NOTE 1—BASIS OF PRESENTATION

The unaudited interim condensed consolidated financial statements of Trinseo S.A. and its subsidiaries (the “Company”) as of and for the periods ended June 30, 2016 and 2015 were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and reflect all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are considered necessary for the fair statement of the results for the periods presented. Because they cover interim periods, the statements and related notes to the financial statements do not include all disclosures normally provided in annual financial statements and, therefore, these statements should be read in conjunction with the 2015 audited consolidated financial statements included within the Company’s Annual Report on Form 10-K (“Annual Report”) filed with the Securities and Exchange Commission (“SEC”) on March 11, 2016.

The December 31, 2015 condensed consolidated balance sheet data presented herein was derived from the Company’s December 31, 2015 audited consolidated financial statements, but does not include all disclosures required by GAAP for annual periods.

Certain prior year amounts have been reclassified to conform to the current period presentation. These reclassifications did not have a material impact on the Company’s financial position.  Refer to Note 2 for further discussion.

NOTE 2—RECENT ACCOUNTING GUIDANCE

In May 2014, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) jointly issued new guidance which clarifies the principles for recognizing revenue and develops a common revenue standard for GAAP and International Financial Reporting Standards (“IFRS”). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, the FASB has issued certain clarifying updates to this guidance, which the Company will consider as part of our adoption. This guidance is effective for public entities for annual and interim periods beginning after December 15, 2017.  The Company is currently assessing the impact of adopting this guidance on its financial position and results of operations.

In April 2015, the FASB issued guidance that requires deferred financing fees related to a recognized debt liability be presented in the balance sheet as a direct reduction of the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for deferred financing fees are not affected. The Company adopted this guidance effective January 1, 2016. Balances as of December 31, 2015 presented herein have been retrospectively adjusted, with $25.7 million of unamortized deferred financing fees being reclassified from “Deferred charges and other assets” and netted against “Long-term debt, net of unamortized deferred financing fees” on the condensed consolidated balance sheet. In accordance with this guidance, unamortized deferred financing fees related to the Company’s revolving debt facilities were not reclassified as a reduction of long-term debt, and remain included within “Deferred charges and other assets” on the condensed consolidated balance sheets.

In July 2015, the FASB issued guidance which simplifies the subsequent measurement of inventory by replacing the lower of cost or market test with a lower of cost or net realizable value (“NRV”) test. NRV is calculated as the estimated selling price less reasonably predictable costs of completion, disposal and transportation.  This pronouncement is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016, and prospective adoption is required.  The Company does not expect the impact of adopting this guidance to be material to its financial position and results of operations.

In February 2016, the FASB issued new guidance related to leases that outlines a comprehensive lease accounting model and supersedes the current lease guidance. The new guidance requires lessees to recognize on the balance sheet lease liabilities and corresponding right-of-use assets for all leases with terms of greater than 12 months. It also changes the definition of a lease and expands the disclosure requirements of lease arrangements. This new guidance is effective for public companies for annual and interim periods beginning after December 15, 2018, with early adoption permitted. The new guidance must be adopted using a modified retrospective transition, and provides for certain practical expedients.  The Company is currently assessing the impact of adopting this guidance on its financial position and results of operations.

In March 2016, the FASB issued new guidance that simplifies several aspects of accounting for share-based payments. The Company adopted this guidance effective April 1, 2016.  Under this guidance, excess tax benefits associated with share-based payment awards are recognized in the statement of operations when the awards vest or settle, rather than in shareholders’ equity, and all tax-related cash flows resulting from share-based payments are reported as operating activities on the statement of cash flows.  In addition, this guidance modified the minimum statutory withholding requirements to allow entities to withhold an amount up to the employees’ maximum individual tax rate in the relevant jurisdiction without triggering liability classification of the award, while also clarifying that all cash payments made to taxing authorities on employees’ behalf for withheld shares are to be reported as financing activities on the statement of cash flows.  The adoption of these changes did not materially impact the Company’s financial position and result of operations. Additionally, as part of this adoption, the Company made an accounting policy election to recognize forfeitures as incurred, rather than estimating the forfeitures in advance.  The impact of this change was applied utilizing a modified retrospective approach, with an adjustment of $0.9 million recorded during the three months ended June 30, 2016 to decrease opening retained earnings and increase opening additional paid-in-capital.

