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, 2003 Commission file number:    1-71

BORDEN CHEMICAL, INC.
 
 
 
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


8 3/8% Sinking Fund Debentures
 
New York Stock Exchange
 
 
 
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 X No____

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 19, 2004: $0.

Number of shares of common stock, par value $0.01 per share, outstanding as of the close of business on March 19, 2004: 200,895,628


DOCUMENTS INCORPORATED BY REFERENCE

Document   Incorporated
none    none
The Exhibit Index is Located herein at sequential pages 81 through 84.
 
     

 


BORDEN CHEMICAL, INC.

INDEX




PART I
 
Item 1 – Business    
 3
Item 2 – Properties    
 6
Item 3 – Legal Proceedings    
 6
Item 4 – Submission of Matters to a Vote of Security Holders    
 8
 
 
PART II
 
Item 5 – Market for the Registrant's Common Equity and Related Stockholder Matters    
 8
Item 6 – Selected Financial Data    
 9
Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations
10
Item 7A – Quantitative and Qualitative Disclosures about Market Risk    
27
Item 8 – Financial Statements and Supplementary Data    
28
    Borden Chemical, Inc. Consolidated Financial Statements
 
    Consolidated Statements of Operations, years ended December 31, 2003, 2002 and 2001
        28
    Consolidated Balance Sheets, December 31, 2003 and 2002                                
        30
    Consolidated Statements of Cash Flows, years ended December 31, 2003, 2002 and 2001    
        32
    Consolidated Statements of Shareholders’ Deficit, years ended December 31, 2003, 2002 and 2001     
        34
     Notes to Consolidated Financial Statements    
        36
     Independent Auditors' Report     
        72
Item 9 – Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
        73
Item 9A – Controls and Procedures    
        73
 
 
PART III
 
Item 10 – Directors and Executive Officers of the Registrant    
        73
Item 11 – Executive Compensation    
        76
Item 12 – Security Ownership of Certain Beneficial Owners and Management    
        80
Item 13 – Certain Relationships and Related Transactions    
        81
Item 14 – Principal Accountant Fees and Services
81
 
 
PART IV
 
Item 15 – Exhibits, Financial Statement Schedules and Reports on Form 8-K    
81
Signatures
87

 

     

 
 
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” or the “Company”) was incorporated on April 24, 1899. We are engaged primarily in the manufacturing and distribution of forest product and industrial resins, formaldehyde, oilfield products and other specialty and industrial chemicals worldwide. Our executive and administrative offices are located in Columbus, Ohio. Production facilities are located throughout the United States and in many foreign countries.

Our business consists of three reportable segments: North American Forest Products (“NAFORP”), North American Performance Resins Group (“NAPRG”) and International. See Note 19 to the Consolidated Financial Statements.

Historical Perspective
In 1995, when affiliates of Kohlberg Kravis Roberts & Co. (“KKR”) acquired control of the Company (then known as Borden, Inc.), our business consisted of the following business segments: Chemical, Foods, Other Consumer Products (including Consumer Adhesives), Decorative Products, Dairy and businesses held for sale. We sold all of these business segments by the end of 2001, except for the Chemical segment.

In 2001, we merged the Company with its subsidiaries, Borden Chemical Holdings, Inc. and Borden Chemical, Inc., executed certain financial transactions with our parent company, Borden Holdings, Inc. ("BHI"), and changed our name to Borden Chemical, Inc. (the “Corporate Reorganization”) to reflect the fact that the sole remaining business of the Company was the Chemical segment. The Corporate Reorganization simplified the legal structure, strengthened the capital structure and reduced costs of the Company. As part of the Corporate Reorganization, certain functions were downsized, eliminated or transferred to a separate legal entity, Borden Capital, Inc. (“Capital”), also owned by BHI.

Acquisitions and Divestitures
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”). Consequently, Consumer Adhesives is reported as a discontinued operation in our financial statements in 2001. 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 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 75% interest.

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

In 1999, we acquired Blagden Chemicals, Ltd. (“Blagden”) in the U.K. and Spurlock Industries, Inc. (“Spurlock”) in the U.S. Blagden produces formaldehyde, forest products and industrial resins. Spurlock produces formaldehyde and forest products resins.

Business Realignment and Corporate Reorganization
In addition to the acquisitions and divestitures discussed above, we have undertaken numerous plant consolidations and other business realignment initiatives. These initiatives are designed to improve efficiency and to focus resources on our core strengths. The associated business realignment charges consist primarily of employee severance, plant consolidation and related environmental remediation costs and asset write-offs. Following is a brief overview of our significant business realignment activities since 2001:

In June 2003, we initiated a realignment program designed to reduce operating expenses and increase organizational efficiency. To achieve these goals, we are reducing our workforce, streamlining processes, consolidating manufacturing processes and reducing general and administrative expenses. We anticipate the program will be completed in 2004.

In 2001, we recorded $126,408 of business realignment and impairment charges related primarily to the closures of our melamine crystal business (“Melamine”) and two forest products plants in the U.S., realignment of our North American workforce organization, reorganization of our corporate headquarters and the discontinuation of a plant construction project. The largest component of the 2001 charge is a $98,163 impairment of Melamine fixed assets, goodwill and spare parts that was the result of our strategic decision late in 2001 to sell or close this business and to enter into a long-term contractual arrangement with a supplier for our future melamine crystal needs.

As part of the Corporate Reorganization, in 2001, we also completed a significant capital restructuring, which consisted primarily of a capital contribution by BHI of $614,369 of preferred stock held by BHI. The significant impact of this transaction was to eliminate future required annual preferred dividend payments of $73,724. Also as part of the capital restructuring, BHI made a capital contribution of cash and purchased certain financial assets from us at their estimated fair values. The cash contribution and the cash received from sale of assets allowed us to substantially repay our affiliated debt as of December 31, 2001. See Note 3 to the Consolidated Financial Statements.

Products
The product lines included in our NAFORP operating segment are formaldehyde and forest product resins. The products in our NAPRG 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.

We are the leading global producer of thermosetting resins for the forest products industry and a leading producer of thermosetting resins for industrial and foundry applications in North America. Our resins are used to bind or coat other materials during the manufacturing process. Our resins are provided to a wide variety of customers for use in the manufacture of structural building panels, medium density fiberboard, particle board, laminate veneers, insulation binders, automotive brakes, and to coat cores and molds in the metal casting process.

We are also the world’s largest producer of formaldehyde. Approximately 50% of the formaldehyde produced by us is consumed internally to produce thermosetting resins, with the remainder sold to third parties.

We manufacture and distribute our products worldwide with the most significant markets being North America, Western Europe, Latin America, Australia, and Malaysia, and we generally hold a leading market position in the areas in which we compete.

Marketing and Distribution
Products are sold in the U.S. primarily through our sales force to industrial users. 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.

Competition
Our major competitors are Dynea International OY, Georgia Pacific Corporation, Ashland Specialty Chemical Company and several regional domestic and international competitors. Price, customer service and product performance are the primary focus of competition.

 
     

 
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.
 
     

 
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. 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, including the Bordenâ and Elsieâ trademarks. We license the use of these two 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 2004 and 2013. Other than the Bordenâ and Elsieâ trademarks, no individual patent or trademark is considered to be material.

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 when it is probable that a liability has been incurred, the amount of the liability can be estimated and in accordance with the guidelines of Statement of Position 96-1, “Environmental Remediation Liabilities”. Although environmental policies and practices are designed to ensure compliance with 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 its 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 $5,234 in 2003, $3,641 in 2002 and $1,190 in 2001. We estimate that $5,400 will be spent for capital expenditures in 2004 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 and requirements change.

Research and Development
Our research and development and technical services expenditures were $17,998, $19,879 and $21,210 in 2003, 2002 and 2001, respectively. Development and marketing of new products are carried out by our operating segments and are integrated with quality control for existing product lines.

Employees
At December 31, 2003, 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, 2003, we operated 27 domestic production and manufacturing facilities in 16 states, the most significant being a plant in Louisville, Kentucky. In addition, we operated 21 foreign production and manufacturing facilities primarily in Canada, South America, Europe, Australia and Malaysia.

Our manufacturing and processing facilities are generally well maintained and effectively utilized. Substantially all of our manufacturing facilities are owned. We lease our executive and administrative offices in Columbus, Ohio.

ITEM 3. LEGAL PROCEEDINGS

Environmental Proceedings
We have been notified that the Company is or may be responsible for environmental remediation at 30 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 $23,400 and $27,100 at December 31, 2003 and 2002, respectively, for environmental remediation costs related to these five sites.

For the remaining 25 sites, we have been notified that the Company is or may be a potentially responsible party (“PRP”) in active proceedings in 15 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 $7,600 and $7,000 at December 31, 2003 and 2002, respectively, for environmental remediation costs related to these 25 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 25 sites, our share is less than 1%. At the remaining nine 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 30 sites referenced above, we are conducting voluntary remediation at 25 other locations. We have recorded liabilities of approximately $7,600 and $9,900 at December 31, 2003 and 2002, respectively, for remediation and restoration liabilities at these locations. See Note 22 to the Consolidated Financial Statements.

The Company is one of over 200 defendants in a private toxic tort action pending in U.S. District Court in Baton Rouge, Louisiana, alleging personal injuries and property damage in connection with two Iberville Parish waste disposal sites in Louisiana. No personal injuries have been specified. Settlement negotiations are near completion, and we expect to be dismissed from the case in exchange for a settlement of a de minimus amount. As with any litigation, the ultimate outcome is uncertain until a final settlement is consummated.

Subsidiary Bankruptcy Proceedings
The Company’s former subsidiary, BCP Management, Inc. (“BCPM”) filed for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware on March 22, 2002. BCPM served as the general partner and held a 1% interest in Borden Chemicals and Plastics Operating Limited Partnership, which was created in November 1987 and operated as a commodity chemicals producer. On April 3, 2001, BCPOLP filed for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. On February 5, 2003, the U.S. Bankruptcy Court approved a Joint Plan of Liquidation for BCPOLP and BCPM which provided for the transfer of the remaining assets of both entities, including preference, avoidance and other claims against third parties (including the Company) to separate liquidating entities for liquidation and distribution to their creditors. The transfer of the remaining assets of both entities to the liquidating agents was effective March 13, 2003. Our ownership interest in BCPM was extinguished, and no distributions from BCPM to the Company are anticipated.

On March 19, 2004, BCPM Liquidating LLC (“BCPM Liquidating”), the successor in interest to BCPM, and the Company reached a tentative agreement providing for the settlement of all claims for a payment by the Company of $6,000. The Company has entered into an Agreement with BCPM Liquidating extending the period within which either party may file claims against the other until May 14, 2004, during which period the terms of the settlement agreement will be finalized and submitted to the bankruptcy court for approval.

In addition, on March 19, 2004, the Company and BCP Liquidating LLC (“BCP Liquidating”), the successor in interest to BCPOLP, also reached a tentative agreement providing for the settlement of all claims for a payment by the Company of $1,050. The Company has entered into an Agreement with BCP Liquidating extending the period within which either party may file claims against the other until June 15, 2004, during which period the terms of the settlement agreement will be finalized and submitted to the bankruptcy court for approval.

No assurance can be given that these settlements will be finalized and approved, and absent such approval, these and other claims could be filed against the Company.
 
Imperial Home Décor Group
In 1998, pursuant to a merger and recapitalization transaction sponsored by The Blackstone Group ("Blackstone") and financed by 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, and Chase provided $295,000 in senior financing. We received approximately $314,400 in cash and 11% of IHDG common stock for our interest in BDPH. 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. Discovery is proceeding and is currently scheduled to conclude by November 2004. The parties are discussing alternatives to litigation.

We have accrued legal expenses for scheduled depositions related to this matter. To the extent that additional depositions or legal work is required, legal defense costs will increase. We have not recorded a liability for any potential losses because a loss is not considered probable based on current information. We believe we have strong defenses to the Trust’s allegations, and we intend to defend the case vigorously if a satisfactory alternative to litigation is not achieved.

Brazilian Excise Tax Administrative Appeal
In 1992, the State of Sao Paolo 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 in the amount of R$52,000, or approximately US$18,000, including 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. 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.

HAI Grand Jury Investigation
HAI, a joint venture in which the Company has a 75% 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, is cooperating with the Department of Justice and has heard nothing further.

Other Legal Proceedings
The Company is involved in various product liability, commercial and employment litigation and other legal proceedings throughout the United States which are not discussed in its periodic filings and are considered to be in the ordinary course of business. There has been increased publicity about asbestos liabilities faced by manufacturing companies. As a result of the bankruptcies of many asbestos producers, plaintiffs' attorneys are increasing their focus on peripheral defendants, including the Company. We believe we have adequate reserves and insurance and do not believe we have a material asbestos exposure.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of 2003, no matters were submitted to a vote of our security holders.

Part II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS

Our authorized common stock consists of 300,000,000 shares with a par value of $0.01 per share. As of December 31, 2003, 200,895,628 common shares were issued and outstanding, of which 99.0% are controlled by affiliates of KKR with the remainder held by two members of management. No shares of such common stock trade on any exchange. We declared no dividends on common stock in 2003 or 2002. Our ability to pay dividends on its common stock is restricted by our Credit Facility (see Note 10 to the Consolidated Financial Statements).

The following table contains certain information regarding our Amended and Restated 1996 Stock Purchase and Option Plan for Key Employees, which is administered by the Compensation Committee of our Board of Directors and which provides for the purchase or grant of stock and stock-based awards to employees or other persons having a unique relationship with the Company or its subsidiaries. (See Note 15 to the Consolidated Financial Statements).
 
                                                                                                                Equity Compensation Plan Information

 
 
 
 
 
 
Plan Category
 
 
 
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights
 
 
 
 
 
Weighted-average exercise price of outstanding options, warrants and rights
 
 
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))




 
(a)
(b)
(c)




Equity compensation plans approved by security holders
 
5,532,360
 
$2.42
 
4,017,639




Equity compensation plans not approved by security holders
 
N/A
 
N/A
 
N/A




 
Total
 
5,532,360
 
$2.42
 
4,017,639





 
     

 
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 16 through 18 for items impacting comparability between 2003, 2002 and 2001.

