For the Fiscal Year Ended December 31, 2004
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 


 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended: December 31, 2004   Commission file number: 1-71

 


 

BORDEN CHEMICAL, INC.

 

LOGO

 


 

New Jersey   13-0511250
(State of incorporation)   (I.R.S. Employer Identification No.)
180 East Broad St., Columbus, OH 43215   614-225-4000
(Address of principal executive offices)   (Registrant’s telephone number)

 


 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

Title of each class


 

Name of each exchange on which registered


None   None

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

NONE

 


 

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  ¨    No  x

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in any amendment to this Form 10-K.  x.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)     Yes  ¨    No  x

 

Aggregate market value in thousands of the voting stock held by nonaffiliates of the Registrant based upon the average bid and asked prices of such stock on March 18, 2005: $0.

 

Number of shares of common stock, par value $0.01 per share, outstanding as of the close of business on March 18, 2005: 96,905,936

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Document


 

Incorporated


none   none

 


 

The Exhibit Index is Located herein at sequential pages 101 through 103.


Table of Contents

BORDEN CHEMICAL, INC.

 

INDEX

 

PART I     

Item 1 – Business

   3

Item 2 – Properties

   9

Item 3 – Legal Proceedings

   11

Item 4 – Submission of Matters to a Vote of Security Holders

   12
PART II     

Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   12

Item 6 – Selected Financial Data

   13

Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

   14

Item 7A – Quantitative and Qualitative Disclosures About Market Risk

   33

Item 8 – Financial Statements and Supplementary Data

   34

Borden Chemical, Inc. Consolidated Financial Statements

    

Consolidated Statements of Operations, years ended December 31, 2004, 2003 and 2002

   35

Consolidated Balance Sheets, December 31, 2004 and 2003

   36

Consolidated Statements of Cash Flows, years ended December 31, 2004, 2003 and 2002

   38

Consolidated Statements of Shareholder’s Deficit, years ended December 31, 2004, 2003 and 2002

   40

Notes to Consolidated Financial Statements

   42

Report of Independent Registered Public Accounting Firm

   88

Item 9 – Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   89

Item 9A - Controls and Procedures

   89

Item 9B – Other Information

   89
PART III     

Item 10 – Directors and Executive Officers of the Registrant

   89

Item 11 – Executive Compensation

   92

Item 12 – Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   97

Item 13 – Certain Relationships and Related Transactions

   97

Item 14 – Principal Accountant Fees and Services

   100
PART IV     

Item 15 – Exhibits and Financial Statement Schedules

   101

Signatures

   106

 

 

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Table of Contents

Part I

 

ITEM 1. BUSINESS

(Dollars in thousands except per share data)

 

Description of Business

 

Borden Chemical, Inc. (which may be referred to as “we,” “us,” “our,” “BCI” or the “Company”) is a leading global integrated producer of thermoset-based resins and adhesives for the global forest products and industrial markets. In addition, we are the world’s largest producer by volume of formaldehyde, an important and versatile building block chemical used in a wide variety of applications. We are the largest North American producer by volume of thermoset-based resins used in the production of engineered wood products, including structural wood panels, beams and non-structural panels, furniture, decorative flooring, door and window assemblies and wallboards. We are also a leading producer of resin-coated proppant systems in North America, which are used in oilfield and natural gas production, and, through HA-International, LLC, or HAI, of foundry resins, which are used in the production of cores and molds for metal castings. We have a strong presence in the production of specialty resins used in the industrial, automotive and electronics markets. Our materials are designed to deliver superior binding and bonding performance to manufacturers of thousands of common, everyday products that enhance modern living. Our strong position in North America is complemented by our significant operations in Latin America and Europe. The Company was incorporated on April 24, 1899.

 

Our strategically located network of facilities provides us with logistical benefits, which minimize delivery expense due to our proximity to our customers. Our customers operate in diverse end-markets, such as new home construction, repair and remodeling, furniture, automotive, oil and gas, chemicals, electronics, communications and agriculture. The diversity of our customer base helps to insulate us from a downturn in any one sector of the economy. Our customer contracts generally allow us to pass raw material price increases on to our customers, which leads to stable gross margins.

 

Our Strategy

 

Our key business strategies are:

 

  Leverage Our Leading Market Position in Our Core Forest Product Business. We are a leading global producer of thermoset-based forest product resins. We have been able to achieve this position by building our infrastructure close to the facilities of the leading wood industry customers, allowing us to effectively provide increased products and services to our customers as they grow. We intend to continue to leverage our competitive advantage to increase our sales of existing products and introduce new products.

 

  Leverage Existing Technologies to Grow Internationally and Enter New Markets. We will continue to grow internationally by expanding our product sales to our multi-national customers outside of North America and by entering new markets. We believe that our leading formaldehyde and formaldehyde-based resin technology and our relationships with large multi-national customers as a “supplier of choice” of formaldehyde offers us a significant competitive advantage as we enter new markets. Our expansion strategy involves employing a total systems approach to meet customer needs. This approach involves using our global technology and experience in order to deliver the appropriate resin for the customer’s application and production process and subsequently providing ongoing in-plant technical support and service.

 

  Develop and Market New Products. We will continue to expand our product offerings through internal product innovation and joint research and development initiatives with our customers and research partnership formations. We employ a systematic approach to new product development and have identified promising new technologies that have begun to yield significant results.

 

  Improve Our Position as a Low Cost Producer. We will continue to focus on opportunities to optimize our resources, improve our cost position and drive new product innovation. In late 2002, we implemented a Six Sigma process initiative, which is adding discipline and focus to the way we approach productivity. In addition, in 2003 we implemented a significant restructuring program which has enabled us to achieve significant cost savings.

 

  Strategic Relationship with Other Affiliate Companies. We believe there are substantial cost reduction and revenue growth opportunities achievable via strategic relationships with other companies affiliated with Apollo Management, L.P. (“Apollo”). Through combined purchasing initiatives, we intend to target reductions in raw material expenses. In addition, we believe there are potential cross-selling opportunities with those Apollo affiliated companies that sell different products to our target markets. We may determine to try to realize such opportunities through potential business combinations with such affiliated chemical companies controlled by Apollo.

 

 

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Our business consists of three reportable segments: Forest Products, Performance Resins and International. See Note 18 to the Consolidated Financial Statements.

 

Historical Perspective

 

On July 6, 2004, Apollo announced that it had signed a definitive agreement to acquire the Company. Previously, on May 7, 2004, the Company filed a registration statement with the U.S. Securities and Exchange Commission for a proposed initial public offering (“IPO”) of its common stock. This IPO was suspended and the registration statement withdrawn on August 31, 2004.

 

On August 12, 2004, BHI Investment, LLC, an affiliate of Apollo, acquired all of the outstanding capital stock of Borden Holdings, Inc. (“BHI”), the Company’s parent at that time, for total consideration of approximately $1.2 billion, including assumption of debt. In conjunction with this transaction, all of the outstanding capital stock of the Company held by management was redeemed and non-vested restricted stock was cancelled. In addition, the Company redeemed approximately 102,069 shares from BHI for cash totaling $294,918.

 

Immediately following the acquisition of BHI, BHI Investment, LLC reorganized the existing corporate structure of the Company so that the Company became directly owned by BHI Acquisition Corporation (“BHI Acquisition”), a subsidiary of BHI Investment, LLC. Following the acquisition of BHI by Apollo, the Company reorganized its foreign subsidiaries.

 

The acquisition of BHI, and the payment of transaction fees and expenses, was financed with the net proceeds of a $475 million second-priority senior secured private debt offering (the “Second Priority Notes”) by two newly formed, wholly owned subsidiaries of the Company and certain equity contributions to BHI Acquisition from Apollo. With a portion of the proceeds, we redeemed our 9.25% debentures on August 12, 2004 for total cash of $49,249. Included in the total cash paid was $47,295 for the principal of the debentures, $1,069 of accrued interest and an early redemption premium of $885. See Note 9.

 

Collectively, the transactions described above are referred to as the “Apollo Transaction.”

 

The Second Priority Notes are guaranteed by the Company and certain of its domestic subsidiaries (the “Guarantors”). The Second Priority Notes and the related guarantees are senior obligations secured by a second-priority lien (subject to certain exceptions and permitted liens) on certain of the Guarantors’ existing and future domestic assets, including the stock of the Company’s Canadian subsidiary.

 

As a result of the suspended IPO and the subsequent acquisition by Apollo, we incurred expenses of $55,586 in 2004. These amounts included charges for investment banking, accounting and legal fees, fees paid to Apollo, payments for cancellation of restricted stock, exercises of stock options and management bonuses pertaining to the activity. Of this amount, compensation costs of $14,264 are included within Transaction related compensation costs, and the remainder is included within Transaction related costs.

 

Prior to the Apollo Transaction, the Company was controlled by an affiliate of Kohlberg Kravis Roberts & Co. (“KKR”) since 1995. The Company’s immediate parent, BHI, was a wholly owned subsidiary of BW Holdings, LLC (“BWHLLC”), an entity controlled by KKR.

 

Acquisitions and Divestitures

 

On October 6, 2004, we entered into an agreement to purchase all outstanding shares of capital stock of Bakelite Aktiengesellschaft (“Bakelite”) for a net purchase price ranging from approximately €175 million to €200 million, subject to certain adjustments. Completion of the purchase is subject to regulatory and other customary closing conditions including European Commission merger clearance. The Company and Bakelite will continue to operate independently until those conditions are satisfied and the closing occurs.

 

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Following is a summary of acquisitions and divestitures we made in the past five years.

 

In the fourth quarter of 2003, we acquired Fentak Pty Ltd. (“Fentak”) in Australia and Malaysia, a producer of specialty chemical products for engineered wood, laminating and paper impregnation markets. We also acquired the business and technology assets of Southeastern Adhesives Company (“SEACO”), a domestic producer of specialty adhesives.

 

In 2001, through a series of transactions with affiliates, we sold Consumer Adhesives for total proceeds of $94,120 (the “Consumer Adhesives Sale”). We retained continuing investments in Consumer Adhesives in the form of preferred stock and notes receivable. We sold the notes receivable to BHI in the fourth quarter of 2001 for their carrying value of $57,691. The preferred stock, with a carrying value of $110,000, was redeemed during the first quarter of 2002 for a $110,000 note receivable from Consumer Adhesives, which we subsequently sold to BHI for face value plus accrued interest and used the proceeds to repay affiliated debt.

 

Also in 2001, we merged our North American foundry resins and coatings businesses with similar businesses of Delta-HA, Inc. to form HA-International, LLC (“HAI”), in which we have a 70% interest.

 

In 2000, the Company acquired the formaldehyde and certain other assets from Borden Chemicals and Plastics Operating Limited Partnership, which was an affiliate of the Company, and acquired East Central Wax, a wax emulsions producer for the forest products business.

 

Products

 

The product lines included in our Forest Products operating segment are formaldehyde and forest product resins. The product lines in our Performance Resins operating segment are oilfield, foundry and specialty resins. The products of our International operating segment are formaldehyde, forest product and performance resins and consumer products.

 

Forest Products

 

Forest Products Resins. We are the leading producer of forest products thermoset-based resins in North America. Our thermoset-based resin systems are used by our customers to bind wood particles and bond wood segments to provide strength and durability to oriented strand board (“OSB”), particleboard, medium density fiberboard (“MDF”) and plywood. The primary end-markets for our forest products resins are new home construction, furniture and repair and remodeling.

 

Products


  

Key Applications


Engineered Wood Resins    Softwood and hardwood plywood, OSB and laminated veneer lumber
Special Wood Adhesives    Laminated beams, structural and nonstructural fingerjoints, wood composite I-beams, cabinets, doors, windows, furniture, mold and millwork and paper laminations
Wax Emulsions    Sizing agent for composite products
Wood Fiber Resins    Particleboard, MDF and hardboard

 

We provide a comprehensive range of resin systems to the world’s leading producers of engineered wood products. Our resins and adhesives, together with our wax sizing agents and other complementary products, are used to produce the following products: OSB, plywood and other construction panel systems; laminated beams, joists and trusses for structural applications; millwork, cabinetry and window and door assemblies; and particleboard and MDF for furniture, flooring and other applications. Used in combination with wood from plantation-grown trees, our resins help provide economical alternatives to traditional solid wood products that consume old-growth timber, while delivering products that achieve superior performance. Depending on the application and customer requirements, our resins are produced by mixing formaldehyde with other chemicals, including urea, phenol, melamine and resorcinol. The result is a completed thermoset resin system.

 

A key component of our success in the engineered wood market is our total systems approach to meeting customer needs. This approach involves first using our global technology and experience in order to deliver the right resin for the customer’s application and production process and then providing in-plant technical support and service.

 

Formaldehyde. We are the world’s largest producer of formaldehyde by volume and the largest provider of formaldehyde to end-users in North America. We manufacture more than five billion pounds of formaldehyde solution each year, of which approximately half is consumed internally for resin production and the other half is sold to external customers. Formaldehyde is a versatile building block chemical used in thousands of diverse end-use applications such as resin systems for forest

 

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products and industrial bonding, household products, including shampoo, cosmetics, disinfectants and fabric softeners, and specialty fabrics, paper products, fertilizers and animal feeds.

 

Products


  

Key Applications


Formaldehyde    Herbicides and fungicides, fabric softeners, oil and gas applications, urea formaldehyde, melamine formaldehyde, phenol formaldehyde and MDI
Hexamine    Accelerator for rubber curing, propellant to solid rocket booster engines and phenolic-based resins for brake shoes
Methaform    Clear automotive topcoats and other coating applications
Urea Formaldehyde Concentrates    Precursor for UF resins used in particleboard, plywood, shingles and slow release fertilizers

 

We manufacture synthetic formaldehyde by reacting methanol with a silver or metal oxide catalyst. Formaldehyde is sold in a water-based solution and also is blended with other materials for specific customer applications.

 

Performance Resins

 

Specialty Resins. We are a major supplier of high performance specialty resins used in the binding and bonding of a diverse range of materials, primarily in the construction, automotive, electronics and steel industries. Typical end-use product applications include electronics for circuit boards, adhesives for brake linings and other friction products, flame-resistant composites for trains and planes, acoustical insulation for automobiles and glass matting for roofing shingles and thermal insulation.

 

Products


  

Key Applications


Automotive PF Resins    Acoustical insulation, filters, friction materials, grinding wheels, interior components, molded electrical parts and assemblies
Composites PF Resins    Aircraft interiors, air ducts, brakes, ballistic applications, industrial grating, pipe and space shuttle engine nozzles
Construction PF Resins, UF Resins, Ketone Formaldehyde and Melamine Colloid    Decorative laminates, fiberglass insulation, floral foam, lamp cement for light bulbs, molded appliance and electrical parts, molding compounds, sandpaper, fiberglass mat, laminates, coatings, crosslinker for thermoplastic emulsions and specialty wet strength paper
Electronics PF Resins    Electrical laminates, computer chip encasement, molding compounds and photolithography
Refractory PF Resins    Steel mill refractory bricks, monolithic shapes, tap hole mix, tundish liners and nozzle visios

 

Our manufacturing complex in Louisville, Kentucky is one of the world’s largest sites producing specialty resins. We have additional manufacturing capacity for these materials dispersed throughout our international network of plants.

 

Foundry Resins. Through HAI, we are the leading producer by volume of foundry resins in North America. We pioneered the development of thermoset-based resins as binders for sand cores and molds used in metal castings over 40 years ago and continue to serve the North American market with a broad distribution network and significant production capability. Our foundry resin manufacturing capabilities include the largest foundry resin plant in the United States, which is located in Louisville, Kentucky. Our foundry resin systems are used by major automotive and industrial companies in the production of engine blocks, transmissions, brake and drive train components and various other casting products.

 

 

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Products


  

Key Applications


Lost Foam Coatings    Specialty refractory coatings for lost foam casting operations featuring high permeability and pattern coverage properties
Refractory Coatings    General purpose products for ferrous and nonferrous applications
Resin-Coated Sand (RCS)—Super F®, FII® and FT®    General purpose high-curing speed RCS for most applications

Resins—SigmaCure®, SigmaSet®, Super Set®, ALpHASET®,

BETASET® and Plastiflake®

   A comprehensive selection of synthetic resins for bonding sand cores and molds in a variety of applications including phenolic urethane cold box resins, phenolic urethane nobake resins, furan and phenolic acid curing resins, ester cured phenolic nobake resins, methyl formate cured phenolic cold box resins and phenolic resins for shell process
Shake-Free® Coated Sand    Specialty RCS for aluminum and light alloy applications
Sigma Sand® Coated Sand    Specialty RCS formulated for reduced emissions and nitrogen levels

 

Our foundry resins business provides PF resin systems, specialty coatings and ancillary products used to produce finished metal castings.

 

Oilfield Products. We are a leading producer of resin-coated proppant systems in North America. Our innovative flow back control technology allows oil and gas service providers to improve yields and extract oil and gas from deeper and more complex geological formations.

 

Products


  

Key Applications


AcFrac®, Ceramax® and XRT Resin Systems    Control flowback and increase well yields using various substrates
Curable Resin-Coated Sand    Bonds down hole to prevent proppant flowback
Curable Resin-Coated Ceramics    Control flowback and increase conductivity
Precured Resin-Coated Sand    Excellent crush resistance and high flow capacities

 

Maximizing flow capacity is critical for oil and gas production around the world, both on land and off-shore. We supply the leading service providers in the oil and gas field industry with products that increase the yields of working wells. Our extensive line of PF resin systems, resin-coated sand and resin-coated ceramic proppants are used in the hydraulic fracturing process to create and maintain pathways from the well bore to the oil or gas-bearing formation. This process enhances the recovery of hydrocarbons and can extend the well’s life.

 

Marketing and Distribution

 

Products are sold to industrial users in the U.S. primarily through our sales force. To the extent practicable, our international distribution techniques parallel those used in the U.S. However, raw materials, production considerations, pricing competition, government policy toward industry and foreign investment and other factors may vary substantially from country to country.

 

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Competition

 

We compete with a variety of companies in each of our product lines. However, we believe that no single company competes with us across all of our existing product lines. The following chart sets forth our principal competitors by segment:

 

Segment


  

Product Line


  

Principal Competitors


Forest Products    Forest Products Resins    Dynea International Oy and Georgia-Pacific Corporation
     Formaldehyde    Dynea International Oy and Georgia-Pacific Corporation
Performance Resins    Specialty Resins    Dynea International Oy, Occidental Petroleum Corporation and Sumitomo Bakelite Co., Ltd.
     Foundry Resins    Ashland Inc. and Technisand Inc.
     Oilfield Products    Carbo Ceramics Inc. and Santrol Corporation
International    Product lines produced and sold outside of North America    Ashland Inc. and Dynea International Oy

 

Manufacturing and Raw Materials

 

The primary raw materials used in our manufacturing processes, for all of our operating segments, are methanol, phenol and urea. Raw materials are available from numerous sources in sufficient quantities but are subject to price fluctuations that cannot always be passed on to customers. We use long-term purchase agreements for our primary and certain other raw materials in certain circumstances to assure availability of adequate supplies at specified prices. These agreements generally do not have minimum purchase requirements.

 

The following table illustrates the average annual price from 1995 to 2004 for methanol, phenol and urea:

 

     Year

Raw Material


   1995

   1996

   1997

   1998

   1999

   2000

   2001

   2002

   2003

   2004

Methanol (1)

   65.77    44.03    58.43    36.08    34.59    54.48    58.98    52.30    74.58    80.03

Phenol (2)

   34.00    32.00    35.50    31.17    23.00    25.88    26.63    28.13    34.48    50.92

Urea (3)

   200.16    182.65    137.96    113.05    91.63    140.38    133.85    115.08    172.17    204.04

(1) Prices based on U.S. cents per gallon (Source: Chemical Market Associates, Inc.)
(2) Prices based on U.S. cents per pound (Source: Chemical Market Associates, Inc.)
(3) Prices based on U.S. dollars per short ton (Source: Blue, Johnson & Associates)

 

Customers

 

Our business does not depend on any single customer nor are any of our operating segments limited to a particular group of customers, the loss of which would have a material adverse effect on the operating segment. In 2004, our largest customer accounted for approximately 5% of our net sales, and our top ten customers accounted for approximately 24% of our net sales. Our primary customers consist of manufacturers, and the demand for our products is generally not seasonal.

 

Patents and Trademarks

 

We own various patents, trademark registrations, patent and trademark applications and technology licenses in our operating segments around the world which are held for use or currently used in our operations. We own two material trademarks, Borden® and Elsie®. We use Borden® in our operations and license both trademarks to third parties for use on non-chemical products. A majority of our patents relate to the development of new products and processes for manufacturing and use thereof and will expire at various times between 2005 and 2023. Other than the Borden® and Elsie® trademarks, no individual patent or trademark is considered to be material; however, our overall portfolio of patents and trademarks are valuable assets.

 

Environmental Regulations

 

Our operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials and are subject to extensive environmental regulation at the Federal, state and international level and are exposed to the risk of claims for environmental remediation or restoration. In addition, our production facilities require operating permits that are subject to renewal or modification. Violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Accruals for environmental matters are recorded in accordance with the guidelines of AICPA Statement of Position 96-1, “Environmental Remediation Liabilities,” when it is probable that a liability has been incurred and the amount of the

 

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liability can be estimated. Although environmental policies and practices are designed to ensure compliance with international, Federal and state laws and environmental regulations, future developments and increasingly stringent regulation could require us to make additional unforeseen environmental expenditures. In addition, our former operations, including our ink, wallcoverings, film, phosphate mining and processing, thermoplastics, food and dairy operations, pose additional uncertainties for claims relating to our period of ownership. There can be no assurance that, as a result of former, current or future operations, there will not be some future impact on us relating to new regulations or additional environmental remediation or restoration liabilities.

 

We are actively engaged in complying with environmental protection laws, including various Federal, state and foreign statutes and regulations relating to manufacturing, processing and distributing our many products. We anticipate incurring future costs for capital improvements and general compliance under environmental laws, including costs to acquire, maintain and repair pollution control equipment. We incurred related capital expenditures of $4,529 in 2004, $5,234 in 2003 and $3,641 in 2002. We estimate that approximately $5,300 will be spent for capital expenditures in 2005 for environmental controls at our facilities. This estimate is based on current regulations and other requirements, but it is possible that material capital expenditures in addition to those currently anticipated could be required if regulations or other requirements change.

 

Research and Development

 

Our research and development and technical services expenditures were $19,744, $17,998 and $19,879 in 2004, 2003 and 2002, respectively. Development and marketing of new products are carried out by our operating segments and are integrated with quality control for existing product lines. In addition, we have an agreement with a not-for-profit research center to assist in certain research projects and new product development initiatives.

 

Employees

 

At December 31, 2004, we had approximately 2,400 employees. Relationships with our union and non-union employees are generally good.

 

Where You Can Find More Information

 

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports are available to the public through our internet website at www.bordenchem.com/home.asp under “About Us”, from the Securities and Exchange Commission at its website www.sec.gov or free of charge from Investor Relations at our administrative offices in Columbus, Ohio.

 

ITEM 2. PROPERTIES

 

As of December 31, 2004, we operated 27 domestic production, manufacturing and distribution facilities in 16 states, the most significant of which is a plant in Louisville, Kentucky. In addition, we operated 22 foreign production, manufacturing and distribution facilities primarily in Canada, Brazil, the United Kingdom, Australia, Malaysia and China. Our production and manufacturing facilities are generally well maintained and effectively utilized. We believe our production and manufacturing facilities are adequate to operate our business.