NOTE 3—INVESTMENTS IN UNCONSOLIDATED AFFILIATES

The Company is supplemented by two strategic joint ventures, the results of which are included within the Basic Plastics & Feedstocks reporting segment: Americas Styrenics LLC (“Americas Styrenics”, a styrene and polystyrene joint venture with Chevron Phillips Chemical Company LP) and Sumika Styron Polycarbonate Limited (“Sumika Styron Polycarbonate”, a polycarbonate joint venture with Sumitomo Chemical Company, Limited). Investments held in the unconsolidated affiliates are accounted for by the equity method.

As of June 30, 2016 and December 31, 2015, respectively, the Company’s investment in Americas Styrenics was $154.5 million and $143.9 million, which was $79.7 million and $91.9 million less than the Company’s 50% share of the underlying net assets of Americas Styrenics. This amount represents the difference between the book value of assets contributed to the joint venture at the time of formation (May 1, 2008) and the Company’s 50% share of the total recorded value of the joint venture’s assets and certain adjustments to conform with the Company’s accounting policies. This difference is being amortized over a weighted average remaining useful life of the contributed assets of approximately 4.3 years as of June 30, 2016. The Company received dividends from Americas Styrenics of $30.0 million and $60.0 million during the three and six months ended June 30, 2016, respectively, compared to $30.0 million and $45.0 million during the three and six months ended June 30, 2015, respectively.

As of June 30, 2016 and December 31, 2015, respectively, the Company’s investment in Sumika Styron Polycarbonate was $35.8 million and $39.0 million, which was $16.2 million and $19.8 million greater than the Company’s 50% share of the underlying net assets of Sumika Styron Polycarbonate. This amount primarily represents the fair value of certain identifiable assets which have not been recorded on the historical financial statements of Sumika Styron Polycarbonate. This difference is being amortized over the remaining useful life of the contributed assets of 9.3 years as of June 30, 2016. The Company received dividends from Sumika Styron Polycarbonate of zero and $6.2 million during the three and six months ended June 30, 2016, respectively. The Company received no dividends from Sumika Styron Polycarbonate during the three and six months ended June 30, 2015.

Both of the unconsolidated affiliates are privately held companies; therefore, quoted market prices for their stock are not available. The summarized financial information of the Company’s unconsolidated affiliates is shown below:

NOTE 4—INVENTORIES

Inventories consisted of the following:

NOTE 5—GOODWILL AND INTANGIBLE ASSETS

Goodwill

The following table shows changes in the carrying amount of goodwill by segment from December 31, 2015 to June 30, 2016:

Other Intangible Assets

The following table provides information regarding the Company’s other intangible assets as of June 30, 2016 and December 31, 2015, respectively:

As of June 30, 2016, the Company had $15.0 million capitalized as software in development, primarily related to our project to upgrade our legacy enterprise resource planning (“ERP”) environment to the latest version of SAP. During the second quarter of 2016, we began a phased implementation of this ERP environment by geographic region, which we anticipate will be completed by the end of 2016.

Amortization expense on other intangible assets totaled $5.8 million and $10.1 million for the three and six months ended June 30, 2016, respectively, and $4.4 million and $8.9 million for the three and six months ended June 30, 2015, respectively.

