10-Q 1 chemco10qq22003.txt SECOND QUARTER 2003 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 29, 2003 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 333-17827-01 ISP CHEMCO INC. (Exact name of registrant as specified in its charter) Delaware 51-0382622 (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 300 DELAWARE AVENUE, SUITE 303, WILMINGTON, DELAWARE 19801 (Address of principal executive offices) (Zip Code) (302) 427-5818 (Registrant's telephone number, including area code) NONE (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) ----------------------------------- SEE TABLE OF ADDITIONAL REGISTRANTS 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes / / No /X/ As of August 12, 2003, 100 shares of the registrant's common stock (par value $.01 per share) were outstanding. There is no trading market for the common stock of the registrant. As of August 12, 2003, each of the additional registrants had the number of shares outstanding which is shown on the table below. There is no trading market for the common stock of the additional registrants. No shares of the registrant or the additional registrants were held by non-affiliates. THE REGISTRANT AND THE ADDITIONAL REGISTRANTS MEET THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND ARE THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT. ADDITIONAL REGISTRANTS

ADDITIONAL REGISTRANTS

PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS ISP CHEMCO INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 1 ISP CHEMCO INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED) DECEMBER 31, JUNE 29, 2002 2003 ------------ ----------- (THOUSANDS) ASSETS Current Assets: Cash and cash equivalents...................... $ 33,291 $ 42,045 Accounts receivable, trade, less allowance of $6,022 and $6,218 at December 31, 2002 and June 29, 2003, respectively.................. 79,780 102,680 Accounts receivable, other..................... 15,371 18,510 Receivables from related parties............... 12,412 19,449 Inventories.................................... 176,217 173,735 Deferred income taxes.......................... 34,687 37,858 Prepaid expenses............................... 9,822 9,328 ---------- ---------- Total Current Assets......................... 361,580 403,605 Property, plant and equipment, net............... 565,441 568,635 Goodwill, net of accumulated amortization of $180,486.................................... 325,706 330,957 Intangible assets, net........................... 9,442 9,154 Long-term receivable from related party.......... 30,298 31,207 Other assets..................................... 43,016 48,075 ---------- ---------- Total Assets..................................... $1,335,483 $1,391,633 ========== ========== LIABILITIES AND SHAREHOLDER'S EQUITY Current Liabilities: Short-term debt................................ $ 144 $ 67 Current maturities of long-term debt........... 2,732 2,722 Accounts payable............................... 53,205 59,011 Accrued liabilities............................ 89,902 82,060 Income taxes payable........................... 34,201 36,221 ---------- ---------- Total Current Liabilities.................... 180,184 180,081 ---------- ---------- Long-term debt less current maturities........... 623,008 622,269 ---------- ---------- Deferred income taxes............................ 100,715 111,590 ---------- ---------- Other liabilities................................ 103,678 110,493 ---------- ---------- Shareholder's Equity: Common stock, $.01 par value per share; 1,000 shares authorized; 100 shares issued and outstanding ............................. - - Additional paid-in capital..................... 398,023 399,474 Accumulated deficit............................ (51,126) (22,872) Accumulated other comprehensive loss........... (18,999) (9,402) ---------- ---------- Total Shareholder's Equity................... 327,898 367,200 ---------- ---------- Total Liabilities and Shareholder's Equity....... $1,335,483 $1,391,633 ========== ========== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 2 ISP CHEMCO INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) SIX MONTHS ENDED -------------------- JUNE 30, JUNE 29, 2002 2003 -------- --------- (THOUSANDS) Cash and cash equivalents, beginning of period............. $ 10,830 $ 33,291 --------- -------- Cash provided by (used in) operating activities: Net income (loss)........................................ (131,061) 28,254 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Cumulative effect of changes in accounting principles 155,400 1,021 Gain on sale of assets............................... (5,468) - Depreciation......................................... 27,678 29,723 Amortization of intangible assets.................... 555 288 Deferred income taxes................................ 4,205 8,304 (Increase) decrease in working capital items............. 5,229 (22,269) Proceeds (repayments) from sale of accounts receivable... (3,883) (688) Increase in receivable from related parties.............. (5,379) (7,946) Change in cumulative translation adjustment.............. 10,584 7,177 Other, net............................................... (1,849) (5,020) -------- -------- Net cash provided by operating activities.................. 56,011 38,844 -------- -------- Cash provided by (used in) investing activities: Capital expenditures and acquisitions.................... (30,610) (33,005) Net proceeds from sale of assets......................... 27,271 - -------- -------- Net cash used in investing activities...................... (3,339) (33,005) -------- -------- Cash provided by (used in) financing activities: Increase (decrease) in short-term debt................... 6 (77) Decrease in borrowings under revolving credit facility... (56,850) - Repayments of long-term debt............................. (183,464) (879) Call premium on redemption of debt....................... (2,734) - Decrease in restricted cash.............................. 182,130 - Debt issuance costs...................................... (797) - Capital contribution from parent company................. 6,891 1,451 -------- -------- Net cash provided by (used in) financing activities........ (54,818) 495 -------- -------- Effect of exchange rate changes on cash.................... 554 2,420 -------- -------- Net change in cash and cash equivalents.................... (1,592) 8,754 -------- -------- Cash and cash equivalents, end of period................... $ 9,238 $ 42,045 ======== ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 3 ISP CHEMCO INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) -- (CONTINUED) SIX MONTHS ENDED -------------------- JUNE 30, JUNE 29, 2002 2003 --------- --------- (THOUSANDS) Supplemental Cash Flow Information: Cash paid during the period for: Interest (net of amount capitalized)................. $ 32,425 $ 26,202 Income taxes (including taxes paid pursuant to the Tax Sharing Agreement)............................ 4,012 5,774 Acquisition of mineral products facility: Fair market value of assets acquired................. $ 11,421 Purchase price of acquisition........................ 11,421 -------- Liabilities assumed.................................. $ - ======== Acquisition of Germinal S.A., net of $436 cash acquired: Fair market value of assets acquired................. $ 7,685 Purchase price of acquisition........................ 7,252 -------- Liabilities assumed.................................. $ 433 ======== The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 4 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The consolidated financial statements for ISP Chemco Inc. (the "Company") reflect, in the opinion of management, all adjustments necessary to present fairly the financial position of the Company and its consolidated subsidiaries at June 29, 2003, and the results of operations and cash flows for the three and six month periods ended June 30, 2002 and June 29, 2003. All adjustments are of a normal recurring nature. These consolidated financial statements should be read in conjunction with the annual consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002 (the "2002 Form 10-K"). NOTE 1. CHARGE FOR EARLY RETIREMENT OF DEBT On January 14, 2002, the Company's indirect parent company, International Specialty Products Inc. ("ISP"), redeemed the remaining $307.9 million aggregate principal amount of its 9% Senior Notes due 2003 (the "2003 Notes"), of which $182.1 million was reflected on the Company's Consolidated Balance Sheet at December 31, 2001. As a result, the Company recorded an extraordinary loss on the early retirement of debt of $2.8 million ($4.3 million before income tax benefit of $1.5 million). In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 eliminates the requirement of SFAS No. 4 that gains and losses on the early extinguishments of debt be recorded as an extraordinary item unless such gains and losses meet the criteria of Accounting Principles Board Opinion No. 30 for classification as extraordinary. The Company adopted SFAS No. 145 effective January 1, 2003 and, as a result, the Consolidated Statement of Operations for the first six months of 2002 was restated to reclassify the pre-tax extraordinary charge of $4.3 million on the early retirement of debt to a separate line item of pre-tax income. The tax benefit of $1.5 million related to the extraordinary charge has been reclassified and is included in "Income taxes." NOTE 2. ASSET RETIREMENT OBLIGATIONS The Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations," effective January 1, 2003. SFAS No. 143 establishes accounting and reporting standards for legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and the normal operation of a long-lived asset. The Company holds long-lived assets that have legal obligations associated with their retirement. These assets include deep wells that require capping, minerals quarries that require reclamation and other plant assets subject to certain environmental regulations. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation ("ARO") be recognized in the period in which it is incurred. Upon initial recognition of such liability, an entity must capitalize the asset retirement cost by increasing the carrying amount of the related long-lived asset and subsequently depreciating the asset retirement cost over the useful life of the related asset. Subsequent to the initial measurement of the ARO, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. If the obligation is settled for other than the carrying amount of the liability, the Company would then recognize a gain or loss on settlement. As a result of adopting SFAS No. 143, effective January 1, 2003, the Company recognized an after-tax charge of $1.0 million ($1.6 million before an income tax benefit of $0.6 million) as the cumulative effect of a change in accounting principle, and recorded an ARO of $1.9 million and a net increase in 5 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 2. ASSET RETIREMENT OBLIGATIONS - (CONTINUED) property, plant and equipment of $0.3 million. The ongoing expense on an annual basis resulting from the initial adoption of SFAS No. 143 is approximately $0.2 million. The change in the ARO during the six months ended June 29, 2003 is as follows: (Thousands) ARO liability recognized as of January 1, 2003....... $ 1,871 Liabilities incurred, quarter ended June 29, 2003.... 