ITEM 1. BUSINESS - -------- -------- (dollars in thousands except per share data)
Current Description Summary - -----------------------------
The Company, Borden Chemical, Inc. (formerly Borden, Inc.) was incorporated on April 24, 1899. After the third quarter 2001 sale of the Consumer Adhesives business ("Consumer Adhesives") to an affiliate, the Company's sole remaining business is the Chemical business. The Company is engaged primarily in the manufacture and distribution of forest products and industrial resins, formaldehyde, coatings and other specialty and industrial chemicals worldwide. The Company's executive and administrative offices are located in Columbus, Ohio. Chemical production facilities are located throughout the United States and in many foreign countries.
In fourth quarter 2001, the Company merged with its subsidiaries, Borden Chemical Holdings, Inc. and Borden Chemical, Inc., executed certain financial transactions with its parent, Borden Holdings, Inc. ("BHI"), and changed its name to Borden Chemical, Inc. (the "Corporate Reorganization") reflecting the fact that the only remaining business of the Company is the Chemical business. The Corporate Reorganization simplified the legal structure, strengthened the capital structure and reduced overhead 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 the Company's parent. Subsequent to the Corporate Reorganization, Capital provided certain management, consulting and board services for the Company as well as for other entities owned by Kohlberg, Kravis, Roberts & Co. (KKR) and charged fees to the Company and the other entities for these services.
During the 2002 year, the Company's parent decided to wind down Capital's operations, with the cessation of operations expected to occur during the first half of 2003. Certain management, consulting and board services previously provided to the Company by Capital will be assumed by the Company, while other such services will continue to be provided to the Company by KKR for an annual fee.
Beginning in 2002, the Company reports three operating segments rather than one, as previously reported, to better reflect the ongoing internal organization. Prior periods have been restated to reflect this change. See Note 21 to Consolidated Financial Statements.
Historical Perspective - -----------------------
On March 14, 1995, affiliates of KKR acquired control of the Company. In late 1995, the Company began the process of redesigning its operating structure in order to maximize value for its owners and determined that certain businesses did not fit into its long-term strategic plan. At the end of 1995, the Company consisted of the following business segments: Chemical, Food, Other Consumer Products, Decorative Products, Dairy and businesses held for sale. All of these businesses were subsequently sold except for Chemical.
The Company has made various acquisitions and divestitures and has also undertaken numerous plant closing and other business realignment initiatives primarily related to the Chemical business (discussed below). Following is a summary by year of the Company's significant transactions impacting recent years' operations.
In 1997, the Company acquired Melamine Chemicals, Inc., a major producer of melamine crystal, for which a substantial amount of production was to be used internally to produce forest products and industrial resins.
In 1998, the Company sold Decorative Products (the entire Decorative Products segment) to an unrelated third party. Also that year the Company acquired a melamine resins and compounds business (a component of the Chemical segment) from Sun Coast Industries, Inc.
In 1999, the Company acquired Blagden Chemicals, LTD. in the United Kingdom and Spurlock Industries, Inc. in the U.S. (both Chemical segment). Blagden produces formaldehyde, forest products and industrial resins. Spurlock produces formaldehyde and forest products resins.
In 2000, the Company acquired the formaldehyde and certain other assets from Borden Chemical and Plastic Operating Limited Partnership, an affiliate of the Company, and East Central Wax, an unrelated wax emulsions producer for the forest products business (both Chemical segment). In 2000, the Company also acquired certain assets and liabilities of a Canadian based business that produces various consumer adhesive and glue products (included in the Consumer Adhesives segment prior to its sale).
In August 2001, an option, sold to BW Holdings, LLC ("BWHLLC") in 1996, to purchase 74% of the common shares of Consumer Adhesives was exercised. The Company is controlled by BWHLLC. At the same time, another company controlled by BWHLLC purchased the remaining 26% of Consumer Adhesives common shares (collectively the "Consumer Adhesives Sale"). At December 31, 2001 the Company still held a $110,000 investment in Consumer Adhesives preferred stock. On March 1, 2002, the Consumer Adhesives preferred stock was redeemed for a $110,000 note receivable from Consumer Adhesives. On March 12, 2002, the note receivable was sold to BHI for $110,000 in cash plus accrued interest, with the proceeds being used to repay affiliated debt. Consequently, Consumer Adhesives is reported as a discontinued operation in the Company's financial statements for all periods presented. Also in 2001, the Company and Delta-HA, Inc. merged their North American foundry resins and coatings businesses to form HA-International in which the Company has a 75% interest.