The following table details the Company’s estimated amortization expense for the next five years, excluding any amortization expense related to software currently in development:

NOTE 6—DEBT

Debt consisted of the following:

2018 Senior Secured Credit Facility

On June 17, 2010, the Company entered into a credit agreement, which was subsequently amended from time to time, and was to mature in January 2018 (“2018 Senior Secured Credit Facility”).  The 2018 Senior Secured Credit Facility included a revolving credit facility (“2018 Revolving Facility”), which, as a result of an amendment in January 2013, included a borrowing capacity of $300.0 million.

In May 2015, upon completion of the refinancing transactions discussed below, the Company terminated the 2018 Senior Secured Credit Facility.  Immediately prior to this termination, the Company had no outstanding borrowings under the 2018 Revolving Facility. As a result of this termination, the Company recognized a $0.7 million loss on extinguishment of long-term debt during the three and six months ended June 30, 2015, comprised entirely of the write-off of a portion of the existing unamortized deferred financing fees related to the 2018 Revolving Facility.

Senior Credit Facility

On May 5, 2015, Trinseo Materials Operating S.C.A. and Trinseo Materials Finance, Inc. (together, the “Issuers” or the “Borrowers”), both wholly-owned subsidiaries of the Company, entered into a senior secured credit agreement (the “Credit Agreement”), which provides senior secured financing of up to $825.0 million (the “Senior Credit Facility”).  The Senior Credit Facility provides for senior secured financing consisting of a (i) $325.0 revolving credit facility, with a $25.0 million swingline subfacility and a $35.0 million letter of credit subfacility (the “2020 Revolving Facility”) maturing in May 2020 and (ii) $500.0 million senior secured term loan B facility maturing in November 2021 (the “2021 Term Loan B”). Amounts under the 2020 Revolving Facility are available in U.S. dollars and euros.

The 2021 Term Loan B bears an interest rate of LIBOR plus 3.25%, subject to a 1.00% LIBOR floor, and was issued at a 0.25% original issue discount.  Further, the 2021 Term Loan B requires scheduled quarterly payments in amounts equal to 0.25% of the original principal amount of the 2021 Term Loan B, with the balance to be paid at maturity. As of June 30, 2016, $5.0 million of these scheduled future payments were classified as current debt on the Company’s condensed consolidated balance sheet.

Loans under the 2020 Revolving Facility, at the Borrowers’ option, may be maintained as (a) LIBO rate loans, which bear interest at a rate per annum equal to the LIBO rate plus the applicable margin (as defined in the Credit Agreement), if applicable, or (b) base rate loans which shall bear interest at a rate per annum equal to the base rate plus the applicable margin (as defined in the Credit Agreement).  As of June 30, 2016, the Borrowers will be required to pay a quarterly commitment fee in respect of any unused commitments under the 2020 Revolving Facility equal to 0.375% per annum.

As of June 30, 2016, the Company had no outstanding borrowings, and had $308.9 million (net of $16.1 million outstanding letters of credit) of funds available for borrowing under the 2020 Revolving Facility. The Senior Credit Facility contains certain customary affirmative, negative and financial covenants. As of June 30, 2016, the Company was in compliance with all debt covenant requirements under the Senior Credit Facility. Refer to the Annual Report for further information.

2019 Senior Notes

In January 2013, the Company issued $1,325.0 million 8.750% senior notes due to mature on February 1, 2019 (the “2019 Senior Notes”). In July 2014, using proceeds from the Company’s initial public offering in June 2014 (the “IPO”), the Company redeemed $132.5 million in aggregate principal amount of the 2019 Senior Notes.

On May 13, 2015, using the net proceeds from the issuance of the 2021 Term Loan B, together with the net proceeds from the issuance of the 2022 Senior Notes (defined and discussed below) and available cash, the Company redeemed all outstanding borrowings under the 2019 Senior Notes, totaling $1,192.5 million in principal, together with a call premium of $68.6 million (with a redemption price of 103% on the first $132.5 million and 106.097% on the remaining balance) and accrued and unpaid interest thereon of $29.6 million.