For the years
2003
2002
(1)  2001
(2)  2000
(3)  1999






Summary of Earnings                           
Net sales
Income (loss) from continuing operations
Net income (loss) applicable to common stock
 
$ 1,434,813
22,976
22,976
 
$ 1,247,885
(6,758)
(36,583)
 
$ 1,372,141
(136,604)
(186,646)
 
$ 1,377,845
(72,259)
(39,750)
 
$ 1,274,740
44,547
(20,778)
Basic and diluted income (loss) per common share from continuing operations
Basic and diluted income (loss) per common share
$ 0.11
0.11
$ (0.03)
(0.18)
$ (0.69)
(0.94)
$ (0.36)
(0.20)
$ 0.22
(0.10)
Dividends per share
Common share
Preferred series A
 
$ -
-
 
$ -
-
 
$ 0.18
2.52
 
$ 0.31
3.00
 
$ 0.32
3.00
Average number of common shares outstanding during the year-basic
200,898
200,458
198,997
198,975
198,975
Average number of common shares outstanding during the year-dilutive
200,924
200,458
198,997
198,975
198,975
Financial Statistics
Total assets
Long-term debt
$993,866
529,966
$ 1,011,780
523,287
$ 1,123,278
532,497
$ 1,520,597
530,530
$ 1,737,906
541,074







(1) 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.

(2) In 2000, we acquired a formaldehyde operation from BCPOLP and East Central Wax, a wax emulsions producer.

(3) In 1999, we acquired Blagden Chemical, Ltd. in the U.K. and Spurlock Industries, Inc. in the U.S.

 
     

 
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.

Overview

We are a leading producer of resins, adhesives and binders for the global wood and industrial markets and are the world’s largest producer of formaldehyde. The majority of our businesses are market leaders, with a number one or number two share in North American or global markets.

Our strategic vision is to become the leading supplier of binders, adhesives and coating resins by providing technical solutions to the global wood and industrial markets. We expect to achieve this by leveraging our core businesses through product extensions, geographic expansion, acquisitions or strategic partnerships; developing innovative products; expanding our technology portfolio and investing in operational excellence through efforts such as Six Sigma.

Our business is managed as three operating segments: North American Forest Products (“NAFORP”), North American Performance Resins Group (“NAPRG”) and International. Our results also include general corporate and administrative expenses disclosed as “Corporate and other” and activities related to Melamine which was shut down in 2002 disclosed as “Divested business.” These are also presented to provide a complete picture of our results.

NAFORP’s product lines include formaldehyde and forest product resins. The key business drivers for NAFORP are housing starts, furniture demand, panel production capacity and consumption, and general chemical sector operating conditions.

NAPRG’s product lines include oilfield, foundry and specialty resins. NAPRG’s key business drivers are housing starts, auto builds, active gas drilling rigs and the general industrial sector performance.

International includes our operations in Latin America, Europe and Asia Pacific, primarily concentrated in Brazil, the U.K., Australia and Malaysia. International 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 ongoing general and administrative expenses, and income and expenses related to liabilities retained from businesses sold in previous years.

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. Most of our products are used by our customers in their production processes; therefore, factors impacting their industries could significantly affect our results.

In 2003, we were positively impacted by the strong U.S. housing market. According to Resource Information Systems, Inc. (“RISI”), housing starts were up 8% in 2003 compared to 2002, driving a 3.5% increase in structural panel consumption. The mix in the structural panel consumption increase also benefited us, as oriented strand board (“OSB”) consumption, which on a per square foot basis uses more of our resins, was up 6.2%, while plywood consumption was essentially flat.

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. North American gas drilling rigs in active production increased 25% in 2003 driving a 43% increase in sales in our oilfield products. We believe continued elevated natural gas prices should continue to drive strong demand for these products in 2004.

The U.S. furniture production sector was down 3.3% in 2003, according to RISI, negatively impacting the demand for our resins used in particleboard and medium density fiberboard (“MDF”). U.S. particleboard consumption was down 2.2% in 2003 due to increased imports and the decrease in furniture production. Current forecasts for 2004 by RISI are predicting that particleboard and MDF consumption will increase in 2004, as the weakened U.S. dollar will decrease the amount of imported products and the continued stable housing market and low interest rates will increase the demand for furniture.

Raw Material Costs
Raw material costs make up approximately 60% of our product costs. The primary raw materials that we use are methanol, phenol and urea. During the past three years, the price of these materials has been volatile. In 2003, for example, the average prices of methanol, phenol and urea increased by 42%, 22% and 50% respectively. To help mitigate this volatility, we have purchase and sale contracts with 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 2003, we had a favorable impact as raw material price increases late in 2002 and 2003 were passed through to customers, having a significant impact on 2003 sales versus 2002.

Regulatory Environment
Various government agencies are conducting formaldehyde health research and evaluating the need for additional regulations. We understand that the International Agency for Research on Cancer has scheduled formaldehyde for an update review of its cancer classification in June 2004. The recently formed Formaldehyde Council, Inc. (“FCI”), of which we are a member, believes that any adverse findings would not be supported by the weight of most scientific evidence and epidemiology studies. Nonetheless, further regulation of formaldehyde could follow over time, from such a determination. We believe that we will be able to comply with any likely regulatory impact.

We support appropriate scientific research and risk-based policy decision-making, and we are working with industry groups, including the FCI, 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. However, as the world’s largest producer of formaldehyde, and due to the significance of formaldehyde as a raw material in our manufacturing processes, we cannot provide any assurance that future unanticipated regulatory changes relating to formaldehyde would not have a material impact on our business.

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, including the difficult decision to modify our postretirement medical benefits plan. 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 6 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 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 NAPRG oilfield products and NAFORP formaldehyde. Slightly offsetting these increases were declines in NAFORP 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 2003 versus a net loss of $36,583 for 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 (see Note 4 to the Consolidated Financial Statements).
 
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 $38,600 and $44,000 at December 31, 2003 and 2002, 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 $24,200 to $73,600. 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 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. We have business strategies that we would execute before any material deferred tax assets would go unused. The Company reviews income tax reserves on a quarterly basis. Management believes the reserves established for probable tax liabilities are appropriate at December 31, 2003.

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 and postretirement assets and liabilities
The amounts recognized in our financial statements related to pension and postretirement (“OPEB”) 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 5.8% for 2003 and 6.5% for 2002)
-   Expected long-term rate of return on pension plan assets (AWR were 8.2% for 2003 and 8.3% for 2002)
-   Health care cost trend rates (used for OPEB, due to our 2003 plan amendment, this assumption is no longer material to the determination of our liability)
-   Rate of salary increases (AWR were 4.2% for 2003 and 4.5% for 2002)
-   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 2003 was 22%. 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 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.

In 2003, we amended our OPEB plan such that, effective September 1, 2003, medical benefits are no longer provided to our retirees and their dependents who are over age 65. We estimate that our liability related to providing OPEB medical benefits will be reduced by approximately $88,000 and annual cash outlays anticipated under the pre-amended retiree medical benefit plan will be decreased by approximately $10,000 on an ongoing basis. This amendment has reduced the potential for changes in health care cost trends to materially impact our financial statements.

Results of Operations by Segment:

Following is a comparison of net sales and earnings before interest, taxes, depreciation and amortization adjusted for business realignment, impairments, non-operating income (expense) and certain other operating income (expense) items (“Adjusted EBITDA”) by segment and for Corporate and other and Divested business. Adjusted EBITDA is the measure used by our chief operating decision maker in the evaluation of our operating results and in determining allocations of capital resources among the business segments.

Net Sales to Unaffiliated Customers:
 
 
 
 
2003
2002
2001



North American Forest Products
$ 755,767
$634,619
$656,694
North American Performance Resins
364,347
340,791
409,081
International
314,693
264,541
282,629
Divested business
6
7,934
23,737



 
$1,434,813
$1,247,885
$1,372,141



 
 
 
 




 
 
Adjusted EBITDA:
 
 
 
 
2003
2002
2001



North American Forest Products
$ 92,548
$ 92,918
$101,655
North American Performance Resins
46,661
45,127
74,321
International
32,250
28,630
17,595
Corporate and other
(43,713)
(44,949)
(54,356)



 
$127,746
$121,726
$139,215



 
 
 
 





Reconciliation of Adjusted EBITDA to Income (Loss) from Continuing Operations Before Income Tax:
 
2003
2002
2001



Adjusted EBITDA
$127,746
$121,726
$139,215
Depreciation and amortization
(47,319)
(47,947)
(59,361)
Adjustments to EBITDA (see pages 16 - 17)
(13,885)
(40,071)
(155,349)
Interest expense
(46,138)
(47,315)
(51,613)
Affiliated interest expense
(558)
(1,402)
(11,488)
Other non-operating (expense) income
(1,529)
5,989
(1,841)
Investment write-downs
-
-
(27,000)



Income (loss) from continuing operations before income tax
$18,317
$ (9,020)
$(167,437)



 
 
 
 





2003 vs. 2002

Net Sales Variance
2003 as a percentage increase (decrease) from 2002


 
 
Volume
 
Price/Mix
 
Translation
 
Other
 
Total





North American Forest Products
(1.0)%
16.3%
3.6%
0.2%
19.1%
North American Performance Resins
3.2%
3.6 %
-
0.1%
6.9%
International
(0.9)%
14.2%
5.4%
0.3%
19.0%






 
 
North American Forest Products (NAFORP)
Our NAFORP 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 urea formaldehyde based (“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 phenolic-based (“PF”) resins driven by the strong housing market and demand for plywood and OSB, which are made with PF resins.

Adjusted EBITDA for NAFORP 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.
 
North American Performance Resins (NAPRG)
Our NAPRG 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, as previously discussed. 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.

Adjusted EBITDA for NAPRG 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 Adjusted 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 the cost of operating a second oilfield products plant to meet customer demand.

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 Adjusted 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.

2002 vs. 2001

Net Sales Variance
2002 as a percentage increase (decrease) from 2001


 
 
Volume
 
Price/Mix
 
Translation
 
Other
 
Total





North American Forest Products
6.9%
(8.8%)
(1.5%)
-
(3.4%)
North American Performance Resins
(13.9%)
(2.8%)
-
-
(16.7%)
International
0.9%
(0.2%)
(4.5%)
(2.6%)
(6.4%)






 
 
North American Forest Products (NAFORP)
Net sales for our NAFORP business declined by $22,075, or 3.4%, in 2002, as decreasing prices due to the pass through of lower raw material prices more than offset volume increases. In addition, competitive pricing pressures negatively impacted the renewal of two large long-term customer contracts in 2002. NAFORP’s 2002 sales were also negatively impacted by foreign currency translation due to the weaker Canadian dollar. Increased volumes were driven by gains in market share and strong demand due to a healthy housing sector.

NAFORP’s Adjusted EBITDA decreased by $8,737, or 8.6%, from prior year. Competitive pressures, a negative lead-lag impact in the second half of the year and increased insurance and benefit costs were the principal causes of the decline.

North American Performance Resins (NAPRG)
Our NAPRG net sales decreased by $68,290, or 16.7%, in 2002, due to volume, mix and lower selling prices. While absolute volumes increased, a decrease in specialty oilfield and coatings volumes led to a decline in sales. The volume decline in oilfield products is due to reduced drilling activity in 2002. The coatings products volume decline is a result of significantly lower demand for fiber optic cable in 2002. Lower selling prices in other specialty resins were the result of competitive pressures and the pass through of raw material price decreases.

Adjusted EBITDA for NAPRG declined by $29,194, or 39.3%, in 2002, relating to the decrease in coatings and oilfield volumes discussed above. This decrease was partially offset by improved processing costs related to decreased energy costs and synergies realized as a result of the 2001 formation of HAI.

International
Our International net sales decreased $18,088, or 6.4%, in 2002, due chiefly to lower selling prices and volumes in Europe and Asia, the 2001 sale of our business in Ecuador and unfavorable foreign currency translation in Latin America. The lower selling prices resulted from the pass through of raw material price decreases in 2002 and competitive pressures in Europe.

Adjusted EBITDA from our International businesses increased $11,035, or 62.7%, in 2002 due to improved operational results in all regions. We attribute these improvements to improved margins relating to a positive lead-lag for the first half of the year and improved processing costs in Europe due to plant consolidations.

Corporate and other
Our Corporate and other expenses decreased by $9,407 compared to 2001. The improvement was driven by the benefits realized from the 2001 Corporate Reorganization and other workforce and cost reduction measures we made in 2002 and 2001.

Divested business
The divested business activity in 2002 and 2001 represents Melamine. Results for 2002 primarily related to the disposition of remaining inventory and other assets following its closure early in the year.

Adjustments To EBITDA

Our chief operating decision maker relies primarily on Adjusted EBITDA in the evaluation of operating results and the allocation of capital resources. This table details items not included in Adjusted EBITDA for purposes of this evaluation of our operating segments. We monitor these activities separately from our operating results. These (expenses) income primarily relate to our realignment programs, pension and legal settlement charges and impairment charges:

Year Ended December 31, 2003
Plant Closure
Severance
Impairment
Other
Total






North American Forest Products
$ (932)
$ (1,125)
$ -
$ (90)
$(2,147)
North American 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)







As part of our ongoing realignment program designed to improve productivity and reduce our costs, we recorded 2003 plant closure costs of $6,988 consisting of plant employee severance of approximately $3,900, asset impairments 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 June 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 Adjusted 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 offset by a $5,929 charge related to tentative legal settlements reached with BCPM Liquidating and BCP Liquidating (see Note 22 to the Consolidated Financial Statements) and severance expense included in general and administrative expense relating to positions to be replaced as part of the June 2003 realignment program.

Year Ended December 31, 2002
Plant Closure
Severance
Impairment
Other
Total






North American Forest Products
$ (1,107)
$ (250)
$ -
$ -
$(1,357)
North American 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 Adjusted 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.

Year Ended December 31, 2001
Plant Closure
Severance
Impairment
Other
Total






North American Forest Products
$ (6,573)
$ (2,080)
$ -
$10,507
$ 1,854
North American Performance Resins
2,433
(2,632)
(2,885)
-
(3,084)
International
(20,020)
(179)
-
(2,303)
(22,502)
Corporate and other
875
(7,691)
-
(37,202)
(44,018)
Divested business
-
-
(98,163)
10,564
(87,599)





Total
$(23,285)
$(12,582)
$(101,048)
$(18,434)
$(155,349)







In 2001, we recorded plant closure costs totaling $23,285 relating to our realignment program. These costs consisted of fixed asset write-offs of $11,863, plant employee severance of $1,862 and demolition, environmental and other costs for plant closure and consolidations of $9,560.