Chemical Realignment and Corporate Reorganization - -----------------------------------------------------
In addition to acquisitions and divestitures discussed above, the Company has undertaken numerous plant closing and other business realignment initiatives primarily related to the Chemical business. These initiatives were designed to improve the effectiveness and efficiency of the Chemical business and to focus the Company's resources on its core strengths. Such business realignment charges have consisted primarily of employee severance, plant closure and environmental remediation costs and asset write-offs. The Company has also recently completed a reorganization of its corporate headquarters function and its capital structure. The following is a brief overview of business realignment activities since 1999.
In 1999, the Company recorded $41,572 of business realignment charges related to the closure of Chemical plants in Brazil, Uruguay and the Philippines and to discontinue a domestic Chemical plant construction project.
In 2000, the Company recorded $38,100 of business realignment charges related to the closure of two forest products plants in the U.S., a formaldehyde and resins plant in the U.K. resulting from the Blagden acquisition, and a formaldehyde and resins plant in Argentina.
In 2001, the Company recorded $126,408 of business realignment charges related primarily to the closures of its melamine crystal plant and two forest products plants in the U.S., realignment of its North American workforce organization, reorganization of its corporate headquarters and the discontinuance of a plant construction project. The largest component of the 2001 charge is a $98,163 impairment of melamine crystal fixed assets, spare parts and goodwill that was the result of the Company's strategic decision late in 2001 to sell or close this plant and to enter into a long-term contractual arrangement with a major supplier for a substantial portion of the Company's future melamine crystal needs.
In 2001, the Company also completed a significant capital restructuring, which consisted primarily of a capital contribution of $614,369 of preferred stock held by the Company's parent. 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, the Company's parent made a cash capital contribution and purchased certain financial assets from the Company for cash in amounts that management believed approximated fair value. The cash contribution and the cash received from sale of assets allowed the Company to substantially repay its affiliated debt as of December 31, 2001.
In March 2002, the Company further paid down its affiliated debt with proceeds received from the sale, to its parent, of its remaining financial investment in Consumer Adhesives.
PRODUCTS Below are the Company's primary products by operating segment:
North American Forest Products: formaldehyde and forest products resins.
North American Performance Resins: specialty, oilfield, industrial, nonwoven, laminate and foundry resins, and UV coatings.
International: formaldehyde, forest product and performance resins.
MARKETING AND DISTRIBUTION Domestic products are sold primarily by in-house sales forces to industrial users. To the extent practicable, international distribution techniques parallel those used in the United States. 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 The Company is the leading global producer of thermosetting resins for the forest products industry and a leading producer of thermosetting resins for industrial and foundry applications. These resins are used to bind or coat other materials during the manufacturing process. The Company is also the world's largest producer of formaldehyde. Approximately 50% of the formaldehyde is consumed internally to produce thermosetting resins, with the remainder sold to third parties. UV Coatings are produced for fiber optics coating applications. The Company manufactures and distributes its products worldwide with the most significant markets being North America, Western Europe, Latin America, Australia, and Malaysia and, generally, holds a leading market position in the areas in which it competes. 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. The major competitors are Ashland Specialty Chemical Company, Georgia Pacific Corporation, Dynea, and several regional domestic and international competitors. Price, customer service and product performance are the primary areas in which the Company competes.
MANUFACTURING AND RAW MATERIALS The primary raw materials used by the Company, in all 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.
The Company uses long-term purchase agreements for its primary and other raw materials in certain circumstances to assure availability of adequate supplies at specified prices.
CUSTOMERS The Company does not depend on any single customer nor is any business limited to a particular group of customers, the loss of which would have a material adverse effect on the business. The primary customers consist of manufacturers, and the business is generally not seasonal.
PATENTS AND TRADEMARKS The Company owns various patents, trademark registrations and patent and trademark applications in all operating segments around the world which are held for use or currently used in its operations. A majority of the patents relate to the development of new products and processes for manufacturing and use thereof and will expire at various times between 2003 and 2013. No individual patent is considered to be material.