As a result of this redemption, during the three and six months ended June 30, 2015, the Company recorded a loss on extinguishment of long-term debt of $94.5 million, which includes the above $68.6 million call premium and $25.9 million write-off of unamortized deferred financing fees related to the 2019 Senior Notes.

2022 Senior Notes

On May 5, 2015, the Issuers executed an indenture (the “Indenture”) pursuant to which they issued $300.0 million aggregate principal amount of 6.750% senior notes due May 1, 2022 (the “USD Notes”) and €375.0 million aggregate principal amount of 6.375% senior notes due May 1, 2022 (the “Euro Notes”, and together with the USD Notes, the “2022 Senior Notes”).  Interest on the 2022 Senior Notes is payable semi-annually on May 1 and November 1 of each year, commencing on November 1, 2015.

The Indenture contains certain provisions allowing the Issuers’ to redeem the 2022 Senior Notes prior to their maturity. Additionally, the Indenture contains certain customary covenants, which the Company was in compliance with as of June 30, 2016. Refer to the Annual Report for further information.  

Accounts Receivable Securitization Facility

The Company’s accounts receivable securitization facility (“Accounts Receivable Securitization Facility”) has a borrowing capacity of $200.0 million and was set to mature in May 2016. In February 2016, the Company amended the facility to extend the maturity date to May 2019.

The Accounts Receivable Securitization Facility is subject to interest charges against the amount of outstanding borrowings as well as the amount of available, but undrawn commitments. In regards to outstanding borrowings, fixed interest charges are 2.60% plus variable commercial paper rates, while for available, but undrawn commitments, fixed interest charges are 1.40%.  

As of June 30, 2016 and December 31, 2015, there were no amounts outstanding under the Accounts Receivable Securitization Facility, with approximately $129.7 million and $123.4 million, respectively, of accounts receivable available to support this facility, based on the pool of eligible accounts receivable.

NOTE 7—DERIVATIVE INSTRUMENTS

The Company’s ongoing business operations expose it to various risks, including fluctuating foreign exchange rates.  To manage these risks, the Company periodically enters into derivative financial instruments such as foreign exchange forward contracts.  The Company does not hold or enter into financial instruments for trading or speculative purposes. All derivatives are recorded on the condensed consolidated balance sheets at fair value.

Foreign Exchange Forward Contracts

Certain subsidiaries have assets and liabilities denominated in currencies other than their respective functional currencies, which creates foreign exchange risk. The Company’s principal strategy in managing its exposure to changes in foreign currency exchange rates is to naturally hedge the foreign currency-denominated liabilities on our balance sheet against corresponding assets of the same currency such that any changes in liabilities due to fluctuations in exchange rates are offset by changes in their corresponding foreign currency assets. In order to further reduce its exposure, the Company also uses foreign exchange forward contracts to economically hedge the impact of the variability in exchange rates on our assets and liabilities denominated in certain foreign currencies. These derivative contracts are not designated for hedge accounting treatment.

As of June 30, 2016, the Company had open foreign exchange forward contracts with a notional U.S. dollar equivalent absolute value of $155.2 million. The following table displays the notional amounts of the most significant net foreign exchange hedge positions outstanding as of June 30, 2016.

Foreign Exchange Cash Flow Hedges

The Company also enters into forward contracts with the objective of managing the currency risk associated with forecasted U.S. dollar-denominated raw materials purchases by one of its subsidiaries whose functional currency is the euro. By entering into these forward contracts, which are designated as cash flow hedges, the Company buys a designated amount of U.S. dollars and sells euros at the prevailing market rate to mitigate the risk associated with the fluctuations in the euro-to-U.S. dollar foreign currency exchange rates. The qualifying hedge contracts are marked-to-market at each reporting date and any unrealized gains or losses are included in accumulated other comprehensive income (AOCI) to the extent effective, and reclassified to cost of sales in the period during which the transaction affects earnings or it becomes probable that the forecasted transaction will not occur.