In addition, we recorded severance costs of $12,582 related to consolidation of general administrative functions including $3,265 related to the 2001 Corporate Reorganization.

We recorded significant impairment charges in 2001, primarily related to our decision to close Melamine. Of the $101,048 impairment charge, $98,163 related to this shut-down. This charge included the impairment of fixed assets, goodwill and spare parts of $62,527, $32,701 and $2,935, respectively. The remaining $2,885 of the impairment charge was for a domestic plant facility for which construction was discontinued in 2001.

Other expenses not reflected in 2001 Adjusted EBITDA primarily include a charge for environmental remediation of $19,028 relating to a former business. In addition, we recorded a pension settlement charge of $15,813 and a loss of $2,303 on the divestiture of our operations in Ecuador. These other expenses were partially offset by a $10,507 gain we recorded on the sale of land associated with a closed plant and earnings of $10,564 from Melamine, which was closed in early 2002.
 
Non-Operating Expenses and Income Tax Expense:

Non-operating expense

 
2003
2002
2001



Interest expense
$46,138
$47,315
$51,613
Affiliated interest expense, net
558
1,402
11,488
Other non-operating expense (income)
1,529
(5,989)
1,841
Investment write-downs and other charges
-
-
27,000



 
$48,225
$42,728
$91,942





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, our affiliated interest expense declined by $10,086 versus 2001 due to lower affiliate borrowings after repayments of debt made with cash received from BHI in connection with the Corporate Reorganization. In addition, our non-affiliated interest expense declined by $4,298 due to lower average borrowings. We also 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.

In 2001, we recorded $27,000 of investment write-downs. Of this amount $17,000 related to the write-down of a receivable from and preferred stock investments in WKI Holding Company, Inc., an affiliate. In addition, we wrote-off our remaining investment in BCPM of $10,000. Our 2001 other non-operating expense also included a loss on an interest rate swap of $1,841.

Income tax benefit

 
2003
2002
2001



Income tax benefit
$(4,659)
$(2,262)
$(30,833)
Effective tax rate
N/M
25%
18%





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 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 Internal Revenue Service (“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.

Our 2001 consolidated tax rate reflects the non-deductible impairment of $31,692 on the fixed assets and goodwill related to the shut-down of Melamine. This rate also reflects $12,397 for the impact of foreign earnings that we expect to repatriate due to the anticipated sale of a foreign business, as well as our inability to use foreign tax credits associated with these earnings due to usage limitations. In early 2001, the IRS completed its final computation of the tax due for tax matters dating back to 1996. This computation was complex and involved multiple years and multiple adjustments. The final resolution resulted in an additional benefit included in our 2001 income tax benefit totaling $14,388.

Cash Flows:

Cash provided by (used in):
 
 
 
 
2003
2002
2001



Operating activities
$34,026
$ 10,360
$ 95,120
Investing activities
(42,314)
81,464
210,981
Financing activities
21,710
(101,716)
(308,403)



Net change in cash and cash equivalents
$13,422
$(9,892)
$(2,302)





Operating Activities
Our 2003 operating activities provided cash of $34,026. This included the generation of $10,006 for net trading capital, an increase of $28,353 versus 2002, and reductions in realignment expenditures of $13,253 and in interest payments of $1,462. This improvement in net trading capital, which consists of accounts receivable, inventory and accounts payable, 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. Realignment expenditures of $11,801 declined from 2002 due to reduced levels of activity. Our cash interest payments were lower than prior year as a result of lower interest rates. These favorable events were partially offset by higher tax payments of $18,390 in 2003 due primarily to international taxes.

Our 2002 operating activities provided cash of $10,360 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. Cash generated by net trading capital decreased by $44,494 versus the prior year. This decline essentially related to higher accounts receivable at year-end 2000, which were collected in 2001, resulting in inflated inflows for 2001. Favorable timing of payments on accounts payable versus 2001 was offset by unfavorable variances on inventory. Realignment expenditures in 2002 totaled $25,054, which was in line with 2001 spending levels. Our interest payments in 2002 were $46,928, a decrease of $23,330 from the prior year, due to debt repayments made late in 2001 and reduced interest rates in 2002.

Our 2001 operating activities provided cash of $95,120. In addition to cash generated by net income, our net trading capital generated $26,147 of cash related to decreases in accounts receivable and lower inventory levels, partially offset by unfavorable timing of accounts payable payments. We also received net tax refunds totaling $36,186, primarily due to favorable settlements of income tax audits. These cash inflows were partially offset by interest payments of $70,258.

Investing Activities
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 made two acquisitions in 2003: Fentak and the business and technology assets of SEACO for cash of $14,691 plus deferred payments totaling about $4,550 over the next five years. 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.

Our 2001 investing activities generated cash of $210,981. During 2001, we sold cash certain non-operating assets to BHI for cash of $160,888 as a part of the Corporate Reorganization. In addition, we received $96,977 from business divestitures, primarily from the Consumer Adhesives sale, with the remainder generated from the sale of our business in Ecuador. These 2001 inflows were partially offset by capital expenditures of $47,408, primarily for plant improvements and expansion.
 
Financing Activities
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.

In 2001, we used cash of $308,403 for financing activities. These expenditures are primarily related to the repayment of affiliated loans of $212,432 and preferred dividend payments of $73,724 using the cash we generated from investing activities previously discussed. We cancelled our preferred stock in 2001 and have not paid common stock dividends since 2001.

Liquidity and Capital Resources:

We have significant available borrowing capacity to augment cash generated by our operations. We expect to have adequate cash available from these sources throughout their duration to fund our cash requirements for operating our business and meeting our cash obligations. The table and related disclosures on pages 21 & 22 indicate our more significant contractual cash obligations. We are confident we will be able to obtain new financing arrangements as needed to replace our existing facilities upon their expiration in future years.

We entered into a three-year asset based revolving credit facility in the third quarter of 2002 (our "Credit Facility"), under which we can borrow up to $175,000. This Credit Facility replaced a temporary uncommitted LOC facility established in 2002 (discussed below) and our previous $250,000 credit facility that expired in the third quarter of 2002.

Our 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. Our maximum borrowing allowable under the Credit Facility is calculated monthly and is based upon specific percentages of eligible accounts receivable, inventory and fixed assets. This Credit Facility contains restrictions on dividends, limitations on borrowings from our affiliates ($30,000), capital expenditures ($68,000 in 2004) and on the payment of management fees ($5,000 per year). It also includes a minimum trailing twelve-month fixed charge coverage ratio of 1.5 to 1.0 if aggregate availability is less than $25,000, 1.25 to 1.0 if aggregate availability is between $25,000 and $50,000 and 1.1 to 1.0 if aggregate availability is between $50,000 and $75,000. However, these requirements do not apply when aggregate availability exceeds $75,000. As of December 31, 2003, our maximum borrowing allowable under the Credit Facility was $144,000, of which $98,000, after outstanding LOCs, was unused and available. As a result, we had no fixed charge coverage ratio requirements at year-end 2003.

We established an uncommitted LOC facility in 2002 to transition our LOC requirements during the last year of operation of our previous credit facility. Under this LOC facility, we were required to provide cash collateral equivalent to 101% of letters of credit outstanding. This amount was classified as Restricted cash on our 2002 Consolidated Balance Sheet. In early July 2003, we completed the process of transferring all the LOCs under this facility to our Credit Facility, resulting in the removal of the restrictions on the cash collateral.
 
Our U.S. entity and HAI had separate borrowing arrangements with an affiliate, Borden Foods Holdings Corporation (“Foods”), evidenced by demand promissory notes bearing interest at variable rates. We reported these loans, which totaled $18,260 at year-end 2003 and $84,680 at year-end 2002, as Loans payable to affiliates on our Consolidated Balance Sheets. The $30,000 limit on borrowings from affiliates under our Credit Facility became effective following the termination of our uncommitted LOC facility in 2003. Of the total loans outstanding, HAI owed $6,000 at December 31, 2003 and had $4,000 available for additional borrowings. The remainder of the loans related to our U.S. entity. Interest rates on these loans ranged from 1.0% to 4.75%, and interest expense totaled $558, $1,857 and $14,538 for the years ended December 31, 2003, 2002 and 2001, respectively. In early 2004, our U.S. entity entered into a similar affiliated borrowing agreement with another affiliate, BW Holdings, LLC (“BWHLLC”), and cancelled its arrangement with Foods.

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 $20,000 (the “HAI facility”). The HAI facility is secured with the assets of HAI. Maximum borrowing allowable under this facility is based upon specific percentages of eligible accounts receivable and inventory. The HAI facility restricts HAI on the payment of dividends, affiliate transactions, additional debt, minimum availability ($2,000) and capital expenditures ($2,000 in 2004). In addition, HAI must maintain a minimum trailing twelve-month debt coverage ratio of 1.5 to 1.0.

Our Australian subsidiary entered into a five-year asset-backed credit facility in the fourth quarter of 2003 (the "Australian facility"), which provides for a maximum borrowing of AUD$19,900, or approximately $15,000. The Australian facility provided the funding for our Fentak acquisition (See Note 5 to the Consolidated Financial Statements for additional information on the acquisition), and it is secured by mortgages on the fixed assets of the Australian business and the stock of Australian subsidiaries. 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 $330). The revolving facility component requires semi-annual principal reductions based on a portion of excess cash as defined in the agreement. At year-end 2003, our Australian subsidiary had AUD$3,178 (approximately $2,400) available under this facility.

We have additional international credit facilities that provide availability to these businesses totaling approximately $29,900. Of this amount, approximately $15,900 (net of letters of credit and other guarantees of $7,700 and $2,300 of other draws) was available to fund working capital needs and capital expenditures. There is an additional $4,000 available for which usage is restricted to capital investments and for foreign currency hedging. While these facilities are primarily unsecured, portions of the lines are secured by equipment and with $1,442 of cash. Our U.S. business guarantees up to $6,700 of the debt of one of our Brazilian subsidiaries, included in these facilities.

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. This increased our availability under the Credit Facility and provided us with additional borrowing capacity.

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 receive a fixed rate of 10% and pay a variable rate equal to the 6-month LIBOR plus 630 basis points. At December 31, 2003, this equates to a rate of 7.6%.

Previous buybacks of our senior unsecured notes will allow us to fulfill our sinking fund requirements through 2013 for our 8-3/8% debentures and our 9-1/4% debentures. In the future, we, or our affiliates, including entities controlled by KKR, 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 2004. 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 and we have eliminated over 200 positions as of the end of 2003 related to this program. As a result of consolidating 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 2004. We expect to incur additional costs in 2004 related to this program. (See Note 6 to the Consolidated Financial Statements for additional information on our realignment programs).

We plan to spend about $40,000 in 2004 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 or borrowings from affiliates.

The following table summarizes our contractual cash obligations at December 31, 2003 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, 2003, 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
 
2004
 
2005
 
2006
 
2007
 
2008
2009
and beyond
 
Total








Long-term debt, including current maturities
$ 8,167
$ 2,219
$ 1,841
$1,420
$3,609
$520,877
$538,133
Operating leases
12,120
10,205
7,882
5,961
4,302
3,789
44,259
Unconditional purchase obligations (1)
16,815
5,992
4,523
2,625
300
-
30,255







Total
$37,102
$18,416
$14,246
$10,006
$8,211
$524,666
$612,647








(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. In addition, loans payable to affiliates are not included in this table because they are demand instruments, and repayments are not predictable, as we use this to fund our daily cash requirements. See Notes 11, 12, 13 and 22 to the Consolidated Financial Statements and the following discussions on minimum pension funding requirements, environmental, taxes and OPEB for more information on these obligations. Our capital lease obligations are not material.

Based on our current projections of the minimum annual funding requirements imposed by Federal laws and regulations with regard to our U.S. pension plan, our projected minimum annual funding requirements range from $0 in 2004 to approximately $25,800 in 2006, with a total funding requirement for the five years ended in 2008 of $73,200. The assumptions used by our actuaries in calculating these projections included an 8.0% annual rate of return on assets for the years 2003 through 2008 and the continuation of current law and plan provisions.

We expect to spend approximately $5,400 for capital expenditures in 2004 related to capital improvements and compliance under environment laws. Of this amount, approximately $2,300 are included in the above table as unconditional purchase obligations, with the remainder being voluntary capital improvement projects. We expect other environmental expenditures for 2004 – 2008 to total approximately $17,700, with approximately $32,700 paid over the next 25 years beginning in 2009.

We have net operating loss carryforwards, future tax deductions and alternative minimum tax credits that can offset approximately $75,000 of future taxes for U.S. federal income tax purposes. We estimate we will pay cash taxes totaling approximately $22,000 in 2004 for state, local and international liabilities.

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 are currently subsidizing 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 reserve the right to continue, terminate or reduce the subsidy provided to our affected retirees and their dependents for periods after December 2004. As a result of these actions, we estimate that our liability related to providing OPEB medical benefits will be reduced by approximately $88,000. Our primary benefit from this amendment was a reduction of future annual cash outlays related to OPEB benefits by approximately $10,000 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 three year term of our Credit Facility with cash received from operations, amounts available under the Credit Facility and amounts available under our subsidiaries’ separate credit facilities. In addition, we have the affiliate borrowing facility, which gives us further flexibility and capacity. However, there is no assurance that borrowings from affiliates will be available in future periods.

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 37% of our sales in 2003 and 35% in 2002. 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, 2003 and 2002. Fair values are determined from quoted market prices at these dates.