 

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Our executive and administrative offices, production, manufacturing and distribution facilities at December 31, 2004 are shown in the following table:

 

Location


 

Function


 

Nature of Ownership


Domestic        
Alexandria, LA   Manufacturing   Owned
Aurora, IL   Manufacturing   Owned
Baytown, TX   Manufacturing   Owned
Bellevue, WA   Executive and Administration   Leased
Brady, TX   Manufacturing   Owned
Cincinnati, OH   Manufacturing   Owned
Columbus, GA   Manufacturing   Owned
Columbus, OH   Executive and Administration   Leased
Demopolis, AL   Manufacturing   Owned
Diboll, TX   Manufacturing   Owned
Dutchtown, LA   Storage Terminal   Owned
Fayetteville, NC   Manufacturing   Owned
Fremont, CA   Manufacturing   Owned
Geismar, LA   Manufacturing   Owned
Gonzales, LA   Manufacturing   Owned
High Point, NC   Manufacturing   Owned
Hope, AR   Manufacturing   Owned
Houston, TX   Executive and Administration   Leased
Houston, TX   Laboratory   Leased
LaGrande, OR   Manufacturing   Owned
Louisville, KY   Manufacturing   Owned
Louisville, KY   Executive and Administration   Leased
Missoula, MT   Manufacturing   Owned
Moreau, NY   Manufacturing   Owned
Morganton, NC   Manufacturing   Owned
Mt. Jewett, PA   Manufacturing   Owned
Oregon, IL   Manufacturing   Owned
Portland, OR   Manufacturing   Owned
Sheboygan, WI   Manufacturing   Owned
Springfield, OR   Manufacturing   Owned
Toledo, OH   Manufacturing   Owned
Virginia, MN   Manufacturing   Owned
International        
Brisbane, Queensland, Australia   Manufacturing   Owned
Laverton North, Victoria, Australia   Manufacturing   Owned
Somersby, New South Wales, Australia   Manufacturing   Owned
Boituva, Brazil   Manufacturing   Owned
Cotia, Brazil   Manufacturing   Owned
Curitiba, Brazil   Manufacturing   Owned
Edmonton, AB, Canada   Manufacturing   Owned
Laval, PQ, Canada   Manufacturing   Owned
St. Romuald, PQ, Canada   Manufacturing   Owned
Vancouver, BC, Canada   Manufacturing   Owned
Heyuan, People’s Republic of China   Manufacturing   Owned
Shanghai, People’s Republic of China  

Executive, Administration

and Manufacturing

  Leased
Yumbo, Colombia   Manufacturing   Owned
Rouen, France   Distribution   Owned
Kedah, Malaysia   Manufacturing   Owned
Kuantan, Malaysia   Manufacturing   Owned
Prai, Malaysia   Manufacturing   Owned
Rotterdam, The Netherlands   Manufacturing   Owned
Barry, South Wales, United Kingdom   Manufacturing   Owned
Chandlers Ford, England, United Kingdom   Manufacturing   Owned
Cowie, Scotland, United Kingdom   Manufacturing   Owned
Peterlee, England, United Kingdom   Manufacturing   Owned

 

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ITEM 3. LEGAL PROCEEDINGS

 

Environmental Proceedings

 

We have been notified that the Company is or may be responsible for environmental remediation at 31 sites in the U.S. Five of these sites, located in four states, involve active proceedings brought under state or Federal environmental laws: Geismar, Louisiana; Fairlawn, New Jersey; Fremont, California; Lakeland, Florida and Newark, California. The most significant of these sites is the site formerly owned by the Company in Geismar, Louisiana. While we cannot predict with certainty the total cost of such cleanups, we have recorded liabilities of approximately $22,800 and $23,400 at December 31, 2004 and 2003, respectively, for environmental remediation costs related to these five sites.

 

For the remaining 26 sites, we have been notified that the Company is or may be a potentially responsible party (“PRP”) in active proceedings in 16 states brought under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) or similar state “superfund” laws. While we cannot predict with certainty the total cost of such cleanup, we have recorded liabilities of approximately $7,900 and $7,600 at December 31, 2004 and 2003, respectively, for environmental remediation costs related to these 26 sites. The Company generally does not bear a significant level of responsibility for these sites and has little control over the costs and timing of cash flows. At 16 of the 26 sites, our share is less than 1%. At the remaining ten sites, the Company has a share of up to 8.8% of the total liability. The Company’s ultimate liability will depend on many factors including: its volumetric share of waste, the financial viability of other PRPs, the remediation methods and technology used, the amount of time necessary to accomplish remediation and the availability of insurance coverage. Our insurance provides very limited, if any, coverage for environmental matters.

 

In addition to the 31 sites referenced above, we are conducting voluntary remediation at 24 other locations. We have recorded liabilities of approximately $7,500 and $7,600 at December 31, 2004 and 2003, respectively, for remediation and restoration liabilities at these locations. See Note 11 to the Consolidated Financial Statements.

 

Imperial Home Décor Group

 

In 1998, pursuant to a merger and recapitalization transaction sponsored by The Blackstone Group (“Blackstone”) and financing arranged by Chase Manhattan Bank, Borden Decorative Products Holdings, Inc. (“BDPH”), a wholly owned subsidiary of the Company, was acquired by Blackstone and subsequently merged with Imperial Wallcoverings to create Imperial Home Décor Group (“IHDG”). Blackstone provided $84,500 in equity, a syndicate of banks funded $198,000 of senior secured financing and $125,000 of senior subordinated notes were privately placed. We received approximately $309,000 in cash and 11% of IHDG common stock for our interest in BDPH at the closing of the merger. On January 5, 2000, IHDG filed for reorganization under Chapter 11 of the U. S. Bankruptcy Code. The IHDG Litigation Trust (the “Trust”) was created pursuant to the plan of reorganization in the IHDG bankruptcy to pursue preference and other avoidance claims on behalf of the unsecured creditors of IHDG. In November 2001, the Trust filed a lawsuit against the Company and certain of its affiliates seeking to have the IHDG recapitalization transaction voided as a fraudulent conveyance and asking for a judgment to be entered against the Company for $314,400 plus interest, costs and attorney fees. An effort to resolve this matter through non-binding mediation was unsuccessful in resolving the case, and the parties are moving forward with discovery in preparation for trial.

 

We have accrued approximately $3,600 for defense costs related to this matter at December 31, 2004. We have not recorded a liability for any potential losses because a loss is not considered probable based on current information. We believe that we have strong defenses to the Trust’s allegations, and we intend to defend the case vigorously. While it is reasonably possible that the resolution of this matter may result in a loss due to the many variables involved, management is not able to estimate the range of possible outcomes at this time.

 

Brazilian Excise Tax Administrative Appeal

 

In 1992, the State of Sao Paulo Tax Bureau issued an assessment against our primary Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes, characterized by the Tax Bureau as intercompany sales. Since that time, we have held discussions with the Tax Bureau, and our subsidiary has filed an administrative appeal seeking cancellation of the assessment. In December 2001, the Administrative Court upheld the assessment, valued at $60.8 million Brazilian Reais, or approximately US$22,900 at December 31, 2004, an amount which includes tax, penalties, monetary correction and interest. In September 2002, our subsidiary filed a second appeal with the highest-level administrative court, again seeking cancellation of the assessment on the grounds that it was unlawfully issued. Argument was made to the court in September 2004, and we are awaiting the court’s ruling. We believe we have a strong defense against the assessment and will pursue the appeal vigorously; however, no assurance can be given that the assessment will not be upheld. At this time, we do not believe a loss is probable; therefore, only related legal fees have been accrued. Reasonably possible losses resulting from the resolution of this matter range from zero to $22,900.

 

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HAI Grand Jury Investigation

 

HAI, a joint venture in which the Company has a 70% interest, received a grand jury subpoena dated November 5, 2003 from the U.S. Department of Justice Antitrust Division relating to a foundry resins Grand Jury investigation. HAI has provided documentation in response to the subpoena. As is frequently the case when such investigations are in progress, various antitrust lawsuits have been filed against the Company alleging that the Company and HAI, along with various other entities, engaged in a price fixing conspiracy. These cases have been consolidated in federal court in Ohio. At this time, we do not believe a loss is probable; therefore, only related legal fees have been accrued. We do not have sufficient information to determine a range of possible outcomes for this matter at this time.

 

CTA Acoustics

 

From the third quarter of 2003 to first quarter 2004, six lawsuits were filed against us in the 27th Judicial District, Laurel County Circuit Court, in Kentucky, arising from an explosion at a customer’s plant where seven plant workers were killed and over 40 other workers were injured. The lawsuits primarily seek recovery for wrongful death, emotional and personal injury, loss of consortium, property damage and indemnity. We expect that a number of these suits will be consolidated. The litigation also includes claims by our customer against its insurer and the Company and a claim against a third party that performed services for the Company in connection with sales to the customer. We are pursuing a claim for indemnity against our customer, based on language in our contract with the customer, and a claim against a third party that performed services for us in connection with the sales to the customer. We have insurance coverage which will address any payments and legal fees in excess of the $5,000 deductible, which was previously accrued.

 

Other Legal Proceedings

 

The Company is involved in various product liability, commercial and employment litigation, personal injury, property damage and other legal proceedings which are considered to be in the ordinary course of business. In large part, as a result of the bankruptcies of many asbestos producers, plaintiffs’ attorneys are increasing their focus on peripheral defendants, including the Company, and asserting that even products that contained a small amount of asbestos caused injury. Plaintiffs are also focusing on alleged harm caused by other products we have made or used, including those containing silica and vinyl chloride monomer. We believe we have adequate reserves and insurance to cover currently pending and foreseeable future claims.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

During the fourth quarter of 2004, no matters were submitted to a vote of our security holder.

 

Part II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

(a) There is no established public trading market for our common stock.

 

(b) As of March 1, 2005, 96,905,936 common shares were held by our parent, BHI Acquisition Corp.

 

(c) We declared no dividends on common stock in 2004, 2003 or 2002. Our ability to pay dividends on our common stock is restricted by our Loan and Security Agreement with certain banks (see the discussion in Note 9 to the Consolidated Financial Statements and under Liquidity and Capital Resources in the Management’s Discussion and Analysis of Financial Condition and Results of Operations).

 

(d) There are no compensation plans that authorize the issuance of our stock to employees or non-employees.

 

 

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ITEM 6. SELECTED FINANCIAL DATA

 

Five Year Selected Consolidated Financial Data

 

The following summarizes our selected financial data for the past five years. See pages 14 through 33 for items impacting comparability between 2004, 2003 and 2002.

 

For the years


   (1)2004

    (2)2003

   (3)2002

    (4)2001

    (5)2000

 

Summary of Earnings

                                       

Net sales

   $ 1,686,021     $ 1,434,813    $ 1,247,885     $ 1,372,141     $ 1,377,845  

(Loss) income from continuing operations

     (179,668 )     22,976      (6,758 )     (136,604 )     (72,259 )

Net (loss) income applicable to common stock

     (179,668 )     22,976      (36,583 )     (186,646 )     (39,750 )

Basic and diluted (loss) income per common share from continuing operations

   $ (1.12 )   $ 0.11    $ (0.03 )   $ (0.69 )   $ (0.36 )

Basic and diluted (loss) income per common share

     (1.12 )     0.11      (0.18 )     (0.94 )     (0.20 )

Dividends per share

                                       

Common share

   $ —       $ —      $ —       $ 0.18     $ 0.31  

Preferred series A

     —         —        —         2.52       3.00  

Average number of common shares outstanding during the year-basic

     159,923       199,310      199,319       198,997       198,975  

Average number of common shares outstanding during the year-dilutive

     159,923       200,267      199,319       198,997       198,975  

Financial Statistics

                                       

Total assets

   $ 1,044,114     $ 993,866    $ 1,011,780     $ 1,123,278     $ 1,520,597  

Long-term debt

     955,816       529,966      523,287       532,497       530,530  

(1) On August 12, 2004, we were acquired by Apollo Management L.P., suspended a proposed initial public offering of our common stock and issued Second Priority Notes totaling $475,000. Our operating results include costs related to the Apollo Transaction of $55,586, of which $14,264 is included in Transaction related compensation costs. Our business realignment expense and impairments totaled $4,427 for the year. Also, primarily in response to changes in circumstances in connection with the Apollo Transaction, we recorded a charge of approximately $87,000 in Income tax expense to increase the valuation reserves related to our net domestic deferred tax asset and an additional provision of approximately $63,000 for taxes associated with the unrepatriated earnings of our foreign subsidiaries.
(2) Our 2003 operating results include $4,748 of business realignment expense and impairments.
(3) In 2002, we adopted Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets,” and recorded a charge upon adoption of $29,825 as Cumulative effect of change in accounting principle. Our operating results include $19,699 in business realignment expense and impairments consisting of plant closure costs of $12,584, severance of $3,265 and non-cash impairments of $6,315 partially offset by a $2,465 gain on the sale of a closed facility.
(4) In 2001, we sold Consumer Adhesives, closed Melamine and impaired the related assets and sold a common stock equity investment. Additionally, in 2001, our prepaid pension asset was reclassified to equity as a minimum pension adjustment. Operating results in 2001 include $126,408 of business realignment expense and impairments consisting of $98,163 in impairment charges, $23,285 in plant closure costs, $12,582 in severance and $2,885 related to the discontinued construction of a new plant. These charges were partially offset by a $10,507 gain on the sale of a closed facility. Our 2001 results also include a $27,000 impairment expense related to investments in and receivables from affiliates.
(5) In 2000, we acquired a formaldehyde operation from BCP Operating Limited Partnership and East Central Wax, a wax emulsions producer. Our operating results in 2000 include business realignment expense of $38,100 consisting entirely of plant closure costs, and our operating results also include a $25,330 charge to exit certain long-term raw material contracts. These charges were partially offset by a $10,500 gain on the sale of certain rights to harvest shellfish. Our 2000 results also include a $67,969 charge to write-down investments in affiliates.

 

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Dollars in thousands)

 

Forward-Looking and Cautionary Statements

 

As management of the Company, we may, from time to time, make written or oral statements regarding the future performance of the Company, including statements contained in this report and our other reports filed with the Securities and Exchange Commission. Investors should be aware that these statements, which may include words such as “believe,” “expect,” “anticipate,” “estimate” or “intend,” are based on our currently available financial, economic, and competitive data and on current business plans. Such statements are inherently uncertain, and investors should recognize that events could cause our actual results to differ materially from those projected in forward-looking statements made by us on behalf of the Company. Such risks and uncertainties are primarily in the areas of results of operations by business unit, liquidity, legal and environmental liabilities and industry and economic conditions.

 

Apollo Transaction

 

On July 6, 2004, Apollo Management L.P., referred to herein as Apollo, announced that it had signed a definitive agreement to acquire BCI. Previously, on May 7, 2004, BCI filed a registration statement with the U.S. Securities and Exchange Commission, the SEC, for a proposed initial public offering, or IPO, of BCI’s common stock. This IPO was suspended and the registration statement withdrawn on August 31, 2004.

 

On August 12, 2004, BHI Investment, LLC, an affiliate of Apollo, acquired all of the outstanding capital stock of our parent, Borden Holdings, Inc., which we call BHI, for total consideration of approximately $1.2 billion, including debt assumed. In addition, all of the outstanding capital stock of BCI held by management was redeemed or otherwise cancelled.

 

Immediately following the acquisition, BHI Investment, LLC reorganized our existing corporate structure so that BCI became directly owned by BHI Acquisition Corporation, which we call BHI Acquisition, a subsidiary of BHI Investment, LLC. Immediately following the acquisition of BHI, we also reorganized the ownership of BCI’s foreign subsidiaries.

 

Collectively, these transactions described above are referred to as the Apollo Transaction.

 

The acquisition of BHI, and the payment of transaction fees and expenses, was financed by the net proceeds of a $475 million second-priority senior secured private debt offering, which we refer to as the Second Priority Notes, issued by two newly formed, wholly owned subsidiaries of BCI, and with certain equity contributions to BHI Acquisition from Apollo and management. With a portion of the proceeds, we redeemed our 9.25% debentures on August 12, 2004 for total cash of $49,249. Included in the total cash paid was $47,295 for the principal of the debentures, $1,069 of accrued interest and an early redemption premium of $885.

 

The Second Priority Notes are guaranteed by the Company and certain of its domestic subsidiaries, which we refer to collectively as the Guarantors. The Second Priority Notes and the related guarantees are senior obligations of BCI secured by a second-priority lien (subject to certain exceptions and permitted liens) on certain of the Guarantors’ existing and future domestic assets, including the stock of BCI’s Canadian subsidiary.

 

We elected to keep our accounting records on the Company’s historical basis of accounting under the public debt exemption permitted by the SEC.

 

Overview

 

We are a leading global integrated producer of thermoset-based resins and adhesives for the global forest products and industrial markets. In addition, we are the world’s largest producer by volume of formaldehyde, an important and versatile building block chemical used in a variety of applications. We are the largest North American producer by volume of thermoset-based resins used in the production of engineered wood products, including structural wood panels, beams and non- structural panels, furniture, door and window assemblies and wallboards. We are also the largest North American producer by volume of resin-coated proppant systems, which are used in oilfield and natural gas production, and (through HAI) of foundry resins, which are used in the production of cores and molds for metal castings. We have a strong presence in the production of specialty resins used in the industrial, automotive and electronics markets.

 

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Our business is managed as three operating segments: Forest Products, Performance Resins and International. Our results also include general corporate and administrative expenses disclosed as “Corporate and Other” and activities related to our melamine crystal business, which we refer to as Melamine, which was shut down in 2002 and is disclosed as “Divested Business.” These are also presented to provide a complete picture of our results.

 

Forest Products includes the forest product resins and formaldehyde product lines produced in North America. The key business drivers for Forest Products are housing starts, furniture demand, panel production capacity and chemical intermediates sector operating conditions.

 

Performance Resins includes the specialty resins, foundry resins and oilfield product lines produced in North America. Performance Resins’ key business drivers are housing starts, auto builds, active gas drilling rigs and the general industrial sector performance.

 

International includes production operations in Europe, Latin America and Asia Pacific. Principal countries of operation are the U.K., Brazil, Australia and Malaysia. Product lines include formaldehyde, forest product and performance resins and consumer products. The key business drivers for International are export levels, panel production capacity, housing starts, furniture demand and the local political and general economic environments.

 

Corporate and Other represents general and administrative expenses and income and expenses related to assets and liabilities retained from legacy businesses.

 

Industry Conditions

 

As is true for many industries, our results are impacted by the effect on our customers of economic upturns or downturns, as well as the impact on our own costs to produce, sell and deliver our products. Our customers use most of our products in their production processes; therefore, factors impacting their industries could significantly affect our results.

 

In 2004, the continuing strong U.S. housing market positively impacted us. According to Resource Information Systems, Inc. (“RISI”), housing starts were up approximately 5% in 2004 compared to 2003, driving a 6% increase in structural panel consumption. Oriented strand board, or OSB, consumption was up 5% in 2004 compared to 2003, while plywood consumption was up 7%. The shift in our sales mix from plywood to OSB also benefited us, as OSB, on a per square foot basis, uses approximately twice the amount of our resins as plywood.

 

U.S. consumption of particleboard, a major end-use for our urea-formaldehyde, or UF, resins, was up 3% in 2004 due primarily to the strong housing and remodeling markets, as well as due to an increase in furniture production in 2004 of 5% compared to 2003, according to RISI. Medium density fiberboard, or MDF, the other major end-use for our UF resins, continued its strong growth in 2004 with an increase of 18% from 2003. Primarily the strong laminate flooring markets, used in both new homes and remodeling, drove this increase. Current forecasts for 2005 by RISI are predicting that particleboard and MDF consumption will increase at slower rates in 2005 than in 2004 due to the predicted slowdown in the record-setting new housing market.

 

Continued higher natural gas prices, while hurting us from a processing cost perspective, increased the demand for our oilfield proppants used in the gas drilling industry. The number of North American gas drilling rigs in active production at the end of 2004 were 11% higher than at the end of 2003, helping to drive a 25% increase in sales in our oilfield products. We believe continued elevated natural gas prices and the need to replenish depleted reserves should continue to drive strong demand for these products in 2005.

 

Raw Material Costs

 

Raw material costs make up approximately 80% of our product costs. The primary raw materials that we use are methanol, phenol and urea. During the past four years, the price of these materials has been volatile. In 2004, for example, the average prices of methanol, phenol and urea increased by 7%, 48% and 19% respectively. To help mitigate this volatility, we have purchase and sale contracts with many of our vendors and customers with periodic price adjustment mechanisms. Due to differences in timing of the pricing mechanism trigger points between our sales and purchase contracts there is often a “lead-lag” impact during which margins are negatively impacted for the short term in periods of rising raw material prices and positively impacted in periods of falling raw material prices. In addition, the pass through of raw material price changes can result in significant variances in sales comparisons from year to year. In 2004, we had a favorable impact as raw material price increases throughout 2003 and 2004 were passed through to customers, having a significant impact on 2004 sales versus 2003.

 

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Regulatory Environment

 

Various government agencies are conducting formaldehyde health research and evaluating the need for additional regulations. Although formaldehyde has been heavily regulated for several years, further regulation of formaldehyde could follow over time. In 2004, the International Agency for Research on Cancer (“IARC”) reclassified formaldehyde as “carcinogenic to humans,” a higher classification than previous IARC evaluations based principally on a study linking formaldehyde exposure to nasopharyngeal cancer, a rare form of cancer in humans. IARC also concluded that there was strong but not sufficient evidence for a finding of a causal association between leukemia and occupational exposure to formaldehyde, although IARC could not identify a mechanism for leukemia induction. We believe that our production facilities will be able to comply with any likely regulatory impact without any material impact on the business.

 

We support appropriate scientific research and risk-based policy decision-making, and we are working with industry groups, including the Formaldehyde Council, Inc., to ensure that governmental assessments and regulations are based on sound scientific information. We believe that we have credible stewardship programs and processes in place to provide compliant and cost-effective resin systems to our customers.

 

In addition, in October 2003, the European Union published the Registration, Evaluation and Authorisation of Chemicals proposal (“REACH”), which would require manufacturers, importers and consumers of certain chemicals to register such chemicals and evaluate their potential impacts on human health and the environment. Based on the results of the evaluation, a newly created regulatory body would then determine if the chemical should be further tested, regulated, restricted or banned from use. If REACH is enacted in its current form, it is possible that significant market restrictions could be imposed on the current and future uses of chemicals sold by us in the European Union.

 

Competitive Environment

 

The chemical industry has been historically competitive, and we expect this competitive environment to continue in the foreseeable future. We compete with companies of varying size, financial strength and availability of resources. Price, customer service and product performance are the primary areas in which we compete.

 

Other Factors Impacting Our Results

 

Other pressures on our profit margins include rising utility costs and increasing benefit, general insurance and legal costs. We are taking a number of steps to control these costs. In addition, we are continuing to analyze our business structure, consolidating plants and functions where we can realize significant cost savings and productivity gains. These consolidations have resulted in asset impairment charges and severance costs, which are more specifically discussed in the following sections and in Note 4 to Consolidated Financial Statements. Future consolidations or productivity initiatives may include additional asset impairment charges and severance costs.

 

We believe that these factors will continue in the foreseeable future. These market dynamics will require us to continue to focus on productivity improvements and risk mitigation strategies to enhance and protect our margins. In the Risk Management section of our report, you will see how we are taking other steps to manage factors impacting our margins through hedges of natural gas and foreign exchange exposures.

 

Overview of Results

 

Our consolidated net sales were $1,686,021 in 2004 versus $1,434,813 in 2003, an increase of $251,208, or 17.5%. The pass through of raw material price increases and favorable product mix in Forest Products and Performance Resins contributed to the increase. Nets sales also benefited from volume increases in Forest Products, Performance Resins, Latin America and Europe. Favorable currency translation, in all foreign countries that we operate in, also contributed to the increase. Fentak, a 2003 acquisition, contributed $7,717 of incremental sales in 2004.

 

We reported a net loss of $179,668 for 2004 versus net income of $22,976 for 2003. The primary driver of the loss for 2004 was income tax expense of $146,337, which primarily consisted of a noncash charge of approximately $87,000 to increase valuation reserves related to certain deferred tax assets, as well as an additional provision of approximately $63,000 for taxes associated with the unrepatriated earnings of our foreign subsidiaries. These charges were made primarily in response to changes in circumstances in connection with the Apollo Transaction. Also contributing to the net loss were Transaction related costs of $55,586, of which $14,264 of compensation costs is included in Transaction related compensation costs, and higher interest expense of $18,045 in 2004 primarily related to the Second Priority Notes (see Liquidity and Capital Resources) issued in connection with the Apollo Transaction. Legal accruals related to legacy legal proceedings of approximately $10,300 also contributed to the net loss in 2004. Partially offsetting these increased expenses were our ability to recover the higher costs of key raw materials, improved volumes in our higher margin products, cost savings related to the 2003 realignment program and amendments to the other post-employment benefits (“OPEB”) medical plan in 2003 and 2004.

 

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Our consolidated net sales increased $186,928, or 15.0%, in 2003 versus 2002. This increase was primarily a result of the pass through of raw material cost increases. In addition, sales benefited from favorable currency translation in Canada, Latin America and Australia and increased demand for oilfield products and formaldehyde. Slightly offsetting these increases were declines in Forest Products’ resins volumes in products servicing the furniture markets due to continued production declines in the North American furniture market and customer inventory reductions.

 

We reported net income of $22,976 for fiscal year 2003 versus a net loss of $36,583 for fiscal year 2002. Of the $59,559 improvement, income from operations increased $32,834 reflecting decreased general and administrative, business realignment, impairment and management fee expenses. In addition, in 2002, we recognized a $29,825 charge taken for goodwill impairments upon the adoption of new accounting rules, which is reflected in the Cumulative effect of change in accounting principle in our 2002 Consolidated Statement of Operations.

 

Critical Accounting Policies:

 

In preparing our financial statements in conformity with generally accepted accounting principles, we have to make estimates and assumptions about future events that affect the amounts of reported assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities in the financial statements and accompanying notes. Some of these accounting policies require the application of significant judgment by management in the selection of appropriate assumptions for determining these estimates. By their nature, these judgments are subject to an inherent degree of uncertainty; therefore, we cannot assure you that actual results will not differ significantly from estimated results. We base these judgments on our historical experience, advice from experienced consultants, forecasts and other available information, as appropriate. Our significant accounting policies are more fully described in Note 2 to the Consolidated Financial Statements.