Open foreign exchange cash flow hedges as of June 30, 2016 have maturities occurring over a period of 18 months, and have a net notional U.S. dollar equivalent of $270.0 million.

Net Investment Hedge

The Company’s outstanding debt includes €375.0 million of Euro Notes (see Note 6 for details).  As of June 30, 2016, the Company has designated a portion (€280.0 million) of the principal amount of these Euro Notes as a hedge of the foreign currency exposure of the Issuers’ net investment in certain European subsidiaries. As this debt was deemed to be a highly effective hedge, changes in the Euro Notes’ carrying value resulting from fluctuations in the euro exchange rate were recorded as cumulative foreign currency translation loss of $2.1 million within accumulated other comprehensive loss as of June 30, 2016.

Summary of Derivative Instruments

Information regarding changes in the fair value of the Company’s derivative instruments, net of tax, including those not designated for hedge accounting treatment, is as follows:

The Company recorded losses of $2.1 million and gains of $1.0 million during the three and six months ended June 30, 2016, respectively, and gains of $7.3 million and losses of $13.7 million during the three and six months ended June 30, 2015, respectively, from settlements and changes in the fair value of outstanding forward contracts (not designated as hedges). The gains and losses from these forward contracts offset net foreign exchange transaction gains of $2.3 million and losses of $2.6 million during the three and six months ended June 30, 2016, respectively, and losses of $10.4 million and gains of $7.6 million during the three and six months ended June 30, 2015, respectively, which resulted from the remeasurement of the Company’s foreign currency denominated assets and liabilities. The cash settlements of these foreign exchange forward contracts are included within operating activities in the condensed consolidated statement of cash flows.

As of June 30, 2016, the Company has no ineffectiveness related to its foreign exchange cash flow hedges. Further, the Company expects to reclassify in the next twelve months an approximate $2.3 million net gain from other comprehensive income (loss) into earnings related to the Company’s outstanding cash flow hedges as of June 30, 2016 based on current foreign exchange rates.

The following table summarizes the net unrealized gains and losses and balance sheet classification of outstanding derivatives recorded in the condensed consolidated balance sheets:

Forward contracts are entered into with a limited number of counterparties, each of which allows for net settlement of all contracts through a single payment in a single currency in the event of a default on or termination of any one contract. As such, in accordance with the Company’s accounting policy, we record these foreign exchange forward contracts on a net basis by counterparty within the condensed consolidated balance sheet. Information regarding the gross amounts of the Company’s derivative instruments and the amounts offset in the condensed consolidated balance sheets is as follows:

Refer to Notes 8 and 17 of the condensed consolidated financial statements for further information regarding the fair value of the Company’s derivative instruments and the related changes in accumulated other comprehensive income.

NOTE 8—FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value are classified using the following hierarchy, which is based upon the transparency of inputs to the valuation as of the measurement date.

Level 1—Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—Valuation is based upon quoted prices for similar assets and liabilities in active markets, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3—Valuation is based upon other unobservable inputs that are significant to the fair value measurement.

The following table summarizes the basis used to measure certain assets and liabilities at fair value on a recurring basis in the condensed consolidated balance sheets as of June 30, 2016 and December 31, 2015.

The Company uses an income approach to value its derivative instruments, utilizing discounted cash flow techniques, considering the terms of the contract and observable market information available as of the reporting date. Significant inputs to the valuation for foreign exchange forward contracts and foreign exchange cash flow hedges are obtained from broker quotations or from listed or over-the-counter market data, and are classified as Level 2 in the fair value hierarchy.

Fair Value of Debt Instruments

The following table presents the estimated fair value of the Company’s outstanding debt not carried at fair value as of June 30, 2016 and December 31, 2015, respectively:

The fair value of the Company’s Term Loan B, USD Notes, and Euro Notes (each Level 2 securities) is determined using over-the-counter market quotes and benchmark yields received from independent vendors.

There were no other significant financial instruments outstanding as of June 30, 2016 and December 31, 2015.