RESEARCH AND DEVELOPMENT Research and development expenditures were $19,080, $22,717 and $22,202 in 2002, 2001 and 2000, respectively. Development and marketing of new products are carried out at the business unit level and integrated with quality control for existing product lines.
EMPLOYEES At December 31, 2002, the Company had approximately 2,600 employees. Relationships with 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 those reports are available to the public from the Securities and Exchange Commission at its website http://sec.gov or free of charge from Investor Relations which can be accessed through the Company's internet website at http://bordenchem.com. ------------------------
ITEM 2.
ITEM 2. PROPERTIES - ------- ----------
As of December 31, 2002, the Company operated 27 domestic production and manufacturing facilities in 16 states, the most significant being a plant in Louisville, Kentucky. In addition, the Company operated 21 foreign production and manufacturing facilities primarily in Canada, South America, Europe, Australia and Malaysia.
The Company's manufacturing and processing facilities are generally well maintained and effectively utilized. Substantially all facilities are owned. The Company leases its corporate headquarters in Columbus, Ohio.
The Company is actively engaged in complying with environmental protection laws, as well as various federal, state and foreign statutes and regulations relating to manufacturing, processing and distributing its many products. In connection with this, the Company incurred capital expenditures of $3,641 in 2002, $1,190 in 2001 and $752 in 2000. The Company estimates $8,047 will be spent for capital expenditures in 2003 for environmental controls at its facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - ------- ------------------
Environmental Proceedings - -------------------------- The Company has been notified that it is or may be a potentially responsible party with respect to the cleanup of approximately 35 sites in active proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") or similar state environmental laws. The Company's ultimate liability will depend on many factors including its volumetric share of waste, the financial viability of other responsible parties, the remediation methods and technology used, the amount of time necessary to accomplish remediation and the availability of insurance coverage. While the Company cannot predict with certainty the total cost of such cleanup, the Company has recorded liabilities of approximately $34,000 and $35,000 at December 31, 2002 and 2001, respectively, for environmental remediation costs for these sites in amounts that it believes are probable and reasonably estimable. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may exceed current reserves by amounts ranging from insignificant to approximately $26,000, in the aggregate. This estimate of the range of reasonably possible additional costs is less certain than the estimates upon which reserves are based, and in order to establish the upper limit of such range, assumptions less favorable to the Company among the range of reasonably possible outcomes were used. In estimating both its current reserves for environmental remediation and the possible range of additional costs, the Company has not assumed that it will bear the entire cost of remediation of every site to the exclusion of other known potentially responsible parties who may be jointly and severally liable. The ability of other potentially responsible parties to participate has been taken into account, based generally on the parties' probable contribution on a per site basis.
In addition to the 35 sites referenced above, the Company is conducting voluntary clean-ups at approximately 20 other locations. The Company has accrued approximately $10,000 and $8,400 at December 31, 2002 and 2001, respectively, for remediation and restoration liabilities at these locations. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may exceed current reserves by amounts ranging from insignificant to approximately $13,000, in the aggregate if assumptions less favorable to the Company among the range of reasonable possible outcomes were used. (See Note 24 to the Consolidated Financial Statements).
During the fourth quarter of 2002, the Company settled its involvement in three superfund sites by making payments totaling $750.
Private actions against the Company and numerous other defendants are pending in U.S. District Court in Baton Rouge, Louisiana, alleging personal injuries and property damage in connection with a waste disposal site in Louisiana.
On October 22, 2002 the U.S. Bankruptcy Court for the District of Delaware approved a Settlement Agreement among the Company, Borden Chemicals and Plastics Operating Limited Partnership ("BCPOLP"), BCP Management, Inc. ("BCPM"), the US Environmental Protection Agency and the Louisiana Department of Environmental Quality, whereby the Company agreed to perform certain of BCPOLP's obligations with respect to environmental remediation at BCPOLP's Geismar, Louisiana site.
Affiliate Bankruptcy Proceedings - ----------------------------------
The Company's 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 has served as the general partner of Borden Chemicals and Plastics Operating Limited Partnership ("the Partnership") which was created in November 1987 and operated as a commodity chemicals producer. On April 3, 2001 the Partnership 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 US Bankruptcy Court approved a Joint Plan of Liquidation for the Partnership and BCPM (the "Joint Plan") which provides 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 agents for liquidation and distribution to their creditors. The Company's ownership interest in BCPM will be extinguished and no distributions from BCPM to the Company are anticipated. The Company recorded charges totaling $30,000 for calendar years 2000 and 2001 to reduce the value of the Company's investment in BCPM to zero. No claims have been filed against the Company in connection with these bankruptcy proceedings; however, no assurance can be given that such claims will not be made in the future.