 
2003
 
2002


 
 
Average
Days
To Maturity
 
Average
Contract
Rate
 
 
Forward
Position
 
 
Fair Value
Gain (Loss)
 
Average
Days
to Maturity
 
Average
Contract
Rate
 
 
Forward
Position
 
 
Fair Value
(Loss)

 









Currency to sell
For U.S. Dollars
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
British Dollars     (1)
7
1.7710
$44,300
$302
31
1.60
$36,916
$(231)
Canadian Dollars  (2)
16
1.3040
4,000
(38)
-
-
-
-
Canadian Dollars  (2)
49
1.3069
4,000
(64)
-
-
-
-
Canadian Dollars  (2)
76
1.3095
4,000
(79)
-
-
-
-
Currency to sell
For CDN Dollars
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

British Pounds    (1)
-
-
-
-
31
2.51
$23,163
$( 171)
Currency to buy  buy WithU.S. Dollars
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

Canadian Dollars   (3)
16
1.3600
4,000
-
-
-
-
-
Canadian Dollars   (3)
49
1.3600
4,000
5
-
-
-
-
Canadian Dollars   (3)
76
1.3600
4,000
13
-
-
-
-









(1)   Forward contracts
(2)   Calls sold
(3)   Puts purchased

Interest Rate Risk
We use 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 levels. 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.

As of December 31, 2003, we had one interest rate swap outstanding with a notional value of $34,000 and a fair value of $(483). Under this arrangement, we paid 7.6% and received 10.0% in 2003. We had a $24,286 swap outstanding during 2002 that matured on December 1, 2002. In 2002, we paid 13.7% and received 1.9% on this swap.

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, 2003 and 2002. All other debt fair values are determined from quoted market interest rates at December 31, 2003 and 2002.

Following is a summary of our outstanding debt as of December 31, 2003 and 2002 (see Note 10 to the Consolidated Financial Statements for additional information on our debt):

 
_____________2003______________
 
________________2002_______________

 


 


Year
Debt
Weighed Average
Interest Rate
Fair Value
 
Debt
Weighted Average
Interest Rate
Fair Value
2003
 
 
 
 
$2,779
10.7%
2,779
2004
$8,167
6.2%
$8,167
 
607
13.8%
602
2005
2,219
9.7%
2,219
 
607
13.8%
602
2006
1,841
8.6%
1,841
 
300
13.8%
298
2007
1,420
6.8%
1,420
 
11
14.3%
11
2008
3,609
6.4%
3,609
 
-
-%
-
2009 and beyond
520,877
8.5%
486,374
 
521,762
8.5%
340,756

 


 


 


 


 
$538,133
 
$503,630
 
$526,066
 
$345,048









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, 2003, we had no material investments in cash equivalent instruments. At December 31, 2002, we had $70,133 invested primarily in time deposits with average maturity periods of 7 days and average rates at 1.2%. Due to the short maturity of our cash equivalents and restricted cash investments, 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, 2003 and 2002.

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 2003, 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 2004. 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 the leading global melamine crystal producer to supply a minimum of 70% of our worldwide melamine crystal requirements. The melamine crystal we purchase under this agreement will be 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 melamine crystal 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. In 2003, we hedged approximately 69% of our actual natural gas usage. During 2003, we entered into futures contracts for natural gas usage through June 2004. 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. Our commitments settled under these contracts totaled $4,866 and our related losses were $224 in 2003. At December 31, 2003, we had future commitments under these contracts of $1,359.

We were in previous natural gas futures contracts with varying settlement dates during 2001and 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 a gain of $11 at December 31, 2003 related to 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 and a loss of $545 at December 31, 2001 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 have 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 November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires a guarantor to recognize a liability, at the inception of the guarantee, for the fair value of obligations it has undertaken in issuing the guarantee and also include more detailed disclosures with respect to guarantees. FIN 45 is effective for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements for interim or annual periods ending after December 15, 2002. We have adopted FIN 45 and included the additional requirements with respect to guarantees in Note 21 to the Consolidated Financial Statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” ("FIN 46”) to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements, the assets, liabilities and activities of another entity. FIN No. 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. In December 2003, the FASB issued a revision of FIN 46 deferring the effective date for implementation. We have no variable interest entities; therefore, the implementation of FIN 46 will not have an impact on our results of operations and financial condition.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The clarification provisions of this statement require that contracts with comparable characteristics be accounted for similarly. This statement is effective for any new derivative instruments entered into after June 30, 2003. We adopted SFAS No. 149 on July 1, 2003, and the adoption did not have an impact on our financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement addresses the accounting for certain financial instruments that, under previous guidance, could be accounted for as equity. SFAS No. 150 requires that those instruments be classified as liabilities in the statement of financial position. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Our adoption of SFAS No. 150 on July 1, 2003 did not have a material impact on our financial statements.

In December 2003, the FASB issued SFAS No. 132 (as revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB Statement No. 132.” The new rules require additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. This Statement is effective for our fiscal years ending after December 15, 2003, except for certain disclosures on foreign plans, which are effective for fiscal years ending after June 15, 2004. We have adopted SFAS No. 132 (as revised 2003) and included the additional disclosures in Notes 12 and 13 to the Consolidated Financial Statements. We elected to include the disclosures for our foreign plans in 2003.

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.
 
     

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
 
 
 
 

 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
 
 
 
 
BORDEN CHEMICAL, INC.
 
 
 
 
 
 
          Year Ended December 31,
(In thousands, except per share data)
2003
 
2002
 
2001






 
 
 
 
 
 
Net sales
$1,434,813
 
$1,247,885
 
$1,372,141
Cost of goods sold
1,148,519
 
968,657
 
1,060,642



 
 
 
 
 
 
Gross margin
286,294
 
279,228
 
311,499



 
 
 
 
 
 
Distribution expense
66,383
 
61,927
 
63,929
Marketing expense
42,398
 
42,503
 
42,046
General & administrative expense
100,021
 
109,237
 
127,967
(Gain) loss on sale of assets
(746)
 
282
 
(3,772)
Loss on divestiture of business
-
 
-
 
2,303
Business realignment expense and impairments
4,748
 
19,699
 
126,408
Other operating expense
6,948
 
11,872
 
28,113



 
 
 
 
 
 
Operating income (loss)
66,542
 
33,708
 
(75,495)



 
 
 
 
 
 
Interest expense
46,138
 
47,315
 
51,613
Affiliated interest expense, net
558
 
1,402
 
11,488
Other non-operating expense (income)
1,529
 
(5,989)
 
1,841
Investment write-downs
-
 
-
 
27,000



 
 
 
 
 
 
Income (loss) from continuing operations before income tax
18,317
 
(9,020)
 
(167,437)
Income tax benefit
(4,659)
 
(2,262)
 
(30,833)



 
 
 
 
 
 
Income (loss) from continuing operations
22,976
 
(6,758)
 
(136,604)
 
 
 
 
 
 
Income from discontinued operations, net of tax
-
 
-
 
11,804



 
 
 
 
 
 
Income (loss) before cumulative effect of change in accounting principle
22,976
 
(6,758)
 
(124,800)
 
 
 
 
 
 
Cumulative effect of change in accounting principle
-
 
(29,825)
 
-



 
 
 
 
 
 
Net income (loss)
22,976
 
(36,583)
 
(124,800)
 
 
 
 
 
 
 Preferred stock dividends
-
 
-
 
(61,846)



 
 
 
 
 
 
Net income (loss) applicable to common stock
$ 22,976
 
$ (36,583)
 
$ (186,646)



 
 
 
 
 
 
Comprehensive income
$ 60,420
 
$ (67,784)
 
$ (198,959)



 
 
 
 
 
 






 
     

 

CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
 
 
 
 
 
BORDEN CHEMICAL, INC.
 
 
 
 
 
 
 
 
Year ended December 31,
(In thousands, except per share data)
2003
 
2002
 
2001






 
 
 
 
 
 
Basic and Diluted Per Share Data
 
 
 
 
 

 
 
 
 
 
 
Income (loss) from continuing operations
$ 0.11
 
$ (0.03)
 
$ (0.69)
 
 
 
 
 
 
Income from discontinued operations, net of tax
-
 
-
 
0.06



 
 
 
 
 
 
Income (loss) before cumulative effect of change in accounting principle
0.11
 
(0.03)
 
(0.63)
 
 
 
 
 
 
Cumulative effect of change in accounting principle
-
 
(0.15)
 
-



 
 
 
 
 
 
Net income (loss)
0.11
 
(0.18)
 
(0.63)
 
 
 
 
 
 
 Preferred stock dividends
-
 
-
 
(0.31)



 
 
 
 
 
 
Net income (loss) applicable to common stock – basic
$ 0.11
 
$ (0.18)
 
$ (0.94)



 
 
 
 
 
 
Net income (loss) applicable to common stock – dilutive
$ 0.11
 
$ (0.18)
 
$ (0.94)



 
 
 
 
 
 
Average number of common shares outstanding during the period – basic
200,898
 
200,458
 
198,997
 
 
 
 
 
 
Average number of common shares outstanding during the period – dilutive
200,924
 
200,458
 
198,997
 
 
 
 
 
 






See Notes to Consolidated Financial Statements
 
 
 
 






 
     

 

CONSOLIDATED BALANCE SHEETS
 
 
 
BORDEN CHEMICAL, INC.
 
 
 
 
 
 
 
(In thousands)
 
 
 
 
   December 31,
 
   December 31,
ASSETS                                                        

    2003

    2002





 
 
 
 
Current Assets
 
 
 
Cash and equivalents
$ 28,162
 
$ 14,740
Restricted cash
 
67,049
Accounts receivable (less allowance for doubtful accounts of
 
 
 
     $14,459 in 2003 and $12,219 in 2002)
 196,093
 
170,822
Accounts receivable from affiliates
 354
 
5,840
Inventories:
 
 
 
     Finished and in-process goods
 42,292
 
45,178
     Raw materials and supplies
 38,819
 
41,079
Deferred income taxes
 27,085
 
28,869
Other current assets
  13,551
 
13,232


 
346,356
 
386,809


 
 
 
 
Investments and Other Assets
 
 
 
Deferred income taxes
 113,434
 
118,368
Other assets
21,725
 
19,615


 
135,159
 
137,983


 
 
 
 
Property and Equipment
 
 
 
Land
 32,585
 
31,964
Buildings
 103,774
 
98,313
Machinery and equipment
 691,249
 
649,782


 
 827,608
 
780,059
Less accumulated depreciation
 (378,724)
 
(340,321)


 
 448,884
 
439,738
 
 
 
 
 
 
 
 
Goodwill
 57,516
 
39,640
Other Intangible Assets
 5,951
 
7,610


 
 
 
 
Total Assets
$993,866
 
$1,011,780


 
 
 
 




See Notes to Consolidated Financial Statements
 
 
 




 
 
     

 
 
 
CONSOLIDATED BALANCE SHEETS
 
 
 
BORDEN CHEMICAL, INC.
 
 
 
 
 
 
 
(In thousands except share data)
 
 
 
 
December 31,
 
December 31,
LIABILITIES AND SHAREHOLDERS’ DEFICIT
2003
 
2002




 
 
 
 
Current Liabilities
 
 
 
Accounts and drafts payable
$ 127,174
 
$ 113,549
Accounts payable to affiliates
16 
 
2,580
Debt payable within one year
8,167
 
2,779
Loans payable to affiliates
18,260
 
84,680
Other current liabilities
  103,231
 
97,932


 
256,848
 
301,520


 
 
 
 
Other Liabilities
 
 
 
Long-term debt
 529,966
 
523,287
Non-pension postemployment benefit obligations
128,723
 
145,384
Other long-term liabilities
174,522
 
202,482


 
833,211
 
871,153


 
 
 
 
Commitments and Contingencies (See Note 22)
 
 
 
 
 
 
 
Shareholders’ Deficit
 
 
 
Common stock - $0.01 par value: authorized 300,000,000 shares,
 
 
 
Issued 200,895,628 and 200,923,628 shares in 2003 and 2002, respectively
2,009
 
2,009
Paid-in capital
1,224,011
 
1,172,344
Receivable from parent
(512,094)
 
(463,516)
Deferred compensation
(1,488)
 
(2,679)
Accumulated other comprehensive income
(128,193)
 
(165,637)
Accumulated deficit
(680,438)
 
(703,414)


 
(96,193)
 
(160,893)


 
 
 
 
Total Liabilities and Shareholders’ Deficit
$ 993,866
 
$1,011,780


 
 
 
 




See Notes to Consolidated Financial Statements
 
 
 




 
     

 

CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
 
 
 
BORDEN CHEMICAL, INC.
 