 

Our most critical accounting policies, which reflect significant management estimates and judgment in determining reported amounts in the Consolidated Financial Statements and the related Notes, are as follows:

 

Environmental remediation and restoration liabilities

 

Accruals for environmental matters are recorded when we believe it is probable that a liability has been incurred and we can reasonably estimate the amount of the liability. Our accruals are established following the guidelines of Statement of Position 96-1, “Environmental Remediation Liabilities.” We have accrued approximately $38,200 and $38,600 at December 31, 2004 and 2003, respectively, for all probable environmental remediation and restoration liabilities, which is our best estimate of these liabilities. Based on currently available information and analysis, we believe that it is reasonably possible that the costs associated with such liabilities may fall within a range of $25,000 to $77,000. This estimate of the range of reasonably possible costs is less certain than the estimates upon which reserves are based, and in order to establish the upper limit of this range, we used assumptions that are less favorable to the Company among the range of reasonably possible outcomes, but we did not assume we would bear full responsibility for all sites, to the exclusion of other potentially responsible parties (“PRPs”).

 

Factors influencing the possible range of costs for environmental remediation include:

 

    The success of the selected method of remediation / closure procedures

 

    The development of new technology and improved procedures

 

    The possibility of discovering additional contamination during monitoring / remediation process

 

    The financial viability of other PRPs, if any, and their potential contributions

 

    The time period required to complete the work, including variations in anticipated monitoring periods

 

    For projects in their early stages, the outcome of negotiations with governing regulatory agencies regarding plans for remediation

 

Income tax assets and liabilities

 

Deferred income taxes represent the tax effect of temporary differences between amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. In 2004, primarily in response to changes in circumstances in connection with the Apollo Transaction, we recorded a charge of approximately $87,000 to increase the valuation reserves related to our net domestic deferred tax asset and an additional provision of approximately $63,000 for taxes associated with the unrepatriated earnings of our foreign subsidiaries. We believe our reserves established for probable tax liabilities are appropriate at December 31, 2004. See Note 17 to the Consolidated Financial Statements for additional information.

 

 

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In estimating accruals necessary for tax exposures, including estimating the outcome of audits by governing tax authorities, we apply the guidance of Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” as well as SFAS No. 109, “Accounting for Income Taxes.” These estimates require significant judgment and, in the case of audits by tax authorities, may often involve negotiated settlements.

 

Factors influencing the final determination of tax liabilities include:

 

    Future taxable income

 

    Execution of business strategies

 

    Negotiations of tax settlements with taxing authorities

 

Pension assets and liabilities

 

The amounts recognized in our financial statements related to pension benefit obligations are determined from actuarial valuations. Inherent in these valuations are certain assumptions including:

 

    Rate to use for discounting the liability (average weighted rates (“AWR”) were 5.5% for 2004 and 5.8% for 2003)

 

    Expected long-term rate of return on pension plan assets (AWR were 8.2% for 2004 and 2003)

 

    Rate of salary increases (AWR were 4.0% for 2004 and 4.2% for 2003)

 

    Mortality rate table (used 1983 GAM Table)

 

The most significant of these estimates is the expected long-term rate of return on pension plan assets. The actual return of our domestic pension plan assets in 2004 was approximately 11%. Future returns on plan assets are subject to the strength of the financial markets, which we cannot predict with any accuracy.

 

These assumptions are updated annually. Actual results that differ from our assumptions are accumulated and amortized over future periods; therefore, these variances affect our expenses and obligations recorded in future periods. Future pension expense and required contributions will also depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in our pension plans.

 

Results of Operations by Segment:

 

Following is a comparison of Net sales and Segment EBITDA. Segment EBITDA is determined by taking net income before depreciation and amortization, interest expense, other non-operating expenses or income, income taxes and other adjustments (which include costs included in operating income associated with the Apollo Transaction, business realignment activities, certain costs primarily related to legacy businesses, dispositions and pension settlement charges, if any). Segment EBITDA is presented by segment and for Corporate and Other and Divested Business for the years ended December 31, 2004, 2003 and 2002. Segment EBITDA is the measure used by our management team in the evaluation of our operating results and in determining allocations of capital resources among the business segments. This is also the profitability measure we use to set management and executive incentive compensation.

 

Net Sales to Unaffiliated Customers:

                        
     2004

    2003

    2002

 

Forest Products

   $ 896,089     $ 755,767     $ 634,619  

Performance Resins

     426,546       364,347       340,791  

International

     363,386       314,693       264,541  

Divested Business

     —         6       7,934  
    


 


 


     $ 1,686,021     $ 1,434,813     $ 1,247,885  
    


 


 


Segment EBITDA:

                        
     2004

    2003

    2002

 

Forest Products

   $ 111,359     $ 92,548     $ 92,918  

Performance Resins

     49,505       46,661       45,127  

International

     31,083       32,250       28,630  

Corporate and Other

     (37,496 )     (43,713 )     (44,949 )
    


 


 


     $ 154,451     $ 127,746     $ 121,726  
    


 


 


 

 

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Reconciliation of Segment EBITDA to Net (Loss) Income:

 

     2004

    2003

    2002

 

Segment EBITDA:

                        

Forest Products

   $ 111,359     $ 92,548     $ 92,918  

Performance Resins

     49,505       46,661       45,127  

International

     31,083       32,250       28,630  

Corporate and Other

     (37,496 )     (43,713 )     (44,949 )

Reconciliation:

                        

Depreciation and amortization

     (49,724 )     (47,319 )     (47,947 )

Adjustments to Segment EBITDA (see pages 22-23)

     (31,150 )     (13,885 )     (40,071 )

Interest expense

     (64,183 )     (46,138 )     (47,315 )

Affiliated interest expense

     (138 )     (558 )     (1,402 )

Transaction related costs

     (41,322 )     —         —    

Other non-operating (expense) income

     (1,265 )     (1,529 )     5,989  

Income tax (expense) benefit

     (146,337 )     4,659       2,262  

Cumulative effect of change in accounting principle

     —         —         (29,825 )
    


 


 


Net (loss) income

   $ (179,668 )   $ 22,976     $ (36,583 )
    


 


 


 

2004 vs. 2003

 

Net Sales Variance


   2004 as a percentage increase (decrease) from 2003

 
     Volume

    Price/Mix

    Translation

    Other

    Total

 

Forest Products

   5.8 %   10.2 %   2.6 %   —       18.6 %

Performance Resins

   10.0 %   6.4 %   0.1 %   0.6 %   17.1 %

International

   5.3 %   (0.4 )%   8.8 %   1.8 %   15.5 %

 

Forest Products

 

Forest Products’ net sales of $896,089 in 2004 were an increase of $140,322, or 18.6%, compared to 2003. Favorable pricing and mix and improved volumes primarily drove the increase in sales. Strong pricing for our phenolic-based, or PF, resins and UF resins was primarily due to the pass through of raw material price increases. We also experienced favorable product mix in our formaldehyde and performance adhesives products. The improved volumes, across all of our products, were due to increased end-use consumption resulting from the continued strong housing market and increased demand for flooring on the resin side and higher demand in the general chemical sector for formaldehyde. Sales also benefited from favorable currency translation as the Canadian dollar strengthened versus the U.S. dollar.

 

Segment EBITDA for Forest Products increased $18,811, or 20.3%, in 2004 versus the prior year. The increase was primarily due to higher volumes and favorable currency translation. Our margins improved despite unprecedented prices for methanol and phenol. The improvement is due to the positive impact of the 2003 realignment program, purchasing productivity and other productivity initiatives, which more than offset the unfavorable lag in passing along raw material price increases.

 

Performance Resins

 

Performance Resins’ net sales in 2004 of $426,546 were an increase of $62,199 or 17.1%, over 2003. Improved volumes and increased selling prices were the main drivers of the increase. Improved volumes for our oilfield products and foundry, non-woven and industrial resins were partially offset by volume declines for our UV coatings products. Volumes for oilfield products increased due to increased drilling activity in East and South Texas, Canada and Russia. Improved volumes in foundry resins were due to continued general recovery in the non-automotive casting segments. Non-woven resins volumes increased due to strong demand in the glass mat market, and industrial resins’ volumes increased due to strong demand from customers in the friction and felt bonding markets. The decline in UV coatings products volumes was due to continued depressed demand for fiber optic cable. Selling price increases for our foundry resins, oilfield products, industrial resins and electronics also contributed to the sales increase and were slightly offset by selling price declines for our laminates and melamine derivative, or LMD, products.

 

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Segment EBITDA for Performance Resins increased $2,844, or 6.1%, in 2004 versus last year, driven by volume increases in oilfield, foundry, electronics and industrial resins and margin improvements in our oilfield products. These positive factors were partially offset by margin declines in our UV coatings, foundry resins and industrial resins. Also offsetting the positive factors were volume declines in LMD products, increased processing costs for oilfield products and increased selling, general and administrative related to increased investments in new product development and geographic expansion.

 

International

 

International net sales of $363,386 increased $48,693, or 15.5%, in 2004 versus last year. Improved volumes in Latin America and Europe were partially offset by price pressures and adverse mix, primarily in Europe. Volume improvements in Latin America were due to increased demand driven by increased exports of wood products. European volume increases were driven by increased demand for formaldehyde and performance resins. The 2003 Fentak acquisition contributed sales of $5,746 to the International segment in 2004. In addition, sales benefited from favorable currency translation across all three international regions.

 

Segment EBITDA for International decreased $1,167, or 3.6%, in 2004 versus the prior year. Improved volumes in Europe and Latin America, favorable currency translation across all three areas and improved processing costs in Europe were more than offset by the impact of costs associated with a mechanical failure at a Brazilian formaldehyde plant and margin reductions due to pricing pressures. We believe the majority of the impact of the mechanical failure is covered by insurance.

 

Corporate and Other

 

Our Corporate and Other expenses decreased $6,217 in 2004 compared to 2003. Net costs related to specific legal and environmental cases were approximately $2,100 lower in 2004, while general insurance costs declined about $2,200 due to 2003 reserve increases for specific cases and revised estimates. In addition, benefit-related costs decreased approximately $2,000. The amendment we made to our OPEB medical benefit plan in 2003 reduced expenses by approximately an additional $2,800 in 2004 compared to 2003. Additionally, our rent costs declined approximately $1,100 in 2004. Offsetting these improvements were the absence of gains reported in 2003 of $2,826 related to a Brazilian foreign exchange claim and $2,355 related to the sale of our airplane.

 

2003 vs. 2002

 

Net Sales Variance


   2003 as a percentage increase (decrease) from 2002

 
     Volume

    Price/Mix

    Translation

    Other

    Total

 

Forest Products

   (1.0 )%   16.3 %   3.6 %   0.2 %   19.1 %

Performance Resins

   3.2 %   3.6 %   —       0.1 %   6.9 %

International

   (0.9 )%   14.2 %   5.4 %   0.3 %   19.0 %

 

Forest Products

 

Our Forest Products’ net sales increased $121,148, or 19.1%, in 2003 compared to 2002. Higher selling prices resulting from the pass through of raw material price increases was the primary reason for the increase. Favorable currency translation also contributed to the sales improvement as the Canadian dollar strengthened versus the U. S. dollar throughout 2003. These improvements were partially offset by a slight decline in volumes. Softer market conditions in the North American furniture sector during the year led to a decrease in demand for MDF and particleboard which are made with our UF resins. Volume for UF resins was also impacted by increased competitive pressures. This decline in UF resin volumes was largely offset by improved formaldehyde volumes due to demand from the general chemical sector and increased volumes in the PF resins driven by the strong housing market and demand for plywood and OSB, which are made with PF resins.

 

Segment EBITDA for Forest Products decreased $370, or 0.4%, in 2003 compared to 2002, primarily due to increased processing and freight costs and the volume decline. Our processing costs increased because of higher energy and insurance costs in 2003. The mix of our formaldehyde product sales changed during 2003, resulting in increased freight costs. Freight costs per pound vary depending on whether product is shipped via pipeline, rail or tanker. These negative factors were largely offset by margin improvements, driven primarily by resins product formulation initiatives and purchasing productivity.

 

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Table of Contents

Performance Resins

 

Our Performance Resins’ net sales increased $23,556, or 6.9%, in 2003 compared to 2002, primarily due to overall higher selling prices and increased volumes. Higher selling prices, primarily in specialty resins and oilfield products, were a result of the pass through of raw material price increases and an improved mix of oilfield products. Improvements in volumes, primarily for oilfield products, also contributed to the increase in sales. The improvement in our oilfield products’ volumes resulted from increased demand due to an expansion in natural gas exploration and drilling activity in 2003. Volume declines in our foundry and specialty resins products reflected continuing weak market conditions in the automotive, felt bonding, laminated flooring and furniture markets, as well as competitive pressures.

 

Segment EBITDA for Performance Resins increased $1,534, or 3.4%, in 2003 compared to 2002. This improvement is primarily due to improved volumes and reduced selling, general and administrative expenses. Improved oilfield volumes, although partially offset by volume declines in foundry and specialty resins, positively impacted Segment EBITDA. Reduced general and administrative expenses were a result of workforce reductions, open positions and a reduction in bad debt expense in 2003 versus 2002, when we experienced several customer bankruptcies. These improvements were partially offset by higher distribution and processing costs. Distribution costs increased because of fuel surcharges and higher freight costs due to shipping oilfield products over a wider geographic area. Higher processing costs were a result of increased energy, equipment repair and insurance costs and higher costs associated with the production of oilfield products.

 

International

 

Our International net sales for 2003 increased by $50,152, or 19.0%, compared to 2002, with our Latin American, Asia Pacific and European businesses all contributing to the sales increase. Latin American sales increased by $15,802 due to favorable currency translation and strong price improvements, slightly offset by a decline in volumes due to adverse market conditions, competitive pressures and market share losses in the consumer products market. Asia Pacific’s $17,000 increase in sales reflected favorable currency translation and improvements in pricing and volumes. Europe’s sales increase of $17,350 was due to strong price improvements, partially offset by unfavorable currency translation and a reduction in volumes due to the difficult market environment. For all three markets, the pricing improvements were a result of the pass through of raw material price increases.

 

International Segment EBITDA increased $3,620, or 12.6%, in 2003 compared to 2002. This improvement was essentially related to a $2,345 gain from the favorable settlement of a Brazilian foreign exchange claim and a $1,100 reserve reduction due to a revised estimate of a potential liability related to an excess duty imposed on the importation of inventory in Brazil. Also contributing to the improvement were productivity improvements in Europe and favorable currency translation in Asia Pacific and Latin America. These improvements were substantially offset by unfavorable product mix and reduced volumes in Latin America and Europe and increased processing costs in Latin America and Asia Pacific due to increased energy and equipment repair costs.

 

Corporate and Other

 

Our Corporate and Other expenses decreased $1,236 in 2003 compared to 2002. Contributing to this net decline in expenses were the following factors: we amended our OPEB medical benefit plan during 2003, resulting in a reduction in plan expenses of approximately $11,500; we settled a Brazilian foreign exchange claim relating to a sold business for a gain of $2,826 and we recognized a $2,355 gain on the sale of the Company’s airplane. In addition, salary and benefit costs were lower in 2003 due to a reduction in workforce. Offsetting these reductions in expense were increased insurance and legal costs of approximately $13,100, and the absence of a 2002 adjustment that reduced our allowance for doubtful accounts.

 

Divested Business

 

Amounts reported as Divested Business in both years represents the disposition of remaining inventory and other assets of Melamine, which was closed in early 2002. We sold this business to a third party in the second quarter of 2003.

 

 

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Adjustments To Segment EBITDA

 

We rely primarily on Segment EBITDA in the evaluation of operating results and the allocation of capital resources. The following tables detail items not included in Segment EBITDA for purposes of this evaluation of our operating segments. We monitor these activities separately from our operating results. These (expense) income items primarily relate to costs incurred associated with the Apollo Transaction (see Note 1 to the Consolidated Financial Statements) and to our realignment programs.

 

Year Ended December 31, 2004


   Plant Closure

    Severance

    Impairment

    Other

    Total

 

Forest Products

   $ 139     $ (334 )   $ (75 )   $ (803 )   $ (1,073 )

Performance Resins

     (251 )     (80 )     (1,552 )     1,007       (876 )

International

     (3,369 )     (119 )     (397 )     (25 )     (3,910 )

Corporate and Other

     13       156       —         (25,460 )     (25,291 )
    


 


 


 


 


Total

   $ (3,468 )   $ (377 )   $ (2,024 )   $ (25,281 )   $ (31,150 )
    


 


 


 


 


 

As part of our ongoing realignment program designed to improve productivity and reduce our costs, we recorded plant closure costs totaling $3,468 in 2004. These costs include environmental remediation costs of $1,399 and $812 for sites previously closed in Brazil and Europe, respectively, additional costs of $1,296 for the conversion of our French manufacturing facility into a distribution center, offset by other income of $39 related to adjustments of reserves at various other sites.

 

Our severance costs of $377 relate to the 2003 realignment program.

 

The asset impairment of $2,024 relates to production assets that were written-down due to changes in our manufacturing footprint.

 

Other expenses of $25,281 not included in Segment EBITDA in 2004 related primarily to compensation costs of $14,264 incurred in connection with the Apollo Transaction and legal accruals of approximately $10,300 related primarily to legacy-related legal proceedings. These costs are included in Transaction related compensation costs and General & administrative expense, respectively.

 

Year Ended December 31, 2003


   Plant Closure

    Severance

    Impairment

    Other

    Total

 

Forest Products

   $ (932 )   $ (1,125 )   $ —       $ (90 )   $ (2,147 )

Performance Resins

     94       (397 )     (1,000 )     —         (1,303 )

International

     (7,720 )     (643 )     (2,183 )     11,692       1,146  

Corporate and Other

     (146 )     (4,672 )     —         (8,732 )     (13,550 )

Divested Business

     1,716       —         —         253       1,969  
    


 


 


 


 


Total

   $ (6,988 )   $ (6,837 )   $ (3,183 )   $ 3,123     $ (13,885 )
    


 


 


 


 


 

We recorded 2003 plant closure costs of $6,988 consisting of plant employee severance of approximately $3,900, asset write-downs related to the closure and consolidation of plants of approximately $3,200, environmental remediation costs relating to plant closures in Brazil of approximately $800 and other costs of approximately $700. These costs were partially offset by a net reduction of reserves of approximately $1,600 no longer required for Melamine due to its sale in the second quarter of 2003.

 

We also recorded severance costs of $6,837 in 2003 related principally to administrative workforce reduction programs, primarily for the 2003 realignment program.

 

The impairment charges we recorded in 2003 relate to a reduction in our estimate of net realizable value for a facility held for sale, the impairment of goodwill related to our Malaysian operations resulting from our year-end analysis of goodwill and the recognition of fixed asset impairments at several international manufacturing facilities.

 

Other income not reflected in 2003 Segment EBITDA primarily represent gains of $12,260 on the sale of a former plant site in the U.K. and on the sale of Melamine, both of which were closed as part of our realignment programs. These gains were partially offset by a $5,929 charge related to legal settlements reached with BCPM Liquidating LLC and BCP Liquidating LLC in connection with the settlement of claims related to the bankruptcies of a former subsidiary and its investee and severance expense included in General & administrative expense relating to positions to be replaced as part of the June 2003 realignment program.

 

 

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Table of Contents

Year Ended December 31, 2002


   Plant Closure

    Severance

    Impairment

    Other

    Total

 

Forest Products

   $ (1,107 )   $ (250 )   $ —       $ —       $ (1,357 )

Performance Resins

     (1,950 )     (102 )     (1,040 )     —         (3,092 )

International

     (2,844 )     (795 )     (5,275 )     2,465       (6,449 )

Corporate and Other

     —         (2,118 )     —         (19,850 )     (21,968 )

Divested Business

     (6,683 )     —         —         (522 )     (7,205 )
    


 


 


 


 


Total

   $ (12,584 )   $ (3,265 )   $ (6,315 )   $ (17,907 )   $ (40,071 )
    


 


 


 


 


 

Plant closure costs recorded in 2002 as part of our realignment programs totaled $12,584 and consisted of plant employee severance of $2,721 and demolition, environmental and other costs relating to plant closure and consolidations of $9,863, including the closure of Melamine.

 

Our 2002 severance costs of $3,265 related primarily to administrative workforce reduction programs.

 

The impairment charges we recorded in 2002 pertain to a reduction in net realizable value for a facility held for sale and to fixed assets at several international manufacturing facilities.

 

Other expenses not reflected in 2002 Segment EBITDA primarily represent a pension settlement charge of $13,600 triggered by lump sum settlements paid to participants. In addition, we recorded additional management fees of $5,500 related to the wind-down of Capital. These expenses were partially offset by a $2,465 gain recognized on the sale of land associated with a closed plant in Spain.

 

Non-Operating Expenses and Income Tax Expense:

 

Non-operating expense

 

     2004

   2003

   2002

 

Interest expense

   $ 64,183    $ 46,138    $ 47,315  

Affiliated interest expense, net

     138      558      1,402  

Transaction related costs

     41,322      —        —    

Other non-operating expense (income)

     1,265      1,529      (5,989 )
    

  

  


     $ 106,908    $ 48,225    $ 42,728  
    

  

  


 

Our total non-operating expenses increased $58,683 in 2004 as compared to 2003. Non-affiliated interest expense increased $18,045 over 2003 due to higher average debt balances resulting from our issuance of the Second Priority Notes in August of 2004 as part of the Apollo Transaction (see Liquidity and Capital Resources). Interest expense in 2004 also reflects the write-off of approximately $1,100 of deferred costs relating to our credit facility, which was amended and restated effective with the Apollo Transaction, and the write-off of deferred costs of approximately $570 relating to the 9.25% debentures that we redeemed, also in conjunction with the Apollo Transaction. We incurred non-operating expenses totaling $41,322 for Transaction related costs during 2004. Included in Other non-operating expense was a loss on the settlement of an interest rate swap of $610, a charge of $885 incurred due to the early redemption of our 9.25% debentures and a charge of $568 incurred due to the early termination of our credit facility. These charges were offset by a $2,076 gain on the mark to market of a deal contingent forward held by us (see Risk Management).

 

In 2003, our interest and net affiliated interest expense decreased $2,021 versus 2002 due to lower debt balances and lower interest rates. Other non-operating expenses increased $7,518. We incurred a $1,367 loss on the settlement of an intercompany loan resulting from foreign currency translation. In addition, interest income declined by $1,409 in 2003 due to lower interest rates and lower average cash balances. The remainder of the variance is primarily related to gains realized in 2002 on interest rate swaps and debt buybacks (see below).

 

In 2002, we recognized a gain of $2,741 on the repurchase of debt in the open market and recorded a gain on an interest rate swap of $1,722.

 

 

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Table of Contents

Income tax expense (benefit)

 

     2004

   2003

    2002

 

Income tax expense (benefit)

   $ 146,337    $ (4,659 )   $ (2,262 )

Effective tax rate

     N/M      N/M       25 %

 

Our 2004 consolidated tax rate reflects a valuation allowance in the amount of $86,541 recorded against our deferred tax assets as our management determined that it is more likely than not that these deferred tax assets will not be fully utilized in the future. The increase in our valuation allowance from prior year is due primarily to a change in circumstances in connection with the Apollo Transaction. In 2004, we also made a determination that the unrepatriated earnings from our foreign subsidiaries were no longer permanently reinvested. As such, our 2004 consolidated tax rate reflects an additional provision of $62,514 for taxes associated with the unrepatriated earnings of our foreign subsidiaries. In addition, the 2004 consolidated tax rate reflects income tax expense of $14,018, which primarily pertains to Apollo Transaction costs, which are not deductible for income tax purposes. These amounts are partially offset by a net tax benefit of $10,948 relating to certain state and Internal Revenue Service (“IRS”) settlements, as well as changes in prior estimates.

 

Our 2003 consolidated rate reflects a benefit of $19,936 from the sale of the stock of Melamine in 2003. The tax basis of the stock exceeded the tax basis of the assets and we could not recognize this additional basis until the stock sale was completed in 2003. This benefit is a capital loss carryforward that can only be used against capital gains; therefore, we established a valuation reserve for the full amount of this benefit. Other 2003 activities reflected in the 2003 consolidated rate include a reduction of a valuation reserve in the amount of $14,534 related to tax assets we believe we are more likely than not to realize. Our 2003 tax rate also reflects the elimination of $1,624 of deferred tax liabilities associated with the BCP Management, Inc. (“BCPM”) bankruptcy. In addition, we reduced reserves for prior years’ Canadian and U.S. tax audits by $3,997 as a result of preliminary settlements of certain matters in the fourth quarter of 2003. The effective rate also reflects additional income tax expense of $9,324 on foreign dividend income and on deemed dividend income related to loans and guarantees from foreign subsidiaries.

 

Our 2002 consolidated tax rate reflects a valuation allowance recorded against the deferred benefit of interest expense deductions in the amount of $16,672 that are no longer more likely than not to be used due to limitations imposed by the IRS. During 2002, we reached preliminary settlement with the IRS regarding tax years 1998 and 1999. The outcome of this settlement was favorable to us, and as a result, we were able to reduce our accruals related to these years by $20,000.

 

Tax Legislation

 

In 2004, the American Jobs Creation Act of 2004 was signed into law. This Act effectively phases out benefits from the utilization of foreign sales corporations, reduces the number of foreign tax credit limitation categories, creates a temporary incentive for U.S. companies to repatriate foreign earnings at a significantly reduced effective U.S. tax rate and domestically provides a number of revenue enhancing and reducing provisions in the taxation of corporations. Our management does not anticipate a material impact from this legislation for the 2004 tax year.

 

Cash Flows:

 

     2004

    2003

    2002

 

Cash provided by (used in):

                        

Operating activities

   $ 24,565     $ 31,940     $ 11,296  

Investing activities

     (26,007 )     (42,314 )     81,464  

Financing activities

     92,165       21,710       (101,716 )

Effect of exchange rates on cash flow

     3,226       2,086       (936 )
    


 


 


Net change in cash and cash equivalents

   $ 93,949     $ 13,422     $ (9,892 )
    


 


 


 

Operating Activities

 

Our 2004 operating activities provided cash of $24,565. This includes cash generated by operations of $17,282 and by net trading capital, consisting of accounts receivable, inventory and accounts and drafts payable, of $41,910. Our positive cash flow in net trading capital resulted from improvement in the timing of payments of our accounts payable. These positive cash flows were partially offset by cash outflows related to income taxes of approximately $15,100, payments related primarily to legacy-related legal and environmental matters of approximately $13,400, realignment expenditures of $11,400 and payments for legal settlements with BCPM Liquidating LLC and BCP Liquidating LLC of $7,050.

 

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Table of Contents

Our 2003 operating activities provided cash of $31,940. This includes cash generated by operations of $82,781 and by net trading capital of $10,006. Our positive cash flow in net trading capital resulted from our continued focus on working capital management during 2003. We focused on reducing days outstanding for accounts receivable, increasing inventory turns and improving the timing of payments of our accounts payable. These positive cash flows were partially offset by tax payments of $19,368 due primarily to international taxes and realignment expenditures of $11,801.

 

Our 2002 operating activities provided cash of $11,296 in 2002. Cash generated from earnings of approximately $77,000 was substantially offset by interest payments of $46,928, net trading capital outflows of $18,347 and taxes paid of $978.

 

Investing Activities

 

Our 2004 net investing activities used cash of $26,007. We used cash of $39,757 for capital expenditures primarily for plant expansions and other improvements. We received cash of $12,061 related to the sale of assets, primarily from the collection of a note receivable for the 2003 sale of land associated with a closed plant in the U.K. and the 2004 sales of previously closed plants. Proceeds from the sale of venture interest of $2,124 were from the sale of 5% of our interest in HA-International LLC, which we call HAI, to Delta-HA (see Note 3 to the Consolidated Financial Statements).

 

Our 2003 net investing activities used cash of $42,314. We spent $41,820 for capital expenditures, primarily for plant expansions and improvements. We also spent $14,691 making two acquisitions in 2003: Fentak and the business and technology assets of SEACO. We realized proceeds of $14,197 from the sale of land associated with a closed plant in the U.K. and other miscellaneous assets.

 

Our 2002 cash inflow for investing activities of $81,464 primarily related to the sale of a note receivable from Consumer Adhesives of $110,000 to BHI and to other assets sales to unrelated parties for $10,237. Our 2002 capital expenditures totaled $38,773 and related primarily to plant expansions and improvements.

 

Financing Activities

 

Our financing activities in 2004 provided cash of $92,165. Net cash generated by financing activities was primarily due to the issuance of debt related to the Apollo Transaction. Approximately $296,000 was used to redeem common shares of the Company from BHI and BCI management. In addition, we paid fees totaling $22,965 related to the debt issuance and credit facility amendment.

 

Our 2003 financing activities provided cash of $21,710. Capital contributions from affiliates of $9,300 and net external borrowings primarily related to the Fentak acquisition accounted for the cash inflow. Early in the third quarter of 2003, we completed the process of converting letters of credit from our uncommitted letter of credit (“LOC”) facility to our Credit Facility (see Liquidity and Capital Resources) resulting in the release of restricted cash of $67,049, most of which was used to repay borrowings from affiliates; thus these net transactions had little impact on total financing cash generated.

 

Our 2002 financing activities used cash of $101,716. The 2002 activities included an increase in restricted cash of $66,165 relating to our establishment of a temporary uncommitted LOC facility, a repayment of a $31,581 note due to a former subsidiary and net repayments of borrowings of $3,379.

 

Liquidity and Capital Resources:

 

Our primary source of liquidity is cash flow generated from operations. We also have availability under our asset-based revolving line of credit in our senior secured credit facility (see below), subject to certain conditions. Our primary liquidity requirements are for debt service, working capital requirements, contractual obligations and capital expenditures.

 

We are a highly leveraged company. Our liquidity requirements are significant, primarily due to our debt service requirements. At December 31, 2004, we had $967,404 principal amount of outstanding indebtedness, of which $150,000 constituted floating rate notes and $817,404 constituted fixed rate indebtedness. We had no amounts borrowed under our senior secured credit facility at December 31, 2004. In 2004 and 2003, our annual debt service payment obligations were approximately $58,300 and $48,200, respectively.

 

In conjunction with the Apollo Transaction, we formed two wholly owned finance subsidiaries that borrowed a total of $475 million through a private debt offering. Of the debt, $325 million is second-priority senior secured notes due 2014, referred

 

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Table of Contents

to herein as the Fixed Rate Notes, which bear an interest rate of 9%. The remaining $150 million of debt is second-priority senior secured floating rate notes due 2010, which we call the Floating Rate Notes. In February 2005, we filed a registration statement with the SEC to consummate an exchange offer on the Fixed Rate and Floating Rate Notes.

 

Interest on the Floating Rate Notes is paid each January 15, April 15, July 15 and October 15. Interest on the Floating Rate Notes accrues at an annual rate, reset quarterly, equal to LIBOR plus 475 basis points. At December 31, 2004, the interest rate on the Floating Rate Notes was 6.82%. The Floating Rate Notes mature July 15, 2010. The Floating Rate Notes may be redeemed at any time on or after July 15, 2006. In addition, up to 35% of the aggregate principal amount of the Floating Rate Notes may be redeemed prior to July 15, 2006 with cash proceeds from certain equity offerings. Prior to July 15, 2009, the Floating Rate Notes may be redeemed at a price equal to 100% of the principal amount plus accrued interest plus the “make- whole” premium as defined in the indenture for the notes. The Floating Rate Notes may also be redeemed upon certain changes in tax laws or upon a change in control. The specific pricing and terms of redemption are described in the indenture for the notes. There is no sinking fund for the Floating Rate Notes.

 

Interest on the Fixed Rate Notes will be paid each January 15 and July 15. The Fixed Rate Notes mature July 15, 2014. These notes may be redeemed at any time on or after July 15, 2009. In addition, up to 35% of the aggregate principal amount of the Fixed Rate Notes may be redeemed prior to July 15, 2007 with cash proceeds from certain equity offerings. Prior to July 15, 2009, the Fixed Rate Notes may be redeemed at a price equal to 100% of the principal amount plus accrued interest plus the “make-whole” premium as defined in the indenture for the notes. The Fixed Rate Notes may also be redeemed upon certain changes in tax laws or upon a change in control. The specific pricing and terms of redemption are described in the indenture for the notes. There is no sinking fund for the Fixed Rate Notes.

 

We entered into a three-year asset based revolving credit facility in the third quarter of 2002, which we refer to herein as our Credit Facility, under which we can borrow in aggregate up to $175,000. We amended this Credit Facility, which we refer to as our Amended Credit Facility, on August 12, 2004 as part of the Apollo Transaction. The Amended Credit Facility provides for loans and letters of credit in a total principal amount of up to $175,000 and will mature in five years. The Amended Credit Facility includes a $57,000 revolving credit subfacility for our Canadian subsidiary, a $30,000 revolving credit subfacility for our U.K. subsidiary and a letter of credit subfacility of at least $100,000.

 

Our Amended Credit Facility is secured with inventory and accounts receivable in the U.S., Canada and the U.K., a portion of property and equipment in Canada and the U.K. and the stock of certain subsidiaries. At December 31, 2004, the net book value of the collateral securing the Amended Credit Facility, excluding the stock of subsidiaries, was approximately $266,000. The maximum borrowing allowable under our Amended Credit Facility is calculated monthly (quarterly, if availability is greater than $100,000) and is based upon specific percentages of eligible accounts receivable, inventory, fixed assets and cash. This Amended Credit Facility contains restrictions on dividends, capital expenditures ($37,500 from August 12, 2004 to December 31, 2004; $75,000 in 2005) and payment of management fees ($3,000 per year or 2% of EBITDA, as defined in the agreement). It also includes a minimum trailing twelve-month fixed charge coverage ratio of 1.1 to 1.0, if aggregate availability is less than $50,000. The trailing twelve-month fixed charge coverage ratio requirement does not apply when aggregate availability exceeds $50,000. At December 31, 2004, our maximum borrowing allowable under the Amended Credit Facility was approximately $174,700 of which about $127,800, after outstanding LOCs and other draws, was unused and available. As a result, we have no fixed charge coverage ratio requirements at year-end 2004.

 

The $34,000 Ascension Parish Industrial Revenue Bonds, or IRBs, are related to the acquisition, construction and installation of air and water pollution control facilities that are no longer owned by the Company. The tax-exempt status of the IRBs is based upon there being no change in the use of the facilities, as defined by the Internal Revenue Code. The Company continues to monitor the use of the facilities by the current owner. If a change in use were to occur, the Company could be required to take remedial action, including redeeming all of the bonds.

 

We redeemed our 9.25% debentures on August 12, 2004, with interest paid through September 12, 2004. The total cash outflow associated with the redemption was $49,249. Included in the total cash paid was $47,295 for the principal of the debentures, $1,069 of accrued interest and an early redemption premium of $885.

 

We also had a borrowing arrangement with BWHLLC, a former affiliate, evidenced by a demand promissory note bearing interest at a variable rate, which terminated upon the completion of the Apollo Transaction. In 2003, we, along with HAI, had similar arrangements with Borden Foods Holdings Corporation, a former affiliate. The loans were reported as Loans payable to affiliates on the Consolidated Balance Sheets and totaled $18,260 at December 31, 2003. Of the total loans outstanding, HAI owed $6,000 at December 31, 2003. Net affiliated interest expense totaled $138, $558 and $1,402 for the years ended December 31, 2004, 2003 and 2002 respectively.

 

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HAI replaced its loan agreement with Foods on January 28, 2004, when they entered into a three-year asset based revolving credit facility, which provides for a maximum borrowing of $15,000, as amended on October 29, 2004 (the “HAI Facility”). Maximum borrowing allowable under this facility is based upon specific percentages of eligible accounts receivable and inventory and is secured with the inventory, accounts receivable and property and equipment of HAI. At December 31, 2004, the net book value of the collateral securing the HAI Facility was approximately $33,600. The HAI Facility restricts HAI on the payment of dividends, affiliate transactions, additional debt, minimum availability ($2,000) and capital expenditures ($2,000 in 2005). In addition, HAI must maintain a minimum trailing twelve-month debt coverage ratio of 1.5 to 1.0 and a monthly debt to tangible capital ratio of less than 2.5 to 1.0. At December 31, 2004, maximum borrowing allowable under the HAI Facility was approximately $13,800, of which about $11,800 was unused and available, after the minimum availability requirement.

 

Our Australian subsidiary entered into a five-year secured credit facility in the fourth quarter of 2003 (the “Australian Facility”), which provides for a maximum borrowing of AUD$19,900, or approximately $15,500. The Australian Facility provided the funding for our Fentak acquisition (See Note 3 to the Consolidated Financial Statements for additional information on the acquisition), and it is secured by liens against substantially all of the assets of the Australian business including the stock of Australian subsidiaries. At December 31, 2004, the net book value of the collateral securing the Australian Facility was approximately $29,700. In addition, the stock of Australia is pledged as collateral for borrowings under the Australian Facility. This facility includes a fixed rate component used for the acquisition, as well as a revolver and LOC facility. This facility restricts the Australian subsidiaries on the payment of dividends, the sale of assets and additional borrowings by the Australian businesses outside of this facility. This facility also contains financial covenants applying to the Australian subsidiaries including current ratio, interest coverage, debt service coverage and leverage. The fixed portion of the Australian Facility requires minimum quarterly principal reductions totaling AUD$450 (approximately $350). The revolving facility component requires semi-annual principal reductions based on a portion of excess cash as defined in the agreement. At December 31, 2004, the maximum borrowing allowable under the Australian Facility was AUD$18,100 (approximately $14,100), of which about AUD$3,600 (approximately $2,800), after outstanding LOCs and other draws, was unused and available.

 

We have additional international credit facilities that provide availability to these businesses totaling approximately $26,100. Of this amount, approximately $12,200 (net of $3,935 of borrowings, $4,600 of LOCs and other guarantees and $5,400 of other draws) was available to fund working capital needs and capital expenditures. These credit facilities have various expiration dates ranging from 2006 through 2008. While these facilities are primarily unsecured, portions of the lines are secured by equipment. At December 31, 2004, the net book value of collateral securing a portion of these facilities was approximately $750. Our U.S. business guarantees up to $6,700 of the debt of one of our Brazilian subsidiaries, included in these facilities.

 

As discussed in Note 3 to the Consolidated Financial Statements, on October 6, 2004, we entered into an agreement to acquire Bakelite Aktiengesellschaft (“Bakelite”). We intend to finance this acquisition through a combination of new debt securities and cash. We believe we will continue to have adequate cash available from operations and our Amended Credit Facility subsequent to the completion of this acquisition despite the additional debt to be incurred.

 

In the fourth quarter of 2003, we exercised our option to redeem, at par, the remaining $885 of County of Maricopa Industrial Revenue Bonds (“IRBs”). Also in the fourth quarter of 2003, we converted our remaining IRB issue, the $34,000 Parish of Ascension IRB, to a fixed interest rate, and, by doing so, we were able to eliminate the requirement to maintain a backup letter of credit for approximately $34,500.

 

Effective December 1, 2003, we entered into a $34,000 interest rate swap agreement structured for the Parish of Ascension IRBs. Under this agreement, we received a fixed rate of 10% and paid a variable rate equal to the 6-month LIBOR plus 630 basis points. At December 31, 2003, this equated to a rate of 7.6%. This swap agreement was terminated in the third quarter of 2004 for a fee of $610.

 

Previous buybacks of our senior unsecured notes allow us to fulfill our sinking fund requirements through 2013 for our 8.375% debentures. In the future, we, or our affiliates, including entities controlled by Apollo, may purchase our senior unsecured notes in the open market or by other means, depending on market conditions.

 

In June 2003, we announced a realignment plan from which we expect annualized savings of approximately $20,000 when the program is fully implemented in 2005. We are taking the following measures to achieve these goals: reducing our workforce, streamlining our processes in manufacturing as well as administration, consolidating manufacturing processes and targeting reductions of general and administrative expenses. We are combining jobs where practical. As a result of consolidating

 

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manufacturing processes, we closed our North Bay, Ontario plant as of the end of 2003 and shifted the manufacturing to another facility. We are executing a similar consolidation in Europe. Our facility in France has been converted into a distribution center, and the manufacturing transitioned to the U.K. To further decrease targeted general and administrative expenses, we have reduced contract work, consolidated and eliminated positions and streamlined the administration of medical benefits and other post-retirement benefits. We anticipate completing this program in 2005. We expect to incur additional costs in 2005 related to this program. (See Note 4 to the Consolidated Financial Statements for additional information on our realignment programs).

 

We plan to spend approximately $45,000 in 2005 for capital expenditures, including plans to continue increasing plant production capacity as necessary to meet demand. We plan to fund capital expenditures through operations and, if necessary, through available lines of credit.

 

The following table summarizes our contractual cash obligations at December 31, 2004 and the effect we expect these obligations to have on our future cash requirements. Our contractual cash obligations consist of legal commitments at December 31, 2004, requiring us to make fixed or determinable cash payments, regardless of the contractual requirements of the vendor to provide future goods or services. This table does not include information on our recurring purchases of materials for use in production, as our raw materials purchase contracts do not meet this definition because they do not require fixed or minimum quantities. Contracts with cancellation clauses are not included, unless such cancellation would result in major disruption to our business. For example, we have contracts for information technology support that are cancelable, but this support is essential to the operation of our business and administrative functions; therefore, amounts payable under these contracts are included.

 

     Payments Due By Year

Contractual Obligations


   2005

   2006

   2007

   2008

   2009

  

2010

and beyond


   Total

Long-term debt, including current maturities

   $ 11,588    $ 1,991    $ 1,489    $ 3,754    $ 34,000    $ 914,582    $ 967,404

Operating leases

     11,641      8,919      6,370      4,734      2,546      4,307      38,517

Unconditional purchase obligations (1)

     11,074      4,667      2,686      300      —        —        18,727

Interest expense on fixed rate debt (2)

     69,806      69,621      69,491      69,390      68,902      545,785      892,995
    

  

  

  

  

  

  

Total

   $ 104,109    $ 85,198    $ 80,036    $ 78,178    $ 105,448    $ 1,464,674    $ 1,917,643
    

  

  

  

  

  

  


(1) This table excludes payments relating to income tax, pension and OPEB benefits and environmental obligations due to the fact that, at this time, we cannot determine either the timing or the amounts of payments for all periods beyond 2004 for certain of these liabilities. See Notes 11, 12, 13 and 17 to the Consolidated Financial Statements and the following discussions on our environmental, pension, OPEB and income tax liabilities, respectively, for more information on these obligations. Our capital lease obligations are not material.
(2) This table excludes interest expense for debt instruments with variable interest rates, which includes a portion of the notes. For the year ended December 31, 2004, this expense was approximately $3,930.

 

We have updated our projected pension plan contributions as reported in our Form 10-K dated December 31, 2003. Our current projections for future contributions range from approximately $7,300 in 2005 to approximately $28,600 in 2006, with a total funding requirement for the five years ended in 2009 of $74,900. The assumptions used by our actuaries in calculating these projections included an 8.0% annual return on assets for the years 2005 – 2009 and the continuation of current law and plan provisions.

 

Our projected future plan benefit payments for our postretirement plans range from approximately $1,500 in 2009 to approximately $3,200 in 2005, with total benefit payments for the five years ended in 2009 of approximately $9,700.

 

As disclosed in Note 17 to the Consolidated Financial Statements, we wrote-off our net deferred domestic income tax asset in 2004. We do not anticipate this will have a negative impact on our cash flow in future years. We estimate we will pay cash taxes totaling approximately $20,000 in 2005 for state, local and international liabilities.

 

We expect other environmental expenditures for 2005 – 2009 to total approximately $19,500, with approximately $29,700 paid over the next 25 years beginning in 2010.

 

Effective September 1, 2003, we amended our OPEB medical benefit plan to eliminate medical benefits for our retirees and their dependents who are over age 65. We have arranged with a major benefits provider to offer affected retirees and their dependents continued access to medical and prescription drug coverage, including coverage for pre-existing conditions. We

 

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subsidized a portion of the cost of coverage for affected retirees and their dependents through December 2004 to assist our retirees’ transition to alternative medical coverage and reserved the right to continue, terminate or reduce the subsidy provided to our affected retirees and their dependents for periods after December 2004. We elected to reduce the subsidy provided effective January 1, 2005 and eliminate the remaining subsidy effective January 1, 2006, except in certain cases where contractual obligations exist. As a result of these actions, our liability related to providing OPEB medical benefits was reduced by approximately $96,000. Our primary benefit from these amendments was a reduction of future annual cash outlays related to OPEB benefits by approximately $11,600 annually, as compared to the cash outlays we anticipated under the pre-amended retiree medical benefit plan.

 

We expect to have adequate liquidity to fund working capital requirements, contractual obligations and capital expenditures over the remainder of the five year term of our Amended Credit Facility with cash received from operations, amounts available under the Amended Credit Facility and amounts available under our subsidiaries’ separate credit facilities.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements.

 

Covenant Compliance

 

Adjusted EBITDA is used to determine compliance with the debt incurrence covenant contained in the indenture governing the Floating and Fixed Rate Notes. Because we are highly leveraged, our compliance with these covenants is important for the investors in the Company’s debt. Therefore, Adjusted EBITDA is a key metric for these investors.

 

Adjusted EBITDA is defined as Net income adjusted to exclude depreciation and amortization, interest expense, non-operating income and expenses, unusual items and certain pro forma adjustments permitted in calculating covenant compliance under the indentures governing the notes and our Amended Credit Facility. We believe that the inclusion of supplemental adjustments to net income applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors to demonstrate compliance with our financing covenants.

 

As of December 31, 2004, we were in compliance with all material covenants contained in our indenture governing the notes.

 

Reconciliation of Adjusted EBITDA to Net (Loss) Income

 

     2004

    2003

 

Net (loss) income

   $ (179,668 )   $ 22,976  

Depreciation and amortization

     49,724       47,319  

Adjustments to Segment EBITDA (see pages 22-23)

     31,150       13,885  

Interest expense

     64,183       46,138  

Affiliated interest expense

     138       558  

Transaction related costs

     41,322       —    

Other non-operating expense

     1,265       1,529  

Income tax expense (benefit)

     146,337       (4,659 )
    


 


       154,451       127,746  

Adjusted EBITDA (a) (c):

                

Management fees

     2,608       3,350  

Brazil reactor impact (b)

     3,000       —    

Full year impact of acquisitions

     —         3,579  

Cost savings

     4,900       11,900  

Benefit plan subsidy amendment

     1,200       7,656  

Purchasing power savings

     6,500       6,500  
    


 


     $ 172,659     $ 160,731  
    


 



(a) To arrive at Adjusted EBITDA, we are required to make adjustments to net income for management fees paid to our sponsors, unusual operating impacts and certain pro forma adjustments. These pro forma adjustments include the full year impact of completed acquisitions and approved amendments to our postretirement plan and cost and purchasing savings we expect to achieve.
(b) Amount represents the estimated impact of the mechanical failure of a Brazilian reactor that occurred in the third quarter of 2004. The Company has filed an insurance claim to recover substantially all losses related to this item.
(c) To incur additional debt under the Floating and Fixed Note indenture, a Fixed Charge Coverage Ratio of greater than 2 to 1 must be maintained. The Company’s ratio as of December 31, 2004 after giving effect to the potential acquisition and additional expected debt was 2.3 to 1.

 

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Risk Management

 

We use various financial instruments, including some derivatives, to help us hedge our foreign currency exchange risk and interest rate risk. We also use raw material purchasing contracts and pricing contracts with customers to mitigate commodity price risks. These contracts generally do not contain minimum purchase requirements.

 

Foreign Exchange Risk

 

Our international operations accounted for approximately 38% of our sales in 2004 and 37% in 2003. As a result, we have exposure to foreign exchange risk on transactions potentially denominated in many foreign currencies. These transactions include foreign currency denominated imports and exports of raw materials and finished goods (both intercompany and third party) and loan repayments. In all cases, the functional currency is the business unit’s local currency.

 

It is our policy to reduce foreign currency cash flow exposure due to exchange rate fluctuations by hedging firmly committed foreign currency transactions wherever economically feasible. Our use of forward and option contracts is designed to protect our cash flows against unfavorable movements in exchange rates, to the extent of the amount under contract. We do not attempt to hedge foreign currency exposure in a manner that would entirely eliminate the effect of changes in foreign currency exchange rates on net income and cash flow. We do not speculate in foreign currency nor do we hedge the foreign currency translation of our international businesses to the U.S. dollar for purposes of consolidating our financial results or other foreign currency net asset or liability positions. The counter-parties to our forward contracts are financial institutions with investment grade credit ratings.

 

Our foreign exchange risk is also mitigated because we operate in many foreign countries, reducing the concentration of risk in any one currency. In addition, our foreign operations have limited imports and exports, reducing the potential impact of foreign currency exchange rate fluctuations. With other factors being equal, such as the performance of individual foreign economies, an average 10% foreign exchange increase or decrease in any one country would not materially impact our operating results or cash flow. However, an average 10% foreign exchange increase or decrease in all countries may materially impact our operating results.

 

As required by current accounting standards, our Consolidated Statements of Operations includes any gains and losses arising from forward and option contracts.

 

The following table summarizes forward currency and option contracts outstanding as of December 31, 2004 and 2003. Fair values are determined from quoted market prices at these dates.

 

     2004

    2003

 
    

Average

Days

To Maturity


  

Average

Contract

Rate


  

Forward

Position


  

Fair Value

Gain (Loss)


   

Average

Days

to Maturity


  

Average

Contract

Rate


  

Forward

Position


  

Fair Value

Gain (Loss)


 

Currency to sell

For U.S. Dollars

                                                  

British Pound (1)

   —      —      $ —      $ —       7    1.7710    $ 44,300    $ (323 )

Canadian Dollars (2)

   183    1.3200      36,000      114     47    1.3600      12,000      18  

Canadian Dollars (3)

   183    1.2300      36,000      (1,547 )   47    1.3068      12,000      (181 )

Currency to sell

For CDN Dollars

                                                  

British Pound (1)

   31    2.3255      41,577      521     —      —        —        —    

Currency to sell
for Euros

                                                  

U.S. Dollars (4)

   90    1.3430      235,025      2,076     —      —        —        —    

(1) Forward contracts
(2) Puts purchased
(3) Calls sold
(4) Deal contingent forward contract (Pending Bakelite acquisition)

 

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Interest Rate Risk

 

We have used interest rate swaps to minimize our interest rate exposures between fixed and floating rates on long-term debt. We do not enter into speculative financial contracts of any type. The fair values of the swaps are determined using estimated market values. Under interest rate swaps, we agree with other parties to exchange at specified intervals the difference between the fixed rate and floating rate interest amounts calculated by reference to the agreed notional principal amount.

 

At December 31, 2003, we had one interest rate swap outstanding with a notional value of $34,000 and a fair value loss of $483. Under this arrangement, we paid 7.6% and received 10.0% in 2003. We cancelled this swap in the third quarter of 2004 for a fee of $610. The swap reduced our interest expense by $456 and $62 in 2004 and 2003, respectively.

 

The interest rates on most of our debt agreements are fixed. A 10% increase or decrease in the interest rates of the variable debt agreements would be immaterial to our net income. The fair value of our publicly held debt is based on the price at which the bonds are traded or quoted at December 31, 2004 and 2003. All other debt fair values are determined from quoted market interest rates at December 31, 2004 and 2003.

 

Following is a summary of our outstanding debt as of December 31, 2004 and 2003 (see Note 9 to the Consolidated Financial Statements for additional information on our debt):

 

     2004

   2003

Year


   Debt

  

Weighted
Average

Interest
Rate


    Fair Value

   Debt

  

Weighted
Average

Interest

Rate


    Fair Value

2004

                       $ 8,167    6.2 %   $ 8,167

2005

   $ 11,588    8.6 %   $ 11,585      2,219    9.7 %     2,219

2006

     1,991    8.2 %     1,991      1,841    8.6 %     1,841

2007

     1,489    6.8 %     1,489      1,420    6.8 %     1,420

2008

     3,754    6.4 %     3,754      3,609    6.4 %     3,609

2009

     34,000    10.0 %     36,720      34,000    10.0 %     33,517

2010 and beyond

     914,582    8.3 %     909,373      486,877    8.4 %     452,857
    

        

  

        

     $ 967,404          $ 964,912    $ 538,133          $ 503,630
    

        

  

        

 

We do not use derivative financial instruments in our investment portfolios. We place any cash equivalent investments in instruments that meet the credit quality standards established within our investment policies, which also limit the exposure to any one issue. At December 31, 2004, we had $74,683 invested, at average rates of 1.9%, primarily in a prime money market account, a guaranteed investment certificate and time deposits with maturity periods of 30 days or less. At December 31, 2003, we had no material investments in cash equivalent instruments. Due to the short maturity of our cash equivalents, the carrying value on these investments approximates fair value and our interest rate risk is not significant. A 10% increase or decrease in interest returns on invested cash would not have a material effect on our net income and cash flows at December 31, 2004 and 2003.

 

Commodity Risk

 

We are exposed to price risks associated with raw material purchases, most significantly with methanol, phenol and urea. For our commodity raw materials, we have purchase contracts, with periodic price adjustment provisions. In 2004, our suppliers were committed under these contracts to provide 100% of our estimated methanol requirements. Commitments with our phenol and urea suppliers provide up to 100% of our estimated requirements and also provide the flexibility to purchase a certain percentage of our needs in the spot market, when favorable to us. We expect these arrangements for raw materials to continue throughout 2005. Our commodity risk also is moderated through our use of customer contracts with selling price provisions that are indexed to publicly available indices for these commodity raw materials. All commodity futures that we enter into are approved by our Board of Directors.

 

We have a long-term contractual arrangement with a leading global producer to supply a minimum of 70% of our worldwide requirements of a key raw material polymer. The material we purchase under this agreement is sourced from numerous supplier production sites and the temporary or permanent loss of any individual site would not likely have a material adverse impact on our ability to satisfy our supply requirements. We have no minimum purchase requirements under this contract.

 

Natural Gas Futures - Natural gas is essential in our manufacturing processes, and its cost can vary widely and unpredictably. In order to control our costs for natural gas, we hedge a portion of our natural gas purchases for all of North America by

 

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entering into futures contracts for natural gas. The contracts are settled for cash each month based on the closing market price on the last day the contract trades on the New York Mercantile Exchange. We hedged approximately 46% and 69% of our actual natural gas usage in 2004 and 2003, respectively. During 2003, we entered into futures contracts for natural gas usage through June 2004, and in 2004 we entered into additional futures contracts through December 2005. Our commitments settled under these contracts totaled $3,125 and $4,866 in 2004 and 2003, respectively. We recorded gains relating to these commitments of $248 in 2004 and losses of $224 in 2003. At December 31, 2004 and 2003, we had future commitments under these contracts of $3,483 and $1,359, respectively.

 

We were in previous natural gas futures contracts with varying settlement dates during 2002. Commitments settled under these contracts totaled $1,210 and our related losses were $264 in 2002. These contracts terminated prior to December 31, 2002.

 

We recognize gains and losses on commodity futures contracts each month as gas is used. Our future commitments are marked to market on a quarterly basis. We recorded losses of $275 and $20 at December 31, 2004 and 2003, respectively, related to future commitments under our natural gas futures contracts.

 

Natural Gas Commitments - In 2000, we entered into fixed rate, fixed quantity contracts to secure a portion of future natural gas usage for certain facilities. We entered into these contracts to partially hedge our risk of natural gas price fluctuations in peak usage months. Our gas purchases under these contracts totaled $402 and $671 in 2003 and 2002, respectively. We recorded a gain of $16 at December 31, 2002 for the difference between the fair value and the carrying value of our future natural gas commitments. These contracts expired early in 2003, and we had no natural gas purchase commitments at year-end 2003.

 

Other Matters

 

Our operations are subject to the usual hazards associated with chemical manufacturing and the related storage and transportation of feedstocks, products and wastes, including, but not limited to, combustion, inclement weather and natural disasters, mechanical failure, unscheduled downtime, transportation interruptions, remediation, chemical spills, discharges or releases of toxic or hazardous substances or gases and other environmental risks. These potential hazards could cause personal injury or loss of life, severe damage to or destruction of property and equipment and environmental damage and could result in suspension of our operations and the imposition of civil or criminal penalties. We have significant operational management systems, preventive procedures and protective safeguards to minimize the risk of an incident and to ensure the safe continuous operation of our facilities. In addition, we maintain property, business interruption and casualty insurance that we believe is in accordance with customary industry practices, but we are not fully insured against all potential hazards incidental to our business.

 

Due to the nature of our business and the current litigious climate, product liability litigation, including class action lawsuits claiming liability for death, injury or property damage caused by our products, or by other manufacturers’ products that include our components, is inherent to our business but historically has been immaterial. However, our current product liability claims and any future lawsuits, could result in damage awards against us, which in turn could encourage additional litigation.

 

Recently Issued Accounting Standards

 

In May 2004, the Financial Accounting Standards Board, or FASB, issued Staff Position SFAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” This Position provides guidance on the accounting, disclosure, effective date, and transition requirements related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. FASB Staff Position SFAS 106-2 is effective for interim or annual periods beginning after June 15, 2004. The adoption of this Position had no material impact on our financial position or results of operations.

 

In November 2004, the FASB issued Statement of Financial Accounting Standard, or SFAS, No. 151, “Inventory Costs.” The statement amends Accounting Research Bulletin, or ARB, No. 43, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. ARB No. 43 previously stated that these costs must be “so abnormal as to require treatment as current-period charges.” SFAS No. 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this statement requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for fiscal years beginning after the issue date of the statement. We do not expect our adoption of SFAS No. 151 to have a material impact on our current financial condition or results of operations.

 

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In December 2004, the FASB revised its SFAS No. 123 (“SFAS No. 123R”), “Accounting for Stock Based Compensation.” The revision establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, particularly transactions in which an entity obtains employee services in share-based payment transactions. The revised statement requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is to be recognized over the period during which the employee is required to provide service in exchange for the award. Changes in fair value during the requisite service period are to be recognized as compensation cost over that period. In addition, the revised statement amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits be reported as a financing cash flow rather than as a reduction of taxes paid. The provisions of the revised statement are effective for our financial statements issued for the first annual reporting period beginning after December 15, 2005, with early adoption encouraged. We are currently evaluating the impact that this statement will have on our financial condition and results of operations.

 

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – An Amendment of APB Opinion No. 29.” APB Opinion No. 29, “Accounting For Nonmonetary Transactions,” is based on the opinion that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. SFAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets whose results are not expected to significantly change the future cash flows of the entity. This statement is effective for nonmonetary asset exchanges beginning December 4, 2005. We do not expect our adoption of SFAS No. 153 to have any impact on our financial condition or results of operations.

 

In December 2004, the FASB issued two FASB Staff Positions, or FSP, that provide accounting guidance on how companies should account for the effects of the American Jobs Creation Act of 2004 that was signed into law on October 22, 2004. FSP FAS 109-1, “Application of FASB Statement No. 109, “Accounting for Income Taxes”, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004”, states that the manufacturers’ deduction provided for under this legislation should be accounted for as a special deduction instead of a tax rate change. FSP FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004”, allows a company additional time to evaluate the effects of the legislation on any plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109, “Accounting for Income Taxes”. These FSPs may affect how a company accounts for deferred income taxes. These FSPs are effective upon issuance. We do not anticipate a material impact from these FSPs on our financial condition or results of operations.

 

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Refer to the “Risk Management” section included in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation.

 

 

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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Audited Consolidated Financial Statements of Borden Chemical, Inc.     

Consolidated Statements of Operations:

    

For the years ended December 31, 2004, 2003 and 2002

   35

Consolidated Balance Sheets:

    

As of December 31, 2004 and 2003

   36

Consolidated Statements of Cash Flows:

    

For the years ended December 31, 2004, 2003 and 2002

   38

Consolidated Statements of Shareholder’s Deficit:

    

For the years ended December 31, 2004, 2003 and 2002

   40

Notes to the Consolidated Financial Statements:

   42

For the years ended December 31, 2004, 2003 and 2002

    

Report of Independent Registered Public Accounting Firm

   88

 

 

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CONSOLIDATED STATEMENTS OF OPERATIONS

BORDEN CHEMICAL, INC.

 

     Year Ended December 31,

 

(In thousands, except per share data)


   2004

    2003

    2002

 

Net sales

   $ 1,686,021     $ 1,434,813     $ 1,247,885  

Cost of goods sold

     1,361,482       1,148,519       968,657  
    


 


 


Gross margin

     324,539       286,294       279,228  
    


 


 


Distribution expense

     75,246       66,383       61,927  

Marketing expense

     46,985       42,398       42,503  

General & administrative expense (see Note 11)

     107,967       100,021       109,237  

Transaction related compensation costs (see Note 1)

     14,264       —         —    

Business realignment expense and impairments

     4,427       4,748       19,699  

Other operating expense

     2,073       6,202       12,154  
    


 


 


Operating income

     73,577       66,542       33,708  
    


 


 


Interest expense

     64,183       46,138       47,315  

Affiliated interest expense, net

     138       558       1,402  

Transaction related costs (see Note 1)

     41,322       —         —    

Other non-operating expense (income)

     1,265       1,529       (5,989 )
    


 


 


(Loss) income before income tax

     (33,331 )     18,317       (9,020 )

Income tax expense (benefit)

     146,337       (4,659 )     (2,262 )
    


 


 


(Loss) income before cumulative effect of change in accounting principle

     (179,668 )     22,976       (6,758 )

Cumulative effect of change in accounting principle

     —         —         (29,825 )
    


 


 


Net (loss) income

   $ (179,668 )   $ 22,976     $ (36,583 )
    


 


 


Comprehensive (loss) income

   $ (158,968 )   $ 60,420     $ (67,784 )
    


 


 


Basic and Diluted Per Share Data

                        

(Loss) income before cumulative effect of change in accounting principle

   $ (1.12 )   $ 0.11     $ (0.03 )

Cumulative effect of change in accounting principle

     —         —         (0.15 )
    


 


 


Net (loss) income – basic

   $ (1.12 )   $ 0.11     $ (0.18 )
    


 


 


(Loss) income before cumulative effect of change in accounting principle

   $ (1.12 )   $ 0.11     $ (0.03 )

Cumulative effect of change in accounting principle

     —         —         (0.15 )
    


 


 


Net (loss) income – dilutive

   $ (1.12 )   $ 0.11     $ (0.18 )
    


 


 


Average number of common shares outstanding during the period:

                        

Basic

     159,923       199,310       199,319  

Dilutive

     159,923       200,267       199,319  

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED BALANCE SHEETS

BORDEN CHEMICAL, INC.

 

(In thousands)

 

     December 31,
2004


    December 31,
2003


 

ASSETS

                

Current Assets

                

Cash and equivalents

   $ 122,111     $ 28,162  

Accounts receivable (less allowance for doubtful accounts of $10,197 in 2004 and $14,459 in 2003)

     226,235       196,093  

Inventories:

                

Finished and in-process goods

     55,656       42,292  

Raw materials and supplies

     54,768       38,819  

Deferred income taxes

     522       27,085  

Other current assets

     22,469       13,905  
    


 


       481,761       346,356  
    


 


Other Assets

                

Deferred income taxes

     3,582       113,434  

Other assets

     49,732       21,725  
    


 


       53,314       135,159  
    


 


Property and Equipment

                

Land

     32,945       32,585  

Buildings

     103,504       103,774  

Machinery and equipment

     733,285       691,249  
    


 


       869,734       827,608  

Less accumulated depreciation

     (421,728 )     (378,724 )
    


 


       448,006       448,884  

Goodwill

     50,682       57,516  

Other Intangible Assets

     10,351       5,951  
    


 


Total Assets

   $ 1,044,114     $ 993,866  
    


 


 

See Notes to Consolidated Financial Statements

 

36


Table of Contents

CONSOLIDATED BALANCE SHEETS

BORDEN CHEMICAL, INC.

 

(In thousands, except share data)

 

     December 31,
2004


    December 31,
2003


 

LIABILITIES AND SHAREHOLDER’S DEFICIT

                

Current Liabilities

                

Accounts and drafts payable

   $ 222,173     $ 127,174  

Debt payable within one year

     11,588       8,167  

Loans payable to affiliates

     —         18,260  

Income taxes payable

     31,556       34,977  

Interest payable

     26,022       12,524  

Other current liabilities

     74,417       71,546  
    


 


       365,756       272,648  
    


 


Other Liabilities

                

Long-term debt

     955,816       529,966  

Non-pension postemployment benefit obligations

     114,502       128,723  

Long-term pension obligations

     64,596       66,656  

Other long-term liabilities

     92,269       92,066  
    


 


       1,227,183       817,411  
    


 


Commitments and Contingencies (See Notes 9 and 11)

                

Shareholder’s Deficit

                

Common stock - $0.01 par value: authorized 300,000,000 shares, issued 200,167,297, treasury 103,261,361, outstanding 96,905,936 in 2004; issued 201,754,598, treasury 858,970, outstanding 200,895,628 in 2003

     969       2,009  

Paid-in capital

     1,274,358       1,224,011  

Treasury stock

     (295,881 )     —    

Receivable from parent

     (560,672 )     (512,094 )

Deferred compensation

     —         (1,488 )

Accumulated other comprehensive loss

     (107,493 )     (128,193 )

Accumulated deficit

     (860,106 )     (680,438 )
    


 


       (548,825 )     (96,193 )
    


 


Total Liabilities and Shareholder’s Deficit

   $ 1,044,114     $ 993,866  
    


 


 

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS

BORDEN CHEMICAL, INC.

 

 

     Year ended December 31,

 

(In thousands)


   2004

    2003

    2002

 

Cash Flows from (used in) Operating Activities

                        

Net (loss) income

   $ (179,668 )   $ 22,976     $ (36,583 )

Adjustments to reconcile net income (loss) to net cash from (used in) operating activities:

                        

Gain on sale of venture interest

     (1,010 )     —         —    

Loss (gain) on the sale of assets

     1,808       (746 )     282  

Deferred tax provision

     139,351       6,223       16,023  

Depreciation and amortization

     49,724       47,319       47,947  

Deferred compensation expense

     2,217       1,191       892  

Business realignment expense and impairments

     4,427       4,748       19,699  

Cumulative effect of change in accounting principle

     —         —         29,825  

Other non-cash adjustments

     433       1,070       (822 )

Net change in assets and liabilities:

                        

Accounts receivable

     (17,158 )     (3,217 )     (12,596 )

Inventories

     (26,502 )     10,731       2,552  

Accounts and drafts payable

     85,570       2,492       (8,303 )

Income taxes

     (8,313 )     (30,291 )     (21,780 )

Other assets

     6,594       3,581       (2,571 )

Other liabilities

     (32,908 )     (34,137 )     (23,269 )
    


 


 


       24,565       31,940       11,296  
    


 


 


Cash Flows (used in) from Investing Activities

                        

Capital expenditures

     (39,757 )     (41,820 )     (38,773 )

Capitalized interest

     (435 )     —         —    

Purchase of businesses

     —         (14,691 )     —    

Proceeds from sale of venture interest

     2,124       —         —    

Proceeds from the sale of assets

     12,061       14,197       10,237  

Proceeds from sale of note receivable to an affiliate

     —         —         110,000  
    


 


 


       (26,007 )     (42,314 )     81,464  
    


 


 


Cash Flows from (used in) Financing Activities

                        

Net short-term debt borrowings

     3,421       5,388       1,255  

Borrowings of long-term debt

     475,249       7,925       —    

Repayments of long-term debt

     (49,399 )     (1,246 )     (10,764 )

Affiliated loan (repayments) borrowings

     (18,260 )     (66,420 )     6,130  

Long-term debt and credit facility financing fees

     (22,965 )     —         —    

Purchase of treasury stock

     (294,918 )     —         —    

Repurchases, net of sale, of common stock from / to management

     (963 )     (286 )     (591 )

Payment of note payable to unconsolidated subsidiary

     —         —         (31,581 )

Decrease (increase) in restricted cash

     —         67,049       (66,165 )

Capital contribution from affiliates

     —         9,300       —    
    


 


 


       92,165       21,710       (101,716 )
    


 


 


Effect of exchange rates on cash

     3,226       2,086       (936 )

Increase (decrease) in cash and equivalents

     93,949       13,422       (9,892 )

Cash and equivalents at beginning of year

     28,162       14,740       24,632  
    


 


 


Cash and equivalents at end of year

   $ 122,111     $ 28,162     $ 14,740  
    


 


 


 

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Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

BORDEN CHEMICAL, INC.

 

 

     Year ended December 31,

 

(In thousands)


   2004

   2003

   2002

 

Supplemental Disclosures of Cash Flow Information

                      

Cash paid (received):

                      

Interest, net

   $ 50,112    $ 45,466    $ 46,928  

Income taxes, net

     15,119      19,368      978  

Non-cash activity:

                      

Reclassification of minimum pension liability adjustment from (to) shareholder’s deficit

     1,978      5,830      (17,075 )

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED STATEMENTS OF SHAREHOLDER’S DEFICIT

BORDEN CHEMICAL, INC.

 

(In thousands)

 

    

Common

Stock


   

Paid-in

Capital


   

Receivable

from Parent


   

Deferred

Compensation


   

Accumulated

Other

Comprehensive

Income


   

Accumulated

Deficit


    Total

 

Balance, December 31, 2001

   $ 1,990     $ 1,106,789     $ (404,817 )   $ —       $ (134,436 )   $ (666,831 )   $ (97,305 )
    


 


 


 


 


 


 


Net loss

                                             (36,583 )     (36,583 )

Translation adjustments

                                     (14,856 )             (14,856 )

Derivative activity (net of $401 tax)

                                     730               730  

Minimum pension liability adjustment (net of $9,194 tax)

                                     (17,075 )             (17,075 )
                                                    


Comprehensive loss

                                                     (67,784 )
                                                    


Interest accrued on notes from parent

             58,699       (58,699 )                             —    

Capital contribution from parent

             3,895                                       3,895  

Repurchases of common stock from management

     (1 )     (1,341 )                                     (1,342 )

Common stock issued to management

     4       747                                       751  

Restricted subsidiary stock issued to management

     16       3,555               (3,571 )                     —    

Compensation expense on restricted stock

                             892                       892  
    


 


 


 


 


 


 


Balance, December 31, 2002

   $ 2,009     $ 1,172,344     $ (463,516 )   $ (2,679 )     (165,637 )   $ (703,414 )   $ (160,893 )
    


 


 


 


 


 


 


Net income

                                             22,976       22,976  

Translation adjustments

                                     31,614               31,614  

Minimum pension liability adjustment (net of $3,139 tax)

                                     5,830               5,830  
                                                    


Comprehensive income

                                                     60,420  
                                                    


Interest accrued on notes from parent

             48,578       (48,578 )                             —    

Capital contribution from parent

             9,300                                       9,300  

Compensation expense on subsidiary restricted stock

                             1,191                       1,191  

Income tax on sale to affiliate of Consumer Adhesives note receivable

             (5,925 )                                     (5,925 )

Repurchases of common stock from management

             (286 )                                     (286 )
    


 


 


 


 


 


 


Balance, December 31, 2003

   $ 2,009     $ 1,224,011     $ (512,094 )   $ (1,488 )   $ (128,193 )   $ (680,438 )   $ (96,193 )
    


 


 


 


 


 


 


 

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED STATEMENTS OF SHAREHOLDER’S DEFICIT

BORDEN CHEMICAL, INC.

 

(In thousands)

 

     Common
Stock


    Paid-in
Capital


    Treasury
Stock


    Receivable
from
Parent


    Deferred
Compensation


   

Accumulated

Other
Comprehensive
Loss


    Accumulated
Deficit


    Total

 

Balance, December 31, 2003

   $ 2,009     $ 1,224,011       —       $ (512,094 )   $ (1,488 )   $ (128,193 )   $ (680,438 )   $ (96,193 )
    


 


 


 


 


 


 


 


Net loss

                                                     (179,668 )     (179,668 )

Translation adjustments

                                             18,722               18,722  

Minimum pension liability adjustment (net of $206 tax)

                                             1,978               1,978  
                                                            


Comprehensive loss

                                                             (158,968 )
                                                            


Redemption of shares from parent

     (1,021 )     1,021       (294,918 )                                     (294,918 )

Interest accrued on notes from parent

             48,578               (48,578 )                             —    

Repurchases of common stock from management

     (3 )     3       (963 )                                     (963 )

Compensation expense on restricted stock prior to cancellation

                                     694                       694  

Cancellation of restricted stock

     (16 )     (3,555 )                     794                       (2,777 )

Compensation expense under BHI Acquisition deferred compensation plan

             4,300                                               4,300  
    


 


 


 


 


 


 


 


Balance, December 31, 2004

   $ 969     $ 1,274,358     $ (295,881 )   $ (560,672 )     —       $ (107,493 )   $ (860,106 )   $ (548,825 )
    


 


 


 


 


 


 


 


 

See Notes to Consolidated Financial Statements

 

41


Table of Contents

Notes to Consolidated Financial Statements

(Dollars in thousands except per share data)

 

1. Background and Nature of Operations

 

Borden Chemical, Inc. (the “Company”) was incorporated on April 24, 1899. The Company is engaged primarily in manufacturing, processing, purchasing and distributing forest products and industrial resins, formaldehyde, oilfield products and other specialty and industrial chemicals worldwide. The Company’s executive and administrative offices are located in Columbus, Ohio. Production facilities are located throughout the U.S. and in many foreign countries.

 

Domestic products are sold by the Company’s sales force throughout the U.S. to industrial users. To the extent practicable, international distribution techniques parallel those used in the U.S. and are concentrated in Canada, Western Europe, Latin America, Australia and Malaysia.

 

At December 31, 2004, 27 of a total 49 production, manufacturing and distribution facilities are located in the U.S., and in 2004, approximately 62% of the Company’s sales were generated in the U.S.

 

The Company has three reportable segments: Forest Products, Performance Resins Group and International. See Note 18.

 

On July 6, 2004, Apollo Management, L.P. (“Apollo”) announced that it had signed a definitive agreement to acquire the Company. Previously, on May 7, 2004, the Company filed a registration statement with the U.S. Securities and Exchange Commission for a proposed initial public offering (“IPO”) of its common stock. The IPO was suspended and the registration statement withdrawn on August 31, 2004.

 

On August 12, 2004, BHI Investment, LLC, an affiliate of Apollo acquired all of the outstanding capital stock of Borden Holdings, Inc. (“BHI”), the Company’s parent at that time, for total consideration of approximately $1.2 billion, including assumption of debt. In conjunction with this transaction, all of the outstanding capital stock of the Company held by management was redeemed and non-vested restricted stock was cancelled. In addition, the Company redeemed approximately 102 million shares from BHI for cash totaling $294,918.

 

Immediately following the acquisition of BHI, BHI Investment, LLC reorganized the existing corporate structure of the Company so that the Company became directly owned by BHI Acquisition Corporation (“BHI Acquisition”), a subsidiary of BHI Investment, LLC. Following the acquisition of BHI by Apollo, the Company reorganized its foreign subsidiaries.

 

The acquisition of BHI, and the payment of transaction fees and expenses, was financed with the net proceeds of a $475 million second-priority senior secured private debt offering (the “Second Priority Notes”) by two newly formed, wholly owned subsidiaries of the Company and certain equity contributions to BHI Acquisition from Apollo. With a portion of the proceeds, the Company redeemed its 9.25% debentures on August 12, 2004 for total cash of $49,249. Included in the total cash paid was $47,295 for the principal of the debentures, $1,069 of accrued interest and an early redemption premium of $885. See Note 9.