Imperial Home Decor 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 merged with an acquisition vehicle created by Blackstone, which subsequently merged with Imperial Wallcoverings to create Imperial Home Decor Group ("IHDG"). Blackstone provided $84,500 in equity and Chase provided $295,000 in senior financing. Borden received approximately $314,400 in cash and 11% of IHDG common stock for its interest in BDPH. On January 5, 2000, IHDG filed for reorganization under Chapter 11 of the U. S. Bankruptcy Code. IHDG emerged from bankruptcy in April 2001. 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 pending in the case with a cut-off currently scheduled for December 2003. The Company believes it has strong defenses to the Trust's allegations and intends to defend the case vigorously.
Brazilian Excise Tax Administrative Appeal - ----------------------------------------------
In 1992, the State of Sao Paolo Tax Bureau issued an assessment against the Company's primary Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes, characterized by the Tax Bureau as intercompany sales. Until 1996, discussions continued between the subsidiary's management and the Tax Bureau which resulted in a downward adjustment in the assessment, at which time the Company's Brazilian subsidiary filed an administrative appeal seeking cancellation of the assessment and, alternatively, a new audit of the company's records. In December 2001, following completion of the second audit, the Administrative Court upheld the assessment in the amount of $R 40,600, including tax, penalties, monetary correction and interest, or approximately $11,000. In September 2002, the Company's Brazilian 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. The Company believes it has 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.
Other Legal Proceedings - -------------------------
The Company is involved in other litigation throughout the United States, which is 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. The Company believes it has adequate reserves and insurance and does not believe it has a material asbestos exposure.
Anticipated Impact - -------------------
Management believes, based upon the information it currently possesses, and taking into account its established reserves for estimated liability, that the ultimate outcome of the foregoing environmental and legal proceedings and actions is unlikely to have a material adverse effect on the Company's financial position or operating results.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - -------- -----------------------------------------------------------
During the fourth quarter of 2002, no matters were submitted to a vote of the Company's security holders.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY - -------------------------------------------------------- AND RELATED STOCKHOLDER MATTERS - ----------------------------------
The Company's authorized common stock consists of 300,000,000 shares with a par value of $0.01 per share. As of December 31, 2002, 200,923,628 common shares were issued and outstanding, of which 99.0% are controlled by affiliates of KKR with the remainder held by thirteen members of management. No shares of such common stock trade on any exchange. The Company declared no dividends on common stock in 2002 and declared $36,434 and $61,578 in dividends in 2001 and 2000, respectively. The Company's ability to pay dividends on its common stock is restricted by its Loan and Security Agreement with certain banks (see Notes 12 and 16 to the Consolidated Financial Statements).
The following table contains certain information regarding the Company's 1996 Stock Purchase and Option Plan for Key Employees, which is administered by the Compensation Committee of the 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 17 to the Consolidated Financial Statements).
EQUITY COMPENSATION PLAN INFORMATION
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA - -------- -------------------------
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - -------- ------------------------------------------------------ CONDITION AND RESULTS OF OPERATIONS ---------------------------------------
CRITICAL ACCOUNTING POLICIES: - ------------------------------- The Company's significant accounting policies are more fully described in Note 3 to the Consolidated Financial Statements. As disclosed in Note 3 to the Consolidated Financial Statements, preparation of financial statements in conformity with generally accepted accounting principles requires management 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. Estimating and predicting future events requires the exercise of judgment and cannot be done with absolute certainty; consequently, there can be no assurance that actual results will not differ significantly from estimated results.
The most significant accounting policies, which reflect significant management estimates, in determining reported amounts in the Consolidated Financial Statements and/or Notes thereto are as follows:
Asset impairments - The Company periodically evaluates the recoverability of property, equipment and investments by assessing whether the carrying value can be recovered over its remaining useful life 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 asset to operating cash flows on a discounted basis. The Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets" in 2002 which requires the determination of estimated fair values of reporting units as assessed against the carrying amount of the assets and liabilities of the reporting units. This resulted in a goodwill impairment charge of $29,825 related to the Company's European reporting unit. The utilization of different methods, procedures or assumptions in determining estimated fair value could have resulted in a charge of a different amount.