 
 
 
 
 
 
 
Year ended December 31,
(In thousands)
2003
 
2002
 
2001






 
 
 
 
 
 
Cash Flows from (used in) Operating Activities
 
 
 
 
 
Net income (loss)
$ 22,976
 
$ (36,583)
 
$ (124,800)
    Adjustments to reconcile net income (loss) to net cash from (used in) operating activities:
 
 
 
 
 
Loss on divestiture of businesses
-
 
-
 
2,303
(Gain) loss on the sale of assets
(746)
 
282
 
(3,772)
Deferred tax provision (benefit)
6,223
 
16,023
 
(25,883)
Depreciation and amortization
47,319
 
47,947
 
59,361
Deferred compensation expense
1,191
 
892
 
-
Business realignment expense and impairments
4,748
 
19,699
 
126,408
Cumulative effect of change in accounting principle
-
 
29,825
 
-
Investment write-downs and other charges
-
 
-
 
27,000
Other non-cash adjustments
1,070
 
(822)
 
3,063
Net change in assets and liabilities:
 
 
 
 
 
Accounts receivable
(3,217)
 
(12,596)
 
31,698
Inventories
10,731
 
2,552
 
14,679
Accounts and drafts payable
2,492
 
(8,303)
 
(20,230)
Income taxes
(30,291)
 
(21,780)
 
44,130
Other assets
3,581
 
(2,571)
 
(72,388)
Other liabilities
(32,051)
 
(24,205)
 
33,551



 
34,026
 
10,360
 
95,120



 
 
 
 
 
 
Cash Flows (used in) from Investing Activities
 
 
 
 
 
Capital expenditures
(41,820)
 
(38,773)
 
(47,408)
(Purchase) proceeds from sale of businesses
(14,691)
 
-
 
96,977
Proceeds from the sale of assets
14,197
 
10,237
 
160,888
Proceeds from sale of note receivable to an affiliate
-
 
110,000
 
-
Other, net
-
 
-
 
524



 
(42,314)
 
81,464
 
210,981



 
 
 
 
 
 
Cash Flows from (used in) Financing Activities
 
 
 
 
 
Net short-term debt borrowings (repayments)
5,388
 
1,255
 
(41,763)
Borrowings of long-term debt
7,925
 
-
 
57,400
Repayments of long-term debt
(1,246)
 
(10,764)
 
(54,000)
Affiliated (repayments) borrowings
(66,420)
 
6,130
 
(212,432)
Payment of note payable to unconsolidated subsidiary
-
 
(31,581)
 
-
Decrease (increase) in restricted cash
67,049
 
(66,165)
 
(884)
Interest received from parent
-
 
-
 
48,578
Common stock dividends paid
-
 
-
 
(48,578)
Preferred stock dividends paid
-
 
-
 
(73,724)
Repurchases, net of sale, of common stock from/to management
(286)
 
(591)
 
-
Capital contribution from affiliates
9,300
 
-
 
17,000



 
21,710
 
(101,716)
 
(308,403)



 
 
 
 
 
 







 
     

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
 
 
 
 
 
BORDEN CHEMICAL, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year ended December 31,
(In thousands)
2003
 
2002
 
2001






 
 
 
 
 
 
Increase (decrease) in cash and equivalents
$13,422
 
$(9,892)
 
$(2,302)
Cash and equivalents at beginning of year
14,740
 
24,632
 
26,934



Cash and equivalents at end of year
$28,162
 
$14,740
 
$24,632



 
 
 
 
 
 
Supplemental Disclosures of Cash Flow Information
 
 
 
 
 
Cash paid (received):
 
 
 
 
 
Interest, net
$45,466
 
$46,928
 
$70,258
Income taxes, net
19,368
 
978
 
(36,186)
Non-cash activity:
 
 
 
 
 
Capital contribution by parent
17,002
 
24,440
 
21,038
Contribution of preferred stock and accrued dividend by parent
-
 
-
 
620,922
        Reclassification of minimum pension liability adjustment from (to) shareholders' equity
5,830
 
(17,075)
 
(66,580)






 
 
 
 
 
 
See Notes to Consolidated Financial Statements
 
 
 
 
 






 
     

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT
BORDEN CHEMICAL, INC.
 
(In thousands)

 
 
 
 
 
Preferred
Stock
 
 
 
 
Common
Stock
 
 
 
 
Paid-in
Capital
 
 
 
 
Receivable
from Parent
 
 
 
 
Deferred
Compensation
 
 
 
Accumulated
Other
Comprehensive
Income
 
 
 
 
Accumulated
Deficit
 
 
 
 
 
Total









Balance, December 31, 2000
$614,369
$1,990
$353,309
$(414,937)
$ -
$(60,277)
$(480,185)
$14,269









Net income
 
 
 
 
 
 
(124,800)
(124,800)
Translation adjustments and other
 
 
 
 
 
(6,849)
 
(6,849)
Cumulative effect of change in accounting principle (net of    $1,900 tax)
 
 
 
 
 
(3,300)
 
(3,300)
Derivative activity (net of $1,300 tax)
 
 
 
 
 
2,570
 
2,570
Minimum pension liability (net of $36,090 tax)
 
 
 
 
 
(66,580)
 
(66,580)

Comprehensive income
 
 
 
 
 
 
 
(198,959)

Preferred stock dividends
 
 
 
 
 
 
(61,846)
(61,846)
Common stock dividends
 
 
(36,434)
 
 
 
 
(36,434)
Interest accrued on notes from parent (net of $13,784 tax)
 
 
24,674
10,120
 
 
 
34,794
Gain on Consumer Adhesives Sale to affiliate (net of $37,428    tax)
 
 
94,847
 
 
 
 
94,847
Gain on sale of common stock equity investment to affiliate    (net of $5,600 tax)
 
 
10,197
 
 
 
 
10,197
Common stock and warrants issued to management
 
 
1,236
 
 
 
 
1,236
Capital contribution from parent of  preferred stock and accrued    dividend
(614,369)
 
620,922
 
 
 
 
6,553
Capital contribution from parent
 
 
38,038
 
 
 
 
38,038









Balance, December 31, 2001
$ -
$1,990
$1,106,789
$(404,817)
$ -
$(134,436)
$(666,831)
$(97,305)










 
     

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ 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 income
 
 
 
 
 
(36,583)
(36,583)
Translation adjustments
 
 
 
 
(14,856)
 
(14,856)
Derivative activity (net of $401 tax)
 
 
 
 
730
 
730
Minimum pension liability (net of $9,194 tax)
 
 
 
 
(17,075)
 
(17,075)

Comprehensive income
 
 
 
 
 
 
(67,784)

Repurchases of common stock from management
(1)
(1,341)
 
 
 
 
(1,342)
Restricted stock issued to mgmt.
16
3,555
 
(3,571)
 
 
-
Interest accrued on notes from parent (net of $20,545 tax)
 
38,154
(58,699)
 
 
 
(20,545)
Compensation expense on restricted stock
 
 
 
892
 
 
892
Common stock issued mgmt.
4
747
 
 
 
 
751
Capital contribution from parent
 
24,440
 
 
 
 
24,440








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 (net of $3,139 tax)
 
 
 
 
5,830
 
5,830

Comprehensive income
 
 
 
 
 
 
60,420

Repurchases of common stock from management
 
(286)
 
 
 
 
(286)
Income tax on sale to affiliate of Consumer Adhesives    note receivable
 
(5,925)
 
 
 
 
(5,925)
Interest accrued on notes from parent (net of tax of    $17,002)
 
31,576
(48,578)
 
 
 
(17,002)
Capital contribution from parent
 
26,302
 
 
 
 
26,302
Compensation expense on restricted stock
 
 
 
1,191
 
 
1,191








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
 
 
 
 
 
 
 








 
     

 
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. In 2001, the Company sold its Consumer Adhesives business. 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, 2003, 27 of a total 48 manufacturing and processing facilities are located in the U.S., and in 2003, approximately 63% of the Company's sales were generated in the U.S.

The Company has three reportable segments: North American Forest Products, North American Performance Resins Group and International. See Note 19.

The Company has been controlled by affiliates of Kohlberg Kravis Roberts & Co. ("KKR") since 1995. The Company's immediate parent is Borden Holdings, Inc. ("BHI"), a wholly owned subsidiary of BW Holdings, LLC ("BWHLLC"), an entity controlled by KKR.
 
In the fourth quarter of 2001, the Company (then known as Borden, Inc.) merged with its subsidiaries Borden Chemical, Inc. (“BCI”) and Borden Chemical Holdings, Inc. ("BCHI"), executed certain financial transactions with its parent and changed its name to Borden Chemical, Inc. (the "Corporate Reorganization"). See Note 3.

In 2001, through a series of transactions with affiliates, the Company sold Consumer Adhesives (the “Consumer Adhesives Sale”) for total proceeds of $94,120. As a result of the Consumer Adhesives Sale, this segment is reflected as a discontinued operation in the Consolidated Financial Statements in 2001. The Company retained continuing investments in Consumer Adhesives in the form of preferred stock and notes receivable. The notes receivable were sold 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 was subsequently sold to BHI in 2002 for face value plus accrued interest. In 2001, a pre-tax gain of $132,275 was recognized in Paid-in capital due to the affiliated nature of the transaction. In 2003, the Company recorded an adjustment of $5,925 in Paid-in capital to reflect additional tax expense associated with the sale of the $110,000 note receivable.

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 Cash Equivalents – The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Included in the Company’s cash equivalents and restricted cash are interest bearing time deposits of $70,133 in 2002. At December 31, 2003, the Company had no material investments in cash equivalent instruments. The effect of exchange rate changes on cash is not material.

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. 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 3%; machinery and equipment 7%). Major renewals and betterments are capitalized. Maintenance, repairs and minor renewals are expensed as incurred.

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. Prior to January 1, 2002, goodwill was amortized on a straight-line basis over not more than 40 years.
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 life of the asset. See Note 4.

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 and other intangibles. See Note 4.

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.

Revenue Recognition – Revenue for product sales 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. 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 $66,383 in 2003, $61,927 in 2002 and $63,929 in 2001. 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.

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' equity and is included in other comprehensive income.

In addition, the Company incurred realized and unrealized net foreign transaction gains (losses) aggregating $438 in 2003, $1,307 in 2002 and $(912) in 2001.

Income Taxes – The Company files a consolidated U.S. Federal Income Tax return with BHI. 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.

Derivative Financial Instruments – The Company primarily uses three types of derivatives: interest rate swaps to effectively convert a portion of the Company’s fixed rate obligations to variable, forward exchange contracts and options to reduce the Company’s cash flow exposure to changes in foreign exchange rates and natural gas futures to reduce the Company’s cash flow exposure to changes in natural gas prices. The Company does not hold or issue derivative financial instruments for trading purposes. The Company’s $34,000 interest rate swap agreement is accounted for as a hedge. All other derivatives 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 Notes 16 and 17.

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.”

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

 
2003
2002
2001




Net income (loss) applicable to common stock
$22,976
$ (36,583)
$ (186,646)
Add: Stock-based employee compensation expense included in reported net income, net of related tax benefit
147
9
-
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
(211)
(94)
(382)



Pro-forma net income
$22,912
$ (36,668)
$ (187,028)



Average shares (in thousands) outstanding - basic
200,898
200,458
198,997
Average share (in thousands) outstanding - diluted
200,924
200,458
198,997
Per share as reported (basic and diluted)
$ 0.11
$ (0.18)
$ (0.94)
Per share pro forma (basic and diluted)
$ 0.11
$ (0.18)
$ (0.94)





Earnings Per Share – Basic and diluted net income attributable to common stock is computed by dividing net income by the weighted average number of common shares outstanding during the period including the effect of dilutive options, when applicable. At December 31, 2003, 5,532,360 options to purchase common shares of the Company were outstanding, of which 4,882,000 are considered dilutive. At December 31, 2002, 198,400 warrants and 3,426,040 options to purchase common shares of the Company were outstanding and not considered dilutive. At December 31, 2001, 1,039,864 warrants and 6,871,380 options to purchase common shares of the Company were outstanding and not considered dilutive. See Note 15.

The Company’s diluted EPS is calculated as follows:

 
2003
2002
2001




Net income (loss) applicable to common shareholders
$ 22,976
$(36,583)
$(186,646)
Effect of dilutive options
-
-
-



Diluted EPS – Numerator
22,976
(36,583)
(186,646)



Average share outstanding (in thousands) – basic
200,898
200,458
198,997
Effect of dilutive options (in thousands)
26
-
-



Diluted EPS – Denominator (in thousands)
200,924
200,458
198,997



Diluted EPS
$ 0.11
$ (0.18)
$ (0.94)





 
     

 
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. 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.

Recently Issued Accounting Standards
In November 2002, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires a guarantor to recognize a liability, at the inception of the guarantee, for the fair value of obligations it has undertaken in issuing the guarantee and also include more detailed disclosures with respect to guarantees. FIN 45 is effective for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements for interim or annual periods ending after December 15, 2002. The Company has adopted FIN 45 and included the additional requirements with respect to guarantees in Note 21 to the Consolidated Financial Statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” ("FIN 46”) to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements, the assets, liabilities and activities of another entity. FIN 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. In December 2003, the FASB issued a revision of FIN 46 deferring the effective date for implementation. The Company has no variable interest entities; therefore, the implementation of FIN 46 will not have an impact on its results of operations and financial condition.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The clarification provisions of this statement require that contracts with comparable characteristics be accounted for similarly. This statement is effective for any new derivative instruments entered into after June 30, 2003. The Company adopted SFAS No. 149 on July 1, 2003, and the adoption did not have an impact on the Company’s financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement addresses the accounting for certain financial instruments that, under previous guidance, could be accounted for as equity. SFAS No. 150 requires that those instruments be classified as liabilities in the statement of financial position. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of SFAS No. 150 on July 1, 2003 did not have a material impact on the Company’s financial statements.

In December 2003, the FASB issued SFAS No. 132 (as revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB Statement No. 132.” The new rules require additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. This Statement is effective for the Company for fiscal years ending after December 15, 2003, except for certain disclosures on foreign plans, which are effective for fiscal years ending after June 15, 2004. The Company has adopted SFAS No. 132 (as revised 2003) and included the additional disclosures in Notes 12 and 13 to the Consolidated Financial Statements. The Company elected to include the disclosures for its foreign plans in 2003.

3.   Corporate Reorganization

In the fourth quarter of 2001, the Company merged with its subsidiaries BCHI and BCI, executed certain financial transactions with BHI and changed its name to Borden Chemical, Inc., from Borden, Inc., reflecting the fact that the only remaining segment of the Company was the chemical business. The Corporate Reorganization was undertaken to simplify the legal structure and strengthen the capital structure of the Company, and to reduce costs. As part of the Corporate Reorganization, certain functions were downsized, eliminated or transferred to a separate legal entity, Borden Capital, Inc. (“Capital”), also owned by BHI.

Subsequent to the Corporate Reorganization, Capital provided certain management, consulting and board services to the Company, as well as other entities owned by KKR, and charged fees to the Company and other affiliates for these services. The Company provided certain administrative services to Capital. The Company was charged a management fee of $9,000 in 2002, payable quarterly in arrears, for the net cost of Capital’s services.

The following transactions occurred as part of the Corporate Reorganization and are included in the 2001 results:

·   BHI contributed all of the outstanding Series A Cumulative Preferred Stock plus accumulated dividends of $6,553 to the Company as a capital contribution. The               significant impact of this transaction was to eliminate required annual future preferred dividend payments of $73,724.

·   The Company recorded severance costs of $1,501 for workforce reductions and additional costs of $2,044 related to the Corporate Reorganization. These amounts are                classified as Business realignment expense and impairments in the 2001 Consolidated Statement of Operations.

·   The Company sold certain assets to BHI for cash. The Company sold a common stock equity investment for its estimated fair value of $55,187 resulting in a pre-tax gain                of $15,797 that is recorded as an increase to Paid-in capital due to the affiliated nature of the transaction. Notes receivable from Consumer Adhesives were sold for their                carrying amount of $57,691, and a loan receivable from WKI Holding Company, Inc. ("WKI"), an affiliate of the Company, of $25,056 was sold for its fair value of                $18,056. Prior to the sale in 2001, the Company recorded a $7,000 charge that is included in investment write-downs and other charges to reflect the decline in fair value                of the WKI loan receivable.