16 ARO liability accretion.............................. 90 -------- ARO liability balance, June 29, 2003................. $ 1,977 ======== The pro forma ARO would have been $1.7 million on January 1, 2002 and $1.8 million on June 30, 2002 if SFAS No. 143 had been applied during all periods affected. For the six months ended June 30, 2002, the reported net loss on a pro forma basis would have been $131.2 million, including an additional $0.1 million due to additional depreciation and liability accretion from AROs. The net income for the six months ended June 29, 2003 would have increased on a pro forma basis by $1.0 million to $29.3 million due to the elimination of the cumulative effect of the change in accounting principle recorded on January 1, 2003 on the adoption of SFAS No. 143. For the second quarter of 2002, the pro forma net income would have been $40 thousand lower, while for the second quarter of 2003, actual and pro forma net income are the same. NOTE 3. NEW ACCOUNTING STANDARDS In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and concludes that an entity's commitment to an exit plan does not by itself create a present obligation that meets the definition of a liability. This Statement also establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. As the Company has no plans at this time for any exit or disposal activities, the adoption of SFAS No. 146 will not have any immediate effect on the Company's consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," an amendment of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 for both annual and interim reporting 6 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 3. NEW ACCOUNTING STANDARDS - (CONTINUED) periods by requiring disclosures in a tabular format to reconcile net income as reported to pro forma net income as if the fair value method was used. Certain of the disclosure modifications required for fiscal years ending after December 15, 2002 were disclosed in the Company's 2002 Form 10-K. However, as discussed in Note 4, with the completion of the going private transaction by ISP in February 2003, the Company's stock-based compensation plans were terminated and payments were made in accordance with the terms of the merger agreement. Therefore, the provisions of SFAS No. 148 are no longer applicable to the Company as it relates to those plans. In addition, the Company currently accounts for incentive units granted to eligible Company employees pursuant to ISP's 2000 Long-Term Incentive Plan and 2003 Executive Long-Term Incentive Plan under the accounting prescribed by FASB Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option and Award Plans" ("FIN 28"), which requires an entity to measure compensation as the amount by which the Book Value of the incentive units covered by the grant exceeds the option price or value specified of such incentive units at the date of grant. Changes, either increases or decreases, in the Book Value of those incentive units between the date of grant and the measurement date result in a change in the measure of compensation for the right or award. The Company expects to continue to account for its long-term incentive units under the accounting prescribed by FIN 28 and has adopted the additional disclosure provisions of SFAS No. 148. Since compensation expense related to such incentive units is included in the actual Consolidated Statements of Operations, the Company's pro forma net income under SFAS No. 123 would have been the same as actual net income. In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements for a guarantor's accounting for and disclosures of certain guarantees issued and outstanding. The provisions of FIN 45 apply to guarantee contracts that contingently require the guarantor to make payments (in cash, financial instruments, other assets, shares of stock or provision of services) to the guaranteed party for guarantees such as a financial standby letter of credit, a market value guarantee on either a financial or nonfinancial asset owned by the guaranteed party and a guarantee of the collection of the scheduled contractual cash flows from financial assets held by a special-purpose entity. FIN 45 also applies to indemnification contracts and indirect guarantees of indebtedness of others. The requirements of FIN 45 for the initial recognition and measurement of the liability for a guarantor's obligations are to be applied only on a prospective basis to guarantees issued or modified after December 31, 2002. The Company currently does not have any guarantees, indemnification contracts or indirect guarantees of indebtedness of others that would be subject to the initial recognition and measurement provisions of FIN 45. As discussed in Note 10, the Company's 10 1/4% Senior Subordinated Notes due 2011 are guaranteed by all of the Company's domestic subsidiaries, other than certain immaterial subsidiaries and the Company's accounts receivable financing subsidiary. In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities." In accordance with FIN 46, a variable interest entity will be consolidated if either the total equity investment at risk is not sufficient to 7 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 3. NEW ACCOUNTING STANDARDS - (CONTINUED) permit the entity to finance its activities without additional subordinated financial support from other parties, or as a group, the holders of the equity investment at risk lack any one of the following three characteristics of a controlling financial interest: (1) the direct or indirect ability to make decisions about an entity's activities; (2) the obligation to absorb the expected losses of the entity if they occur; (3) the right to receive the expected residual returns of the entity if they occur. All companies with variable interests in variable interest entities created after January 31, 2003 shall apply the provisions of FIN 46 immediately. A public entity with a variable interest in a variable interest entity created before February 1, 2003 shall apply the provisions of FIN 46 to that entity no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003. The Company does not have an interest in a variable interest entity. Therefore, FIN 46 does not currently have an impact on the Company's consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments and hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company does not expect that the adoption of SFAS No. 149 will have an immediate impact on the Company's consolidated financial statements. NOTE 4. OTHER OPERATING GAINS AND CHARGES On February 28, 2003, ISP completed a going private transaction whereby stockholders of ISP approved the Agreement and Plan of Merger dated as of November 8, 2002 of International Specialty Products Holdings Inc. with and into ISP and pursuant to which holders of ISP common stock received $10.30 per share in cash for each share of ISP common stock owned (except as otherwise provided in the merger agreement). As a result of completing this going private transaction, the Company's stock-based compensation plans were terminated and payments were made in accordance with the terms of the merger agreement. As a result, holders of approximately 2.7 million vested, in-the-money stock options outstanding and exercisable on February 28, 2003 received a cash amount equal to the excess of $10.30 over the exercise price of such stock options, aggregating $1.5 million. Compensation expense of $1.5 million related to the payment for stock option terminations was recorded in the first quarter of 2003 and is included in "Other operating gains and (charges), net." In addition, outstanding restricted common stock awards were replaced with long-term incentive units of comparable vesting and a value equivalent to the previous awards based on the buyout price of $10.30 per award. First quarter 2002 results included an other operating gain of $2.8 million for a contract termination related to the sale of the Company's FineTech business. The Company recorded an additional second quarter 2002 pre-tax gain, after expenses, of $5.5 million related to this sale. In the second quarter of 2002, the Company received $4.0 million in settlement of a manufacturing and supply contract with a customer of the fine chemicals business. After related expenses, a pre-tax gain of $3.9 million was recognized. For additional information, reference is made to Note 6 to Consolidated Financial Statements contained in the 2002 Form 10-K. 8 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 5. 2003 EXECUTIVE LONG-TERM INCENTIVE PLAN In May 2003, ISP adopted the 2003 Executive Long-Term Incentive Plan (the "Plan"), which authorizes the grant of incentive units ("Incentive Units") to eligible employees of the Company. The Plan is administered by a committee (the "Committee") appointed by the Board of Directors of ISP from among the employees of ISP. The Committee, in its sole discretion, determines the number of Incentive Units to be granted to each eligible employee. The Plan will terminate ten years after its effective date of May 15, 2003. NOTE 6. GOODWILL AND INTANGIBLE ASSETS On June 30, 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". With the adoption of SFAS No. 142, goodwill is no longer subject to amortization over its estimated useful life. However, goodwill is subject to at least an annual assessment for impairment and more frequently if circumstances indicate a possible impairment. The Company adopted SFAS No. 142 effective as of January 1, 2002. Accordingly, during the second quarter of 2002, the Company completed a transitional impairment test, effective January 1, 2002, and recognized a goodwill impairment loss of $155.4 million as the cumulative effect of a change in accounting principle. The following schedule reconciles the changes in the carrying amount of goodwill, by business segment, for the six months ended June 29, 2003. See Note 8 for a discussion of a change in the composition of the Company's business segments, effective January 1, 2003. Also, see Note 10 for a discussion of the acquisition of Germinal S.A.