 

Collectively, the transactions described above are referred to as the “Apollo Transaction.”

 

The Second Priority Notes are guaranteed by the Company and certain of its domestic subsidiaries (the “Guarantors”). The Second Priority Notes and the related guarantees are senior obligations secured by a second-priority lien (subject to certain exceptions and permitted liens) on certain of the Guarantors’ existing and future domestic assets, including the stock of the Company’s Canadian subsidiary (“BCCI”). Because BCCI meets the definition of a significant subsidiary under Rule 3-16 of Regulation S-X under the Securities Act of 1933, the audited financial statements of BCCI are included in this report.

 

As a result of the suspended IPO and the subsequent acquisition by Apollo, the Company incurred expenses of $55,586. These amounts included charges for investment banking, accounting and legal fees, fees paid to Apollo, payments for cancellation of restricted stock, exercises of stock options and management bonuses pertaining to the activity. Of this amount, compensation costs of $14,264 are included within Transaction related compensation costs, and the remainder is included within Transaction related costs.

 

Prior to the Apollo Transaction, the Company was controlled by an affiliate of Kohlberg Kravis Roberts & Co. (“KKR”) since 1995. The Company’s immediate parent, BHI, was a wholly owned subsidiary of BW Holdings, LLC (“BWHLLC”), an entity controlled by KKR.

 

42


Table of Contents

2. Summary of Significant Accounting Policies

 

Significant accounting policies followed by the Company, as summarized below, are in conformity with generally accepted accounting principles.

 

Principles of Consolidation – The Consolidated Financial Statements include the accounts of the Company and its subsidiaries, after elimination of intercompany accounts and transactions. The Company’s share of the net earnings of 20% to 50% owned companies is included in income on an equity basis.

 

Use of Estimates – The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. The most significant estimates reflected in the financial statements include environmental remediation, legal liabilities, deferred tax assets and liabilities and related valuation allowances, income tax accruals, pension and postretirement assets and liabilities, valuation allowances for accounts receivable and inventories, general insurance liabilities, asset impairments and related party transactions. Actual results could differ from estimated amounts.

 

Cash and Equivalents – The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 2004, the Company had interest bearing time deposits and other cash equivalent investments of $71,975 included on the Consolidated Balance Sheet as Cash and equivalents. At December 31, 2003, the Company had no material investments in cash equivalent instruments.

 

Inventories – Inventories are stated at lower of cost or market. Cost is determined using the first-in, first-out method.

 

Property and Equipment – Land, buildings and machinery and equipment are carried at cost and include capitalized interest of $435 in 2004. Depreciation is recorded on the straight-line basis by charges to expense at rates based on estimated useful lives of properties (average rates for buildings 4%; machinery and equipment 7%). Major renewals and betterments are capitalized. Maintenance, repairs and minor renewals are expensed as incurred.

 

Deferred Expenses - Deferred financing costs are classified as Other assets on the balance sheets and are amortized over the lives of the related debt or credit facility using the straight-line method since no installment payments are required. Upon retirement of any of the related debt, a proportional share of debt issuance costs is expensed. At December 31, 2004 and 2003, the unamortized balance was $30,302 and $9,946, respectively.

 

Goodwill and Intangibles – The excess of purchase price over net tangible and identifiable intangible assets of businesses acquired is carried as Goodwill on the Consolidated Balance Sheet. As of January 1, 2002, the Company no longer amortizes goodwill. Certain trademarks, patents and other intangible assets used in the operations of the business are carried as Other Intangible Assets on the Consolidated Balance Sheet. These intangible assets are amortized on a straight-line basis over the shorter of the legal or useful lives which range from 5 to 10 years. See Note 7.

 

Impairment – As events warrant, but at least annually, the Company evaluates the recoverability of long-lived assets by assessing whether the carrying value can be recovered over their remaining useful lives through the expected future undiscounted operating cash flows of the underlying business. Any impairment loss required is determined by comparing the carrying value of the assets to operating cash flows on a discounted basis.

 

The Company performs an annual impairment test for goodwill. See Note 7.

 

General Insurance – The Company is generally self-insured for losses and liabilities relating to workers’ compensation, health and welfare claims, physical damage to property, business interruption and comprehensive general, product and vehicle liability. The Company maintains insurance policies for certain items exceeding deductible limits. Losses are accrued for the estimated aggregate liability for claims using certain actuarial assumptions followed in the insurance industry and the Company’s experience.

 

Legal Costs – The Company accrues for legal costs in the period in which a claim is made or an event becomes known, if the amounts are probable and reasonably estimable. Each claim is assigned a range of potential liability, with the most likely amount being accrued. The amount accrued includes all costs associated with a claim, including settlements, assessments, judgments, fines and legal fees.

 

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Revenue Recognition – Revenue for product sales, net of allowances, is recognized as risk and title to the product transfer to the customer, which usually occurs at the time shipment is made. Substantially all of the Company’s products are sold FOB (“free on board”) shipping point. Other terms include sales where risk and title passes upon delivery (FOB destination point). In situations where our product is delivered by pipeline, risk and title transfers when our product moves across an agreed transfer point, which is typically the customers’ property line. Product sales delivered by pipeline are measured based on daily flow meter readings. The Company’s standard terms of delivery are included in its contracts of sales and invoices.

 

Shipping and Handling – The Company records freight billed to customers in net sales. Shipping costs are incurred to move the Company’s products from production and storage facilities to the customers. Handling costs are incurred from the point the product is removed from inventory until it is provided to the shipper and generally include costs to store, move and prepare the products for shipment. The Company incurred shipping costs of $75,246 in 2004, $66,383 in 2003 and $61,927 in 2002. These costs are classified as Distribution expense in the Consolidated Statements of Operations. Due to the nature of the Company’s business, handling costs incurred prior to shipment are not significant.

 

Research and Development Costs – Funds are committed to research and development for technical improvement of products that are expected to contribute to operating profits in future years. All costs associated with research and development are charged to expense as incurred. Research and development and technical service expenditures were $19,744, $17,998 and $19,879 for 2004, 2003 and 2002, respectively.

 

Foreign Currency Translations – Assets and liabilities of foreign affiliates are translated at the exchange rates in effect at the balance sheet date, and income and expenses are translated at average exchange rates prevailing during the year. The effect of translation is accounted for as an adjustment to Shareholders’ Deficit and is included in Accumulated other comprehensive loss.

 

In addition, the Company incurred realized and unrealized net foreign transaction (losses) gains aggregating $(848) in 2004, $438 in 2003, and $1,307 in 2002.

 

Income Taxes - The Company files a consolidated U.S. Federal Income Tax return. Income tax expense is based on reported results of operations before income taxes. Deferred income taxes represent the tax effect of temporary differences between amounts of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. Deferred tax balances are adjusted to reflect tax rates, based on current tax laws, that will be in effect in the years in which temporary differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. See Note 17.

 

Derivative Financial Instruments – The Company is party to forward exchange contracts and options and natural gas futures to reduce its cash flow exposure to changes in foreign exchange rates and natural gas prices. The Company does not hold or issue derivative financial instruments for trading purposes. These instruments are not accounted for using hedge accounting, but are measured at fair value and recorded on the balance sheet as an asset or liability, depending upon the Company’s underlying rights or obligations. See Note 8.

 

Stock-Based Compensation – The Company accounts for stock-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123.” During 2004, BHI Acquisition granted options to purchase BHI Acquisition common stock to key employees of the Company under the BHI Acquisition Corp. 2004 Stock Incentive Plan (“the BHI Option Plan”). Prior to the Apollo Transaction, the Company had granted options under its Amended and Restated 1996 Stock Purchase and Option Plan for Key Employees (“the BCI Option Plan”). Together these plans are referred to as the Option Plans.

 

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The following table sets forth the required annual reconciliation of reported and proforma net (loss) income and earnings per share (“EPS”) under SFAS No. 148:

 

     2004

    2003

    2002

 

Net (loss) income applicable to common stock

   $ (179,668 )   $ 22,976     $ (36,583 )
    


 


 


Add: Stock-based employee compensation expense included in reported net income, net of related tax benefit

     8,521       909       581  

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards granted since January 1, 1996, net of related tax effects

     (6,198 )     (973 )     (665 )
    


 


 


Pro-forma net (loss) income

   $ (177,345 )   $ 22,912     $ (36,667 )
    


 


 


Average shares (in thousands) outstanding- basic

     159,923       199,310       199,319  

Average share (in thousands) outstanding - diluted

     159,923       200,267       199,319  

Per share as reported – basic

   $ (1.12 )   $ 0.11     $ (0.18 )

Per share as reported – diluted

   $ (1.12 )   $ 0.11     $ (0.18 )

Per share pro forma (basic and diluted)

   $ (1.11 )   $ 0.11     $ (0.18 )

 

To determine proforma compensation cost for the Option Plans in accordance with SFAS No. 123, the fair value of each option grant was estimated at the date of grant using the minimum value method and the Black-Scholes options pricing model with a risk-free weighted average interest rate of 3.54%, 2.91% and 5.0% for grants made in 2004, 2003 and 2002, respectively, an expected life of five years and a dividend rate of zero. The weighted average fair values, as determined under these assumptions, of option grants at the dates of grant were $0.47 for options grants to purchase shares of BHI Acquisition common stock granted at the date of the Apollo Transaction and $0.30 for options granted to purchase shares of the Company, which were granted in the first quarter of 2004. The weighted average fair values of options granted to purchase the common stock of the Company during 2003 and 2002 were $0.27 and $0.49, respectively. Proforma compensation cost also includes expense related to the deferred compensation plans for BCI and BHI Acquisition.

 

Earnings Per Share – Basic and diluted net (loss) income per share is computed by dividing net (loss) income by the weighted average number of common shares outstanding during the period including the effect of dilutive options, when applicable. The Company had no potentially dilutive instruments outstanding at December 31, 2004. At December 31, 2003, 5,532,360 options to purchase common shares of the Company were outstanding, of which 1,492,000 were considered dilutive. In addition, there were 1,587,301 shares of restricted stock outstanding, which were dilutive. At December 31, 2002, due to the Company’s net loss, the potentially dilutive securities outstanding were anti-dilutive.

 

The Company’s diluted EPS is calculated as follows:

 

     2004

    2003

   2002

 

Net (loss) income applicable to common shareholders

   $ (179,668 )   $ 22,976    $ (36,583 )
    


 

  


Average share outstanding (in thousands) – basic

     159,923       199,310      199,319  

Effect of dilutive options (in thousands)

     —         957      —    
    


 

  


Average share outstanding (in thousands) - diluted

     159,923       200,267      199,319  

Diluted EPS

   $ (1.12 )   $ 0.11    $ (0.18 )

 

Concentrations of Credit Risk – Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and accounts receivable. The Company places its temporary cash investments with high quality institutions and, by policy, limits the amount of credit exposure to any one institution. At December 31, 2004, investments included $52,400 in a prime money market account and $18,319 in a guaranteed investment certificate. Remaining cash is primarily held in nine financial institutions. Concentrations of credit risk with respect to accounts receivable are limited, due to the large number of customers comprising the Company’s customer base and their dispersion across many different industries and geographies. The Company generally does not require collateral or other security to support customer receivables.

 

Reclassification – In 2003, income taxes payable of $15,800, representing probable tax liabilities, was classified as Other long-term liabilities. This amount was reclassified as Income taxes payable to conform to the current year presentation.

 

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Recently Issued Accounting Standards

 

In May 2004, the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”) 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” This Position provides guidance on the accounting, disclosure, effective date, and transition requirements related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. FSP 106-2 is effective for interim or annual periods beginning after June 15, 2004. The adoption of this FSP had no material impact on the Company’s financial position or results of operations.

 

In November 2004, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 151, “Inventory Costs.” The statement amends Accounting Research Bulletin (“ARB”) No. 43, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. ARB No. 43 previously stated that these costs must be “so abnormal as to require treatment as current-period charges.” SFAS No. 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this statement requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted for fiscal years beginning after the issue date of the statement. The adoption of SFAS No. 151 is not expected to have a material impact on the Company’s current financial condition or results of operations.

 

In December 2004, the FASB revised its SFAS No. 123 (“SFAS No. 123R”), “Accounting for Stock Based Compensation.” The revision establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, particularly transactions in which an entity obtains employee services in share-based payment transactions. The revised statement requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is to be recognized over the period during which the employee is required to provide service in exchange for the award. Changes in fair value during the requisite service period are to be recognized as compensation cost over that period. In addition, the revised statement amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits be reported as a financing cash flow rather than as a reduction of taxes paid. The provisions of the revised statement are effective for financial statements of the Companies issued for the first annual reporting period beginning after December 15, 2005, with early adoption encouraged. The Company is evaluating the impact that this statement will have on its financial condition and results of operations.

 

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets – An Amendment of APB Opinion No. 29.” APB Opinion No. 29, “Accounting For Nonmonetary Transactions,” is based on the opinion that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. SFAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets whose results are not expected to significantly change the future cash flows of the entity. The statement is effective for nonmonetary asset exchanges beginning December 4, 2005 and is not expected to have any impact on the Company’s current financial condition or results of operations.

 

In December 2004, the FASB issued two FSPs that provide accounting guidance on how companies should account for the effects of the American Jobs Creation Act of 2004 that was signed into law on October 22, 2004. FSP 109-1, Application of FASB Statement No. 109, “Accounting for Income Taxes”, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004”, states that the manufacturers’ deduction provided for under this legislation should be accounted for as a special deduction instead of a tax rate change. FSP FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004”, allows a company additional time to evaluate the effects of the legislation on any plan for reinvestment or repatriation of foreign earnings for purposes of applying Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”. The Company does not anticipate a material impact from these FSPs on its financial condition or results of operations.

 

3. Business Acquisitions and Divestitures

 

Pending Acquisition

 

On October 6, 2004, the Company entered into a share purchase agreement with RÜTGERS AG and RÜTGERS Bakelite Projekt GmbH (collectively, the “Sellers”). Pursuant to the terms of the share purchase agreement, the Company agreed to purchase from the Sellers all outstanding shares of capital stock of Bakelite Aktiengesellschaft (“Bakelite”) for a net purchase price ranging from approximately €175 million to €200 million, subject to certain adjustments. Based in Iserlohn-Letmathe, Germany, Bakelite is a leading source of phenolic and epoxy thermosetting resins and molding compounds with 13 manufacturing facilities and 1,700 employees in Europe and Asia.

 

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The share purchase agreement contains customary representations, warranties and covenants, including non-compete, non-solicitation and confidentiality agreements by the Sellers. The Sellers have also agreed, subject to various provisions set forth in the share purchase agreement, to indemnify the Company for breaches of the representations and warranties contained in the share purchase agreement and in connection with various tax, environmental, certain pension and other matters. Until the closing date, the Sellers have agreed to operate the business of Bakelite in the ordinary course. Completion of the share purchase is subject to regulatory and other customary closing conditions including European Commission merger clearance. The Company and Bakelite will continue to operate independently until those conditions are satisfied and the closing occurs. The Company intends to finance this transaction through a combination of available cash and debt financing. There is no material relationship between the Company or its affiliates and any of the Sellers other than in respect of the share purchase agreement.

 

Acquisitions

 

The Company accounts for acquisitions using the purchase method of accounting. Accordingly, results of operations of the acquired entities have been included from the date of acquisition, and any excess of purchase price over the sum of amounts assigned to identified assets and liabilities has been recorded as goodwill. The proforma effects of the acquisitions are not material.

 

During 2003, the Company acquired Fentak Pty. Ltd. (“Fentak”), an international manufacturer of specialty chemical products for engineered wood, laminating and paper impregnation markets, and the business and technology assets of Southeastern Adhesives Company (“SEACO”), a domestic producer of specialty adhesives, for total cash of $14,691. Fentak was acquired in November 2003 and SEACO was acquired on December 31, 2003. As of December 31, 2004, the Company is required to make additional deferred payments for these acquisitions of $3,009 and contingent future payments of $1,500.

 

At the time of the Fentak and SEACO acquisitions in 2003, the Company recorded goodwill totaling $18,455. In 2004, purchase accounting adjustments in the amount of $7,314 were made to allocate amounts originally recorded as goodwill to other intangible assets. Separately identifiable intangible assets included customer lists, proprietary technology and trade names.

 

Divestitures

 

In 2001, the Company merged its North American foundry resins and coatings businesses with similar businesses of Delta-HA, Inc. (“Delta”) to form HA-International, LLC (“HAI”), in which the Company had a 75% interest at that time. The Limited Liability Agreement of HAI provides Delta the right to purchase between 3-5% of additional interest in HAI each year, beginning in 2004. Delta is limited to acquiring a maximum of 25% of additional interest in HAI under this arrangement. Pursuant to this provision, in the first quarter of 2004, Delta provided the Company with written notice of its intention to exercise its option to purchase an additional 5% interest in 2004, and the purchase was completed in the third quarter of 2004. Delta’s purchase price of the interest is based on the enterprise value of HAI determined by applying a contractually agreed upon multiple to EBITDA, as defined in the agreement. The Company received cash proceeds of $2,124, as determined by the agreement, and recorded a gain of $1,010 related to the sale, which is included in Other operating expense in the 2004 Consolidated Statement of Operations. In the first quarter of 2005, Delta provided the Company with written notice of its intention to purchase an additional 5% interest in 2005.

 

In 2003, the Company sold its idled melamine crystal business (“Melamine”). The gain from the sale was recorded as business realignment income. See Note 4.

 

4. Business Realignment and Asset Impairments

 

In June 2003, the Company initiated a realignment program (the “2003 realignment program”) designed to reduce operating expenses and increase organizational efficiency. The components of this program include reducing headcount, streamlining processes, consolidating manufacturing facilities and reducing general and administrative expenses. We expect to complete this program in 2005 and will incur additional expenses through its completion. In addition, we have certain additional long-term realignment programs initiated prior to 2003 (the “prior years’ programs”), which primarily relate to the consolidation of plant facilities.

 

Year ended December 31, 2004

 

During 2004, the Company recorded Business realignment expense and impairments of $4,427. This amount includes plant closure costs (which include plant employee severance and plant asset impairments) of $3,468, offset by gains of $1,442 from the sale of three former U.S. plant sites. The expense also includes other severance and employee costs of $377 and asset impairment charges of $2,024.

 

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Plant Closure Costs

 

Plant closure costs in 2004 of $3,468 primarily represent additional costs pertaining to the conversion of the French manufacturing facility into a distribution center and the transition of related production to the U.K. ($1,296), environmental remediation for previously closed sites in Brazil ($1,399) and Europe ($812), offset by income related to other plant closure adjustments at various sites ($39).

 

Other Severance Costs

 

Business realignment expense includes additional net severance costs incurred during 2004 totaling $377 related to the 2003 realignment program.

 

Gain on the Sale of Assets

 

During 2004, the Company sold two U.S. plants closed under a prior year realignment program for a gain of $1,214 and a U.S. plant closed under the 2003 realignment program for a gain of $228. These gains are recorded in Business realignment expense.

 

Asset Impairment

 

The asset impairment charges of $2,024 primarily relate to production assets that were written-down due to changes in the Company’s manufacturing footprint. The impairment charges represent the excess of the carrying value of the assets over the expected proceeds from their sale.

 

Provided below is a roll forward of the business realignment reserves for 2004.

 

     December 31,
2003


   2004
Expenses


   2004
Charges


    December 31,
2004


Plant closure costs

                            

2003 realignment program

   $ 3,488    $ 2,241    $ (5,491 )   $ 238

Prior years’ programs

     4,741      1,227      (2,312 )     3,656

Other severance costs

                            

2003 realignment program

     2,784      377      (2,515 )     646

Prior years’ programs

     1,151      —        (1,151 )     —  
    

  

  


 

     $ 12,164    $ 3,845    $ (11,469 )   $ 4,540

 

Year Ended December 31, 2003

 

During 2003, the Company recorded net business realignment expense and impairments of $4,748, consisting of plant closure costs (which include plant employee severance and plant asset impairments) and other severance and employee costs of $13,825, gains on the sale of assets of $12,260 and other non-cash asset impairment charges of $3,183.

 

Plant Closure Costs

 

Plant closure costs in 2003 include $144 for prior years’ programs and $6,844 for the 2003 realignment program.

 

Costs relating to prior years’ programs include environmental remediation of approximately $800 for closed plants in Brazil and other plant closure costs of approximately $900. Partially offsetting these costs was a reduction of reserves of approximately $1,600 for Melamine, which was sold in the second quarter of 2003.

 

The $6,844 of charges relating to the 2003 realignment program included costs associated with two plant consolidation programs. As a result of consolidating manufacturing processes, the Company’s facility in France has been converted into a distribution center, and the manufacturing has transitioned to the U.K., resulting in plant closure costs of $5,414, including plant employee severance of approximately $3,600, asset impairment charges of $1,427 and other costs of approximately $400. Additionally, manufacturing was transitioned from the Company’s North Bay, Ontario plant to another facility. The North Bay site was idled as of the end of 2003, resulting in asset impairment charges of $1,430. The impairment charges represent the excess of the carrying value of the assets over the undiscounted cash flows expected to result from the eventual conversion of the France site and disposition of the North Bay site.

 

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Other Severance Costs

 

Other severance costs for 2003 include $3,167 relating to the 2003 realignment program and $3,670 relating to prior years’ programs. The 2003 severance is related to the elimination of 200 positions under the 2003 realignment program, as discussed above.

 

Gain on the Sale of Assets

 

In 2003, the Company sold Melamine and land associated with a closed plant in the U.K. for gains of $12,260. The gains related to these sales were recorded as business realignment income because the facilities were closed in conjunction with prior years’ programs.

 

Asset Impairment

 

The Company recorded other asset impairment charges of $3,183 in 2003. Of the total, $1,421 was for the write-down of assets at various international manufacturing facilities and $1,000 was for a facility held for sale. The impairment charges represent the excess of the carrying value of the assets over the expected proceeds from their sale. The remaining $762 related to the write-down of goodwill carried by the Company’s Malaysian operations. See Note 7.

 

Provided below is a rollforward of the business realignment reserves for 2003:

 

     Reserves
12/31/02


  

2003

Expense


  

2003
Settlements/

Payments


   

Reserves

12/31/03


Plant closure costs

                            

2003 realignment program

   $ —      $ 6,844    $ (3,356 )   $ 3,488

Prior years’ programs

     9,568      144      (4,971 )     4,741

Other severance costs

                            

2003 realignment program

     —        3,167      (383 )     2,784

Prior years’ programs

     3,996      3,670      (6,515 )     1,151
    

  

  


 

Total reserve activity

   $ 13,564    $ 13,825    $ (15,225 )   $ 12,164
    

  

  


 

 

Year Ended December 31, 2002

 

During 2002, the Company recorded net business realignment expense and impairments of $19,699, consisting of plant closure costs of $12,584, other severance and employee costs of $3,265, a gain on the sale of assets of $2,465 and non-cash impairment charges of $6,315.

 

Plant Closure and Other Severance Costs

 

Plant closure costs in 2002 of $12,584 consist of plant employee severance of $2,721, demolition, environmental and other costs of $8,764 and a $1,099 increase to the reserve related to revised estimates of environmental clean-up and demolition for several locations closed in previous years.

 

Gain on the Sale of Assets

 

In 2002, the Company sold land associated with a closed plant in Spain and recorded a gain of $2,465. The gain related to this sale was recorded as business realignment income because the facility was closed in conjunction with prior years’ realignment programs.

 

Asset Impairment

 

The Company recorded asset impairment charges of $6,315 in 2002. Of the total, $5,275 related to the write-down of fixed assets at various international manufacturing facilities and $1,040 was for a facility held for sale. The impairment charges represent the excess of the carrying value of the assets over the expected proceeds from their sale.

 

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Provided below is a roll forward of the business realignment reserve activity for 2002:

 

    

Reserves

12/31/01


   2002
Expense


  

2002
Settlements/

Payments


   

Reserves

12/31/02


Plant closure costs

   $ 14,067    $ 12,584    $ (17,083 )   $ 9,568

Other severance costs

     8,360      3,265      (7,629 )     3,996
    

  

  


 

Total reserve activity

   $ 22,427    $ 15,849    $ (24,712 )   $ 13,564
    

  

  


 

 

5. Investments

 

In 2004, the Company formed two separate joint venture companies to produce formaldehyde, resins and UV-curable coatings and adhesives in China. The Company has a 50% ownership interest in each of the joint ventures. The joint ventures are accounted for using the equity method of accounting for investments.

 

Asia Dekor Borden (Heyuan) Chemical Company Limited (“Asia Dekor Borden”) was formed as an alliance between a subsidiary of the Company and a subsidiary of Asia Dekor Holdings Limited. Each party contributed $700 to the joint venture, and each party holds two of the four seats on the Board of Directors. In August 2004, Asia Dekor Borden opened a new formaldehyde and resin plant in Heyuan, China with the capacity to deliver 60,000 metric tons of advanced resins used in the production of high and medium density fiberboard and particleboard.

 

The second joint venture, Borden UV Coatings (Shanghai) Company, Limited (“Borden Shanghai”), is a collaborative effort between a subsidiary of the Company and UVITech, a Chinese producer of UV-curable coatings. Borden Shanghai manufactures UV-curable coatings and adhesives for fiber optics, digital media and other applications. Each party contributed $250 and their respective business in the Chinese market to the newly formed entity. The joint venture has a Board of Directors with five seats, of which the Company holds three; however, a super majority (four of five board members) is needed for adoption of the annual business plan and other key decisions. The Company has the option to purchase an additional 25% interest in the joint venture from UVITech anytime between 2009 and 2019 at a share price to be calculated on the basis of a multiple of earnings less debt.

 

The Company had no investments at December 31, 2003.

 

6. Related Party Transactions

 

Financing and Investing Arrangements

 

The Company had a borrowing arrangement with BWHLLC, evidenced by a demand promissory note bearing interest at a variable rate, which was terminated upon completion of the Apollo Transaction. Interest expense totaled $138 for the year ended December 31, 2004.

 

In 2003, the Company and HAI had separate borrowing arrangements with Borden Foods Holdings Corporation (“Foods”), a former affiliate, evidenced by demand promissory notes bearing interest at variable rates. The loans were reported as Loans payable to affiliates on the Consolidated Balance Sheet and totaled $18,260 at December 31, 2003. Of the total loans outstanding, the Company owed $12,260 and HAI owed $6,000 at December 31, 2003. Interest rates on these loans ranged from 1.0% to 4.75%. In early 2004, the Company entered into the arrangement with BWHLLC and canceled its arrangement with Foods. In early 2004, HAI obtained a $20,000 credit facility with an external bank and terminated its affiliated borrowing arrangement with Foods. Interest expense, related to the Foods loans, totaled $558 and $1,857 for the years ended December 31, 2003 and 2002, respectively.

 

The Company holds a $404,817 note receivable ($560,672 including accrued interest at December 31, 2004) from its parent, which is accounted for as a reduction of equity. The Company accrues interest quarterly on the note receivable in Paid-in capital. Historically, the interest due on the note was funded through common dividends received from the Company. However, quarterly interest has not been paid, nor an associated dividend declared, since October 15, 2001. See Note 15.

 

The Company had a note payable to BCP Management, Inc. (“BCPM”), a former subsidiary, for $34,181 that was settled in the first quarter of 2002. The Company accrued $151 of interest expense for the years ended December 31, 2002, related to this note. The Company settled in full this note payable by making cash payments of $31,581 and $2,600 of certain set-offs asserted by the Company against amounts due under this note.

 

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At December 31, 2001, the Company had a $110,000 preferred stock investment in Consumer Adhesives, a former affiliate. The preferred stock was redeemed in 2002 for a $110,000 note receivable from Consumer Adhesives which was subsequently sold to BHI for cash proceeds of $110,000 plus accrued interest of $455. In 2003, the Company recognized an income tax charge of $5,925 related to the sale of the note receivable to BHI. Consistent with the gain on the Consumer Adhesives Sale, this income tax charge was recorded in Paid-in capital due to the affiliated nature of the transaction.

 

Administrative Service, Management and Consulting Arrangements

 

In connection with the Apollo Transaction, the Company entered into a transaction fee agreement with Apollo and its affiliates for the provision of certain structuring and advisory services. The agreement allows Apollo and its affiliates to provide certain advisory services to the Company for a seven-year period, with an automatic extension of the term for a one-year period beginning on the fourth anniversary of the commencement of the agreement and at the end of each year thereafter, unless notice to the contrary is given by either party. The agreement, as later supplemented, provides for an annual fee of $2,500 for each annual period after January 1, 2005. Upon closing the Apollo Transaction, the Company paid $10,000 of aggregate transaction and advisory fees, under this agreement, and reimbursed expenses of $750. In the fourth quarter of 2004, the Company paid $975 of additional fees pursuant to the agreement. Under the agreement, the Company has also agreed to indemnify Apollo and its affiliates and their directors, officers and representatives for potential losses relating to the services contemplated under this agreement.

 

Prior to the Apollo Transaction, KKR provided certain management, consulting and board services to the Company for an annual fixed fee. In 2003 and through April 2004, the fixed fee was $3,000 annually. Beginning in May 2004, the fee was reduced to $1,000 annually. For the year ended December 31, 2004, the Company recorded expense of $1,284 for amounts due to KKR under this arrangement. For the year ended December 31, 2003, the management fee, recorded in Other operating expense, was $3,000.

 

During 2002, Borden Capital, Inc., a former affiliate, provided management, consulting and board services to the Company, and the Company provided certain administrative services to Capital. Capital charged the Company an annual fee of $9,000, payable quarterly in arrears, which represented the net amount of Capital’s services less the Company’s fee for providing administrative services to Capital. During 2002, BHI made a decision to cease the operations of Capital by the end of the first quarter of 2003. This decision resulted in the immediate recognition by Capital of incremental expenses and liabilities related primarily to severance and rent obligations. These incremental expenses were the legal obligation of Capital and have been funded by Capital. The Company’s share of Capital’s incremental costs was $5,500 and was recognized by the Company as an additional management fee in 2002. Since the Company was not responsible for settling these liabilities, the offset to the charge was recorded as a capital contribution of $3,550 (the liability net of tax) to the Company from BHI.

 

Prior to the Apollo Transaction, the Company provided certain administrative services to BWHLLC and other affiliates under a service agreement. Fees charged under this agreement were based on the projected cost to the Company to provide these services, primarily based on employee costs. For the years ended December 31, 2004 and 2003, the Company charged these affiliates $294 and $540 for these services, respectively.

 

Other Transactions and Arrangements

 

The Company sells finished goods to certain Apollo affiliates. These sales totaled $3,413 from the date of the Apollo Transaction through December 31, 2004. Accounts receivable from these affiliates totaled $2,345 at December 31, 2004.

 

In addition, upon closing the Apollo Transaction, the Company paid transaction-related costs of $8,721 on behalf of BHI Investment LLC, $21,851 on behalf of BWHLLC and shared compensation costs of $14,264. Of these amounts, $14,264 is included within Transaction related compensation costs, and the remainder is included within Transaction related costs.

 

Prior to the Apollo transaction, the Company utilized Willis Group Holdings, Ltd. (“Willis”), an entity controlled by KKR, as its insurance broker. Through the date of the Apollo Transaction, the Company had paid $598 to Willis for their services. For the years ended December 31, 2003 and 2002, the Company paid Willis $429 and $241, respectively, for their services.

 

7. Goodwill and Intangible Assets

 

At December 31, 2004, the Company’s management performed the annual goodwill impairment test. As required by SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company identified the appropriate reporting units and identified the assets and liabilities (including goodwill) of the reporting units. The Company determined estimated fair values of the reporting units and assessed whether the estimated fair value of each reporting unit was more or less than the carrying amount of the assets and liabilities assigned to the units.

 

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Valuations were performed using a standard methodology based upon a combination of comparable company analysis and the purchase multiple of the Apollo Transaction. Comparable company analysis ascribes a value to an entity by comparing certain operating metrics of the entity to those of a set of comparable companies in the same industry. Using this method, market multiples and ratios based on operating, financial and stock market performance are compared across different companies and to the entity being valued. The Company employed a comparable analysis technique commonly used in the investment banking and private equity industries to estimate the values of its reporting units - the EBITDA (earnings before interest, taxes, depreciation and amortization) multiple technique. Under this technique, estimated values are the result of an EBITDA multiple derived from this process applied to an appropriate historical EBITDA amount. At December 31, 2004, the fair value of each reporting unit exceeded the carrying amount of assets and liabilities assigned to the units.

 

At December 31, 2003 and 2002, the Company’s management performed the goodwill impairment test using the same methodology described above. As a result of this test at December 31, 2003, the fair value of each reporting unit exceeded the carrying amount of assets and liabilities, except for the Company’s Malaysian reporting unit. Based on the excess of the carrying value over the estimated fair value of its Malaysian reporting unit, the Company recorded a goodwill impairment charge of $762 due to a decline in operating performance that represented 100% of the unit’s recorded goodwill balance. This impairment charge is reflected in the 2003 Consolidated Statement of Operations as Business realignment expense and impairments.

 

At December 31, 2002, no impairment charge was necessary, as the fair values of all reporting units exceeded the carrying amount of the assets and liabilities assigned to the units.

 

Upon the adoption of SFAS No. 142, on January 1, 2002, fair values of the Company’s reporting units as of December 31, 2001 were determined by employing a methodology similar to that described above. As a result of the initial test, the fair value of each reporting unit exceeded the carrying amount of assets and liabilities assigned, except for the Company’s European reporting unit. Based on the excess of the carrying value over the estimated fair value of its European reporting unit, the Company recorded a goodwill impairment charge of $29,825 that represented 100% of the December 31, 2001 carrying amount. This impairment charge is reported as Cumulative effect of change in accounting principle in the 2002 Consolidated Statement of Operations.

 

The changes in the carrying amount of goodwill for the years ended December 31, 2004 and 2003 are as follows:

 

     Forest
Products


    Performance
Resins


    International

    Total

 

Goodwill balance at December 31, 2002

   $ 20,719     $ 18,144     $ 777     $ 39,640  

Acquisitions

     4,068       —         14,387       18,455  

Impairment

     —         —         (762 )     (762 )

Foreign currency translation

     167       —         16       183  
    


 


 


 


Goodwill balance at December 31, 2003

   $ 24,954     $ 18,144     $ 14,418     $ 57,516  

Divestitures

     —         (131 )     —         (131 )

Purchase accounting adjustments

     (1,839 )     —         (5,475 )     (7,314 )

Foreign currency translation

     66       —         545       611  
    


 


 


 


Goodwill balance at December 31, 2004

   $ 23,181     $ 18,013     $ 9,488     $ 50,682  
    


 


 


 


 

The $131 goodwill divestiture in 2004 pertains to the sale of a 5% ownership interest in HAI (see Note 3). The $7,314 of purchase accounting adjustments in 2004 reflects the allocation of the Fentak and SEACO purchase price to separately identifiable intangible assets (see Note 3).

 

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Intangible assets consist of the following:

 

     At December 31, 2004

   At December 31, 2003

     Gross
Carrying
Amount


   Accumulated
Amortization


   Gross
Carrying
Amount


   Accumulated
Amortization


Intangible assets:

                           

Customer list and contracts

   $ 11,950    $ 6,181    $ 7,559    $ 4,619

Formulas and technology

     8,678      5,833      6,524      4,925

Unrecognized prior service cost on pension plan

     919      —        1,348      —  

Other

     1,523      705      744      680
    

  

  

  

     $ 23,070    $ 12,719    $ 16,175    $ 10,224
    

  

  

  

 

The impact of foreign currency translation adjustments is included in accumulated amortization.

 

Total intangible amortization expense for the years ended December 31, 2004, 2003 and 2002 was $2,495, $1,508 and $1,555, respectively.

 

Estimated annual intangible amortization expense for 2005 through 2009 is as follows:

 

2005

   $ 2,490

2006

     1,370

2007

     1,065

2008

     1,004

2009

     803

 

8. Financial Instruments

 

The following table presents the carrying or notional amounts and fair values of the Company’s financial instruments at December 31, 2004 and 2003. The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair values are determined from quoted market prices where available or based on other similar financial instruments.

 

The carrying amounts of cash and equivalents, accounts receivable, accounts payable and other accruals are considered reasonable estimates of their fair values. The carrying value of the loans payable to affiliates approximates fair values, as management believes the loans bear interest at market interest rates.

 

The following table includes the carrying and fair values of the Company’s financial instruments.

 

     2004

    2003

 
     Carrying
Amount


   Fair Value

    Carrying
Amount


   Fair Value

 

Nonderivatives

                              

Liabilities

                              

Debt

   $ 967,404    $ 964,912     $ 538,133    $ 503,630  
    

  


 

  


     Notional
Amount


   Fair Value
Gain (Loss)


    Notional
Amount


   Fair Value
(Loss) Gain


 

Derivatives relating to:

                              

Foreign currency contracts

   $ 41,577    $ 521     $ 44,300    $ (323 )

Deal contingent forward

     235,025      2,076       —        —    

Interest rate swaps

     —        —         34,000      (483 )

Put options purchased

     36,000      114       12,000      18  

Call options sold

     36,000      (1,547 )     12,000      (181 )

Natural gas futures

     3,483      (275 )     1,359      (20 )

 

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At December 31, 2004, the Company had derivative losses of $1,822 classified as Other current liabilities and derivative gains of $2,711 classified as Other assets. At December 31, 2003, the Company had derivative losses of $1,007 classified as Other current liabilities and derivative gains of $18 classified as Other assets.

 

Foreign Exchange

 

International operations account for a significant portion of the Company’s revenue and operating income. It is the policy of the Company to reduce foreign currency cash flow exposure due to exchange rate fluctuations by hedging anticipated and firmly committed transactions when economically feasible. The Company enters into forward and option contracts to buy and sell foreign currencies to reduce foreign exchange exposure and protect the U.S. dollar value of such transactions to the extent of the amount under contract. These contracts are designed to minimize the impact from foreign currency exchange on operating income and on certain balance sheet exposures.

 

Gains and losses arising from contracts are recognized on a quarterly basis through the Consolidated Statement of Operations (see Note 2). The Company does not hold or issue derivative financial instruments for trading purposes.

 

At December 31, 2004 and 2003, the Company had $41,577 and $44,300, respectively, of notional value of foreign currency exchange forward contracts outstanding. At December 31, 2004, the Company recorded a gain of $521 related to its foreign currency exchange forward contract outstanding. At December 31, 2003, the Company recorded a loss of $323 related to its foreign currency exchange forward contract outstanding.

 

At December 31, 2004, the Company’s forward position of $41,577 was to sell British Pounds for Canadian Dollars at a rate of 2.3255. At December 31, 2003, the Company’s forward position of $44,300 was to sell British Pounds for U.S. Dollars at a rate of 1.7710. The unsecured contracts mature within 31 days and are placed with financial institutions with investment grade credit ratings. The Company is exposed to credit loss in the event of non-performance by the other parties to the contracts. The Company evaluates the credit worthiness of the counterparties’ financial condition and does not expect default by the counterparties.

 

At December 31, 2004 and 2003, the Company had put options totaling $36,000 and $12,000, respectively, to buy U.S. Dollars with Canadian Dollars. The 2004 options have an average maturity of 183 days and a contract rate of 1.3200. The 2003 options had average maturities of 47 days and a contract rate of 1.3600. At December 31, 2004 and 2003, the Company recorded gains of $114 and $18, respectively, related to these options. During 2004, the Company also recorded gains of $69 related to put options that were exercised in 2004.

 

The Company also is a party to call options held by financial institutions totaling $36,000 and $12,000 at December 31, 2004 and 2003, respectively, to sell Canadian Dollars for U.S. Dollars. The 2004 options have an average maturity of 183 days and a contract rate of 1.2300. The 2003 options had average maturities of 47 days and an average contract rate of 1.3068. At December 31, 2004 and 2003, the Company recorded a loss of $1,547 and $181, respectively, related to these options.

 

Deal Contingent Forward

 

On December 14, 2004, the Company entered into a foreign currency forward position of $235,025 to purchase Euros with U.S. Dollars at a rate of $1.3430. The contract is contingent upon the close of the Bakelite share purchase agreement (see Note 3) and has a target settlement date of March 31, 2005 and provides for an extension and adjustments through July 6, 2005. The purpose of the hedge is to mitigate the risk of foreign currency exposure related to the pending transaction. At December 31, 2004, the Company recorded a gain of $2,076 related to its deal contingent forward contract. This amount is included as Other non-operating income in the 2004 Consolidated Statement of Operations.

 

Option and Commodity Future Contracts

 

The Company is exposed to price fluctuations associated with raw materials purchases, most significantly with methanol, phenol and urea. For these commodity raw materials, the Company has purchase contracts, with periodic price adjustment provisions. The Company also adds to customer contracts selling price provisions that are indexed to publicly available indices for these commodity raw materials. The Board of Directors approves all commodity futures and commodity commitments.

 

Natural Gas Futures –The Company hedges a portion of natural gas purchases for North America. In March 2003, the Company entered into futures contracts with varying settlement dates through June 2004, and in 2004, the Company entered into additional contracts with varying settlement dates through December 2005. The Company used futures contracts to hedge 46% and 69%, respectively, of its 2004 and 2003 North American natural gas usage. The contracts are settled for cash each month based on the closing market price on the last day the contract trades on the New York Mercantile Exchange. Commitments settled under these contracts totaled $3,125 and $4,866 in 2004 and 2003, respectively. The Company recorded gains relating to these commitments of $248 in 2004 and losses of $224 in 2003. At December 31, 2004 and 2003, the Company had future commitments under these contracts of $3,483 and $1,359, respectively.

 

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The Company entered into similar futures contracts to hedge portions of its natural gas purchases in June 2001 with varying settlement dates through November 2002. Commitments settled under these contracts totaled $1,210 in 2002, and related losses were $264 in 2002. There were no remaining obligations under these contracts at December 31, 2002.

 

Gains and losses on commodity futures contracts are recognized each month as gas is used. Remaining obligations are marked to market on a quarterly basis. The Company recorded losses of $275 and $20 at December 31, 2004 and 2003, respectively, related to future commitments under its natural gas futures contracts.

 

Natural Gas Commitments - In 2000, the Company entered into fixed rate, fixed quantity contracts to secure a portion of anticipated natural gas usage at certain of the Company’s facilities. The contracts were entered into to partially hedge the Company’s risk associated with natural gas price fluctuations in peak usage months through March 2003. Gas purchases under these contracts totaled $402 and $671 in 2003 and 2002, respectively. These contracts covered approximately 75% of 2003 and 86% of 2002 natural gas usage during the periods of the contracts at those facilities. The Company had no natural gas commitments outstanding at December 31, 2004 and 2003. The Company recorded a gain of $16 at December 31, 2002 for the difference between the fair value and carrying value of its remaining natural gas commitments.

 

Interest Rate Swaps

 

The Company periodically uses interest rate swaps to alter interest rate exposures between fixed and floating rates on certain long-term debt. Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts calculated by reference to an agreed notional principal amount.

 

Effective December 1, 2003, the Company entered into a $34,000 interest rate swap agreement structured for the Parish of Ascension IRBs (see Note 9). Under this agreement, the Company received a fixed rate of 10.0% and paid a variable rate equal to the 6-month LIBOR plus 630 basis points. The Company cancelled this swap in the third quarter of 2004 for a fee of $610. The Company realized a gain in 2002 of $1,722 related to a swap that matured on December 1, 2002.

 

The net impact of interest rate swaps was a decrease in the Company’s interest expense of $456 and $62 in 2004 and 2003, respectively, and an increase in interest expense of $2,566 in 2002. The 2003 year-end fair value loss on the $34,000 interest rate swap was $483.

 

The following table summarizes the weighted average interest rates for the swaps used by the Company. The Company had no swaps outstanding at December 31, 2004.

 

     2004

    2003

    2002

 

Average rate paid

   7.9 %   7.6 %   13.7 %

Average rate received

   10.0 %   10.0 %   1.9 %

 

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9. Debt and Lease Obligations

 

Debt outstanding at December 31, 2004 and 2003 is as follows:

 

     December 31, 2004

   December 31, 2003

     Long-Term

   Due Within
One Year


   Long-Term

   Due Within
One Year


9.2% debentures due 2021

   $ 114,800      —      $ 114,800      —  

7.875% debentures 2023

     246,782      —        246,782      —  

Sinking fund debentures:

                           

8.375% due 2016

     78,000      —        78,000      —  

9.25% due 2019

     —        —        47,295      —  

9% second-priority senior secured notes due 2014

     325,000      —        —        —  

Floating rate second-priority senior secured notes due 2010 (at an average rate of 6.6% in 2004)

     150,000      —        —        —  

Industrial Revenue Bonds (at an average rate of 10.0% in 2004 and 3.1% in 2003)

     34,000      —        34,000      —  

Other (at an average rate of 9.3% in 2004 and 8.1% in 2003)

     7,234    $ 2,383      9,089    $ 2,221
           

         

Total current maturities of long-term debt

            2,383             2,221

Short-term debt (primarily foreign bank loans at an average rate of 8.4% in 2004 and 4.8% in 2003)

     —        9,205      —        5,946
    

  

  

  

Total debt

   $ 955,816    $ 11,588    $ 529,966    $ 8,167
    

  

  

  

 

The Company entered into a three-year asset based revolving credit facility in the third quarter of 2002 (the “Credit Facility”), which provides for a maximum borrowing of $175,000, including letters of credit (“LOC”). The Company amended this Credit Facility (the “Amended Credit Facility”) on August 12, 2004 as part of the Apollo Transaction. The Amended Credit Facility is a five-year asset based revolving credit facility with the same borrowing capacity as the Credit Facility. The Amended Credit Facility is secured with inventory and accounts receivable in the U.S., Canada and the U.K., a portion of property and equipment in Canada and the U.K. and the stock of certain subsidiaries. At December 31, 2004, the net book value of the collateral securing the Amended Credit Facility, excluding the stock of subsidiaries, was approximately $266,000. Maximum borrowing allowable under the Amended Credit Facility is calculated monthly (quarterly, if availability is greater than $100,000) and is based upon specific percentages of eligible accounts receivable, inventory and fixed assets. The Amended Credit Facility contains restrictions on dividends, capital expenditures ($37,500 from August 12, 2004 to December 31, 2004; $75,000 in 2005) and payment of management fees ($3,000 per year or 2% of Segment EBITDA). It also includes a minimum trailing twelve-month fixed charge coverage ratio of 1.1 to 1.0 if aggregate availability is less than $50,000. The trailing twelve-month fixed charge coverage ratio requirement does not apply when aggregate availability exceeds $50,000. At December 31, 2004, the maximum borrowing allowable under the Amended Credit Facility was approximately $174,700, of which approximately $127,800, after outstanding LOCs and other draws, was unused and available. As a result, the Company has no fixed charge coverage ratio requirements at the end of 2004.

 

Under the terms of the Amended Credit Facility, the Company has the ability to borrow funds at either the prime rate plus an applicable margin (“the prime rate option”) or at LIBOR plus an applicable margin. The Company must designate which option it chooses at the time of the borrowing. Currently, the applicable margin for any prime rate borrowing is 50 basis points and for any LIBOR borrowing is 200 basis points. For LOCs issued under the Amended Credit Facility, the Company pays a per annum fee equal to the LIBOR applicable margin, or 2.00%, plus a fronting fee of .125%. In addition, the Company pays a .375% per annum fee on the amount of the revolving loan commitment less any borrowings or outstanding LOCs. The Company incurred commitment fees of $650, $557 and $363 in 2004, 2003 and 2002, respectively, related to the Amended Credit Facility.

 

As discussed in Note 1, in conjunction with the Apollo Transaction, the Company formed two wholly owned finance subsidiaries that borrowed a total of $475 million through a private debt offering. Of the debt, $325 million is second-priority senior secured notes due 2014 (“the Fixed Rate Notes”), which bear an interest rate of 9%. The remaining $150 million of debt is second-priority senior secured floating rate notes due 2010 (“the Floating Rate Notes”).

 

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Interest on the Floating Rate Notes will be paid each January 15, April 15, July 15 and October 15. Interest on the Floating Rate Notes accrues at an annual rate, reset quarterly, equal to LIBOR plus 475 basis points. At December 31, 2004, the interest rate on the Floating Rate Notes was 6.82%. The notes mature July 15, 2010. These notes may be redeemed at any time on or after July 15, 2006 at the applicable redemption price set forth in the indenture for the notes. In addition, up to 35% of these notes may be redeemed prior to July 15, 2006 with cash proceeds from certain equity offerings at the applicable redemption price set forth in the indenture for the notes. Prior to July 15, 2009, the Floating Rate Notes may be redeemed at a price equal to 100% of the principal amount plus accrued interest plus the “make-whole” premium as defined in the indenture for the notes. The Floating Rate Notes may also be redeemed upon certain changes in tax laws or upon a change in control. There is no sinking fund for the Floating Rate Notes.

 

Interest on the Fixed Rate Notes will be paid each January 15 and July 15. The notes mature July 15, 2014. These notes may be redeemed at any time on or after July 15, 2009 at the applicable redemption price set forth in the indenture for the notes. In addition, up to 35% of these notes may be redeemed prior to July 15, 2007 with cash proceeds from certain equity offerings at the applicable redemption price set forth in the indenture for the notes. Prior to July 15, 2009, the Fixed Rate Notes may be redeemed at a price equal to 100% of the principal amount plus accrued interest plus the “make-whole” premium as defined in the indenture for the notes. The Fixed Rate Notes may also be redeemed upon certain changes in tax laws or upon a change in control. There is no sinking fund for the Fixed Rate Notes.

 

The Company’s Australian subsidiary entered into a five-year secured credit facility in the fourth quarter of 2003 (the “Australian Facility”), which provides for a maximum borrowing of AUD$19,900, or approximately $15,500. At December 31, 2004, outstanding debt under this facility was $11,295, of which $6,557 is classified as long-term. In addition, there was approximately $3,334 of short term debt under the facility. The Australian Facility provided the funding for the Fentak acquisition made in the fourth quarter of 2003 (see Note 3) and is secured by liens against substantially all of the assets of the Australian business including the stock of Australian subsidiaries. At December 31, 2004, the net book value of the collateral securing the Australian Facility was approximately $29,700. In addition, the Company pledged the stock of its Australian subsidiary as collateral for borrowing under the Australian Facility. This facility includes a fixed rate facility used for the acquisition, as well as a revolver. At December 31, 2004, $7,961 was outstanding under the fixed rate facility at an interest rate of 6.4%. The Australian Facility contains restrictions relative to the Australian businesses on dividends, the sale of assets and additional borrowings. The Australian Facility also contains financial covenants applying to the Australian subsidiaries including current ratio, interest coverage, debt service coverage and leverage. The fixed portion of the Australian Facility requires minimum quarterly principal reductions totaling AUD$450 (approximately $350). The Australian Facility requires semi-annual principal reductions based on a portion of excess cash as defined in the agreement. At December 31, 2004, the maximum borrowing allowable under the Australian Facility was AUD$18,100 (approximately $14,100), of which about AUD$3,600 (approximately $2,800), after outstanding LOCs and other draws, was unused and available. The Company incurred commitment fees of $173 in 2004 related to the Australian Facility.

 

Additional international credit facilities provide availability totaling approximately $26,100. Of this amount, approximately $12,200 (net of approximately $3,900 of borrowings, LOCs and other guarantees of approximately $4,600 and $5,400 of other draws) was available to fund working capital needs and capital expenditures at December 31, 2004. These credit facilities have various expiration dates ranging from 2006 through 2008. Of the total $3,935 of outstanding debt, $677 was classified as long-term. While these facilities are primarily unsecured, portions of the lines are secured by equipment. At December 31, 2004, the net book value of collateral securing a portion of these facilities was approximately $750. The Company guarantees up to $6,700 of the debt of one of its Brazilian subsidiaries, included in these facilities.

 

The Company and HAI had affiliated borrowing arrangements with Foods and BWHLLC during 2003 and 2004. See Note 6.

 

HAI entered into a three-year asset based revolving credit facility on January 28, 2004, which provides for a maximum borrowing of $15,000, as amended on October 29, 2004 (the “HAI Facility”). The HAI Facility replaced the affiliated loan agreement with Foods. Maximum borrowing allowable under the HAI Facility is based upon specific percentages of eligible accounts receivable and inventory and is secured with inventory, accounts receivable and property and equipment of HAI. At December 31, 2004, the net book value of collateral securing the HAI Facility was approximately $33,600. The HAI Facility provides up to $2,000 for LOCs. The HAI Facility contains restrictions relative to HAI on dividends, affiliate transactions, minimum availability ($2,000), additional debt and capital expenditures ($2,000 in 2005). In addition, HAI is required to maintain a minimum trailing twelve-month debt coverage ratio of 1.5 to 1.0 and a monthly debt to tangible capital ratio of less than 2.5 to 1.0. At December 31, 2004, borrowing allowable under the HAI Facility was approximately $13,800, of which approximately $11,800 was unused and available, after the minimum availability requirement. Commitment fees of $66 were incurred in 2004 related to the HAI Facility.

 

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Table of Contents

At December 31, 2004, the Company was in compliance with the material covenants and restrictions in all of the Company’s credit facilities.

 

In addition, the Company finances certain insurance premiums. Short-term borrowings under this arrangement include $3,588 and $2,548 at December 31, 2004 and 2003, respectively.

 

On October 1, 2003, the Company exercised its option to redeem, at par, the remaining $885 of County of Maricopa Industrial Revenue Bonds (“IRBs”).

 

In October 2003, the Company converted the $34,000 Parish of Ascension (IRBs) to a fixed interest rate and, by doing so, eliminated the requirement to maintain a backup letter of credit of approximately $34,500. The $34,000 IRBs are related to the acquisition, construction and installation of air and water pollution control facilities that are no longer owned by the Company. The tax-exempt status of the IRBs is based upon there being no change in the use of the facilities, as defined by the Internal Revenue Code. The Company continues to monitor the use of the facilities by the current owner. If a change in use were to occur, the Company could be required to take remedial action, including redeeming all of the bonds.

 

In addition, the Company redeemed its 9.25% debentures on August 12, 2004 for total cash of $49,249. Included in the total cash paid was $47,295 for the principal of the debentures, $1,069 of accrued interest and an early redemption premium of $885. The redemption was funded with cash received from the $475 million private debt offering discussed above.

 

During the fourth quarter of 2002, the Company repurchased $7,368 of the outstanding publicly held bonds for $4,510 plus fees. A $2,741 gain on the extinguishment of the bonds was recognized in 2002 and is included in Other non-operating income.

 

Aggregate maturities of total debt and minimum annual rentals under operating leases at December 31, 2004, for the Company are as follows:

 

Year


   Debt

   Minimum Rentals
Under Operating
Leases


2005

   $ 11,588    $ 11,641

2006

     1,991      8,919

2007

     1,489      6,370

2008

     3,754      4,734

2009

     34,000      2,546

2010 and beyond

     914,582      4,307
    

  

     $ 967,404    $ 38,517
    

  

 

Rental expense amounted to $13,451, $15,362 and $15,152 in 2004, 2003 and 2002, respectively.

 

10. Guarantees, Indemnifications and Warranties

 

Standard Guarantees / Indemnifications

 

In the ordinary course of business, the Company enters into numerous agreements that contain standard guarantees and indemnities whereby the Company indemnifies another party for, among other things, breaches of representations and warranties. Such guarantees or indemnifications are granted under various agreements, including those governing (i) purchases and sales of assets or businesses, (ii) leases of real property, (iii) licenses of intellectual property and (iv) long-term supply agreements. The guarantees or indemnifications issued are for the benefit of the (i) buyers in sale agreements and sellers in purchase agreements, (ii) landlords or lessors in lease contracts, (iii) licensors or licensees in license agreements and (iv) vendors or customers in long-term supply agreements.

 

These parties may also be indemnified against any third party claim resulting from the transaction that is contemplated in the underlying agreement. Additionally, in connection with the sale of assets and the divestiture of businesses, the Company may agree to indemnify the buyer with respect to liabilities related to the pre-closing operations of the assets or businesses sold. Indemnities related to pre-closing operations generally include tax liabilities, environmental liabilities and employee benefit liabilities not assumed by the buyer in the transaction.

 

Indemnities related to the pre-closing operations of sold assets normally do not represent additional liabilities to the Company, but simply serve to protect the buyer from potential liability associated with the Company’s existing obligations at the time of sale. As with any liability, the Company has accrued for those pre-closing obligations that are considered probable and reasonably estimable. Amounts recorded are not significant at December 31, 2004.

 

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While some of these guarantees extend only for the duration of the underlying agreement, many survive the expiration of the term of the agreement or extend into perpetuity (unless subject to a legal statute of limitations). There are no specific limitations on the maximum potential amount of future payments that the Company could be required to make under its guarantees nor is the Company able to develop an estimate of the maximum potential amount of future payments to be made under these guarantees as the triggering events are not predictable. With respect to certain of the aforementioned guarantees, the Company maintains limited insurance coverage that mitigates potential payments to be made. The Company had limited reimbursement agreements from affiliates that were terminated as a result of the Apollo Transaction, and as a result, the Company accrued $620 for environmental obligations previously covered by an affiliate reimbursement agreement.

 

In connection with the Apollo Transaction, the Company entered into a transaction fee agreement with Apollo and its affiliates for the provision of certain structuring and advisory services. The Company has agreed to indemnify Apollo and its affiliates and their directors, officers and representatives for potential losses relating to the services contemplated under this agreement.

 

In addition, the Company had previously agreed to indemnify KKR for any claims resulting from its services to the Company and its affiliates. The indemnification was terminated as a result of the Apollo Transaction.

 

The Company has not entered into any significant agreement subsequent to January 1, 2003 that would require it, as a guarantor, to recognize a liability for the fair value of obligations it has undertaken in issuing the guarantee.

 

Subsidiary Guarantees

 

The Company and certain of its subsidiaries guarantee the debt of its two finance subsidiaries totaling $475 million. See Note 19.

 

The Company guarantees the bank debt of one of its Brazilian subsidiaries up to a maximum U.S. equivalent of $6,700.

 

In connection with the conversion in 2003 of the $34,000 Parish of Ascension IRBs to a fixed rate, the Company’s Canadian and U.K. subsidiaries have guaranteed its IRBs.

 

Warranties

 

The Company does not make express warranties on its products, other than that they comply with the Company’s specifications; therefore, the Company does not record a warranty liability. Adjustments for product quality claims are not material and are charged against sales revenues.

 

11. Commitments and Contingencies

 

Environmental Matters

 

Because the Company’s operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials, the Company is subject to extensive environmental regulation at the Federal and state level and is exposed to the risk of claims for environmental remediation or restoration. In addition, violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

 

Accruals for environmental matters are recorded following the guidelines of Statement of Position 96-1, “Environmental Remediation Liabilities,” when it is probable that a liability has been incurred and the amount of the liability can be estimated. Environmental accruals are reviewed on an interim basis and as events and developments warrant. Based on management’s estimates, which are determined through historical experience and consultation with outside experts, the Company has recorded liabilities, relating to 55 locations, of approximately $38,200 and $38,600 at December 31, 2004 and 2003, respectively, for all probable environmental remediation, indemnification and restoration liabilities. These amounts include estimates of unasserted claims the Company believes are probable of loss and reasonably estimable. Based on the factors discussed below and currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may fall within a range of $25,000 to $77,000, in the aggregate, at December 31, 2004. This estimate of the range of reasonably possible costs is less certain than the estimates upon which the liabilities are based, and in order to establish the upper end of such range, assumptions less favorable to the Company among the range of reasonably possible outcomes were used. As with any estimate, if facts or circumstances change, the final outcome could differ

 

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materially from these estimates. The Company has not taken into consideration insurance coverage or any anticipated recoveries from other third parties in determining the liability or range of possible outcomes. The Company’s current insurance coverage provides very limited, if any, coverage for environmental matters.

 

Following is a more detailed discussion of the Company’s environmental liabilities and related assumptions:

 

BCP Geismar Site – The Company formerly owned a basic chemicals and polyvinyl chloride business which was taken public as Borden Chemicals and Plastics Operating Limited Partnership (“BCPOLP”) in 1987. The Company retained a 1% interest and the general partner interest, which were held by its subsidiary, BCPM. The Company also retained the liability for certain environmental matters after BCPOLP’s formation. Under a Settlement Agreement approved by the United States Bankruptcy Court for the District of Delaware among the Company, BCPOLP, BCPM, the United States Environmental Protection Agency (“EPA”) and the Louisiana Department of Environmental Quality, the Company agreed to perform certain of BCPOLP’s obligations with respect to environmental conditions at BCPOLP’s Geismar, Louisiana site. These obligations are related to soil and groundwater contamination at the Geismar site. The Company bears the sole responsibility for these obligations, as there are no other potentially responsible parties (“PRPs”) or third parties from which the Company can seek reimbursement, and no additional insurance recoveries are expected.

 

A groundwater pump and treat system for the removal of contaminants is operational, and preliminary natural attenuation studies are proceeding. The Company has performed extensive soil and groundwater testing. Regulatory agencies are reviewing the current findings and remediation efforts. If closure procedures and remediation systems prove inadequate, or if additional contamination is discovered, this could result in the costs approaching the higher end of the range of possible outcomes discussed below.

 

The Company has recorded a liability of approximately $21,100 and $21,600 at December 31, 2004 and 2003, respectively, related to the BCP Geismar site. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with this site may fall within a range of $13,900 to $32,100, depending upon the factors discussed above. Due to the long-term nature of the project, the reliability of timing and the ability to estimate remediation payments, this liability was recorded at its net present value, assuming a 3% discount rate and a time period of thirty years and the range of possible outcomes is discounted similarly. The undiscounted liability is approximately $32,100 over thirty years.

 

Following are expected payments for each of the next five years, and a reconciliation of the expected aggregate payments to the liability reflected at December 31, 2004:

 

2005

   $ 2,600  

2006

     1,600  

2007

     1,600  

2008

     1,500  

2009

     700  

Remaining aggregate payments

     24,100  
    


Total undiscounted liability

     32,100  

Less: discount to net present value

     (11,000 )
    


Liability per Consolidated Balance Sheet

   $ 21,100  
    


 

Superfund Sites / Offsite Landfills - The Company is currently involved in environmental remediation activities at 26 sites in which it has been notified that it is, or may be, a PRP under the United States Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) or similar state “superfund” laws. The Company has recorded liabilities of approximately $7,900 and $7,600 at December 31, 2004 and 2003, respectively, related to these sites. The Company anticipates approximately 60% of this liability will be paid within the next five years, with the remaining payments occurring over the next twenty-five years. The Company generally does not bear a significant level of responsibility for these sites, and therefore, has little control over the costs and timing of cash flows. At 16 of the 26 sites, the Company’s share is less than 1%. At the remaining 10 sites, the Company has a share of up to 8.8% of the total liability which accounts for $6,700 and $6,400 of the total amount reserved for superfund / offsite landfill sites at December 31, 2004 and 2003, respectively. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with all superfund sites may be as low as $5,200 or as high as $17,300, in the aggregate. In estimating both its current reserves for environmental remediation at these sites and the possible range of additional costs, the Company has not assumed that it will bear the

 

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entire cost of remediation of every site to the exclusion of other known PRPs who may be jointly and severally liable. The Company has limited information to assess the viability of other PRPs and their probable contribution on a per site basis. The range of possible outcomes also takes into account the maturity of each project, which results in a more narrow range as the project progresses. The Company’s ultimate liability will depend on many factors including its volumetric share of waste, the financial viability of other PRPs, the remediation methods and technology used, the amount of time necessary to accomplish remediation, and the availability of insurance coverage. The Company’s insurance provides very limited, if any, coverage for these environmental matters.

 

Sites Under Current Ownership - The Company is conducting environmental remediation at 7 locations currently owned by the Company, of which 4 sites are no longer operating. There are no other parties responsible for remediation at these sites. Much of the remediation is being performed by the Company on a voluntary basis; therefore, the Company has greater control over the costs to be incurred and the timing of cash flows. The Company has accrued approximately $5,400 and $5,200 at December 31, 2004 and 2003, respectively, for remediation and restoration liabilities at these locations. The Company anticipates approximately $3,700 of these liabilities will be paid within the next three years, with the remaining amounts being paid over the next ten years. Approximately $3,700 of these reserves is included in the Company’s business realignment reserve, as the environmental clean up is being handled in conjunction with planned closure of the location (see Note 4). Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may fall within a range of $3,200 to $14,100, in the aggregate. The factors influencing the ultimate outcome include the methods of remediation to be elected, the conclusions and assessment of site studies remaining to be completed and the time period required to complete the work.

 

Other Sites - The Company is conducting environmental remediation at 9 locations (10 locations as of December 31, 2003) formerly owned by the Company. The Company has accrued approximately $2,500 and $2,400 at December 31, 2004 and 2003, respectively, for remediation and restoration liabilities at these locations. The Company anticipates cash outflows of approximately $2,000 within the next three years, with the remainder occurring over the next ten years. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may fall within a range of $1,900 to $11,300, in the aggregate. The primary drivers in determining the final costs to the Company on these matters are the method of remediation selected and the level of participation of third parties.

 

In addition, the Company is responsible for 11 sites that require monitoring where no additional remediation is expected and has also established accruals for other related costs, such as fines and penalties. The Company has accrued approximately $1,300 and $1,800 at December 31, 2004 and 2003, respectively, related to these sites. Payment of these liabilities is anticipated to occur over the next ten years. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may fall within a range of $800 and $2,200, in the aggregate. The ultimate cost to the Company will be influenced by any variations in projected monitoring periods or by findings that are better or worse than anticipated findings.

 

The Company formerly operated the Smith Douglass fertilizer business which included a phosphate processing operation in Manatee County, Florida and an animal food processing operation in Hillsborough County, Florida. Both operations were sold in 1980. The EPA has sent the Company and another former owner of the Manatee County facility a request for $112 relating to oversight costs incurred when the site was abandoned by its current owner. The Company is disputing the charge. The Company is aware that state and Federal environmental agencies have taken measures to prevent the off-site release of water from rainfall that accumulated in the drainage ditches and lagoons surrounding the gypsum piles located on this site. The Company is aware that the current owner of the Hillsborough County site ceased operations in March of 2004 and is working with governmental agencies to effect closure of that site. At this time, the Company has received an information request from the EPA, but has not received any demands from any governmental agencies or others regarding the closure and environmental cleanup at this site, which the Company believes is the responsibility of the current owner. While it is reasonably possible some costs could be incurred related to these sites, the Company has inadequate information to enable it to estimate a potential range of liability, if any. As of December 31, 2004, the Company had a reserve of $63 relating to these matters.

 

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Non-Environmental Legal Matters

 

Following is a discussion of non-environmental legal proceedings that are not in the ordinary course of business:

 

Imperial Home Décor Group - In 1998, pursuant to a merger and recapitalization transaction sponsored by The Blackstone Group (“Blackstone”) and financing arranged by The Chase Manhattan Bank (“Chase”), Borden Decorative Products Holdings, Inc. (“BDPH”), a wholly owned subsidiary of the Company, was acquired by Blackstone and subsequently merged with Imperial Wallcoverings to create Imperial Home Décor Group (“IHDG”). Blackstone provided $84,500 in equity, a syndicate of banks funded $198,000 of senior secured financing and $125,000 of senior subordinated notes were privately placed. The Company received approximately $309,000 in cash and 11% of IHDG common stock for its interest in BDPH at the closing of the merger. On January 5, 2000, IHDG filed for reorganization under Chapter 11 of the U. S. Bankruptcy Code. The IHDG Litigation Trust (the “Trust”) was created pursuant to the plan of reorganization in the IHDG bankruptcy to pursue preference and other avoidance claims on behalf of the unsecured creditors of IHDG. In November 2001, the Trust filed a lawsuit against the Company and certain of its affiliates in U.S. Bankruptcy Court in Delaware seeking to have the IHDG recapitalization transaction voided as a fraudulent conveyance and asking for a judgment to be entered against the Company for $314,400 plus interest, costs and attorney fees. An effort to resolve this matter through non-binding mediation was unsuccessful in resolving the case and the parties are preparing for trial.

 

The Company has an accrual of $3,600 for legal defense costs related to this matter. The Company has not recorded a liability for any potential losses because a loss is not considered probable based on current information. The Company believes it has strong defenses to the Trust’s allegations and intends to defend the case vigorously. While it is reasonably possible the resolution of this matter may result in a loss due to the many variables involved, the Company is not able to estimate the range of possible outcomes at this time.

 

Brazil Tax Claim - In 1992, the State of Sao Paulo Administrative Tax Bureau issued an assessment against the Company’s primary Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes, characterized by the Tax Bureau as intercompany sales. Since that time, management and the Tax Bureau have held discussions, and the subsidiary has filed an administrative appeal seeking cancellation of the assessment. The Administrative Court upheld the assessment in December 2001. In 2002, the subsidiary filed a second appeal with the highest-level Administrative Court, again seeking cancellation of the assessment. Argument was made to the court in September 2004 and the Company is awaiting its ruling.

 

At December 31, 2004, the amount of the assessment, including tax, penalties, monetary correction and interest, is 60.8 million Brazilian Reais, or approximately $22,900. The Company believes it has a strong defense against the assessment and will pursue the appeal vigorously, including appealing to the judicial level; however, there is no assurance that the assessment will not be upheld. At this time the Company does not believe a loss is probable; therefore, only related legal fees have been accrued. Reasonably possible losses to the Company resulting from the resolution of this matter range from zero to $22,900.

 

HAI Grand Jury Investigation –HAI received a grand jury subpoena dated November 5, 2003 from the U.S. Department of Justice Antitrust Division relating to a foundry resins Grand Jury investigation. HAI has provided documentation in response to the subpoena. As is frequently the case when such investigations are in progress, various antitrust lawsuits have been brought against the Company alleging that the Company and HAI, along with various other entities, engaged in a price fixing conspiracy. At this time the Company does not believe a loss is probable; therefore, only related legal fees have been accrued. The Company does not have sufficient information to determine a range of possible outcomes for this matter at this time.

 

CTA Acoustics – From the third quarter 2003 to the first quarter 2004, six lawsuits were filed against the Company in the 27th Judicial District, Laurel County Circuit Court, in Kentucky, arising from an explosion at a customer’s plant where seven plant workers were killed and over 40 other workers were injured. The lawsuits primarily seek recovery for wrongful death, emotional and personal injury, loss of consortium, property damage and indemnity. The Company expects that a number of these suits will be consolidated. The litigation also includes claims by its customer against its insurer and the Company. The Company is pursuing a claim for indemnity against its customer, based on language in its contract with the customer, and a claim against a third party that performed services for the Company in connection with sales to the customer. The Company previously accrued $5,000, the amount of its insurance deductible, relating to these actions and has insurance coverage to address any payments and legal fees in excess of this amount.

 

Other Legal Matters - The Company has been served in two lawsuits filed in Hillsborough County, Florida Circuit Court which name the Company and several other parties, relating to an animal feed supplement processing site formerly operated by the Company and sold in 1980. The lawsuits are filed on behalf of multiple residents of Hillsborough County living near the site and allege various injuries related to exposure to toxic chemicals. At this time, the Company has inadequate information from which to estimate a potential range of liability, if any.

 

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The Company is involved in various product liability, commercial and employment litigation, personal injury, property damage and other legal proceedings which are considered to be in the ordinary course of business. There has been increased publicity about asbestos liabilities faced by manufacturing companies. In large part, as a result of the bankruptcies of many asbestos producers, plaintiff’s attorneys are increasing their focus on peripheral defendants, including the Company, and asserting that even products that contained a small amount of asbestos caused injury. Plaintiffs are also focusing on alleged harm caused by other products we have made or used, including those containing silica and vinyl chloride monomer. The Company does not believe that it has a material exposure relating to these claims and believes it has adequate reserves and insurance to cover currently pending and foreseeable future claims.

 

The Company has reserved approximately $19,800 and $24,000 at December 31, 2004 and 2003, respectively, relating to all non-environmental legal matters for legal defense and settlement costs that it believes are probable and estimable at this time. For the years ended December 31, 2004 and 2003, the Company recorded, in General and Administrative expense, legal fees of approximately $17,000 and $17,300, respectively, related to the non-environmental legal matters described above.

 

Other Commitments and Contingencies

 

The Limited Liability Agreement of HAI provides Delta, the Company’s partner in HAI, the right to purchase between 3-5% of additional interest in HAI each year, beginning in 2004. Delta is limited to acquiring a maximum of 25% of additional interest in HAI under this arrangement. Pursuant to this provision, in the first quarter of 2004, Delta provided the Company with written notice of its intention to exercise its option to purchase an additional 5% interest in 2004, and the purchase was completed in the third quarter of 2004 (see Note 3). Delta’s purchase price of the interest is based on the enterprise value of HAI determined by applying a contractually agreed upon multiple to EBITDA, as defined in the agreement. In the first quarter of 2005, Delta provided the Company with written notice of its intention to purchase an additional 5% interest in 2005.

 

The Fentak Pty. Ltd. acquisition agreement includes a contingent purchase consideration provision based on achievement of certain targeted earnings before interest and taxes. No payment was required in 2004. Maximum annual payments are AU$600 for the period 2005-2006.

 

12. Pension and Retirement Savings Plans

 

Most U.S. employees of the Company are covered under a non-contributory defined benefit plan (“the U.S. Plan”). The U.S. Plan provides benefits for salaried and certain hourly employees based on eligible compensation and years of credited service and for hourly employees who are covered under a collective bargaining agreement based on years of credited service. Certain employees in other countries are covered under other contributory and non-contributory defined benefit foreign plans that, in the aggregate, are insignificant and are included in the data presented herein.

 

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Following is a rollforward of the assets and benefit obligations of the Company’s defined benefit plans. The Company uses a September 30 measurement date for its plans.

 

     2004

    2003

 
Change in Benefit Obligation                 

Benefit obligation at beginning of year

   $ 259,079     $ 263,364  

Service cost

     2,949       2,316  

Interest cost

     13,983       15,228  

Actuarial losses

     9,198       12,038  

Foreign currency exchange rate changes

     526       1,165  

Benefits paid

     (31,543 )     (34,403 )

Acquisitions / divestitures

     —         (325 )

Settlements / curtailments

     —         (304 )
    


 


       254,192       259,079  
    


 


Change in Plan Assets                 

Fair value of plan assets at beginning of year

     189,686       190,831  

Actual return on plan assets

     20,537       30,683  

Foreign currency exchange rate changes

     345       805  

Employer contribution

     973       1,770  

Benefits paid

     (31,543 )     (34,403 )
    


 


Fair value of plan assets at end of year

     179,998       189,686  
    


 


Plan assets less than benefit obligation

     (74,194 )     (69,393 )

Unrecognized net actuarial loss

     120,897       122,261  

Unrecognized initial transition loss

     12       21  

Unrecognized prior service cost

     919       1,348  
    


 


Net amount recognized

   $ 47,634     $ 54,237  
    


 


 

Amounts recognized in the balance sheets, after reclassification of the prepaid pension asset to reflect a minimum pension liability adjustment, consist of:

 

     2004

    2003

 

Accrued benefit liability

   $ (71,928 )   $ (67,526 )

Intangible asset

     919       1,348  

Accumulated other comprehensive income

     118,643       120,415