·   The Company paid Capital $8,741 to assume certain liabilities, the estimated fair value at the date of sale, net of certain assets transferred, including accounts receivable                from WKI of $3,594. These liabilities were for accrued compensation, certain employee benefit obligations and accrued liabilities associated with the transferred                employees and functions.

·   Outstanding stock options on the stock of BCHI held by its management became options of the Company (see Note 15).

·   In addition, the Company settled the minority interest liability related to managements’ ownership of shares in BCHI by exchanging shares of the Company’s stock and               common stock warrants for the BCHI shares held by management. This resulted in an increase to Paid-in capital for 2001 of $1,236, the approximate fair value of the                liability.

In 2002, BHI decided to cease Capital's operations during the first half of 2003. Certain management, consulting and board services previously provided to the Company by Capital were assumed by the Company, while other such services were provided to the Company by KKR for an annual fee of $3,000. The Company recorded a charge, funded by BHI, of $5,500 in 2002 related to costs allocable to the Company in connection with the cessation of Capital's operations.

4.   Goodwill and Intangible Assets

At December 31, 2003, 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.

Valuations were performed using a standard methodology based largely on comparable company analysis. 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.

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 that represented 100% of the carrying amount. This impairment charge is reflected in the 2003 Consolidated Statement of Operations as Business realignment expense and impairments.

At December 31, 2002, the Company’s management performed the goodwill impairment test using the same methodology described above. No impairment charge was necessary as of December 31, 2002, 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, the Company engaged Capital to determine estimated fair values of the Company’s reporting units as of December 31, 2001. Capital employed the same methodology used by the Company, as described above, to estimate the fair value of the reporting units. 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 following table provides a comparison of 2003, 2002 and 2001 as if the new accounting principle were applied in 2001:

 
Year Ended December 31,


 
2003
2002
2001




Reported net income (loss)
$22,976
$(36,583)
$(124,800)
Add back goodwill amortization
-
-
3,712



Adjusted net income (loss)
22,976
(36,583)
(121,088)
Add back cumulative effect of change in accounting principle
-
29,825
-



Adjusted net income (loss) before cumulative effect of change in accounting principle
$22,976
$ (6,758)
$121,088)



 
Basic and diluted per share data:
 
 
 

Reported net income (loss)
$0.11
$(0.18)
$(0.63)
Add back goodwill amortization
-
-
0.02



Adjusted net income (loss)
0.11
(0.18)
(0.61)
Add back cumulative effect of change in accounting principle
-
0.15
-



Adjusted net income (loss) before cumulative effect of change in accounting principle
$0.11
$(0.03)
$(0.61)



 
 
 
 




 
 
The changes in the carrying amount of goodwill for the year ended December 31, 2003 and 2002 are as follows:
 
 
N.A. Forest Products
N.A. Performance Resins
International
Total





Goodwill balance at December 31, 2001
$20,713
$19,487
$31,199
$71,399
Less goodwill impairment recognized upon adoption of SFAS No.      142
 
-
 
-
 
(29,825)
 
(29,825)
Acquisitions/divestitures
-
(1,343)
-
(1,343)
Foreign currency translation
6
-
(597)
(591)




Goodwill balance at December 31, 2002
$20,719
$18,144
$ 777
$39,640
Acquisitions/divestitures
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





 
     

 
Intangible assets with identifiable useful lives, which continue to be amortized, consist of the following:

 
At December 31, 2003
At December 31, 2002



 
Gross Carrying Amount
Accumulated Amortization
Gross Carrying Amount
Accumulated Amortization
Intangible assets:
 
 
 
 
Customer list and contracts
$ 7,559
$ 4,619
$ 6,559
$3,736
Formulas and technology
6,524
4,925
6,524
4,331
Unrecognized prior service cost
2,657
1,309
2,657
153
Other
744
680
744
654




 
$17,484
$11,533
$16,484
$8,874




 
 
 
 
 






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

Total intangible amortization expense for the year ended December 31, 2003, 2002 and 2001 was $1,508, $1,555 and $1,653, respectively.

Estimated annual intangible amortization expense for 2004 through 2008 is as follows:
2004
$1,700
2005
970
2006
350
2007
180
2008
150


 
    5.   Business Acquisitions and Divestitures
 
Acquisitions
All of the Company’s acquisitions described below have been accounted for 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 pro forma 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. The Company is required to make additional deferred payments for these acquisitions of approximately $3,050 and contingent future payments of $1,500. The Company recorded goodwill totaling $18,455 for these acquisitions.

In the second quarter of 2001, the Company and Delta-HA, Inc. (“Delta”) merged their North American foundry resins and coatings businesses forming HA-International, LLC (“HAI”). In conjunction with the merger, the Company recorded an accrual of approximately $7,000 to restructure operations of the acquired entity, a minority interest liability of $4,500 to recognize the 25% minority interest and goodwill of approximately $9,000.

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 their intention to exercise their option to purchase an additional 5% interest in 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.

Divestitures
In 2003, the Company sold its idled melamine crystal business (“Melamine”). The gain from the sale was recorded as business realignment income. See Note 6.

In 2001, the Company divested its chemical operation in Ecuador. Proceeds from the sale of the Ecuador chemical business were $5,275, which resulted in a pre-tax loss of $2,303.

6.   Business Realignment and Asset Impairments

In June 2003, the Company initiated a realignment program designed to reduce operating expenses and increase organizational efficiency. To achieve these goals, the Company is reducing headcount, streamlining processes, consolidating manufacturing processes and reducing general and administrative expenses. The Company is combining jobs where practical and has eliminated over 200 positions as of the end of 2003 related to this program. To further reduce future general and administrative expenses, the Company has reduced contract work, consolidated and eliminated positions and streamlined the administration of medical and other postretirement benefits. The Company anticipates this program will be completed in 2004. The Company expects to incur additional costs in 2004 related to this program.

In addition to the June 2003 realignment program, the Company has realignment activities from programs initiated in previous years, primarily related to plant consolidations and reorganization of certain administrative functions. Following is a discussion of realignment activities and impairments recognized during the past three years.

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.

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
 
 
 
 
 Prior years’ programs
$ 9,568
$ 144
$ (4,971)
$ 4,741
June 2003 program
-
6,844
(3,356)
3,488
Other severance costs
 
 
 
 
Prior years’ programs
3,996
3,670
(6,515)
1,151
June 2003 program
-
3,167
(2,020)
1,147




 
 
 
 
 
Total reserve activity
$13,564
$13,825
$(16,862)
10,527
 
 
 
 
 






Plant Closure Costs
Plant closure costs in 2003 include $144 for prior years’ programs and $6,844 for 2003 programs.

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, and the North Bay site was idled as of the end of 2003, resulting in asset impairment charges of $1,430.

Other Severance Costs
Other severance costs for 2003 include $3,167 relating to the 2003 program and $3,670 relating to prior years’ programs. The 2003 severance related to the elimination of 200 positions under the June 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’ realignment 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, $1,000 was for a facility held for sale and the remaining $762 related to the write-down of goodwill carried by the Company’s Malaysian operations.

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 and Employee Costs
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






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.

Year Ended December 31, 2001

During 2001, the Company recorded net business realignment expense and impairments of $126,408, consisting of plant closure costs of $23,285, other severance and employee costs of $12,582, a gain on the sale of assets of $10,507 and non-cash impairment charges of $101,048.

Plant Closure and Other Severance and Employee Costs
Plant closure costs in 2001 of $23,285 consist of fixed asset write-offs of $11,863, plant employee severance of $1,862 and demolition, environmental and other costs of $9,560.

Gain on the Sale of Assets
In 2001, the Company sold land associated with a closed domestic plant and recorded a gain of $10,507. 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
In the fourth quarter of 2001, the Company decided to cease operations at Melamine and to offer it for sale. As of the end of 2001, no sale had been negotiated, and in January 2002, the plant was shut-down. Under SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” the Company recorded a 2001 impairment charge of $98,163 for the fixed assets ($62,527), goodwill ($32,701) and spare parts ($2,935) of Melamine.

Also, in the fourth quarter of 2001, the Company discontinued construction of a new plant facility and recorded an impairment charge of $2,885 to write-down the engineering, construction and other costs incurred to the estimated net realizable value of the land and building.

7.   Discontinued Operations

The summary of discontinued operations below includes Consumer Adhesives’ results through August 2001, the date of the Consumer Adhesives Sale:
 
2001


Net sales
$106,307

Income before income taxes
17,404
Income tax expense
5,600

Income from discontinued operations
$ 11,804

 
 



Proceeds from the Consumer Adhesives sale were $94,120, net of cash sold with the business, resulting in a pre-tax gain of $132,275, which was recorded in Paid-in capital due to the affiliated nature of the transaction. See Note 1.

8.   Comprehensive Income

Comprehensive income includes the following items:

 
2003
2002
2001




Net income (loss)
$22,976
$(36,583)
$(124,800)
Foreign currency translation adjustments
31,614
(14,856)
(12,649)
Reclassification adjustments
-
-
5,800
Cumulative effect of change in accounting principle
-
-
(3,300)
Derivative activity
-
730
2,570
Minimum pension liability (see Note 12)
5,830
(17,075)
(66,580)



 
$60,420
$(67,784)
$(198,959)





The foreign currency translation adjustments in 2003 primarily relate to favorable exchange rates in Canada, Latin America and Australia. In 2002, the foreign currency translation adjustments primarily relate to unfavorable exchange rates in Latin America. The 2001 foreign currency translation adjustments primarily relate to unfavorable exchange rates in Latin America and Canada.

The 2001 reclassification adjustment reflects the accumulated translation adjustment recognized on the sale of the Company’s operations in Ecuador.

The cumulative effect of change in accounting principle and derivative activity represents the impact of the adoption of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” on January 1, 2001. The Company recorded a pre-tax initial transition adjustment to Accumulated other comprehensive income of $5,200 of which $1,330 and $3,870 was reclassified into earnings for the year ended December 31, 2002 and 2001, respectively.

The components of Accumulated other comprehensive income as of December 31, 2003 and 2002 are as follows:

 
2003
2002



Cumulative foreign currency translation adjustments
$ (49,923)
$ (81,537)
Minimum pension liability, net of tax
(78,270)
(84,100)


 
$(128,193)
$(165,637)




9.   Investments in Affiliates

The Company had no continuing investments in affiliates at December 31, 2003 and 2002.

The Company sold a common stock equity investment in 2001 for $64,141. Of the total proceeds, $55,187 was received from BHI as part of the Corporate Reorganization (see Note 3), and the related pre-tax gain of $15,797 was recorded in Paid-in capital due to the affiliated nature of the transaction. The remaining $8,954 was received from sales to third parties, and a related gain of $4,400 was reflected in the 2001 Consolidated Statement of Operations as Gain on the sale of assets.

In 2001, the Company wrote-off its $10,000 investment in WKI preferred stock, $7,000 of a loan receivable from WKI and its remaining $10,000 investment in BCP Management, Inc. (“BCPM”), a former subsidiary of the Company. The write-offs are reflected in Investment write-downs and other charges in the 2001 Consolidated Statement of Operations.

BCPM filed for protection under Chapter 11 of the United States Bankruptcy Code, in the United States Bankruptcy Court for the District of Delaware on March 22, 2002. As a result of the bankruptcy of BCPM, the Company no longer consolidated BCPM in its Consolidated Financial Statements. There was no impact on previously reported amounts of net (loss) income as a result of the deconsolidation. The Company’s investment in BCPM was written-off in 2001, as described above. In the first quarter of 2003, the assets of BCPM were transferred to a liquidating agent, and the Company’s ownership interest was extinguished.

10.   Debt and Lease Obligations

Debt outstanding at December 31, 2003 and 2002 is as follows:

 
2003
2002



 
Long-Term
Due Within One Year
Long-Term
Due Within One Year





9.2% debentures due 2021
$114,800
 
$114,800
 
7.875% debentures due 2023
246,782
 
246,782
 
Sinking fund debentures:
 
 
 
8-3/8% due 2016
78,000
 
78,000
 
9-1/4% due 2019
47,295
 
47,295
 
Industrial Revenue Bonds (at an average rate of 3.1% in 2003 and 1.6% in 2002)
34,000
 
34,885
 
Other (at an average rate of 8.1% in 2003 and 13.8% in 2002)
9,089
$2,221
1,525
 

Total current maturities of long-term debt
 
2,221
 
 
 
 
 
 
 
Short-term debt (primarily foreign bank loans at an average rate of 4.8% in 2003 and 10.7% in 2002)
-
5,946
-
$2,779




Total debt
$529,966
$8,167
$523,287
$2,779






The Company entered into a three-year asset based revolving credit facility dated September 23, 2002 (the "Credit Facility") which provides for a maximum borrowing of $175,000, including letters of credit (“LOC”). The Credit Facility replaced an uncommitted LOC facility (discussed below) and the prior $250,000 credit facility that expired on July 13, 2002.

The Credit Facility is secured with inventory and accounts receivable in the United States, Canada and the U.K., a portion of property and equipment in Canada and the U.K. and the stock of certain subsidiaries. Maximum borrowing allowable under the Credit Facility is determined monthly and is based upon specified percentages of eligible accounts receivable, inventory and fixed assets. The Credit Facility contains restrictions on dividends, limitations on borrowings from affiliates ($30,000), capital expenditures ($68,000 in 2004) and payment of management fees ($5,000 per year). It also has a minimum trailing EBITDA twelve-month fixed charge coverage ratio requirement (as defined) of 1.5 to 1.0 if aggregate availability is less than $25,000, 1.25 to 1.0 if aggregate availability is between $25,000 and $50,000 and 1.1 to 1.0 if aggregate availability is between $50,000 and $75,000. There are no fixed coverage ratio requirements when aggregate availability exceeds $75,000. As of December 31, 2003, the maximum borrowing allowable under the Credit Facility was approximately $144,000, of which approximately $98,000, net of LOCs, was unused and available; therefore, the Company had no fixed charge coverage ratio requirements.
 
Under the terms of the 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 75 basis points and for any LIBOR borrowing is 225 basis points. As of December 31, 2003 there were borrowings of $220 outstanding under the prime rate option, equivalent to 6.0%. For LOCs issued under the Credit Facility, the Company pays a per annum fee equal to the LIBOR applicable margin, or 2.25%, plus a fronting fee of .125%. In addition, the Company pays a .50% per annum fee on the amount of the revolving loan commitment less any borrowings or outstanding LOCs. The Company incurred commitment fees of $557 in 2003 related to the Credit Facility.

Under an uncommitted LOC facility, the Company provided cash collateral equivalent to 101% of LOCs outstanding which was classified as Restricted cash on the Consolidated Balance Sheet as of December 31, 2002. In early July 2003, the Company completed the process of transferring all the LOCs under this facility to the Credit Facility.

The Company’s Australian subsidiary entered into a five-year asset-backed credit facility in the fourth quarter of 2003 (the "Australian facility"), which provides for a maximum borrowing of AUD$19,900, or approximately $15,000. At December 31, 2003, outstanding debt under this facility was $12,178, of which $7,670 is classified as long-term. In addition, there were approximately $400 of outstanding LOCs under the facility. The Australian facility provided the funding for the Fentak acquisition made in the fourth quarter of 2003 (see Note 5) and is secured by mortgages on the fixed assets of the Australian business and the stock of Australian subsidiaries. This facility includes a fixed rate facility used for the acquisition, as well as a revolver. 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 $330). The Australian facility requires semi-annual principal reductions based on a portion of excess cash as defined in the agreement. As of December 31, 2003, of the maximum borrowing allowable under the Australian Facility, AUD$3,178 (approximately $2,400) was unused and available.

Additional international credit facilities provide availability totaling approximately $29,900. Of this amount, approximately $15,900 (net of LOCs and other guarantees of approximately $7,700 and $2,300 of other draws) was available to fund working capital needs and capital expenditures at December 31, 2003. Of the total $2,310 of outstanding debt, $1,419 was classified as long-term. There is an additional $4,000 available for which usage is restricted to capital investments and for foreign currency hedging. While these facilities are primarily unsecured, portions of the lines are secured by equipment and with $1,442 of cash. 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 Borden Foods Holding Corporation (“Foods”) during 2003. See Note 20.

HAI entered into a three-year asset based revolving credit facility on January 28, 2004, which provides for a maximum borrowing of $20,000 (the “HAI facility”). The HAI facility replaced the affiliated loan agreement with Foods. The HAI facility is secured with inventory, accounts receivable and property and equipment of HAI. Maximum borrowing allowable under the HAI facility is based upon specific percentages of eligible accounts receivable and inventory.  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 2004). In addition, HAI is required to maintain a minimum trailing twelve-month debt coverage ratio of 1.5 to 1.0.

The Company finances certain insurance premiums outside of the Credit Facility. Short-term borrowings include $2,548 and $975 related to this arrangement at December 31, 2003 and 2002, 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 elimination of this LOC increased availability under the Credit Facility.

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, 2003, for the Company are as follows:

Year
Debt
Minimum Rentals Under Operating Leases



2004
$ 8,167
$12,120
2005
2,219
10,205
2006
1,841
7,882
2007
1,420
5,961
2008
3,609
4,302
2009 and beyond
520,877
3,789


 
$538,133
$44,259




Rental expense amounted to $14,595, $14,399 and $19,566 in 2003, 2002 and 2001, respectively.

11.   Income Taxes

Comparative analysis of the Company’s income tax benefit related to continuing operations follows:

 
__________Current__________
 
___________Deferred__________


 
2003
2002
2001
 
2003
2002
2001








Federal
$(9,899)
$(29,479)
$ (363)
 
$4,662
$12,040
$(25,800)
State & Local
(737)
(380)
(4,365)
 
566
187
(805)
Foreign
(246)
11,574
(222)
 
995
3,796
722






 
$(10,882)
$(18,285)
$(4,950)
 
$6,223
$16,023
$(25,883)









In 2001, the Company’s income tax expense related to discontinued operations was $5,600 (see Note 7). The Company's income tax expense from the gain on disposal of discontinued operations was $37,428 in 2001, which is reflected as a reduction to shareholders' equity due to the affiliated nature of the transaction (see Note 1).

A reconciliation of the Company’s difference between income taxes related to continuing operations computed at Federal statutory tax rates and provisions for income taxes is as follows:

 
2003
2002
2001




Income taxes computed at Federal statutory tax rate
$ 6,411
$ (3,157)
$(58,602)
State tax provision, net of Federal benefits
(111)
(193)
(5,842)
Foreign tax differentials
(813)
3,502
1,187
Foreign source income also subject to U.S. taxation
9,324
1,777
12,397
Losses and other expenses not deductible for tax
373
(863)
2,723
Impairment of non-deductible goodwill
-
-
31,692
Valuation allowance
5,401
16,672
-
Elimination of deferred tax liabilities of BCPM
(1,624)
-
-
Capital loss on sale of Melamine
(19,936)
-
-
Adjustment of prior estimates and other
(3,684)
(20,000)
(14,388)



Income tax benefit
$(4,659)
$(2,262)
$(30,833)





The 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 this additional basis was not recognized until the stock sale was completed in 2003. This benefit is a capital loss carryforward that can only be used against capital gains; therefore, a valuation reserve was established for the full amount of this benefit. The 2003 consolidated rate also reflects a reduction of the valuation reserve in the amount of $14,534 related to benefits which the Company now believes are more likely than not to be realized. The 2003 tax rate also reflects the elimination of $1,624 of deferred tax liabilities associated with the BCPM bankruptcy. In addition, reserves for prior years’ Canadian and U.S. tax audits were reduced 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.

The 2002 consolidated tax rate reflects a valuation allowance in the amount of $16,672 recorded against the benefit of certain deferred interest expense deductions, which are subject to usage limitations by the Internal Revenue Service (“IRS”), that are no longer more likely than not to be used. This expense is offset by the reduction of a $20,000 reserve for U.S. Federal income tax audits reflecting preliminary settlement of certain matters for the years 1998 and 1999 that were resolved in 2002.

The 2001 consolidated tax rate includes a $31,692 effect of the non-deductible impairment of the fixed assets and goodwill related to the 2001 shutdown of Melamine. Additionally, tax expense of $12,397 is reflected in the tax rate for the impact of earnings related to the expected sale of foreign businesses that are no longer expected to be permanently reinvested in foreign locations, as well as the inability to use foreign tax credits associated with those earnings due to usage limitations. Offsetting this charge was a tax benefit of $14,388 relating to the settlement of U.S. Federal income tax audits for the years 1987 to 1991 that were finalized in 2001.

The domestic and foreign components of the Company’s Income (loss) from continuing operations before income taxes are as follows:

 
2003
2002
2001




Domestic
$(30,706)
$(42,929)
$(165,478)
Foreign
49,023
33,909
(1,959)



 
$ 18,317
$ (9,020)
$(167,437)






The tax effects of the Company’s significant temporary differences, and loss and credit carryforwards, which comprise the deferred tax assets and liabilities at December 31, 2003 and 2002, are as follows:
 
2003
2002



Assets
 
 
Non-pension postemployment benefit obligations
$ 46,261
$ 52,411
Accrued and other expenses
75,493
91,332
Loss and credit carryforwards
162,308
169,302
Pension liability
23,448
23,071


Gross deferred tax assets
307,510
336,116
Valuation allowance
(81,992)
(89,321)


 
225,518
246,795
 
 
 
Liabilities
 
 
Property, plant, equipment and intangibles
77,558
76,107
Foreign property, plant, equipment and other
9,338
5,975
Prepaid pension
2,404
293
Deferred gain on sale of a partnership interest
-
17,264
Other prepaids and intangibles
(277)
1,300


Gross deferred tax liabilities
89,023
100,939


 
 
 
Net deferred tax asset
$136,495
$145,856




The Company's net deferred tax asset at December 31, 2003 was $136,495, which is the net of $140,519 of deferred tax assets and a $4,024 current deferred tax liability. Of this amount, $139,336 represents net domestic deferred tax assets related to future tax benefits. The Company's deferred tax asset related to loss and credit carryforwards, net of valuation allowance is $80,316. The deferred tax assets are reduced by a valuation allowance when it is determined that it is more likely than not that these assets will not be fully utilized in the future. This $80,316 includes net operating loss carryforwards and future deductions of $43,369 for U.S. federal tax purposes, which will begin expiring in 2021. This amount also includes minimum tax credits of $33,132, which do not expire, and other available carryforwards of $3,815, with various expiration dates.

Realization of the $139,336 net domestic deferred tax asset is dependent on generation of approximately $400,000 of future taxable income. The Company has certain business strategies that it would execute before any material deferred tax assets would go unused.

Credit carryforwards and valuation allowances both decreased from 2002 principally due to the expiration of foreign tax credits and the valuation allowances previously established against those credits. Loss carryforwards increased from 2002 due to the generation of additional net operating loss carryforwards in 2003.

At December 31, 2003, the Company has approximately $66,000 accrued for probable tax liabilities, of which $19,800 is recorded in other current liabilities and $46,200 is recorded in other long-term liabilities. Of the $66,000, approximately $35,000 relates to the provision for taxes on foreign unrepatriated earnings, and the balance of $31,000 relates to U.S. Federal, state and local and Canadian taxes.

The IRS has substantially completed audits of all years through 1999, and unresolved issues for the years 1994-1999 are currently under discussion with the Appeals Office of the IRS and the Competent Authority group of the U.S. Treasury Department. These unresolved issues generally include appropriateness of: expense allocations and royalty charges between U.S. and foreign jurisdictions, compensation excise tax assessments, certain carryback claims filed by the Company and the treatment of various business sale transactions undertaken by the Company during the period. The IRS has substantially completed the audit of tax years 2000-2001, and the results have been discussed and agreed upon by the Company. The years 2002 and 2003 remain open for examination.

The 2003 consolidated tax rate reflects the reversal of $3,997 of the aforementioned tax reserves. This reversal reflects the settlement of potential U.S. Federal, state and local tax matters, an adjustment of foreign tax credits available for future use, Canadian audit issues related to the divestiture of operating businesses in prior years and the settlement of other audit related tax issues offset by the utilization of available tax assets.

The Canada Revenue Agency is currently auditing the Company’s Canadian subsidiary for the period 1993-1994. The years 1995-2003 remain open for inspection and examination by various Canadian taxing authorities. Deposits have been made to offset any probable additional taxes related to the divestiture of Canadian operating businesses. Since 1995, the Company has divested its Foods, Consumer Adhesives, and wallcoverings businesses, all of which had operations in Canada.

The Company and some of its affiliates have historically operated in over forty states across the U.S. Since 1995, the Company has divested a significant number of its businesses and generated significant taxable gains from these sales and divestitures. The Company has also utilized certain affiliated legal entities for the purposes of licensing its intellectual properties to related and unrelated parties and for providing loans and other financing for operations. Reserves have been established to provide for probable additional tax liabilities related to these transactions. As the various state and city taxing jurisdictions continue with their audit/examination programs, and as the corresponding audit years are finalized at the U.S. federal audit level, the Company will adjust its reserves to reflect these settlements.

The Company has not recorded income taxes applicable to undistributed earnings of foreign subsidiaries that are permanently reinvested in foreign operations. Undistributed earnings permanently reinvested amounted to approximately $173,400 at December 31, 2003.

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 employees based on eligible compensation and years of credited service and for hourly employees 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.

 
     

 
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.

 
2003
2002
Change in Benefit Obligation
 
 
 
 
 
Benefit obligation at beginning of year
$263,364
$288,107
 
 
 
Service cost
2,316
3,844
Interest cost
15,228
19,148
Actuarial losses
12,038
4,693
Foreign currency exchange rate changes
1,165
84
Benefits paid
(34,403)
(28,942)
Plan amendments
-
330
Acquisitions / divestitures
(325)
-
Settlements/curtailments
(304)
(23,900)


 
259,079
263,364


Change in Plan Assets
 
 
 
 
 
Fair value of plan assets at beginning of year
190,831
260,540
Actual return on plan assets
30,683
(18,000)
Foreign currency exchange rate changes
805
34
Employer contribution
1,770
1,099
Benefits paid
(34,403)
(28,942)
Settlements/curtailments
-
(23,900)


Fair value of plan assets at end of year
189,686
190,831


 
 
 
Plan assets less than benefit obligation
(69,393)
(72,533)
Unrecognized net actuarial loss
122,261
131,658
Unrecognized initial transition gain
21
13
Unrecognized prior service cost   
1,348
2,534


Net amount recognized
$ 54,237
$ 61,672




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

 
2003
2002



Accrued benefit liability
$(67,526)
$(70,216)
Intangible asset
1,348
2,504
Accumulated other comprehensive income
120,415
129,384


Net amount recognized
$ 54,237
$ 61,672




The weighted average rates used to determine benefit obligations for the Company were as follows:

 
2003
2002



Discount rate
5.8%
6.5%
Rate of increase in future compensation levels
4.0%
4.2%




The following summarizes defined benefit pension plans with an accumulated benefit obligation in excess of plan assets:

 
2003
2002



Projected benefit obligation
$259,079
$263,364
Accumulated benefit obligation
256,972
259,655
Fair value of plan assets
189,686
190,831




While the Company reports the entire liability for the U.S. Plan, which is sponsored by the Company, its participants also include certain Foods' former associates and Consumer Adhesives’ associates. Foods and Consumer Adhesives reimbursed the Company for the expense associated with their respective participants in the U.S. plan. Therefore, the tables summarizing the pension activities for the Company’s defined benefit pension plans include the liabilities and assets relating to these businesses. However, the expense table excludes the expense relating to Foods and Consumer Adhesives. Expense reimbursements received by the Company from Foods and Consumer Adhesives totaled $1,061, $1,012 and $952 for 2003, 2002 and 2001, respectively. The Company does not anticipate any future reimbursements from either Foods or Consumer Adhesives.

Following are the components of net pension expense recognized by the Company for the years ended December 31:

 
2003
2002
2001




Service cost
$2,101
$ 3,602
$ 3,352
Interest cost on projected benefit obligation
14,803
16,727
18,701
Expected return on assets
(15,481)
(19,386)
(22,925)
Amortization of prior service cost
386
395
436
Amortization of initial transition asset
10
12
(122)
Recognized actuarial loss
7,116
4,102
3,706
Settlement/curtailment loss
411
13,600
16,300



Net pension expense
$9,346
$19,052
$19,448





The weighted average rates used to determine net pension expense for the Company were as follows:

 
2003
2002
2001




Discount rate
6.5%
7.2%
7.7%
Rate of increase in future compensation levels
4.2%
4.5%
4.7%
Expected long-term rate of return on plan assets
8.2%
8.3%
8.7%





The 2003 curtailment loss includes a $710 charge for the U.S. Plan, partially offset by a curtailment gain of $299 on an international plan. During 2002, the Company recognized a settlement charge of $13,600 related to lump sum payments made by the U.S. Plan. During 2001, the Company recorded settlement and curtailment charges of $10,700 relating to the partial settlement of U.S. Plan liabilities for Foods and an additional $5,600 settlement for other lump sum payments made by the U.S. Plan.

In determining the expected overall long-term rate of return on assets, the Company takes into account the rates on long-term debt investments held within the portfolio, as well as expected trends in the equity markets. Peer data and historical returns are reviewed, and the Company consults with actuarial experts to confirm that the Company’s assumptions are reasonable.

The Company’s investment strategy for defined benefit pension plan assets is to maximize the long-term return on plan assets using a mix of equities and fixed income investments and accepting a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status and expected timing of future cash flow requirements. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value and small and large capital investments. Investment risk and performance is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements and periodic asset / liability studies.

Following is a summary of actual 2003 and 2002, at the measurement date, and target 2004 allocations of Plan assets by investment type:

 
      Actual
Target
 
2003
2002
2004




Fixed income securities
49%
43%
40%
Equity securities
31%
32%
60%
Cash and short-term investments
20%
25%
-



 
100%
100%
100%





The Company recently reviewed its target allocation of plan assets based on projections and expected timing of future benefit payments. Based on this review the Company has set a new allocation target in 2004 of 60% equities and 40% debt. The re-allocation process is expected to be completed by the end of the second quarter of 2004. The Company’s pension portfolio does not include any significant holdings in real estate.

The Company expects to make contributions totaling $870 to its defined benefit plans in 2004.

The Company has been informed by the IRS that cash balance plans may be required to be amended because of recent ERISA rulings that found some cash balance plans to be discriminatory. The IRS indicated that the U.S. Plan should continue to operate as currently designed until new guidance is available. There is insufficient information to assess any potential impact to the Company of the ERISA ruling at this time.

Most employees not covered by the Company’s U.S. and foreign defined benefit pension plans are covered by collective bargaining agreements, which are generally effective for five years. Under Federal pension law, there would be continuing liability to these pension trusts if the Company ceased all or most participation in any such trust, and under certain other specified conditions. The Consolidated Statements of Operations include charges of $472, $504 and $367 in 2003, 2002 and 2001, respectively, for payments to pension trusts on behalf of employees not covered by the Company’s plans.

The Company also provides a defined contribution plan to its U.S. employees (“the Retirement Savings Plan”). Eligible salaried and hourly employees may contribute up to 5% of their pay (7% for certain longer service salaried employees), as basic contributions to the plan. The Company contributes monthly to the plan an amount equal to at least 50% and up to 100% of basic contributions. The Company has the option to make additional contributions based upon financial performance. Charges to operations for matching contributions under the Retirement Savings Plan in 2003, 2002 and 2001 totaled $6,560, $5,647 and $5,289 respectively.

    13. Non-Pension Postretirement Benefit

The Company provides certain health and life insurance benefits for eligible domestic and Canadian retirees and their dependents. The cost of postretirement benefits is accrued during employees’ working careers. Domestic participants who are not eligible for Medicare are generally provided with the same medical benefits as active employees. Until September 2003, participants who were eligible for Medicare were provided with supplemental benefits. In September 2003, the plan was amended, as is discussed below. Canadian participants are provided with supplemental benefits to the national healthcare plan in Canada. The domestic postretirement medical benefits are contributory; the Canadian medical benefits are non-contributory. The domestic and Canadian postretirement life insurance benefits are non-contributory. Benefits are funded on a pay-as-you-go basis.

In 2003, the Company amended its medical benefit plan such that, effective September 1, 2003, medical benefits are no longer provided to the Company’s retirees and their dependents who are over age 65. The Company has made an arrangement 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. The Company is subsidizing a portion of the cost of coverage for affected retirees and dependents through December 2004 to assist retirees’ transition to alternative medical coverage. The Company has reserved the right to continue, terminate or reduce the subsidy provided to affected retirees and dependents in the future. This subsidy will be reviewed for periods after December 2004. As a result of these actions, based on current actuarial estimates and assumptions, the Company’s liability related to providing post-retirement medical benefits has been reduced by approximately $88,000. The Company’s unrecognized prior service cost has been adjusted for the impact of the amendment, and the adjustment is being amortized over the estimated remaining years of service of approximately nine years.

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) that provides several options for Medicare eligible participants and employers, including a federal subsidy to companies that elect to provide a retiree prescription drug benefit which is at least actuarially equivalent to Medicare Part D. The Act provides for a two-year transitional period to allow for, among other items, the possibility that companies may amend existing plans. There are significant uncertainties regarding the eventual regulations required to implement the Act, as well as the Act’s overall affect on plan participant’s coverage choices and the related impact on their health care costs. As such, the effects of the Act are not reflected in the accumulated postretirement benefit obligation as of December 31, 2003 or in the 2003 net periodic postretirement benefit cost. Once the regulations regarding the implementation of the Act and FASB’s authoritative guidance on the accounting for the federal subsidy is issued, the Company may be required to change its previously reported information. The Company is currently evaluating the provisions of the Act and its potential impact to the Company’s postretirement medical plans.

Following is a rollforward of the changes in the non-pension postretirement benefit obligations of the Company for the years ended December 31. The Company uses a measurement date of September 30.

 
2003
2002



Change in Benefit Obligation
 
 
 
 
 
Benefit obligation at beginning of year
$131,609
$128,499
Service cost
72
64
Interest cost
3,938
8,822
Contributions by plan participants
2,176
2,797
Actuarial (gains) losses
(4,683)
5,240
Plan amendments
(88,168)
-
Benefits paid
(12,889)
(13,818)
Foreign exchange
150
5


Benefits obligation at end of year
32,205
131,609
 
 
 
Unrecognized net actuarial gain
3,809
496
Unrecognized prior service benefit
86,830
7,214


Accrued postretirement obligation at end of year
$122,844
$139,319




The weighted average rates used to determine benefit obligations for the Company were as follows:

 
2003
2002



Discount rate
5.8%
6.5%




The net postretirement (benefit) expense table excludes the expense related to Foods for 2002, as Foods reimbursed the Company $509 for the expense related to Foods' participants in that year. Foods reimbursed the Company in 2001 to assume their remaining postretirement liability following the sale of its businesses.

Following are the components of net postretirement (benefit) expense recognized by the Company for 2003, 2002 and 2001:

 
2003
2002
2001




Service cost
$ 72
$ 64
$ 44
Interest cost on projected benefit obligation
3,938
8,249
7,884
Amortization of prior service cost
(8,552)
(3,294)
(8,923)
Recognized actuarial gain
(122)
(1)
(523)
Settlement/curtailment gain
-
-
(487)



Net postretirement (benefit) expense
$(4,664)
$5,018
$(2,005)





The weighted average rates used to determine net postretirement (benefit) expense for the Company were as follows:

 
2003
2002
2001




Discount rate
6.5%
7.3%
7.7%





Following are the assumed health care cost trend rates at December 31, which are no longer significant due to the 2003 plan amendment.

 
2003
2002



Health care cost trend rate assumed for next year-pre-age 65
5.25%
5.25%
Health care cost trend rate assumed for next year-post-age 65
7.75%
8.25%
Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)
5.25%
5.25%
Year that the rate reaches the ultimate trend rate
2008
2008



A one-percentage-point change in the assumed health care cost trend rates would not have a material impact on the Company.

 
1% increase
1% decrease


Effect on total service cost and interest cost components
$ 9
$ (10)
Effect on postretirement benefit obligation
145
(150)




Also included in the Consolidated Balance Sheets at December 31, 2003 and 2002 are other postemployment benefit obligations of $5,879 and $6,065, respectively.

    14. Shareholders’ Deficit

Common Stock and Warrants
The Company has 200,895,628 shares of $0.01 par value common stock issued and outstanding and 300,000,000 shares authorized. At December 31, 2003, management held a total of 1,920,634 common shares of the Company, including 1,587,301 shares of restricted stock granted during 2002, which become unrestricted on the third anniversary of the grant date. During 2002, the Company sold 333,333 shares to management at the estimated fair value of $2.25 per share. In 2002, the Company repurchased shares and retired warrants at amounts greater than fair market value and recognized compensation expense of $487.

Preferred Stock
The Company is authorized to issue up to 100,000,000 shares of Series A Preferred Stock. There were no shares outstanding in 2003 or 2002, and the Company currently has no plans to issue Preferred shares. In 2001, the Company had 24,574,751 shares of Preferred Stock issued to BHI. Each share had a liquidation preference of $25.00 and was entitled to cumulative dividends at an annual rate of 12% payable quarterly in arrears. BHI contributed all of the outstanding Preferred Stock of $620,922, including accumulated dividends of $6,553 to the Company as a capital contribution in 2001 (see Note 3). During 2001, the Company declared preferred stock cash dividends of $61,846.

Other Shareholders’ Equity
There were no common stock dividends declared in 2003 and 2002. The Company declared common stock cash dividends of $36,434 in 2001. The dividends were recorded as a charge to Paid-in capital to reflect a return of capital to BHI.

At December 31, 2003, the Company held $404,817 of notes receivable from BHI, which accrue interest at 12% per year, payable quarterly, and mature on September 29, 2005. The notes were received from affiliates as proceeds from the 1996 sales of businesses and options to purchase businesses formerly owned by the Company. The Receivable from parent, reflected as a reduction in the Consolidated Statements of Shareholders' Deficit, includes accrued interest of $107,277, $58,699 and $0 related to these notes receivable at December 31, 2003, 2002 and 2001. Paid-in capital includes the related net of tax interest income of $31,576, $38,154 and $24,674 for the years ended December 31, 2003, 2002 and 2001. In the Company’s 2001 Annual Report on Form 10-K, the Company expressed its intention to cancel this note receivable; therefore; a valuation allowance was placed on the accrued interest at that date. During 2002, the Company decided to defer canceling the note, reversed this valuation allowance and resumed accruing the related interest. Historically, BHI funded the payment of the interest on the note through common dividends received from the Company. BHI has not made a payment on the accrued interest, nor has the Company paid an associated dividend, since October 15, 2001.

Deferred compensation expense of $3,571, related to the restricted shares granted in 2002, is being amortized over the three-year vesting period. At December 31, 2003, the unamortized deferred compensation was $1,488.

Capital Contributions
Following is a summary of capital contributions received by the Company during 2003, 2002 and 2001:

 
2003
2002
2001



Income tax benefits
$17,002
$20,890
$21,038
Non-compete agreement
5,000
-
-
Foods pension liability payment
4,300
-
-
Capital wind-down costs
-
3,550
-
Preferred stock and accumulated dividends
-
-
620,922
Cash contributions
-
-
17,000



 
$26,302
$24,440
$658,960





BHI contributed tax benefits to the Company of $17,002, $20,890 and $21,038 during 2003, 2002 and 2001, respectively. The Company is included in BHI’s tax return, and the deductible interest expense on BHI’s notes payable reduces the Company’s tax liability.

BHI also made a $5,000 payment to the Company in 2003, relating to a non-compete agreement entered into by BHI with the third party purchaser of Consumer Adhesives, which was sold by BWHLLC in the fourth quarter of 2003. The Company does not currently market the product line disallowed under the agreement and has no plans to market such a product; therefore, there is no impact on the Company’s operations resulting from the non-compete agreement. This amount is reflected in Paid-in capital because BHI is a related party.

In the fourth quarter of 2003, Foods made a $4,300 payment to the Company related to the U.S. pension obligation retained upon the sale of Foods’ operations. This payment is reflected as a credit to Paid-in capital because it is a related party transaction.

During 2002, the Company also recorded a capital contribution from BHI of $3,550 (net of tax) related to the allocation of Capital wind-down costs to the Company, which the Company had no responsibility to fund. See Note 3.
 
Other Equity Transactions
In 2001, the Company recorded a pre-tax gain on the Consumer Adhesives Sale of $132,275, which was recorded in Paid-in capital. In 2002, the Company sold its remaining investment of a $110,000 note receivable from Consumer Adhesives for face value plus accrued interest. In 2003, the Company recorded an adjustment of $5,925 in Paid-in capital to reflect additional tax expense associated with the sale of the $110,000 note receivable. See Note 1.

The Corporate Reorganization resulted in the issuance of shares of common stock of the Company and warrants to purchase common stock to certain management members, in exchange for the shares they held in BCHI. This resulted in an increase to Paid-in capital of $1,236 in 2001, the value of the minority interest liability that represented their previous interest in BCHI.

The Company recorded net of tax minimum pension liability adjustments of $5,830, $(17,075) and $(66,580) for 2003, 2002 and 2001, respectively, relating to underfunded pension plans, which is included in accumulated other comprehensive income.

    15. Stock Option Plans and Other Stock Based Compensation

Stock Options
The Company accounts for stock-based compensation under APB No. 25 and has adopted the disclosure-only provisions of SFAS No. 123 "Accounting for Stock-Based Compensation.” The Company has granted options under its Amended and Restated 1996 Stock Purchase and Option Plan for Key Employees (“the Option Plan”).

Following is a summary of option activity for the three years ended December 31, 2003:

 
                 2003                  
                 2002                   
                  2001                 
 
 
Shares
Weighted Average Exercise Price
 
Shares
Weighted Average Exercise Price
 
Shares
Weighted Average Exercise Price







Options outstanding beginning of year
3,426,040
$3.59
6,871,380
$4.38
4,382,500
$5.43
Options exercised
-
-
-
-
-
-
Options granted
3,457,500
2.00
1,492,000
2.25
-
-
Option conversion
-
-
-
-