Intangible assets at December 31, 2002 and June 29, 2003 relate to the Company's biocides business, which was acquired on December 31, 2001. The following is information as of December 31, 2002 and June 29, 2003 related to the Company's acquired intangible assets:

9 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 6. GOODWILL AND INTANGIBLE ASSETS - (CONTINUED) Estimated amortization expense: Year ended December 31, (Thousands) 2003................................................ $ 575 2004................................................ 290 2005................................................ 290 2006................................................ 290 2007................................................ 26 NOTE 7. COMPREHENSIVE INCOME (LOSS)

Changes in the components of "Accumulated other comprehensive loss" for the six months ended June 29, 2003 are as follows: Cumulative Additional Foreign Minimum Accumulated Currency Pension Other Translation Liability Comprehensive Adjustment Adjustment Loss ---------- ---------- ------------- (Thousands) Balance, December 31, 2002....... $ (13,595) $ (5,404) $ (18,999) Change for the period............ 9,597 - 9,597 ---------- --------- --------- Balance, June 29, 2003........... $ (3,998) $ (5,404) $ (9,402) ========== ========= ========= 10 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 8. BUSINESS SEGMENT INFORMATION

(1) Effective January 1, 2003, the Company changed the composition of its reportable segments to be consistent with the current structure of the Company's businesses. Over the last several years, the Company has increased its focus on its higher margin consumer-oriented businesses. Consistent with that business focus, the Company now reports three business segments: Specialty Chemicals, Industrial Chemicals and Mineral Products. The Company's Specialty Chemicals segment consists of the personal care, pharmaceutical, food, beverage, performance chemicals and fine chemicals product lines. Sales and operating income by business segment for the second quarter and six months ended June 30, 2002 have been restated to conform to the 2003 presentation. (2) Includes sales to Building Materials Corporation of America, an affiliate, and its subsidiaries, of $19.7 and $20.0 million for the second quarter of 2002 and 2003, respectively, and $38.8 and $39.7 for the first six months of 2002 and 2003, respectively. NOTE 9. INVENTORIES Inventories comprise the following: December 31, June 29, 2002 2003 ------------ -------- (Thousands) Finished goods................ $113,912 $116,395 Work-in-process............... 32,407 31,034 Raw materials and supplies.... 29,898 26,306 -------- -------- Inventories................... $176,217 $173,735 ======== ======== 11 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 9. INVENTORIES - (CONTINUED) At December 31, 2002 and June 29, 2003, $62.0 and $55.6 million, respectively, of domestic inventories were valued using the LIFO method. If the FIFO inventory method had been used for these inventories, the value of inventories would have been $2.8 and $3.9 million higher at December 31, 2002 and June 29, 2003, respectively. NOTE 10. ACQUISITION In May 2003, the Company acquired 100% of the stock of Germinal S.A., a supplier of food ingredients to the meat and dairy industry in southern Latin America, for $7.3 million in cash, net of $0.4 million cash acquired. Germinal has a manufacturing facility at its headquarters in Cabreuva, Brazil. In accordance with SFAS No. 141, "Business Combinations," the purchase price was allocated on a preliminary basis to the estimated fair value of the identifiable assets acquired, primarily property plant and equipment, and the excess of $5.5 million was recorded as goodwill. The Company is in the process of evaluating the fair value of the net assets acquired and, therefore, the purchase price allocation is subject to refinement. The results of the Germinal business are included in the Company's results of operations from the date of acquisition and are not expected to have a material impact on the Company's results of operations for the year 2003. NOTE 11. GUARANTOR FINANCIAL INFORMATION In 2001, the Company and three of its wholly owned subsidiaries jointly issued, in three separate transactions, a total of $405.0 million aggregate principal amount of 10 1/4% Senior Subordinated Notes due 2011 (the "2011 Notes"). The 2011 Notes are guaranteedby all of the Company's domestic subsidiaries, other than certain immaterial subsidiaries and the Company's accounts receivable financing subsidiary. These guarantees are full, unconditional and joint and several. ISP Global Technologies Inc., which is a guarantor of the 2011 Notes, is party to a License and Royalty Agreement with non-guarantor foreign affiliates. Under this agreement, ISP Global Technologies granted a license to certain non-guarantor foreign affiliates for the use of the Patent Rights, Know-how and Trademarks in connection with the manufacture, use and sale of the Company's products. Presented below is condensed consolidating financial information for the Company, the guarantor subsidiaries and the non-guarantor subsidiaries. This financial information should be read in conjunction with the Consolidated Financial Statements and other notes related thereto. Separate financial information for the Company's guarantor subsidiaries and non-guarantor subsidiaries is not included herein because management has determined that such information is not material to investors. 12 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 11. GUARANTOR FINANCIAL INFORMATION - (CONTINUED) ISP CHEMCO INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SECOND QUARTER ENDED JUNE 30, 2002 (THOUSANDS)

ISP CHEMCO INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SECOND QUARTER ENDED JUNE 29, 2003 (THOUSANDS)

13 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 11. GUARANTOR FINANCIAL INFORMATION - (CONTINUED) ISP CHEMCO INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2002 (Thousands)

ISP CHEMCO INC. CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS SIX MONTHS ENDED JUNE 29, 2003 (THOUSANDS)

14 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 11. GUARANTOR FINANCIAL INFORMATION - (CONTINUED) ISP CHEMCO INC. CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2002 (THOUSANDS)

15 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 11. GUARANTOR FINANCIAL INFORMATION - (CONTINUED) ISP CHEMCO INC. CONDENSED CONSOLIDATING BALANCE SHEET JUNE 29, 2003 (THOUSANDS)

16 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 11. GUARANTOR FINANCIAL INFORMATION - (CONTINUED) ISP CHEMCO INC. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOW SIX MONTHS ENDED JUNE 30, 2002 (THOUSANDS)

17 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 11. GUARANTOR FINANCIAL INFORMATION - (CONTINUED) ISP CHEMCO INC. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOW SIX MONTHS ENDED JUNE 29, 2003 (THOUSANDS)

18 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 12. CONTINGENCIES Environmental Litigation The Company, together with other companies, is a party to a variety of proceedings and lawsuits involving environmental matters ("Environmental Claims") under the Comprehensive Environmental Response Compensation and Liability Act, Resource Conservation and Recovery Act and similar state laws, in which recovery is sought for the cost of cleanup of contaminated sites or remedial obligations are imposed. A number of these Environmental Claims are in the early stages or have been dormant for protracted periods. While the Company cannot predict whether adverse decisions or events can occur in the future, in the opinion of the Company's management, the resolution of the Environmental Claims should not be material to the business, liquidity, results of operations, cash flows or financial position of the Company. However, adverse decisions or events, particularly as to increases in remedial costs, discovery of new contamination, assertion of natural resource damages, and the liability and the financial responsibility of the Company's insurers and of the other parties involved at each site and their insurers, could cause the Company to increase its estimate of its liability in respect of those matters. It is not currently possible to estimate the amount or range of any additional liability. For further information regarding environmental matters, reference is made to Note 21 to Consolidated Financial Statements contained in the 2002 Form 10-K. Tax Claim Against G-I Holdings Inc. The predecessor of ISP and certain of its domestic subsidiaries were parties to tax sharing agreements with members of a consolidated group for Federal income tax purposes that included G-I Holdings Inc. (the "G-I Holdings Group") in certain prior years. Until January 1, 1997, ISP and its domestic subsidiaries were included in the consolidated Federal income tax returns of the G-I Holdings Group and, accordingly, would be severally liable for any tax liability of the G-I Holdings Group in respect of those prior years. Those tax sharing agreements are no longer applicable with respect to the tax liabilities of ISP for periods subsequent to January 1, 1997, because neither the Company nor any of its domestic subsidiaries are members of the G-I Holdings Group for periods after January 1, 1997. In January 2001, G-I Holdings filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code due to its asbestos-related bodily injury claims relating to the inhalation of asbestos fiber. On September 15, 1997, G-I Holdings received a notice from the Internal Revenue Service (the "IRS") of a deficiency in the amount of $84.4 million (after taking into account the use of net operating losses and foreign tax credits otherwise available for use in later years) in connection with the formation in 1990 of Rhone-Poulenc Surfactants and Specialties, L.P. (the "surfactants partnership"), a partnership in which G-I Holdings held an interest. G-I Holdings has advised the Company that it believes that it will prevail in the tax matter arising out of the surfactants partnership, although there can be no assurance in this regard. The Company believes that the ultimate disposition of this matter will not have a material adverse effect on its business, financial position or results of operations. On September 21, 2001, the IRS filed a proof of claim with respect to 19 ISP CHEMCO INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED) NOTE 12. CONTINGENCIES - (CONTINUED) such deficiency against G-I Holdings and one of its subsidiaries, ACI Inc., that also filed for protection under Chapter 11 of the Bankruptcy Code, in the G-I Holdings bankruptcy. If such proof of claim is sustained, ISP and/or certain of its subsidiaries together with G-I Holdings and several current and former subsidiaries of G-I Holdings would be severally liable for taxes and interest in an amount of approximately $276 million, computed as of June 29, 2003. On May 7, 2002, G-I Holdings filed an objection to that proof of claim. Such objection will be heard by the United States District Court for the District of New Jersey which oversees the G-I Holdings bankruptcy court. For additional information relating to G-I Holdings, reference is made to Notes 9 and 21 to Consolidated Financial Statements contained in the 2002 Form 10-K. 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless otherwise indicated by the context, "we," "us" and "our" refer to ISP Chemco Inc. and its consolidated subsidiaries. RESULTS OF OPERATIONS - SECOND QUARTER 2003 COMPARED WITH SECOND QUARTER 2002 We recorded second quarter 2003 net income of $16.0 million compared with net income of $17.2 million in the second quarter of 2002. The lower results for the second quarter of 2003 were attributable to $4.5 million lower operating income, partially offset by $2.1 million lower interest expense and $1.5 million higher other income, net. Operating income in the second quarter of 2002 included $9.4 million of other operating gains resulting from a $5.5 million gain on the sale of our FineTech business and a $3.9 million gain on a contract settlement. Effective January 1, 2003, we changed the composition of our reportable segments to be consistent with the current structure of our businesses. Over the last several years, we have increased our focus on our higher margin consumer-oriented businesses. Consistent with that business focus, we now report three business segments: Specialty Chemicals, Industrial Chemicals and Mineral Products. Our Specialty Chemicals segment consists of the personal care, pharmaceutical, food, beverage, performance chemicals and fine chemicals product lines. Sales and operating income by business segment for the second quarter and six months ended June 30, 2002 have been restated to conform to the 2003 presentation. Net sales for the second quarter of 2003 were $229.5 million compared with $214.7 million for the second quarter of 2002. The $14.8 million (7%) increase in sales resulted from higher unit volumes in the pharmaceutical, food and beverage product lines (totaling $6.8 million) and the favorable impact of the weaker U.S. dollar in Europe ($11.6 million). These sales gains were partially offset by lower volumes in Industrial Chemicals and the fine chemicals product line (totaling $3.5 million) and lower pricing ($2.0 million), mainly in the Mineral Products segment and personal care product line. The gross margin for the second quarter of 2003 was 35.9% compared with 35.4% in the second quarter of 2002. The improved margin resulted primarily from the higher volumes in the pharmaceutical and beverage product lines and the favorable impact of the weaker U.S. dollar. Lower gross margins for the Mineral Products and Industrial Chemicals segments were adversely impacted by higher energy costs. While operating income in the second quarter of 2003 was $37.0 million compared with $41.5 million in the second quarter of 2002, excluding the other operating gains in the second quarter of 2002 mentioned above, operating income increased from $32.1 million in the second quarter of 2002 to $37.0 million in the second quarter of 2003 21 - up 15% (see reconciliation below of non-GAAP financial measures). The higher comparable operating income for the second quarter of 2003 includes improved results in the Specialty Chemicals business segment, partially offset by losses in the Industrial Chemicals segment and lower results in the Mineral Products segment. On a comparable basis, excluding the aforementioned other operating gains, operating income for the Specialty Chemicals segment improved 38% to $33.7 million compared with $24.4 million in last year's second quarter. The improved results were primarily attributable to higher unit volumes and the favorable impact of the weaker U.S. dollar in the pharmaceutical and beverage product lines and, with respect to the personal care product line, the favorable impact of the weaker U.S. dollar and manufacturing efficiencies. The Industrial Chemicals segment recorded an operating loss of $1.4 million in the second quarter of 2003 compared with operating income of $0.4 million in the second quarter of 2002. The Industrial Chemicals manufacturing operations are principally based in Europe and costs for this business have been adversely impacted by the stronger Euro and higher energy costs, partially offset by manufacturing efficiencies. Operating income for the Mineral Products business segment decreased by $2.5 million (35%) to $4.7 million in the second quarter of 2003 because of unfavorable manufacturing costs, primarily higher energy costs, as well as lower pricing. Selling, general and administrative expenses for the second quarter of 2003 increased by 3% to $45.1 million from $43.8 million in the same period last year as a result of higher administrative and distribution costs, mainly due to the weaker U.S. dollar. Selling, general and administrative expenses as a percentage of sales were reduced to 19.7% compared with 20.4% in last year's second quarter. Interest expense for the second quarter of 2003 was $13.2 million versus $15.3 million for the same period last year. The $2.1 million (14%) decrease was primarily due to lower average interest rates ($1.3 million impact) and, to a lesser extent, lower average borrowings ($0.8 million impact). Other income, net, for the second quarter of 2003 was $1.4 million compared with other expense, net, of $0.1 million in last year's second quarter, with the higher income due primarily to favorable foreign exchange. Business Segment Review A discussion of operating results for each of our business segments follows. We operate our business through three reportable business segments: Specialty Chemicals; Industrial Chemicals; and Mineral Products. As discussed above, we changed the composition of our reportable segments, effective January 1, 2003. Sales and operating income by business segment for the second quarter of 2002 have been restated to conform to the 2003 presentation. See also Note 8 to consolidated financial statements. The business segment review below and the discussion of operating income above contain information regarding non-GAAP financial measures contained within the meaning of Item 10 of Regulation S-K promulgated by 22 the Securities and Exchange Commission. As used herein, "GAAP" refers to accounting principles generally accepted in the United States of America. We use non-GAAP financial measures to eliminate the effect of certain other operating gains and charges on reported operating income. Management believes that these financial measures are useful to investors and financial institutions because such measures exclude transactions that are unusual due to their nature or infrequency and therefore allow investors and financial institutions to more readily compare our company's performance from period to period. Management uses this information in monitoring and evaluating our company's performance and the performance of individual business segments. The non-GAAP financial measures included herein have been reconciled to the most directly comparable GAAP financial measure as is required under Item 10 of Regulation S-K regarding the use of such financial measures. These non-GAAP measures should be considered in addition to, and not as a substitute, or superior to, operating income or other measures of financial performance in accordance with generally accepted accounting principles. Second Quarter --------------------- 2002 2003 --------- ------- (Millions) Reconciliation of non-GAAP financial measures: Operating income per GAAP............................... $ 41.5 $ 37.0 Non-GAAP adjustments: Less: Other operating (gains) charges(1)........... (9.4) - --------- ------- Operating income, as adjusted........................... $ 32.1 $ 37.0 ========= ======= Supplemental Business Segment Information: Operating income: Operating income per GAAP - Specialty Chemicals.... $ 33.8 $ 33.7 Non-GAAP adjustments (1)........................... (9.4) - --------- ------- Operating income - Specialty Chemicals as adjusted. $ 24.4 $ 33.7 ========= ======= Operating income per GAAP - Industrial Chemicals... $ 0.4 $ (1.4) Non-GAAP adjustments............................... - - --------- ------- Operating income - Industrial Chemicals as adjusted $ 0.4 $ (1.4) ========= ======= Operating income per GAAP - Mineral Products....... $ 7.2 $ 4.7 Non-GAAP adjustments............................... - - --------- ------- Operating income - Mineral Products as adjusted.... $ 7.2 $ 4.7 ========= ======= (1) Non-GAAP adjustments in the second quarter of 2002 included an other operating gain of $5.5 million related to the sale of our company's FineTech business and an other operating gain of $3.9 million related to a contract settlement with a customer of our fine chemicals product line, each of which related to the Specialty Chemicals business segment. Specialty Chemicals Sales in the second quarter of 2003 were $159.0 million compared with $146.7 million for the same period last year, while operating income for the second quarter of 2003 was $33.7 million compared with $33.8 million in last year's second quarter. The 8% increase in sales 23 was attributable to higher unit volumes in the pharmaceutical, beverage and food product lines (totaling $6.8 million), and the favorable effect of the weaker U.S. dollar in Europe ($8.0 million). Partially offsetting these sales increases were lower unit volumes in the fine chemicals product line ($2.1 million) and lower pricing ($0.9 million), mainly in the personal care product line in both the skin care and hair care markets. Higher pharmaceutical volumes were primarily attributable to strong growth in the excipients markets (Plasdones for tablet binders and Polyplasdones for tablet disintegrants). Excluding the other operating gains in the second quarter of 2002, discussed above, operating income for the Specialty Chemicals segment increased by 38% for the second quarter of 2003 to $33.7 million compared with $24.4 million in last year's second quarter. The improvement resulted primarily from the favorable effect of the weaker U.S. dollar ($6.0 million) and the impact of higher unit volumes in the pharmaceutical, beverage and food product lines (totaling $3.7 million), partially offset by unfavorable pricing ($0.9 million). Industrial Chemicals Sales in the second quarter of 2003 were $44.4 million compared with $42.3 million in the second quarter of 2002. The 5% increase in sales was attributable to the favorable effect of the weaker U.S. dollar ($3.6 million), partially offset by lower volumes ($1.5 million). The Industrial Chemicals segment recorded an operating loss of $1.4 million in the second quarter of 2003 compared with operating income of $0.4 million in the second quarter of 2002. The Industrial Chemicals manufacturing operations are principally based in Europe and costs for this business have been adversely impacted by the stronger Euro. The unfavorable results also included higher energy costs and operating expenses (totaling $3.9 million), partially offset by manufacturing efficiencies ($6.1 million). Mineral Products Sales for the Mineral Products segment for the second quarter of 2003 were $26.1 million compared with $25.7 million for the second quarter of 2002, as higher unit volumes ($1.0 million), mainly increased sales to Building Materials Corporation of America, an affiliate, which we refer to as BMCA, were offset by lower pricing ($0.8 million). Operating income for the second quarter of 2003 was $4.7 million compared with $7.2 million for the second quarter of 2002. The $2.5 million (35%) decrease in operating income was due to unfavorable manufacturing costs, primarily as a result of higher energy costs, as well as lower pricing. 24 RESULTS OF OPERATIONS - FIRST SIX MONTHS 2003 COMPARED WITH FIRST SIX MONTHS 2002 We have restated our previously issued consolidated financial statements for the first six months of 2002. See Note 1 and Note 8 to consolidated financial statements for further information. For the first six months of 2003, we recorded net income of $28.3 million compared with a net loss of $131.1 million in the first six months of 2002. First six months 2003 results include a $1.0 million after-tax charge for the cumulative effect of a change in accounting principle from the adoption of Statement of Financial Accounting Standards, which we refer to as "SFAS," No. 143, "Accounting for Asset Retirement Obligations." First six months 2002 results included a $155.4 million goodwill impairment charge, effective January 1, 2002, for the cumulative effect of a change in accounting principle related to the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets." Income before the cumulative effect of changes in accounting principles was $29.3 million for the first six months of 2003 compared with $24.3 million in the first six months of 2002. The improved results for the first six months of 2003 were attributable to $5.1 million lower interest expense and $2.0 million higher other income, net, partially offset by $3.6 million lower operating income. The results for the first six months of 2002 included a $4.3 million pre-tax charge for the early retirement of debt and other operating gains of $12.2 million, while first six months 2003 results include an other operating charge of $1.5 million for stock option payments related to a going private transaction by our indirect parent company, International Specialty Products Inc., which we refer to as ISP. The other operating gains of $12.2 million in the first six months of 2002 included a $2.8 million gain from a contract termination related to the sale of our company's FineTech business, a $5.5 million gain on the sale of the FineTech business and a $3.9 million gain on a contract settlement. Net sales for the first six months of 2003 were $462.1 million compared with $433.8 million for the first six months of 2002. The $28.3 million (6.5%) increase in sales resulted primarily from higher unit volumes in Industrial Chemicals and Mineral Products and the pharmaceutical, food and beverage product lines (totaling $22.3 million) and the favorable impact of the weaker U.S. dollar in Europe ($23.5 million). These sales gains were partially offset by lower pricing in Industrial Chemicals and the personal care product line (totaling $5.3 million) and lower volumes ($12.0 million) in the fine chemicals product line, mainly as a result of the loss of sales to Polaroid, which is operating under bankruptcy court protection. The gross margin for the first six months of 2003 was 35.1% compared with 34.5% in the first six months of 2002. The improved margin resulted primarily from manufacturing efficiencies and the favorable impact of the weaker U.S. dollar in the Specialty Chemicals business segment. Lower gross margins for the Mineral Products and Industrial Chemicals segments were adversely impacted by higher energy costs and lower pricing. 25 Operating income for the first six months of 2003 was $71.6 million compared with $75.2 million for the first six months of 2002. Excluding the other operating gains and charges in each period mentioned above, operating income on a comparable basis was $73.1 million and $63.0 million for the first six months of 2003 and 2002, respectively (see reconciliation below of non-GAAP financial measures). The higher comparable operating income for the first six months of 2003 includes improved results in the Specialty Chemicals business segment, partially offset by losses in the Industrial Chemicals segment and lower results in the Mineral Products segment. On a comparable basis, excluding the aforementioned other operating gains and charges, operating income for the Specialty Chemicals segment improved 44% to $68.0 million compared with $47.1 million in last year's first six months. The improved results were primarily attributable to higher volumes, manufacturing efficiencies, lower operating expenses and the favorable impact of the weaker U.S. dollar, partially offset by lower pricing. The improved results in Specialty Chemicals were adversely impacted by the lack of sales to Polaroid. The Industrial Chemicals segment recorded an operating loss of $4.1 million in the first six months of 2003 compared with operating income of $3.1 million in the first six months of 2002. The results were mainly attributable to lower pricing and to the adverse impact of the stronger Euro on European-based manufacturing costs and higher energy costs, partially offset by manufacturing efficiencies. Operating income for the Mineral Products business segment decreased by $4.2 million (33%) to $8.7 million in the first six months of 2003 due to unfavorable manufacturing costs, primarily as a result of higher energy costs. Selling, general and administrative expenses for the first six months of 2003 increased by 3% to $88.9 million from $86.3 million in the same period last year as a result of higher administrative and distribution costs, mainly due to the weaker U.S. dollar. Selling, general and administrative expenses as a percentage of sales were reduced to 19.2% compared with 19.9% in last year's first six months. Interest expense for the first six months of 2003 was $26.7 million versus $31.8 million for the same period last year. The $5.1 million (16%) decrease was primarily due to lower average borrowings ($3.0 million impact) and, to a lesser extent, lower average interest rates ($2.1 million impact). Other income, net, for the first six months of 2003 was $0.1 million compared with other expense, net, of $2.0 million in last year's first six months, with the higher income due primarily to favorable foreign exchange. Business Segment Review A discussion of operating results for each of our business segments follows. We operate our business through three reportable business segments: Specialty Chemicals; Industrial Chemicals; and Mineral Products. As discussed above, we changed the composition of our reportable segments, effective January 1, 2003. Sales and operating income by business segment for the first six months of 2002 26 have been restated to conform to the 2003 presentation. See also Note 8 to consolidated financial statements. The business segment review below and the discussion of operating income above contain information regarding non-GAAP financial measures contained within the meaning of Item 10 of Regulation S-K promulgated by the Securities and Exchange Commission. See "- Results of Operations - Second Quarter 2003 Compared With Second Quarter 2002" for additional discussion of our use of non-GAAP financial measures. First Six Months ------------------- 2002 2003 -------- -------- (Millions) Reconciliation of non-GAAP financial measures: Operating income per GAAP............................... $ 75.2 $ 71.6 Non-GAAP adjustments: Less: Other operating (gains) charges(1)........... (12.2) 1.5 -------- -------- Operating income, as adjusted........................... $ 63.0 $ 73.1 ======== ======== Supplemental Business Segment Information: Operating income: Operating income per GAAP - Specialty Chemicals.... $ 59.3 $ 66.9 Non-GAAP adjustments (1)........................... (12.2) 1.1 -------- -------- Operating income - Specialty Chemicals as adjusted. $ 47.1 $ 68.0 ======== ======== Operating income per GAAP - Industrial Chemicals... $ 3.1 $ (4.1) Non-GAAP adjustments (1)........................... - 0.2 -------- -------- Operating income - Industrial Chemicals as adjusted $ 3.1 $ (3.9) ======== ======== Operating income per GAAP - Mineral Products....... $ 12.9 $ 8.7 Non-GAAP adjustments (1)........................... - 0.2 -------- -------- Operating income - Mineral Products as adjusted.... $ 12.9 $ 8.9 ======== ======== Total segment operating income as adjusted......... $ 63.1 $ 73.0 Unallocated corporate office per GAAP.............. (0.1) 0.1 -------- -------- Operating income, as adjusted...................... $ 63.0 $ 73.1 ======== ======== (1) Non-GAAP adjustments in the first six months of 2003 represent an other operating charge of $1.5 million for stock option payments related to ISP's going private transaction, which is also presented by business segment. In the first six months of 2002, non-GAAP adjustments included other operating gains of $2.8 million for a contract termination related to the sale of our company's FineTech business, a gain of $5.5 million on the sale of the FineTech business and a $3.9 million gain from the settlement of a manufacturing and supply agreement with a customer of the fine chemicals product line. All non-GAAP adjustments for the first six months of 2002 related to the Specialty Chemicals business segment. Specialty Chemicals Sales in the first six months of 2003 were $316.9 million compared with $306.3 million for the same period last year, while operating income for the first six months of 2003 increased by 13% to $66.9 million from $59.3 million in last year's first six months. The 3% increase in sales was attributable to the favorable effect of the weaker U.S. dollar ($16.4 million) and higher unit volumes in the 27 pharmaceutical, food and beverage product lines (totaling $9.2 million). Partially offsetting these sales increases were lower unit volumes ($12.0 million) in the fine chemicals product line, mainly as a result of the loss of sales due to the termination of the supply and license agreement with Polaroid, and unfavorable pricing ($3.2 million), primarily in the personal care product line in both the skin care and hair care markets. Favorable pharmaceutical volumes were primarily attributable to strong growth in the excipients markets (Plasdones for tablet binders and Polyplasdones for tablet disintegrants). Excluding the other operating gains