NOTE 9—PROVISION FOR INCOME TAXES

Provision for income taxes for the three and six months ended June 30, 2016 were $28.6 million, resulting in an effective tax rate of 23.0%, and $50.5 million, resulting in an effective tax rate of 22.6%, respectively. Provision for income taxes for the three and six months ended June 30, 2015 were $7.5 million, resulting in an effective tax rate of 90.9%, and $25.4 million, resulting in an effective tax rate of 39.8%, respectively.  

The effective income tax rate for the three and six months ended June 30, 2016 was impacted by losses generated primarily within our holding companies incorporated in Luxembourg and our primary operating company incorporated in Brazil, which were not anticipated to provide a tax benefit to the Company in the future. For the three and six months ended June 30, 2016, these losses totaled approximately $29.0 million and $41.7 million, respectively. Included in these losses was an impairment charge of $12.9 million for the estimated loss on sale of Trinseo Brazil. Refer to Note 15 for further information.

The effective income tax rate for the three and six months ended June 30, 2015 was impacted by losses generated primarily within our holding companies incorporated in Luxembourg, which were not anticipated to provide a tax benefit to the Company in the future. For the three and six months ended June 30, 2015, these losses totaled approximately $41.2 million and $58.8 million, respectively. Included in these losses were payments made during the three months ended June 30, 2015 of $18.1 million related to a portion of the fees associated with the call premium paid to retire the Company’s 2019 Senior Notes and $4.3 million related to the write-off of the related unamortized deferred financing fees. Refer to Note 6 for further information.

NOTE 10—COMMITMENTS AND CONTINGENCIES

Environmental Matters

Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law, existing technologies and other information. As of June 30, 2016 and December 31, 2015, the Company had no accrued obligations for environmental remediation and restoration costs. Pursuant to the terms of the sales and purchase agreement for the Styron business, the pre-closing environmental conditions were retained by Dow and the Company has been indemnified by Dow from and against all environmental liabilities incurred or relating to the predecessor periods. There are several properties which the Company now owns on which Dow has been conducting investigation, monitoring or remediation to address historical contamination. Those properties include Allyn’s Point, Connecticut; Dalton, Georgia; and Livorno, Italy. There are other properties with historical contamination that are owned by Dow that the Company leases for its operations, including its facilities in Midland, Michigan; Schkopau, Germany; and Terneuzen, The Netherlands. No environmental claims have been asserted or threatened against the Company, and the Company is not a potentially responsible party at any Superfund Sites.

Inherent uncertainties exist in the Company’s potential environmental liabilities primarily due to unknown conditions, whether future claims may fall outside the scope of the indemnity, changing governmental regulations and legal standards regarding liability, and evolving technologies for handling site remediation and restoration. In connection with the Company’s existing indemnification, the possibility is considered remote that environmental remediation costs will have a material adverse impact on the condensed consolidated financial statements.

Purchase Commitments

In the normal course of business, the Company has certain raw material purchase contracts where it is required to purchase certain minimum volumes at current market prices. These commitments range from 1 to 5 years. In certain raw material purchase contracts, the Company has the right to purchase less than the required minimums and pay a liquidated damages fee, or, in case of a permanent plant shutdown, to terminate the contracts. In such cases, these obligations would be less than the annual commitment as disclosed in the consolidated financial statements included in the Annual Report.

Litigation Matters

From time to time, the Company may be subject to various legal claims and proceedings incidental to the normal conduct of business, relating to such matters as product liability, antitrust/competition, past waste disposal practices and release of chemicals into the environment. While it is impossible at this time to determine with certainty the ultimate outcome of these routine claims, the Company does not believe that the ultimate resolution of these claims will have a material adverse effect on the Company’s results of operations, financial condition or cash flow. Legal costs, including those legal costs expected to be incurred in connection with a loss contingency, are expensed as incurred.

NOTE 11—PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS

The components of net periodic benefit costs for all significant plans were as follows: