                          | )          | (29,087          | )          |
| Intergroup other, net                         |       | —             |       | (913                        | )          | 913                             |       | —           |       |
| Foreign exchange gain (loss), net             |       | (3,012             | )          | (12                         | )          | 11,656                          |       | 8,632            |       |
| Other, net                                    |       | —             |       | —                      |       | (3,980                          | )          | (3,980           | )          |
| Net                                           |       | 1,462              |       | (27,584                     | )          | 1,687                           |       | (24,435          | )          |
| INCOME BEFORE TAXES                           |       | 1,362              |       | 28,217                      |       | 15,848                          |       | 45,427           |       |
| INCOME TAX PROVISION                          |       | 545                |       | 11,732                      |       | 7,316                           |       | 19,593           |       |
| NET INCOME                                    |       | $                  | 817        |                        | $          | 16,485                          |       | $                | 8,532      |   | $ | 25,834 |   |

 

**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF OPERATIONS**

**SIX MONTHS ENDED JUNE 30, 2003**

 
| ** **                                    | ** ** | **Parent Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| NET SALES                                     |       | $                  | —     |                        | $          | 255,353                         |       | $                | 137,499    |   | $ | 392,852 |   |
| COST OF PRODUCTS SOLD                         |       | —             |       | 181,860                     |       | 104,979                         |       | 286,839          |       |
| GROSS PROFIT                                  |       | —             |       | 73,493                      |       | 32,520                          |       | 106,013          |       |
| SELLING, GENERAL AND ADMINISTRATIVE  EXPENSES |       | 110                |       | 42,030                      |       | 15,212                          |       | 57,352           |       |
| RESTRUCTURING CHARGE, net                     |       | —             |       | 1,035                       |       | —                          |       | 1,035            |       |
| OPERATING INCOME (LOSS)                       |       | (110               | )          | 30,428                      |       | 17,308                          |       | 47,626           |       |
| OTHER INCOME (EXPENSES):                      |       |               |       |                        |       |                            |       |             |       |
| Intergroup interest, net                      |       | 28,525             |       | (26,895                     | )          | (1,630                          | )          | —           |       |
| Interest, net                                 |       | (34,655            | )          | 17                          |       | (8,518                          | )          | (43,156          | )          |
| Intergroup other, net                         |       | —             |       | (1,146                      | )          | 1,146                           |       | —           |       |
| Foreign exchange gain (loss), net             |       | (9,140             | )          | (6                          | )          | (11,070                         | )          | (20,216          | )          |
| Net                                           |       | (15,270            | )          | (28,030                     | )          | (20,072                         | )          | (63,372          | )          |
| INCOME (LOSS) BEFORE TAXES                    |       | (15,380            | )          | 2,398                       |       | (2,764                          | )          | (15,746          | )          |
| INCOME TAX (BENEFIT) PROVISION                |       | (4,614             | )          | 720                         |       | (829                            | )          | (4,723           | )          |
| NET (LOSS) INCOME                             |       | $                  | (10,766    | )                           | $          | 1,678                           |       | $                | (1,935     | ) | $ | (11,023 | ) |

 

15

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING BALANCE SHEET**

**JUNE 30, 2004**

 
| ** **                                      | ** ** | **Parent Company** | ** ** | **Guarantor Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|----------------------------|------------|--------------------------------|------------|------------------|------------|------------------|------------|
| **ASSETS**                                      |       |               |       |                       |       |                           |       |             |       |             |       |
| CURRENT ASSETS:                                 |       |               |       |                       |       |                           |       |             |       |             |       |
| Cash and cash equivalents                       |       | $                  | (27,961    | )                          | $          | 89,569                         |       | $                | 6,670      |             | $          | — |   | $ | 68,278 |   |
| Accounts receivable, net                        |       | —             |       | 91,691                     |       | 68,799                         |       | —           |       | 160,490          |       |
| Inventories                                     |       | —             |       | 46,648                     |       | 40,814                         |       | —           |       | 87,462           |       |
| Deferred income taxes                           |       | (933               | )          | 2,782                      |       | 1,911                          |       | —           |       | 3,760            |       |
| Prepaid expenses and other                      |       | —             |       | 12,338                     |       | 3,948                          |       | —           |       | 16,286           |       |
| Total current assets                            |       | (28,894            | )          | 243,028                    |       | 122,142                        |       | —           |       | 336,276          |       |
| PROPERTY, PLANT AND EQUIPMENT, net              |       | 2                  |       | 185,911                    |       | 218,706                        |       | —           |       | 404,619          |       |
| INVESTMENT IN SUBSIDIARIES                      |       | 660,412            |       | —                     |       | —                         |       | (660,412         | )          | —           |       |
| GOODWILL                                        |       | —             |       | 363,959                    |       | 318,526                        |       | —           |       | 682,485          |       |
| INTERGROUP RECEIVABLE                           |       | 586,899            |       | 565,842                    |       | 64,545                         |       | (1,217,286       | )          | —           |       |
| OTHER INTANGIBLE ASSETS, net                    |       | —             |       | 4,523                      |       | 17,290                         |       | —           |       | 21,813           |       |
| DEFERRED DEBT ISSUANCE COSTS, net               |       | 2,197              |       | 8,681                      |       | 2,268                          |       | —           |       | 13,146           |       |
| OTHER ASSETS                                    |       | —             |       | 10,468                     |       | 285                            |       | —           |       | 10,753           |       |
| TOTAL ASSETS                                    |       | $                  | 1,220,616  |                       | $          | 1,382,412                      |       | $                | 743,762    |             | $          | (1,877,698 | ) | $ | 1,469,092 |   |
|                                            |       |               |       |                       |       |                           |       |             |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**   |       |               |       |                       |       |                           |       |             |       |             |       |
| CURRENT LIABILITIES:                            |       |               |       |                       |       |                           |       |             |       |             |       |
| Accounts payable                                |       | $                  | —     |                       | $          | 59,573                         |       | $                | 50,146     |             | $          | — |   | $ | 109,719 |   |
| Income taxes payable                            |       | (577               | )          | (1,385                     | )          | 15,380                         |       | —           |       | 13,418           |       |
| Accrued expenses and other liabilities          |       | 10,442             |       | 40,702                     |       | 18,635                         |       | —           |       | 69,779           |       |
| Long-term debt, current portion                 |       | 2,697              |       | —                     |       | 8,795                          |       | —           |       | 11,492           |       |
| Total current liabilities                       |       | 12,562             |       | 98,890                     |       | 92,956                         |       | —           |       | 204,408          |       |
| LONG-TERM DEBT                                  |       | 640,685            |       | —                     |       | 170,422                        |       | —           |       | 811,107          |       |
| INTERGROUP PAYABLE                              |       | 13,750             |       | 1,073,343                  |       | 130,193                        |       | (1,217,286       | )          | —           |       |
| DEFERRED INCOME TAXES                           |       | (29,610            | )          | 31,491                     |       | 18,008                         |       | —           |       | 19,889           |       |
| OTHER LIABILITIES                               |       | 17,975             |       | 23,448                     |       | 22,532                         |       | 94               |       | 64,049           |       |
| Total liabilities                               |       | 655,362            |       | 1,227,172                  |       | 434,111                        |       | (1,217,192       | )          | 1,099,453        |       |
| STOCKHOLDERS’ EQUITY:                      |       |               |       |                       |       |                           |       |             |       |             |       |
| Common stock                                    |       | 4                  |       | 190,606                    |       | 70,037                         |       | (260,643         | )          | 4                |       |
| Paid-in capital                                 |       | 478,331            |       | 135,849                    |       | 253,546                        |       | (399,863         | )          | 467,863          |       |
| Accumulated other comprehensive income  (loss)  |       | 16,539             |       | (3,092                     | )          | 63,604                         |       | —           |       | 77,051           |       |
| Accumulated deficit                             |       | 70,380             |       | (168,123                   | )          | (77,536                        | )          | —           |       | (175,279         | )          |
| Total stockholders’ equity                 |       | 565,254            |       | 155,240                    |       | 309,651                        |       | (660,506         | )          | 369,639          |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |       | $                  | 1,220,616  |                       | $          | 1,382,412                      |       | $                | 743,762    |             | $          | (1,877,698 | ) | $ | 1,469,092 |   |

 

16

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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 |   |

 

17

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF CASH FLOWS**

**SIX MONTHS ENDED JUNE 30, 2004**

 
| ** **                                                                                              | ** ** | **Parent Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                   |       |               |       |                        |       |                            |       |             |       |
| Net income                                                                                              |       | $                  | 817        |                        | $          | 16,485                          |       | $                | 8,532      |   | $ | 25,834 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                      |       |               |       |                        |       |                            |       |             |       |
| Depreciation and amortization                                                                           |       | —             |       | 11,794                      |       | 16,377                          |       | 28,171           |       |
| Deferred financing costs amortization                                                                   |       | 138                |       | 641                         |       | 157                             |       | 936              |       |
| Foreign exchange (gain) loss                                                                            |       | 3,012              |       | 12                          |       | (11,656                         | )          | (8,632           | )          |
| Fair value adjustments of derivatives                                                                   |       | (6,656             | )          | —                      |       | (1,980                          | )          | (8,636           | )          |
| Bad debt provision                                                                                      |       | —             |       | 900                         |       | 35                              |       | 935              |       |
| Deferred income taxes                                                                                   |       | 545                |       | 11,732                      |       | —                          |       | 12,277           |       |
| Changes in assets and liabilities, net of  the effect of foreign currency translation and acquisitions: |       |               |       |                        |       |                            |       |             |       |
| Accounts receivable                                                                                     |       | —             |       | (13,699                     | )          | (9,893                          | )          | (23,592          | )          |
| Inventories                                                                                             |       | —             |       | 949                         |       | (1,181                          | )          | (232             | )          |
| Prepaid expenses and other assets                                                                       |       | (280               | )          | (47                         | )          | (34                             | )          | (361             | )          |
| Accounts payable                                                                                        |       | —             |       | 6,789                       |       | 4,965                           |       | 11,754           |       |
| Income taxes payable                                                                                    |       | —             |       | (1,472                      | )          | 3,261                           |       | 1,789            |       |
| Accrued expenses and other liabilities                                                                  |       | 18,961             |       | (16,665                     | )          | 2,167                           |       | 4,463            |       |
| Net cash provided by operating activities                                                               |       | 16,537             |       | 17,419                      |       | 10,750                          |       | 44,706           |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   |       |               |       |                        |       |                            |       |             |       |
| Capital expenditures                                                                                    |       | —             |       | (7,069                      | )          | (6,248                          | )          | (13,317          | )          |
| Sale of property, plant and equipment                                                                   |       | —             |       | 6                           |       | 27                              |       | 33               |       |
| Net cash used in investing activities                                                                   |       | —             |       | (7,063                      | )          | (6,221                          | )          | (13,284          | )          |
| 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                                                                 |       | —             |       | —                      |       | (1,314                          | )          | (1,314           | )          |
| NET INCREASE  IN CASH AND CASH EQUIVALENTS                                                         |       | 15,189             |       | 10,356                      |       | 36                              |       | 25,581           |       |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD                                                         |       | (43,150            | )          | 79,213                      |       | 6,634                           |       | 42,697           |       |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                |       | $                  | (27,961    | )                           | $          | 89,569                          |       | $                | 6,670      |   | $ | 68,278 |   |

 

18

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**ROCKWOOD SPECIALTIES GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATING STATEMENT OF CASH FLOWS**

**SIX MONTHS ENDED JUNE 30, 2003**

 
| ** **                                                                                              | ** ** | **Parent Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                   |       |               |       |                        |       |                            |       |             |       |
| Net (loss) income                                                                                       |       | $                  | (10,766    | )                           | $          | 1,678                           |       | $                | (1,935     | ) | $ | (11,023 | ) |
| Adjustments to reconcile net (loss) income  to net cash (used in) provided by operating activities:     |       |               |       |                        |       |                            |       |             |       |
| Depreciation and amortization                                                                           |       | —             |       | 11,213                      |       | 13,513                          |       | 24,726           |       |
| Deferred financing costs amortization                                                                   |       | 2,549              |       | —                      |       | 549                             |       | 3,098            |       |
| Foreign exchange loss                                                                                   |       | 9,273              |       | —                      |       | 11,276                          |       | 20,549           |       |
| Fair value adjustments of derivatives                                                                   |       | 1,147              |       | —                      |       | 1,105                           |       | 2,252            |       |
| Bad debt provision                                                                                      |       | —             |       | 56                          |       | 140                             |       | 196              |       |
| Changes in assets and liabilities, net of  the effect of foreign currency translation and acquisitions: |       |               |       |                        |       |                            |       |             |       |
| Accounts receivable                                                                                     |       | —             |       | (5,495                      | )          | (8,613                          | )          | (14,108          | )          |
| Inventories                                                                                             |       | —             |       | (1,230                      | )          | 842                             |       | (388             | )          |
| Prepaid expenses and other assets                                                                       |       | —             |       | (2,681                      | )          | 726                             |       | (1,955           | )          |
| Accounts payable                                                                                        |       | —             |       | 10,858                      |       | (1,502                          | )          | 9,356            |       |
| Income taxes payable                                                                                    |       | (4,641             | )          | 189                         |       | (7,305                          | )          | (11,757          | )          |
| Accrued expenses and other liabilities                                                                  |       | (77,827            | )          | 57,467                      |       | 2,810                           |       | (17,550          | )          |
| Net cash (used in) provided by operating  activities                                                    |       | (80,265            | )          | 72,055                      |       | 11,606                          |       | 3,396            |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   |       |               |       |                        |       |                            |       |             |       |
| Acquisitions, net of cash acquired                                                                      |       | —             |       | (12,465                     | )          | —                          |       | (12,465          | )          |
| Capital expenditures                                                                                    |       | —             |       | (6,391                      | )          | (9,669                          | )          | (16,060          | )          |
| 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                                                                   |       | —             |       | (18,685                     | )          | (6,388                          | )          | (25,073          | )          |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                   |       |               |       |                        |       |                            |       |             |       |
| Payments on long-term debt                                                                              |       | (8,259             | )          | —                      |       | (6,047                          | )          | (14,306          | )          |
| Proceeds from long-term debt                                                                            |       | 8,000              |       | —                      |       | —                          |       | 8,000            |       |
| Net cash provided by financing activities                                                               |       | (259               | )          | —                      |       | (6,047                          | )          | (6,306           | )          |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                 |       | —             |       | —                      |       | 3,532                           |       | 3,532            |       |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                                                   |       | (80,524            | )          | 53,370                      |       | 2,703                           |       | (24,451          | )          |
| CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD                                                         |       | 42,392             |       | (1,738                      | )          | 2,242                           |       | 42,896           |       |
| CASH AND CASH EQUIVALENTS, END OF PERIOD                                                                |       | $                  | (38,132    | )                           | $          | 51,632                          |       | $                | 4,945      |   | $ | 18,445 |   |

 

19

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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 report. In this section, unless we indicate otherwiseor the context otherwise requires, any references to “we,”“our,” and “us” referto Rockwood Specialties Group, Inc. and its consolidated subsidiaries.*

 

**General**

 

We are a global developer, manufacturer and marketer of highvalue-added specialty chemicals and performance materials in our specificmarkets. We serve customers across a wide variety of industries and geographicareas. As of June 30, 2004, we operated through three business segments:(i) Performance Additives; (ii) Specialty Compounds; and(iii) Electronics, which generated approximately 63.2%, 20.3% and 16.5%,respectively, of our net sales for the six months ended June 30, 2004, and79.3%, 15.1% and 14.1%, respectively, of our Adjusted EBITDA for the six monthsended June 30, 2004 with corporate costs and eliminations representing (8.5%)of such Adjusted EBITDA, and 92.4%, 17.5% and 5.3%, respectively, of ouroperating income for the six months ended June 30, 2004, with corporate costsand eliminations representing (15.2%) of such operating income. Our seniormanagement uses Adjusted EBITDA as the primary measure to evaluate our ongoingfinancial performance. In addition, management uses Adjusted EBITDA on aconsolidated basis as the most significant criterion in the calculation ofperformance-based cash bonuses. We believe this financial measure on aconsolidated basis is helpful in highlighting trends in our overall businessbecause Adjusted EBITDA excludes those items that have little or no bearing onour day-to-day operating performance. See “Adjustments from Net income (loss)to Adjusted EBITDA” for a detailed discussion of this measure as well as areconciliation of net income (loss) to such measure.

 

**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 wood treatment chemical productsand the phase out of chromated copper arsenate (“CCA”) wood treatment productsfor residential use has had a positive impact on our Timber Treatment Chemicalsbusiness, which is a leading supplier of such products. This trend has helpedour Timber Treatment Chemicals business increase its portion of sales of highermargin ACQ products, and we expect this trend to continue as ACQ products aretransitioned into the North American 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 through plantconsolidation, 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.

 

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•                                          Demandfor the services performed by our Wafer Reclaim business have risen in thecurrent year due to the improved market conditions. However, pricing pressurestill exists due to 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 half of 2004. Duringthis period, we served our diverse and extensive customer base with 39manufacturing facilities in nine countries. Although we sell and manufactureour products 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. No other currency is significant to our results of operations. Unlessotherwise noted, all references below to currency exchange rate changesprimarily relate to the strengthening of the euro and the pound against theU.S. dollar in the periods compared.

 

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 three andsix months ended June 30, 2004.

 

Our balance sheet is subject to the effect of currency fluctuations onthe translation of our foreign currency denominated debt and cash. Gains andlosses on the translation of debt and cash denominated in a currency other thanthe functional currency of the borrower are included as a component of “otherincome 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 operating margins historically have not beensignificantly impacted by currency transaction risk, currency fluctuationscould have a material impact on our future operating income and operatingmargins.

 

**Raw Materials**

 

As of June 30, 2004, our most significant raw materials are iron oxide,used in Pigments; copper, amine and quat used in ACQ wood preservationchemicals in our Timber Treatment Chemicals business; quaternary amines used inClay-based Additives; and polyvinyl chloride resin and plasticizers used inSpecialty 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 steadily 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

 

21

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and masonry coloring services to the construction industry. Inaddition, this acquisition includes blending and packaging services for majorcement producers, as well as color and specialty products for the brick andready-mix markets and decorative concrete surface treatments including stains,sealers and overlay products. We financed this acquisition using a combinationof existing cash flows from operations and borrowings under our then existingrevolving credit facility. Results of operations for Southern Color wereincluded in our results of operations effective as of the acquisition date.

 

See also “—Liquidity and Capital Resources” below for discussion ofacquisitions consummated or to be consummated in the third quarter of 2004.

 

**Adjustmentsfrom Net income (loss) to Adjusted EBITDA**

 

Certain items are added to or subtracted from net income (loss) toarrive at Adjusted EBITDA. One significant item is foreign exchange (gain)loss.We have recorded foreign exchange (gains) and losses related to our long-termdebt. These amounts reflect the non-cash impact on our euro-denominated debtresulting from the strengthening or weakening of the euro against the U.S.dollar during the applicable periods. The current year amount also includes the impact of currency fluctuationson cash balances denominated in a currency different than the applicable localcurrency and a mark-to-market loss of $2,878 during the quarter ended June 30,2004 on the call options related to the DN Acquisition.

 

Systems/organization establishment expenses include costs that arose inconnection with the KKR Acquisition and our resulting organization as astand-alone company and primarily relate to the amortization of sign-oncompensation arrangements for key executives. These are reflected in the “corporatecosts and eliminations” column when our results are presented on a segmentbasis. For the three and six months ended June 30, 2004, systems/organizationestablishment expenses also include certain costs in connection with theintegration of the DN Acquisition as well as professional fees incurredregarding systems and internal control documentation in connection with theSarbanes-Oxley Act of 2002.

 

The Stamp Duty tax is a tax on certain assets transferred in the UnitedKingdom in connection with the KKR Acquisition.

 

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.

 

22

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

 

| ** **                                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                             |       | $                               | 10,822     |                          | $          | 2,252 |   | $ | 25,834 |   | $ | (11,023 | ) |
| Income tax provision (benefit)                |       | 11,785                          |       | 967                           |       | 19,593 |   | (4,723 | ) |
| Interest expense, net                         |       | 12,441                          |       | 22,383                        |       | 29,087 |   | 43,156 |   |
| Depreciation and amortization                 |       | 14,384                          |       | 12,664                        |       | 28,171 |   | 24,726 |   |
| Restructuring and related charges             |       | 55                              |       | 740                           |       | 55 |   | 1,035 |   |
| Systems/organization establishment expenses   |       | 984                             |       | 372                           |       | 1,068 |   | 744 |   |
| Cancelled acquisition and disposal costs      |       | 65                              |       | 513                           |       | 65 |   | 602 |   |
| Stamp duty tax                                |       | 3,980                           |       | —                        |       | 3,980 |   | — |   |
| Business interruption and insurance  recovery |       | —                          |       | (4,532                        | )          | — |   | (4,532 | ) |
| Inventory write-up reversal                   |       | —                          |       | —                        |       | — |   | 143 |   |
| Foreign exchange (gain) loss                  |       | 3,625                           |       | 6,644                         |       | (8,632 | ) | 20,216 |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Total Adjusted EBITDA                         |       | $                               | 58,141     |                          | $          | 42,003 |   | $ | 99,221 |   | $ | 70,344 |   |

 

Particularly given our leverage, Adjusted EBITDA is also critical toevaluating our liquidity position because Adjusted EBITDA is a key componentused in the calculation of financial ratios used in certain long-term debtfinancial covenants, including the ratio of Adjusted EBITDA to cash interestexpense, net and the ratio of net debt (debt, net of cash) to Adjusted EBITDA.

 

Adjusted EBITDA, which is referred to under the indenture governing our10 5/8% Notes and under the new senior subordinated loan agreement (the “2004Senior Subordinated Loan Agreement”) as “EBITDA,” is defined therein asconsolidated net income (which, as defined therein, excludes gains and losseson disposed operations and goodwill impairment charges) plus (i) incometax expense, (ii) interest expense, (iii) depreciation and amortizationexpense, (iv) expenses related to any equity offerings, permittedinvestments, acquisitions, dispositions, recapitalizations or debt permitted tobe incurred thereunder, (v) any restructuring charges, including anyone-time costs incurred in connection with acquisitions after July 23, 2003,(vi) other non-cash charges that reduce consolidated net income,(vii) minority interest, (viii) systems/organization establishmentexpenses and, prior to December 31, 2001, unusual patent litigation expenses,less (ix) non-cash items that increase consolidated net income.

 

The key financial ratios in our new senior secured credit agreement(the “2004 Senior Secured Credit Agreement”) are net debt to Adjusted EBITDA,which is required to be less than 6.95 to 1 for the quarter ending December 31,2004, and Adjusted EBITDA to cash interest expense (interest expense, netexcluding deferred debt issuance cost amortization and the movements in themark-to-market value of our interest rate and cross-currency interest ratederivatives), will be required to be at least 1.60 to 1 for the quarter endingDecember 31, 2004. Adjusted EBITDA in our 2004 Senior Secured Credit Agreementis calculated in a manner similar to the definition of such measure in theindenture governing the 10 5/8 Notes and the 2004 Senior Subordinated LoanAgreement.

 

Given the importance of the financial ratios used in certain covenantsof our long-term debt agreements, we believe Adjusted EBITDA is a relevantfinancial measure for our investors. Given this additional use of AdjustedEBITDA as a liquidity measure, the following table presents a reconciliation ofnet cash provided by operating activities to Adjusted EBITDA:

 

| ** **                                                                                                      | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                      | ** ** | **2004**                      | ** ** | **2003** | ** ** |
| Net cash provided by operating activities                                                                       |       | $                             | 44,706     |   | $ | 3,396 |   |
| Changes in assets and liabilities net of  the effect of foreign currency translation and acquisitions           |       | 6,179                         |       | 36,402 |   |
| Current portion of income tax (benefit)  provision                                                              |       | 7,567                         |       | (4,723 | ) |
| Interest expense, net, excluding  amortization of deferred financing costs and unrealized losses on derivatives |       | 36,786                        |       | 37,806 |   |
| Restructuring and related charges                                                                               |       | 55                            |       | 1,035 |   |
| Systems/organization establishment expenses                                                                     |       | 1,068                         |       | 744 |   |
| Cancelled acquisition and disposal costs                                                                        |       | 65                            |       | 602 |   |
| Business interruption and insurance  recovery                                                                   |       | —                        |       | (4,532 | ) |
| Stamp duty tax                                                                                                  |       | 3,980                         |       | — |   |
| Inventory write-up reversal                                                                                     |       | —                        |       | 143 |   |
| Bad debt provision                                                                                              |       | (935                          | )          | (196 | ) |
| Foreign currency gain                                                                                           |       | (250                          | )          | (333 | ) |
| Total Adjusted EBITDA                                                                                           |       | $                             | 99,221     |   | $ | 70,344 |   |

 

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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 a substitutefor any GAAP financial measure. We strongly urge you to review thereconciliations of Adjusted EBITDA contained in this section, including therelated explanations described herein and in our 2003 10-K, the limitations ofthese exclusions 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 measures. 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, financialposition 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 bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily 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 reviewed onan annual basis during the fourth quarter. Additionally, the recoverability ofgoodwill, long-lived tangible, and certain intangible assets is reviewed whenevents or changes in

 

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circumstances occur indicating that the carrying value of the assetsmay not be recoverable. The measurement of possible impairment for assets otherthan goodwill is based upon the ability to recover the carrying value of theasset through the expected future undiscounted cash flows from the use of theasset and its eventual disposition. An impairment loss, equal to the differencebetween the asset’s fair value and its carrying value, is recognized when theestimated future undiscounted cash flows are less than its carrying amount.

 

*Legal Matters.*  We are involved in various legal proceedings,including product liability and environmental matters, of a nature considerednormal to our business. It is our policy to accrue for amounts related to thesematters in accordance with SFAS No. 5, “Accounting for Contingencies,” ifit is probable that a liability has been incurred and an amount can bereasonably estimated. It is our policy to disclose such matters when there isat least a reasonable possibility that a loss may have been incurred.

 

*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 more likelythan not to be realized. While we have considered future taxable income andongoing prudent and feasible tax planning strategies in assessing the need forvaluation allowances, if we were to determine that we would be able to realizedeferred tax assets in the future in excess of our net recorded amount, anadjustment to the deferred tax asset would increase income in the period suchdetermination was made. Likewise, should we determine that we would not be ableto realize all or part of our recorded net deferred tax assets in the future,an adjustment to the deferred tax asset would decrease income in the periodsuch determination was made.

 

 **Results of Operations**

 

Net sales consist of sales of our products in our three segments, netof sales discounts, product returns and allowances. Sales are primarily made ona purchase order basis. Revenues are recognized when the earnings process iscomplete which is generally when products are shipped and title and risk ofloss 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 followingtable presents the major components of our operations, including as apercentage of net sales.

 
| ** **                                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **(dollars  in thousands)**     | ** ** |
| **Statement of operations data:**             |       |                            |       |                          |       |   |   |   |   |
| Net sales:                                    |       |                            |       |                          |       |   |   |   |   |
| Performance Additives                         |       | $                               | 173,204    |                          | $          | 131,422 |   | $ | 312,282 |   | $ | 232,197 |   |
| Specialty Compounds                           |       | 52,584                          |       | 46,146                        |       | 100,464 |   | 90,136 |   |
| Electronics                                   |       | 41,181                          |       | 35,129                        |       | 81,593 |   | 70,519 |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Total                                         |       | 266,969                         |       | 212,697                       |       | 494,339 |   | 392,852 |   |
| Gross profit:                                 |       |                            |       |                          |       |   |   |   |   |
| Performance Additives                         |       | 59,458                          |       | 43,589                        |       | 104,191 |   | 73,077 |   |
|                                          |       | 34.3                            | %          | 33.2                          | %          | 33.4 | % | 31.5 | % |
| Specialty Compounds                           |       | 10,470                          |       | 8,775                         |       | 19,542 |   | 17,091 |   |
|                                          |       | 19.9                            | %          | 19.0                          | %          | 19.5 | % | 19.0 | % |
| Electronics                                   |       | 8,657                           |       | 7,602                         |       | 17,240 |   | 15,845 |   |
|                                          |       | 21.0                            | %          | 21.6                          | %          | 21.1 | % | 22.5 | % |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Total                                         |       | 78,585                          |       | 59,966                        |       | 140,973 |   | 106,013 |   |
|                                          |       | 29.4                            | %          | 28.2                          | %          | 28.5 | % | 27.0 | % |
| Selling, general and administrative  expenses |       | 35,877                          |       | 26,980                        |       | 71,056 |   | 57,352 |   |
|                                          |       | 13.4                            | %          | 12.7                          | %          | 14.4 | % | 14.6 | % |
| Restructuring charges                         |       | 55                              |       | 740                           |       | 55 |   | 1,035 |   |
| Operating income (loss):                      |       |                            |       |                          |       |   |   |   |   |
| Performance Additives                         |       | 39,609                          |       | 26,696                        |       | 64,555 |   | 39,700 |   |
|                                          |       | 22.9                            | %          | 20.3                          | %          | 20.7 | % | 17.1 | % |
| Specialty Compounds                           |       | 6,828                           |       | 4,795                         |       | 12,228 |   | 9,582 |   |
|                                          |       | 13.0                            | %          | 10.4                          | %          | 12.2 | % | 10.6 | % |
| Electronics                                   |       | 2,104                           |       | 5,191                         |       | 3,694 |   | 7,153 |   |
|                                          |       | 5.1                             | %          | 14.8                          | %          | 4.5 | % | 4.2 | % |
| Corporate costs and eliminations              |       | (5,888                          | )          | (4,436                        | )          | (10,615 | ) | (8,809 | ) |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Total                                         |       | 42,653                          |       | 32,246                        |       | 69,862 |   | 47,626 |   |
|                                          |       | 16.0                            | %          | 15.2                          | %          | 14.1 | % | 12.1 | % |
| Other income (expenses):                      |       |                            |       |                          |       |   |   |   |   |
| Interest expense, net                         |       | (12,441                         | )          | (22,383                       | )          | (29,087 | ) | (43,156 | ) |
| Foreign exchange (loss) gain, net             |       | (3,625                          | )          | (6,644                        | )          | 8,632 |   | (20,216 | ) |
| Other, net                                    |       | (3,980                          | )          | —                        |       | (3,980 | ) | — |   |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Income (loss) before taxes                    |       | 22,607                          |       | 3,219                         |       | 45,427 |   | (15,746 | ) |
| Income tax (benefit) provision                |       | 11,785                          |       | 967                           |       | 19,593 |   | (4,723 | ) |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Net income (loss)                             |       | $                               | 10,822     |                          | $          | 2,252 |   | $ | 25,834 |   | $ | (11,023 | ) |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Adjusted EBITDA:                              |       |                            |       |                          |       |   |   |   |   |
| Performance Additives                         |       | $                               | 46,630     |                          | $          | 33,366 |   | $ | 78,684 |   | $ | 52,916 |   |
| Specialty Compounds                           |       | 8,221                           |       | 6,451                         |       | 14,997 |   | 12,474 |   |
| Electronics                                   |       | 7,392                           |       | 5,588                         |       | 14,032 |   | 11,783 |   |
| Corporate costs and eliminations              |       | (4,102                          | )          | (3,402                        | )          | (8,492 | ) | (6,829 | ) |
|                                          |       |                            |       |                          |       |   |   |   |   |
| Total                                         |       | $                               | 58,141     |                          | $          | 42,003 |   | $ | 99,221 |   | $ | 70,344 |   |

 

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The following table presents the changes in the major components of ouroperations on a historical basis in dollars and percentages.

 
| ** **                                        | ** ** | **Change: Three Month Ended June 30, 2004 versus 2003** | ** ** | **Change: Six Month Ended June 30, 2004 versus 2003** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                        | ** ** | **Total**                                               | ** ** | **%  Change**                                         | ** ** | **FX  Effect** | ** ** | **Acquisition &  Divestitures,  net** | ** ** | **Other** | ** ** | **Total** | ** ** | **%  Change** | ** ** | **FX  Effect** | ** ** | **Acquisition &  Divestitures,  net** | ** ** | **Other** | ** ** |
| **Statement of operations data:**                 |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net sales:**                                    |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Performance Additives                             |       | $                                                       | 41,782     |                                                  | 31.8       | % | $ | 3,086 |   | $ | 1,229 |   | $ | 37,467 |   | $ | 80,085 |   | 34.5 | % | $ | 7,651 |   | $ | 5,748 |   | $ | 66,686 |   |
| Specialty Compounds                               |       | 6,438                                                   |       | 14.0                                                  | %          | 1,406 |   | — |   | 5,032 |   | 10,328 |   | 11.5 | % | 3,377 |   | — |   | 6,951 |   |
| Electronics                                       |       | 6,052                                                   |       | 17.2                                                  | %          | 1,524 |   | 412 |   | 4,116 |   | 11,074 |   | 15.7 | % | 3,813 |   | 1,526 |   | 5,735 |   |
|                                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | 54,272                                                  |       | 25.5                                                  | %          | 6,016 |   | 1,641 |   | 46,615 |   | 101,487 |   | 25.8 | % | 14,841 |   | 7,274 |   | 79,372 |   |
| **Gross Profit:**                                 |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Performance Additives                             |       | 15,869                                                  |       | 36.4                                                  | %          | 989 |   | 8 |   | 14,872 |   | 31,114 |   | 42.6 | % | 2,162 |   | 719 |   | 28,233 |   |
| Specialty Compounds                               |       | 1,695                                                   |       | 19.3                                                  | %          | 298 |   | — |   | 1,397 |   | 2,451 |   | 14.3 | % | 598 |   | — |   | 1,853 |   |
| Electronics                                       |       | 1,055                                                   |       | 13.9                                                  | %          | (210 | ) | (81 | ) | 1,346 |   | 1,395 |   | 8.8 | % | (302 | ) | (54 | ) | 1,751 |   |
|                                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | 18,619                                                  |       | 31.0                                                  | %          | 1,077 |   | (73 | ) | 17,615 |   | 34,960 |   | 33.0 | % | 2,458 |   | 665 |   | 31,837 |   |
| **Selling, general and administrative expenses:** |       | 8,897                                                   |       | 33.0                                                  | %          | 719 |   | 93 |   | 8,085 |   | 13,704 |   | 23.9 | % | 2,447 |   | 718 |   | 10,539 |   |
| Restructuring charges                             |       | (685                                                    | )          |                                                  |       |   |   |   |   |   |   | (980 | ) |   |   |   |   |   |   |   |   |
| **Operating income (loss):**                      |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Performance Additives                             |       | 12,913                                                  |       | 48.4                                                  | %          | 529 |   | 7 |   | 12,377 |   | 24,855 |   | 62.6 | % | 690 |   | 133 |   | 24,032 |   |
| Specialty Compounds                               |       | 2,033                                                   |       | 42.4                                                  | %          | 184 |   | — |   | 1,849 |   | 2,646 |   | 27.6 | % | 279 |   | — |   | 2,367 |   |
| Electronics                                       |       | (3,087                                                  | )          | (59.5                                                 | )%         | (323 | ) | (173 | ) | (2,591 | ) | (3,459 | ) | (48.4 | )% | (892 | ) | (186 | ) | (2,381 | ) |
| Corporate costs and eliminations                  |       | (1,452                                                  | )          | 32.7                                                  | %          | (32 | ) | — |   | (1,420 | ) | (1,806 | ) | 20.5 | % | (66 | ) | — |   | (1,740 | ) |
|                                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | 10,407                                                  |       | 32.3                                                  | %          | 358 |   | (166 | ) | 10,215 |   | 22,236 |   | 46.7 | % | 11 |   | (53 | ) | 22,278 |   |
| **Other income (expenses):**                      |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense, net                             |       | 9,942                                                   |       | (44.4                                                 | )%         | (389 | ) | — |   | 10,331 |   | 14,069 |   | (32.6 | )% | (827 | ) | — |   | 14,896 |   |
| Foreign exchange gain, net                        |       | 3,019                                                   |       |                                                  |       |   |   |   |   |   |   | 28,848 |   |   |   |   |   |   |   |   |   |
| Other, net                                        |       | (3,890                                                  | )          |                                                  |       |   |   |   |   |   |   | (3,890 | ) |   |   |   |   |   |   |   |   |
|                                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income before taxes**                           |       | 19,388                                                  |       |                                                  |       |   |   |   |   |   |   | 61,173 |   |   |   |   |   |   |   |   |   |
| Income tax provision                              |       | 10,818                                                  |       |                                                  |       |   |   |   |   |   |   | 24,316 |   |   |   |   |   |   |   |   |   |
| **Net income:**                                   |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Performance Additives                             |       | (2,811                                                  | )          |                                                  |       |   |   |   |   |   |   | 3,497 |   |   |   |   |   |   |   |   |   |
| Specialty Compounds                               |       | (2,392                                                  | )          |                                                  |       |   |   |   |   |   |   | (2,128 | ) |   |   |   |   |   |   |   |   |
| Electronics                                       |       | 2,793                                                   |       |                                                  |       |   |   |   |   |   |   | (2,281 | ) |   |   |   |   |   |   |   |   |
| Corporate costs and eliminations                  |       | 16,566                                                  |       |                                                  |       |   |   |   |   |   |   | 37,769 |   |   |   |   |   |   |   |   |   |
|                                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | $                                                       | 8,570      |                                                  |       |   |   |   |   |   |   |   | $ | 36,857 |   |   |   |   |   |   |   |   |   |
|                                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Adjusted EBITDA:**                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Performance Additives                             |       | $                                                       | 13,264     |                                                  | 39.8       | % | 802 |   | 11 |   | 12,451 |   | $ | 25,768 |   | 48.7 | % | 1,483 |   | 286 |   | 23,999 |   |
| Specialty Compounds                               |       | 1,770                                                   |       | 27.4                                                  | %          | 248 |   | — |   | 1,522 |   | 2,523 |   | 20.2 | % | 452 |   | — |   | 2,071 |   |
| Electronics                                       |       | 1,804                                                   |       | 32.3                                                  | %          | 8 |   | (119 | ) | 1,915 |   | 2,248 |   | 19.1 | % | (123 | ) | (94 | ) | 2,466 |   |
| Corporate costs and eliminations                  |       | (700                                                    | )          | 20.6                                                  | %          | (32 | ) | — |   | (668 | ) | (1,663 | ) | 24.4 | % | (66 | ) | — |   | (1,597 | ) |
|                                              |       |                                                    |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                             |       | $                                                       | 16,138     |                                                  | 38.4       | % | $ | 1,026 |   | $ | (108 | ) | $ | 15,220 |   | $ | 28,877 |   | 41.1 | % | $ | 1,746 |   | $ | 192 |   | $ | 26,939 |   |

 

27

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***Threemonths ended June 30, 2004 compared with three months ended June 30, 2003***

 

**Net sales**

 

Net sales were $267.0 million for the second quarter of 2004 ascompared to $212.7 million for the second quarter of 2003. The 25.5% increaseis principally due to strong demand in our Performance Additives segment,primarily within our Timber Treatment Chemicals and Pigments businesses.Currency exchange rate changes positively impacted net sales in the secondquarter of 2004 by approximately $6.0 million.

 

*Performance Additives.*  Net sales for our Performance Additivessegment increased 31.8% primarily due to higher sales of our Timber TreatmentChemicals and Pigments businesses and favorable currency exchange rateschanges. The increase in Timber Treatment Chemicals was primarily due to agreater mix of ACQ products versus CCA products as a result of the ACQconversion within the Timber Treatment Chemicals business line. Our Pigmentsbusiness had stronger volume due to an increase in demand for construction products.

 

*Specialty Compounds.*  Net sales for our Specialty Compounds segmentincreased 14.0% in the second quarter of 2004 primarily due to increased salesvolumes and more favorable pricing of certain products in our wire and cablecompounds business, with the remaining increase in net sales of$1.4 million primarily due to currency exchange rate changes.

 

***Electronics.*** Net sales for our Electronics segment increased 17.2% in the secondquarter of 2004 primarily due to higher sales volumes, offset in part by pricingpressure in certain businesses. Conditions in certain of our ElectronicChemicals businesses continued to improve in the second quarter of 2004 due toimprovement in general market conditions in the industries served.

 

**Gross profit**

 

Gross profit margin was 29.4% in the second quarter of 2004 as comparedto 28.2% in the second quarter of 2003. Gross profit increased$18.6 million primarily due to increased sales discussed above.

 

*Performance Additives.*  Gross profit margin was 34.3% in the secondquarter of 2004 as compared to 33.2% in the second quarter of 2003 due tofavorable mix in our Timber Treatment Chemicals business and higher salesvolume in the Pigments business.

 

*Specialty Compounds.*  Gross profit margin was 19.9% in the secondquarter of 2004 and 19.0% in the second quarter of 2003. The increase of$1.7 million was due to increased sales volumes, favorable pricing andfavorable currency changes offset by higher PVC raw material costs.

 

*Electronics.*  Gross profit margin was 21.0% in the secondquarter of 2004 as compared to 21.6% in the second 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” increased33.0% primarily due to bad debt expense consistent with higher sales levels andhigher bonus accruals. Currency exchange rate changes unfavorably affectedSG&A.

 

**Operating income**

 

Operating income increased for the same reasons as gross profit, offsetin part by the SG&A increase described above. After adjusting for theeffects of currency exchange rate changes and acquisitions, the operatingincome increase of $10.2 million was comprised of increases of$12.4 million and $1.8 million in our Performance Additives segment andour Specialty Compounds segment, respectively; and decreases of$2.6 million and $1.4 million in our Electronics segment and corporatecosts and eliminations, respectively.

 

**Adjusted EBITDA**

 

*Performance Additives.*  Adjusted EBITDA for our Performance Additivessegment increased 39.8% primarily due to the increase in sales discussed above.

 

*Specialty Compounds.*  Adjusted EBITDA for our Specialty Compoundssegment increased 27.4% primarily due to the

 

28

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increase in sales volumes discussed above.

 

*Electronics.*  Adjusted EBITDA for our Electronics segmentincreased 32.3% primarily due to the increase in sales.

 

*Corporate.*  Adjusted EBITDA loss at Corporate increased20.6% primarily due to higher bonus accruals offset in part by lowerdiscretionary spending, including certain professional fees.

 

**Other income (expenses)**

 

*Interest expense, net.*  For the second quarter of 2004 and 2003,interest expense, net, included a gain of $6.4 million and a loss of$1.3 million, respectively, representing the movement in the mark tomarket valuation of our interest rate and cross currency hedging instruments aswell as $0.4 million and $1.6 million, respectively, of amortizationexpense related to deferred financing costs. This amortization decreased in2004 due to the effect of the 2003 Refinancing, (see “—Liquidity and CapitalResources”), which substantially reduced our deferred financing cost balance.Currency exchange rate changes increased interest expense, net, by$0.4 million. The remaining decrease of $1.5 million was due to the lowerinterest rates from the 2003 Refinancing.

 

*Foreign exchange loss.* In the second quarter of 2004, theforeign exchange losses reflected the non-cash currency impact on oureuro-denominated debt of the weakening of the pound against the euro and alsoincluded a $2.9 million mark-to-market loss on certain foreign currency calloptions (see- “Liquidity and Capital Resources”). In the second quarter of2003, the foreign exchange losses reflected the non-cash currency impact on oureuro-denominated debt of the strengthening of the euro against the U.S. dollar.

 

*Provision for income taxes.*  An income tax provision of $11.8 millionon income before taxes of $22.6 million in the second quarter of 2004resulted in an effective income tax rate of 52.2%. This compared to an incometax provision of $1.0 million on income before taxes of $3.2 millionin the second quarter of 2003, which resulted in an effective income tax rateof 30.0%. The effective tax rate is different from the statutory rate primarilydue to our inability to realize tax benefits from our UK taxable losses in bothperiods.

** **

**Net income**

 

Net income for the second quarter of 2004 was $10.8 million ascompared to $2.3 million for the second quarter of 2003 for the reasonsdiscussed above.

 

***Sixmonths ended June 30, 2004 compared with six months ended June 30, 2003***

*** ***

**Net sales**

 

Net sales were $494.3 million for the first six months of 2004 ascompared to $392.9 million for the first six months of 2003. The 25.8% increaseis principally due to strong demand in our Performance Additives segment,primarily within our Timber Treatment Chemicals and Pigments businesses.Currency exchange rate changes positively impacted net sales in the first sixmonths of  2004 by approximately $14.8million.

 

*Performance Additives.*  Net sales for our Performance Additivessegment increased 34.5% over the prior year period primarily due to highersales of our Timber Treatment Chemicals and Pigments businesses, as well asacquisitions (primarily Southern Color) and favorable currency exchange rates.The increase in Timber Treatment Chemicals was primarily due to a greater mixof ACQ products versus CCA products  as aresult of the ACQ conversion within the Timber Treatment Chemicals businessline. Our Pigments business had stronger volume due to an increase in demandfor construction products.

 

*Specialty Compounds.*  Net sales for our Specialty Compounds segmentincreased 11.5% over the prior year period to increased sales volumes and morefavorable pricing of certain products in our wire and cable compounds businesswith the remaining increase in net sales of $3.4 million primarily due tocurrency exchange rate changes.

 

***Electronics.*** Net sales for our Electronics segment increased 15.7% primarily due tohigher sales volumes, offset in part by pricing pressure in certain businesses.Conditions in certain of our Electronic Chemicals business continued to improvein the first half of 2004 due to improvement in general market conditions inthe industries served.

 

**Gross profit**

 

Gross profit margin was 28.5% in the first six months of 2004 ascompared to 27.0% in the first six months of 2003. Gross profit increased$35.0 million primarily due to increased sales discussed above.

 

29

----

 

*Performance Additives.*  Gross profit margin was 33.4% in the firsthalf of 2004 as compared to 31.5% in the first half of 2003 due to favorablemix in our Timber Treatment Chemicals and higher sales volume in the Pigmentsbusiness.

 

*Specialty Compounds.*  Gross profit margin was 19.5% in the firsthalf of 2004 and 19.0% in the first half of 2003. The increase of$2.5 million was due to increased sales volumes, favorable pricing andfavorable currency exchange rate changes offset by higher PVC raw materialcosts.

 

*Electronics.*  Gross profit margin was 21.1% in the firsthalf of 2004 as compared to 22.5% in the first half of 2003, although actualgross 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”, increased23.9% due to bad debt expense consistent with higher sales levels and higherbonus accruals. Currency exchange 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. After adjusting for theeffects of currency exchange rate changes and acquisitions, the operatingincome increase of $22.3 million was comprised of increases of$24.0 million and $2.4 million in our Performance Additives segment andour Specialty Compounds segment, respectively; and decreases of$2.4 million and $1.7 million in our Electronics segment and corporatecosts and eliminations, respectively.

 

**Adjusted EBITDA**

 

*Performance Additives.*  Adjusted EBITDA for our Performance Additivessegment increased 48.7% primarily due to the increase in sales discussed above.

 

*Specialty Compounds.*  Adjusted EBITDA for our Specialty Compoundssegment increased 20.2% primarily due to the increase in sales discussed above.

 

*Electronics.*  Adjusted EBITDA for our Electronics segmentincreased 19.1% primarily due to the increase in sales.

 

*Corporate.*  Adjusted EBITDA loss at Corporate increased24.4% primarily due to higher bonus accruals offset in part by lowerdiscretionary spending including certain professional fees. The current yearamount also includes the impact of currency fluctuations on cash balancesdenominated in a currency different from the applicable local currency.

 

**Other income (expenses)**

 

*Interest expense, net.*  For the first six months of 2004 and 2003,interest expense, net, included a gain of $8.6 million and a loss of$2.3 million, respectively, representing the movement in the mark tomarket valuation of our interest rate and cross currency hedging instruments aswell as $0.9 million and $3.1 million, respectively, of amortizationexpense related to deferred financing costs. This amortization decreased in2004 due to the effect of the 2003 Refinancing (see “—Liquidity and CapitalResources”), which substantially reduced our deferred financing cost balance.Currency exchange rate changes increased interest expense, net by$0.8 million. The remaining decrease of $1.8 million was due to the lowerinterest rates from the 2003 Refinancing.

 

*Foreign exchange gain (loss).*  In the first six months of 2004, the foreignexchange gains reflected the non-cash currency impact on our euro-denominateddebt of the strengthening of the pound against the euro and also included a$2.9 million mark-to-market loss on certain foreign currency call options (see-“Liquidity and Capital Resources”). In the first six months of 2003, theforeign exchange losses reflected the non-cash currency impact on oureuro-denominated debt of the strengthening of the euro against the U.S. dollar.

 

*Provision for income taxes.*  An income tax provision of $19.6 millionon income before taxes of $45.4 million in the first six months of 2004resulted in an effective income tax rate of 43.2%. This compared to an incometax benefit of $4.7 million on a loss before taxes of $15.7 millionin the first six months of 2003, which resulted in an effective income tax rateof 29.9%. The 2003 effective tax rate was lower due to valuation allowances inconnection with a portion of the pre-tax loss for that period.

 

30

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**Net income (loss)**

 

Net income for the first six months of 2004 was $25.8 million ascompared to a net loss of $11.0 million for the first six months of 2003for the reasons discussed above.

 

**Liquidity and Capital Resources**

 

**Cash Flows**

 

Net cash provided by operating activities was $44.7 million forthe six months ended June 30, 2004 as compared to $3.4 million for the sixmonths ended June 30, 2003. This increase was primarily due to the strongeroperating results discussed above as well as the smaller increase in workingcapital accounts in 2004 compared to 2003, including the impact of lowerinterest payments in 2004 primarily due to the scheduled timing of thesepayments.

 

Net cash used for investing activities was $13.3 million for thesix months ended June 30, 2004 and $25.1 million for the six months endedJune 30, 2003. This decrease was primarily due to the 2003 acquisition ofSouthern Color, partially offset by insurance proceeds from fire damagereceived in 2003.

 

Net cash used for financing activities was $4.5 million for thesix months ended June 30, 2004 and net cash used in financing activities was$6.3 million for the six months ended June 30, 2003.

 

**Indebtedness - Pre-Dynamit Nobel Acquisition**

 

In connection with the KKR Acquisition, we incurred substantial amountsof debt, including amounts outstanding under our then existing senior creditfacilities and our then existing senior subordinated loan facility. In December2003, we refinanced a portion of the borrowings under the then new seniorcredit facilities in order to reduce our interest expense. We refer to the July2003 refinancing and the December 2003 refinancing collectively as the “2003Refinancing.” Interest payments on the indebtedness incurred in connection withthe KKR Acquisition and the debt resulting from the 2003 Refinancing weresignificant. In July 2003, we repaid the borrowings under our then-existingsenior subordinated loan facility and repaid all amounts outstanding under ourthen existing senior credit facilities with the borrowings under the 2003senior credit facilities, $375.0 million of senior subordinated notes and newequity contributions of $95.0 million from our parent companies.

 

The new equity contribution of $95.0 million consisted of an equitycontribution of $70.0 million by our immediate parent company, RockwoodSpecialties International, Inc., which represented gross proceeds from theissuance of 12% senior discount notes due 2011 ($111.6 million aggregateprincipal amount at maturity), and an equity contribution of $25.0 million byour ultimate parent company, Rockwood Holdings, Inc. with the proceeds from theissuance of Series A Participating Preferred Stock and warrants to purchaseshares of common stock to an affiliate of KKR. The senior discount notes do notrequire Rockwood Specialties International to pay cash interest on these notesuntil 2007, at which point interest will accrue on the notes at a rate of 12%per annum. Rockwood Specialties International, Inc. will rely on incomegenerated by our operations (as available after providing for cash flows usedin investing and financing activities), paid to it as dividends, to make these interestpayments. The indenture governing the 10 5/8 Notes and our new seniorsubordinated loan facility allow such dividends to be made in accordance withthe terms of the senior discount notes of our parent company, RockwoodSpecialties International, Inc., commencing in 2007. In addition, ourultimate parent company, Rockwood Holdings, Inc., issued shares ofSeries A Participating Preferred Stock and warrants to purchase shares ofcommon stock to an affiliate of KKR resulting in proceeds of $25.0 millionwhich was contributed to us through our parent companies.

 

As a result of the July 2003 Refinancing, the 2003 Senior CreditFacilities consisted of tranche A term loans and tranche B term loans. InDecember 2003, we refinanced all of the U.S. dollar borrowings under ourtranche B term loan facility with the proceeds of a tranche C term loanfacility in order to reduce our interest expense. The tranche A term loans andthe revolving credit facility were due to mature in July 2009 and each ofthe tranche B term loans and tranche C term loans were due to mature inJuly 2010. As of June 30, 2004, we had aggregate borrowings of$822.6 million, no outstanding borrowings under our $100.0 millionrevolving credit facility, and $14.2 million of letters of credit, whichreduced our availability under our revolving credit facility.

 

**Indebtedness - Post-Dynamit Nobel Acquisition**

 

On July 31, 2004, we completed the acquisition of four businesses ofDynamit Nobel from mg technologies ag. At the same time, we refinanced all outstandingborrowings under the then existing senior secured credit facilities.

 

31

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Approximate sources and uses offunds are as follows (in millions):

 
| **SOURCES:**                                                                                                                                          |   |    |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|---------|
| ***Stockholders’  equity***                                                                                                                      |   |    |    |
| Capital contributions from affiliates of  KKR and affiliates of CSFB to Holdings                                                                      |   | $       | 425.0   |   |
| Less repayment of RSCI PIK Notes                                                                                                                      |   | (21.0   | )       |
| Net capital contributed to us                                                                                                                         |   | $       | 404.0   |   |
|                                                                                                                                                  |   |    |    |
| ***Long term debt  (excludes assumed DN debt of $162,000)***                                                                                          |   |    |    |
| 2004 Senior Credit Facilities (excludes  $50.0 Term Loan and $250.0 revolving credit facility undrawn at July 31,  2004):                             |   |    |    |
| Term Loan A                                                                                                                                           |   | $       | 202.0   |   |
| Term Loan B                                                                                                                                           |   | 985.0   |    |
| Term Loan C                                                                                                                                           |   | 267.0   |    |
| 2004 Senior Subordinated Loan Facility                                                                                                                |   | 855.0   |    |
|                                                                                                                                                  |   | $       | 2,309.0 |   |
|                                                                                                                                                  |   |    |    |
| ***Existing Cash  Utilized***                                                                                                                         |   | 49.0    |    |
|                                                                                                                                                  |   |    |    |
|                                                                                                                                                  |   | $       | 2,762.0 |   |
|                                                                                                                                                  |   |    |    |
| **USES:**                                                                                                                                             |   |    |    |
| Repayment of 2003 Senior Credit Facilities                                                                                                            |   | $       | 442.0   |   |
| Purchase price (subject to adjustment) of  net assets of DN businesses (includes assumed DN debt to be repaid at or  shortly after closing of $191.0) |   | 2,160.0 |    |
| Cash settlement of derivative transactions  related to DN Acquisition                                                                                 |   | 20.0    |    |
| Estimated transaction costs                                                                                                                           |   | 70.0    |    |
| Estimated financing costs                                                                                                                             |   | 70.0    |    |
|                                                                                                                                                  |   |    |    |
|                                                                                                                                                  |   | $       | 2,762.0 |   |

 

Under the 2004 Senior Credit Facilities, Term Loans A and B as well asthe revolving credit facility generally bear interest at an annual rate ofLIBOR + 2.5%.  Term Loan C generally hasan annual interest rate of LIBOR + 3.0%. Term Loan A is payable in January and July of each year at escalatingpercentages of the original principal amount with a final maturity date of July2011. Term Loans B and C are payable in January and July of each year atamounts equal to 0.5% of the original principal balance, with the remainder dueat the final maturity date of July 2012. At July 31, 2004 we had noprincipal outstanding and approximately $15.0 million of standby letters ofcredit outstanding under the revolving credit facility, which has a finalmaturity date of July 2010. In connection with the DN Acquisition, we assumed certainstandby letters of credit and comparable obligations. Many of these obligationswill have to be renewed upon expiration and will then reduce availability underthe revolving credit facility.

 

Similar to the 2003 Senior Credit Facilities, the 2004 Senior CreditFacilities are subjected to certain financial covenants including therequirement of a maximum debt to earnings before interest, taxes, depreciation,and amortization and other items, as defined (“EBITDA”), ratio, and a minimumEBITDA to interest expense ratio, all as defined therein. The 2004 Senior CreditFacilities also contains certain restrictions on the ability of the Company to,among other things: incur indebtedness; merge or consolidate; dispose ofassets; make investments or capital expenditures; pay dividends and makepayments to shareholders; make payments on certain indebtedness; and enter intosale leaseback transactions. The 2004 Senior Credit Facilities borrowings arecollateralized by substantially all of our assets and equity including our USsubsidiaries as well as by assets and a portion of equity of certain non-USsubsidiaries. Additionally, these borrowings are guaranteed by RockwoodSpecialties International, Inc., our immediate parent.

 

The 2004Senior Subordinated Loan Facility is due in 2014; provided however, in theevent the existing 10 5/8% Notes has not been refinanced or repaid in full, the2004 Senior Subordinated Loan Facility will be due February 2011. The 2004Senior Subordinated Loan Facility is *paripassu* to our existing 10 5/8% Notes, with initial interest at a rateequal to the greater of 9.0% and LIBOR + 7.0% (in the case of euro borrowings)or LIBOR + 8.0% (in the case of U.S. dollar borrowings) annually with a 75basis point increase every six months for the first 18 months. If the 2004 SeniorSubordinated Loan Facility is not

 

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refinanced within 18 months, the interest rate will be 14.5%, of which12.0% (12.5% under certain circumstances) is payable in cash with the remainderpayable in-kind at our option.  All otherterms are comparable to our 10 5/8% Notes.

 

$974.0 millionof the debt outstanding as a result of the 2004 Financing are denominated ineuros, using exchange rates in effect on July 31, 2004. In order to mitigate theeffect of any exchange rate changes which may have taken place prior to theclosing of the DN Acquisition (and its related 2004 Financing), we entered intocall options, permitting us to purchase up to €750.0 million at a price of$1.225 per euro. We recorded a mark-to-market loss of $2.9 million during thequarter ended June 30, 2004 on the call options. The options expired unexercisedand we recorded an additional loss of $8.1 million in the third quarter of2004. The Company also entered into a forward contract in July to purchase$1.057 billion of euros at a fixed U.S. dollar rate related to the 2004 Financing,which was utilized to pay for a portion of the purchase price at closing. Wewill record a charge of approximately $4.0 million in the third quarter of2004.

 

Financing costs will becapitalized and amortized using the effective interest rate method over theterm of the debt outstanding under the 2004 Financing. Acquisition costs willbe capitalized into the overall cost of the DN Acquisition. We will record awrite-off in the third quarter of 2004 of $1.8 million of unamortized fees thathad been capitalized as part of the 2003 Refinancing for loans repaid under the2004 Financing.

 

Approximately $21.5million of the transaction and financing fees were paid to KKR or itsaffiliates and approximately $34.5 million to CSFB or its affiliates. Effectivewith the DN Acquisition, KKR and CSFB have agreed to provide us consulting andmanagement advisory services for an aggregate annual fee of $2.0 million, whichamount will be increased by 5% each year.