and charges discussed above, operating income for the Specialty Chemicals segment increased by 44% for the first six months of 2003 to $68.0 million compared with $47.1 million in last year's first six months. The improvement resulted primarily from manufacturing efficiencies ($10.0 million), the favorable effect of the weaker U.S. dollar ($11.1 million), the impact of higher unit volumes in the personal care, pharmaceutical, food and beverage product lines (totaling $6.1 million) and lower operating expenses ($3.2 million), partially offset by unfavorable pricing and mix ($4.8 million). The improved results for this segment were adversely impacted by the lower volumes in the fine chemicals product line ($5.1 million), mainly due to the loss of sales to Polaroid. Industrial Chemicals Sales in the first six months of 2003 were $93.5 million compared with $77.9 million in the first six months of 2002. The 20% increase in sales was attributable to higher unit volumes ($11.3 million) and the favorable effect of the weaker U.S. dollar ($7.1 million), partially offset by the continuing adverse effect of unfavorable pricing ($2.9 million) for butanediol. The Industrial Chemicals segment recorded an operating loss of $4.1 million in the first six months of 2003, compared with operating income of $3.1 million in the first six months of 2002. The unfavorable results for this business have been adversely impacted by the stronger Euro on European-based manufacturing costs. The unfavorable results also included higher energy costs and operating expenses ($6.5 million) and unfavorable pricing ($2.9 million), partially offset by manufacturing efficiencies ($4.8 million) and the impact of higher volumes and mix ($1.7 million). There is ongoing pressure on our pricing and revenue related to commodity type butanediol and related solvents and intermediates. A key competitor in this market completed construction of additional production capacity in Europe for these products during the third quarter of 2002. Another competitor is expected to complete construction of additional capacity in Asia during the fourth quarter of 2003. With the opening of these two facilities, the increase in the supply of these products to the merchant market is resulting in increased downward pressure on pricing. Mineral Products Sales for the Mineral Products segment for the first six months of 2003 were $51.7 million compared with $49.7 million for the first six months of 2002. The 4% increase was due to higher unit volumes 28 ($1.7 million) and included $1.1 million (9%) in higher third party sales and $0.9 million (2%) in higher sales to BMCA. Operating income for the first six months of 2003 was $8.7 million compared with $12.9 million for the first six months of 2002. The $4.2 million (33%) decrease in operating income was due to unfavorable manufacturing costs, primarily as a result of higher energy costs. LIQUIDITY AND FINANCIAL CONDITION Cash Flow and Cash Position During the first six months of 2003, our net cash flow before financing activities was $5.8 million and included $38.8 million of cash generated from operations and the reinvestment of $33.0 million for capital programs and the acquisition of Germinal S.A. (see Note 10 to consolidated financial statements). Cash generated from operations in the first six months of 2003 of $38.8 million included a cash outflow of $7.9 million due to an increase in receivables from related parties, primarily related to an increase in the receivable from BMCA, resulting from the sale of mineral products. Cash invested in additional working capital items totaled $22.3 million during the first six months of 2003, including a $24.8 million increase in receivables as a result of higher sales and a $0.8 million decrease in payables and accrued liabilities. Partially offsetting this increase in working capital items was a $2.9 million decrease in inventories. Net cash provided by financing activities during the first six months of 2003 totaled $0.5 million, primarily a $1.5 million capital contribution from ISP for the payment of stock options related to ISP's going private transaction in February 2003, offset by repayments of long-term debt totaling $0.9 million. As a result of the foregoing factors, cash and cash equivalents increased by $8.8 million during the first six months of 2003 to $42.0 million. Current Maturities of Long-Term Debt As of June 29, 2003, our current maturities of long-term debt, scheduled to be repaid during the twelve month period ended June 2004, totaled $2.7 million, including $2.3 million related to the term loan under our senior credit facilities. Freetown Facility As part of our acquisition of our Freetown, Massachusetts plant in 1998, we entered into a multi-year agreement to supply the imaging dyes and polymers used by Polaroid in its instant film business. In October 2001, Polaroid filed for protection under Chapter 11 of the U.S. Bankruptcy Code. In the third quarter of 2002, the majority of Polaroid's assets were acquired by a new owner. As a result, we no longer have a long-term supply contract with Polaroid. These events have negatively 29 impacted the sale of our fine chemicals products and reduced the utilization of our Freetown plant. We have an operating lease related to equipment at the Freetown facility, which was entered into as part of a 1998 sale-leaseback transaction. The lease had an initial term of four years and, at our option, up to three one-year renewal periods. The first renewal term commenced during 2002. The lease provides for a substantial guaranteed payment by us, adjusted at the end of each renewal period, and includes purchase and return options at fair market values determined at the inception of the lease. We have the right to exercise a purchase option with respect to the leased equipment, or the equipment can be returned to the lessor and sold to a third party. We are obligated to pay a maximum guaranteed payment amount upon the return of the equipment, currently $32.6 million, reduced by 50% of any proceeds from the subsequent sale of the equipment in excess of $4.8 million. Under generally accepted accounting principles, we cannot recognize this future obligation or recognize an impairment loss relative to the Freetown equipment since, as an operating lease, the Freetown equipment is not carried as a long-lived asset on our balance sheet. However, given the current utilization of the Freetown facility as a result of the Polaroid bankruptcy, if we should exercise the purchase option at the end of any future renewal period or at the termination of the lease in 2005, we would then perform a review for possible impairment of the Freetown assets. We are working toward increasing the utilization of the Freetown plant with additional production of certain personal care products. Contractual Obligations We have a contract with a multinational supplier to supply a substantial amount of our acetylene needs to our Texas City, Texas facility. This supplier generates this raw material as a by-product from the manufacture of ethylene. Pricing under the contract is on a fixed basis and we are obligated to purchase a specified amount of acetylene under the contract. This supplier has closed its operation that was the primary source of acetylene for our Texas City facility. The supplier has an obligation to provide product to us until the end of March 2004 and has confirmed that it will meet this obligation through that date by delivering product from another of its facilities. We have identified several alternative sources of supply of acetylene for the Texas City facility for the period after March 2004. The annualized, incremental cost of acetylene from these sources is estimated to be less than $2.0 million. Although we believe that these alternative sources of supply will be sufficient for our projected needs, there can be no assurance in this regard. We also had a contract with another supplier for the delivery of additional amounts of acetylene to our Texas City facility, which expired on June 30, 2003. We have entered into a five-year contract with an alternative source under which we are obligated to purchase specified quantities of acetylene. Pricing is fixed with escalators tied to the Producer Price Index. In May 2003, we entered into a long-term contract with BMCA to supply BMCA and its subsidiaries substantially all of their colored roofing granules and algae-resistant granules requirements, except for the requirements of certain of their roofing plants that are supplied by third parties. The contract includes pricing discounts based on volume purchase 30 targets, which, if the highest discount levels are reached over the term of the contract, could adversely impact gross margins and operating income from the Mineral Products segment. Our supply arrangements with BMCA and its subsidiaries are at prices and on terms that we believe are no less favorable to it than could be obtained from an unaffiliated third party. New Accounting Standards In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and concludes that an entity's commitment to an exit plan does not by itself create a present obligation that meets the definition of a liability. This Statement also establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. As we have no plans at this time for any exit or disposal activities, the adoption of SFAS No. 146 will not have any immediate effect on our consolidated financial statements. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," an amendment of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 for both annual and interim reporting periods by requiring disclosures in a tabular format to reconcile net income as reported to pro forma net income as if the fair value method was used. Certain of the disclosure modifications required for fiscal years ending after December 15, 2002 were disclosed in our 2002 Form 10-K. However, as discussed in Note 4 to consolidated financial statements, with the completion of the going private transaction by ISP in February 2003, our stock-based compensation plans were terminated and payments were made in accordance with the terms of the merger agreement. Therefore, the provisions of SFAS No. 148 are no longer applicable to us as it relates to those plans. In addition, we currently account for incentive units granted to our eligible employees pursuant to ISP's 2000 Long-Term Incentive Plan and 2003 Executive Long-Term Incentive Plan under the accounting prescribed by FASB Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option and Award Plans" ("FIN 28"), which requires an entity to measure compensation as the amount by which the Book Value of the incentive units covered by the grant exceeds the option price or value specified of such incentive units at the date of grant. Changes, either increases or decreases, in the Book Value of those incentive units between the date of grant and the measurement date result in a change in the measure of compensation for the right or award. We expect to continue to account for our long-term incentive units under the accounting prescribed by FIN 28 and have adopted the additional disclosure provisions of SFAS No. 148. Since compensation expense related to such incentive units is included in the actual consolidated statements of operations, our pro forma net income under SFAS No. 123 would have been the same as actual net income. 31 In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements for a guarantor's accounting for and disclosures of certain guarantees issued and outstanding. The provisions of FIN 45 apply to guarantee contracts that contingently require the guarantor to make payments (in cash, financial instruments, other assets, shares of stock or provision of services) to the guaranteed party for guarantees such as a financial standby letter of credit, a market value guarantee on either a financial or nonfinancial asset owned by the guaranteed party and a guarantee of the collection of the scheduled contractual cash flows from financial assets held by a special-purpose entity. FIN 45 also applies to indemnification contracts and indirect guarantees of indebtedness of others. The requirements of FIN 45 for the initial recognition and measurement of the liability for a guarantor's obligations are to be applied only on a prospective basis to guarantees issued or modified after December 31, 2002. We currently do not have any guarantees, indemnification contracts or indirect guarantees of indebtedness of others that would be subject to the initial recognition and measurement provisions of FIN 45. As discussed in Note 9 to consolidated financial statements, our 10 1/4% Senior Subordinated Notes due 2011 are guaranteed by all of our domestic subsidiaries, other than certain immaterial subsidiaries and our accounts receivable financing subsidiary. In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities." In accordance with FIN 46, a variable interest entity will be consolidated if either the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or as a group, the holders of the equity investment at risk lack any one of the following three characteristics of a controlling financial interest: (1) the direct or indirect ability to make decisions about an entity's activities; (2) the obligation to absorb the expected losses of the entity if they occur; (3) the right to receive the expected residual returns of the entity if they occur. All companies with variable interests in variable interest entities created after January 31, 2003 shall apply the provisions of FIN 46 immediately. A public entity with a variable interest in a variable interest entity created before February 1, 2003 shall apply the provisions of FIN 46 to that entity no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003. We do not have an interest in a variable interest entity. Therefore, FIN 46 does not currently have an impact on our consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments and hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. We do not expect that the adoption of SFAS No. 149 will have an immediate impact on our consolidated financial statements. See Note 12 to Consolidated Financial Statements for information regarding contingencies. 32 * * * Forward-looking Statements This Quarterly Report on Form 10-Q contains both historical and forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. These forward-looking statements are only predictions and generally can be identified by use of statements that include phrases such as "believe", "expect", "anticipate", "intend", "plan", "foresee" or other words or phrases of similar import. Similarly, statements that describe our objectives, plans or goals also are forward-looking statements. Our operations are subject to certain risks and uncertainties that could cause actual results to differ materially from those contemplated by the relevant forward-looking statement. The forward-looking statements included herein are made only as of the date of this Quarterly Report on Form 10-Q and we undertake no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. No assurances can be given that projected results or events will be achieved. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Reference is made to Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2002, for a discussion of "Market-Sensitive Instruments and Risk Management." At December 31, 2002 and June 29, 2003, there were no equity-related financial instruments employed by us to reduce market risk. Item 4. CONTROLS AND PROCEDURES Disclosure Controls and Procedures: Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports filed, furnished or submitted under the Exchange Act. Internal Control Over Financial Reporting: There have not been any changes in our internal control over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 33 PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: Exhibit Number -------------- 31.1 Certification of CEO pursuant to Section 302 of the Sarbanes- Oxley Act of 2002. 31.2 Certification of CFO pursuant to Section 302 of the Sarbanes- Oxley Act of 2002. 32.1 Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K filed during the current quarter: No reports on Form 8-K were filed during the three-month period ended June 29, 2003. 34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, each registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ISP CHEMCO INC. ISP CHEMICALS INC. ISP MINERALS INC. ISP TECHNOLOGIES INC. ISP MANAGEMENT COMPANY, INC. BLUEHALL INCORPORATED VERONA INC. ISP REAL ESTATE COMPANY, INC. ISP FREETOWN FINE CHEMICALS INC. ISP INTERNATIONAL CORP. ISP (PUERTO RICO) INC. ISP ALGINATES INC. ISP ENVIRONMENTAL SERVICES INC. ISP GLOBAL TECHNOLOGIES INC. ISP INVESTMENTS INC. DATE: August 12, 2003 BY: /s/ Neal E. Murphy --------------- ------------------ Neal E. Murphy Senior Vice President and Chief Financial Officer (Principal Financial Officer) DATE: August 12, 2003 BY: /s/Kenneth M. McHugh --------------- -------------------- Kenneth M. McHugh Vice President and Controller (Principal Accounting Officer) 35 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, each registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ISP CHEMICALS LLC By: ISP Chemicals Inc., its Sole Member ISP MANAGEMENT LLC By: ISP Management Company, Inc., its Sole Member ISP MINERALS LLC By: ISP Minerals Inc., its Sole Member ISP TECHNOLOGIES LLC By: ISP Technologies Inc., its Sole Member ISP INVESTMENTS LLC By: ISP Investments Inc., its Sole Member ISP GLOBAL TECHNOLOGIES LLC By: ISP Global Technologies Inc., its Sole Member DATE: August 12, 2003 BY: /s/Neal E. Murphy --------------- ----------------- Neal E. Murphy Senior Vice President and Chief Financial Officer (Principal Financial Officer) DATE: August 12, 2003 BY: /s/Kenneth M. McHugh --------------- -------------------- Kenneth M. McHugh Vice President and Controller (Principal Accounting Officer) 36

BLUEHALL INC 10-Q