 

Apart from obligations inconnection with the acquisition detailed above, there have been no materialchanges in our contractual obligations since December 31, 2003.

 

In July 2004,we agreed to acquire the Pigments and Dispersions business of Johnson MattheyPlc (“JM”) for approximately $48.0 million (subject to post-closing adjustment).  Subject to regulatory clearance, we expect tocomplete this acquisition during the third quarter of 2004.  We will utilize the remaining $50.0 millionof undrawn funds from the term loan portion of the 2004 Senior CreditFacilities to finance this transaction.

 

We believethat the acquisitions described above 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 end marketand geographic diversification.  However,in the short term, the proposed capital structure described above may result inless favorable financial ratios, measures commonly used in debt covenants suchas those governing our existing long-term debt. Our annual capital expenditures will increase in amount, but we do notbelieve they will change significantly from current levels in proportion to theexpected size of the combined entity.

 

# **CapitalExpenditures**

# ** **

For the sixmonths ended June 30, 2004 and 2003, our capital expenditures amounted to $13.3million and $16.1 million, respectively. Our capital expenditures have averaged$34.9 million per year for the three years ended December 31, 2003,which consisted primarily of replacements of worn, obsolete or damagedequipment as well as investments in new equipment, mostly for our Pigments andTimber Treatment Chemicals business lines. From 2001 through 2003, we madesignificant investments in new facilities to expand capacity across ourbusiness lines including expenditures made in connection with the expansion ofour ACQ production capabilities in our Timber Treatment Chemicals business lineand expansion and refurbishment of two wafer reclaim facilities and productionequipment—the water reclaim facility in Providence, Rhode Island and theGreasque, France facility.

 

Our ability topay principal and interest on our debt, fund working capital and makeanticipated capital expenditures depends on our future performance, which issubject to general economic conditions and other factors, some of which arebeyond our control. We believe that based on current and anticipated levels ofoperations and conditions in our industry and markets, cash flows fromoperations and borrowings available under our revolving credit facility will beadequate for the foreseeable future to make required payments of principal andinterest on our debt 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 in forward-lookingstatements are reasonable, we can give no assurance that those expectationswill prove to have been correct. All forward-looking statements contained inthis document are qualified by reference to this cautionary statement.

 

**Item 3****.  Quantitativeand Qualitative Disclosures About 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 areemployed as risk management tools and not for trading purposes.

 

**Interest Rate Risk.**

 

The 2004 Financing (which took effect on July 31, 2004) includes $2.309billion of variable rate debt, $819 million of which is subject to floors andcaps on the interest rate.  Additionalborrowings permissible under the terms of the 2004 Senior Credit Facilities(approximately $300 million) would also be at a variable rate.  We are not required under the terms of any ofour long-term debt facilities to hedge or otherwise protect against interestrate fluctuation in our variable rate debt. However, in February 2001, weentered into six derivative contracts to hedge interest rate risk whichcurrently cover notional amounts of $166.2 million and €123.5 million. Thematurity date of all six contracts is February 2006. A 0.125% increase or decreasein the assumed weighted average interest rate would change annual interestexpense by $2.5 million.

 

**Foreign Currency Risk**

 

We conduct operations in many countries around the world. Our resultsof operations are subject to both currency transaction

 

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risk and currency translation risk. As a result of the DN Acquisition,we expect to generate a significant portion of our net sales outside of theUnited States.  We now serve our diverseand extensive customer base with 100 manufacturing facilities in 31 countries.Although we sell and manufacture our products in many countries, our sales andproduction costs are mainly denominated in U.S. dollars, euros and poundssterling. Our results of operations and financial condition are thereforeimpacted by the fluctuation of the euro and the pound sterling against ourreporting currency, the U.S. dollar. Due to the consummation of the DNAcquisition, a significantly larger share of sales and production costs is nowdenominated in euros. This increases the impact of the fluctuation of the euroagainst 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 consolidated financial statements. Exchange rates between thesecurrencies and the U.S. dollar in recent years have fluctuated significantlyand may do so in the future.

 

Our financial results are subject to the effect of currencyfluctuations on the translation of our euro-denominated debt. The 2004Financing includes approximately $974.0 million of euro denominated debt as ofJuly 31, 2004, and we assumed an additional $262.0 million of euro denominateddebt in connection with the DN Acquisition. Gains and losses on the translationof debt denominated in a currency other than the functional currency of theborrower are included as a separate component of “Other income andexpenses.”  We had previously enteredinto cross-currency interest rate swaps, with a June 30, 2004 notional amountof $75.0 million, that effectively converted US dollar LIBOR-based debt intoeuro LIBOR-based debt.  Gains and losseson these swaps have been included in interest expense.  We settled $53.4 million of these swapssimultaneously with the 2004 Financing.

 

**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 andProcedures**

 

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 June 30, 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 June 30, 2004 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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## **PARTII – 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**

 

Our TimberTreatment Chemicals subsidiary was named in the following actions:

 

•                  On April 22,2004, our Timber Treatment Chemicals subsidiary was named in an action entitledHayden, et. al. v. Menard Inc., et. al. in federal district court inIndiana.  Defendants include formulatorsof CCA, wood treaters, such as Georgia Pacific Corp. and Southeast WoodTreating, Inc., and retailers, such as Lowes Inc. and Menard, Inc.;

 

•                  On May 12, 2004,our Timber Treatment Chemicals subsidiary was named in an action entitled Mehl,et. al.  v. Stuart Lumber, et. al. instate court in Florida.  Defendantsinclude formulators of CCA, such as Arch Wood Protection, Inc., wood treaters,such as Georgia Pacific Corp., and local retailers;

 

•                  On June 29,2004, our Timber Treatment Chemicals subsidiary was named in an action entitledNapier, et. al. v. Chemical Specialties, Inc., et. al. in the federal districtcourt in Michigan.  Defendants includethe formulators of CCA, namely Osmose, Inc. and Arch Wood Protection, Inc.; and

 

•                  On July 12,2004, our Timber Treatment Chemicals subsidiary was named in an action entitledSmith, et. al. v. Western Cleanwood Preservers, et. al. in state court inIdaho.  Defendants include formulators ofCCA, wood treaters and retailers of CCA treated wood.

 

The plaintiffs allege variouscauses of actions related to the use of or exposure to CCA treated wood.

 

In addition,certain previously disclosed items are updated as follows:

 

•                  On August 3,2004, in the action entitled Touchstone v. Pea Ridge Cash and Carry Inc., et.al., our Timber Treatment Chemicals subsidiary was voluntarily dismissed by theplaintiffs; and

 

•                  In Ardoin, et.al. v. Stine Lumber, et. al., we settled all claims and causes of action withthe all of the various plaintiffs for a nominal amount.

 

Our Timber Treatment Chemicals subsidiary denies the allegations of allof the various CCA related claims and has vigorously defended; and willcontinue to vigorously defend; against these lawsuits. These CCA relatedlawsuits are subject to a number of uncertainties.  As a result, the outcome of the suits andtheir impact, if any, is difficult to assess. As these proceedings have not progressed significantly to date, we areunable to predict the outcome or the extent, if any, of our possible lossexposure from these actions.

 

**Item 2. Unregistered Sales of Equity Securitiesand Use of Proceeds.**

 

None.

 

**Item 3. Defaults upon Senior Securities.**

 

None.

 

**Item 4. Submission of Matters to a Vote of SecurityHolders.**

 

None.

 

**Item 5. Other Information.**

 

None.

 

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**Item 6. 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:

During the second quarter of 2004, theRegistrant filed the following reports on Form 8-K.

 

(i) Report dated April 19, 2004, reporting under Item 5 thesigning of an agreement to acquire the four businesses of Dynamit Nobel from mgtechnologies ag, and filing under Item 7 the press release as an exhibit.

 

(ii) Report dated April 26, 2004, reporting under Item 5 the approvalof the purchase agreement relating to the acquisition of four businesses of DynamitNobel by the supervisory board of mg technologies ag filing under Item 7 thepurchase agreement as an exhibit, reporting under Item 12 the Registrant’sfinancial results for the quarter ended March 31, 2004 and including atranscript of the Registrant’s conference call materials as an exhibit.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
|   | ROCKWOOD SPECIALTIES GROUP, INC. |
|--------|---------------------------------------|
|   |                                  |
|   |                                  |
|   | By:                                   | /s/ SEIFI GHASEMI |
|   |                                  | Seifi Ghasemi |
|   |                                  | Chairman of the Board and Chief Executive Officer |
|   |                                  | Date: August 16, 2004 |

 

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