Business realignment liabilities - The Company has continued to review and adjust its structure and streamline its operations to improve financial results. During this process, the Company has recorded costs to close or consolidate facilities, write-down assets and reflect employee severance costs, partially offset by proceeds of related asset sales.
Environmental remediation and restoration liabilities - Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. The Company has accrued approximately $44,000 and $43,400 at December 31, 2002 and 2001, respectively, for all probable environmental remediation, indemnification and restoration liabilities, which is management's best estimate of these liabilities. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such liabilities may exceed current reserves by amounts that may prove insignificant, or by amounts, in the aggregate, of up to approximately $39,000. This estimate of the range of reasonably possible additional costs is less certain than the estimates upon which reserves are based, and in order to establish the upper limit of such range, assumptions less favorable to the Company among the range of reasonably possible outcomes were used.
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 such amounts recognized for tax purposes. 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. The Company has tax strategies that it would execute before any deferred tax assets would go unused. Additionally in the normal course of business various federal and state tax authorities review the Company's tax returns. Significant judgment is used in estimating the accruals necessary for such tax exposures.
Pension and postretirement assets and liabilities - The Company utilizes various weighted average rates in determining net pension expense and postretirement benefit obligations, as well as certain percentage rate increases for health care costs. Historically, these estimates have proven reasonable but there is no assurance that these estimates will be as accurate as in the past. In determining net pension expense, the Company used a discount rate of 7.2% in 2002 as compared to 7.7% for 2001 and 2000 and an expected long-term rate of return on plan assets of 8.3% as compared to 8.7% for 2001 and 2000. In determining the present value of year-end pension obligations discount rates of 6.5% and 7.2% were used in 2002 and 2001, respectively. For postretirement benefit obligations, the Company used a weighted average discount rate of 6.5% for 2002 as compared to 7.25% for 2001.
Related party transactions - The Company records related party transactions at amounts that management believes approximates fair value and are at amounts that are not more favorable or unfavorable than could be obtained from third parties. The specifics of each major transaction and the basis for accounting are described in the notes to the financial statements. RESULTS OF OPERATIONS BY SEGMENT: - ------------------------------------
Beginning in 2002, the Company reports three operating segments rather than one, as previously reported, to better reflect the ongoing internal organization. Prior periods have been restated to reflect this change. The three segments reported are North American Forest Products, North American Performance Resins Group and International. In addition, Corporate and Other is reported separately. The product lines included in the North American Forest Products segment are formaldehyde and forest products resins. The key business drivers in the North American Forest Products segment are housing starts, furniture demand, panel production capacity and chemical sector operating conditions. The North American Performance Resins Group segment includes specialty, oilfield, industrial, nonwoven, laminate and foundry resins, and UV coatings. In the North American Performance Resins Group segment, the key business drivers are housing starts, auto builds, active gas drilling rigs, fiber optic demand and the general industrial sector. The International segment consists of operations in Latin America, Europe and Asia Pacific. Principal countries of operation are Brazil, the United Kingdom, Malaysia and Australia. Product lines include forest product and performance resins. In the International segment, the key business drivers are export levels, panel production capacity, housing starts, furniture demand and the local political environment. Corporate and Other represents general and administrative expenses and income and expenses related to divested businesses.
The threat of potential military action or war, as well as the attendant political activity has created an atmosphere of economic uncertainty throughout the world. This environment can significantly affect the macro drivers of our business. A prolonged downturn or change in macro drivers may have a material adverse effect on our financial position, cash flow or results of operations in any reporting period.
Following is a comparison of net sales, operating income (loss), depreciation and amortization and EBITDA by reportable business segment for the Company:
EBITDA information is presented with the Company's segment disclosures because it is the basis for a primary measure used by the Company to evaluate its operating results and is determined by adding depreciation and amortization to Operating Income (Loss).
Included within EBITDA are the following expenses, income, gains and losses related to business realignment activities undertaken by the Company, pension curtailment expenses and certain other significant charges.
2002 VS. 2001
North American Forest Products - ---------------------------------
North American Forest Product sales decreased by $22,075 or 3.4% in 2002 as decreasing prices more than offset a volume increase. The lower selling prices were due to lower raw material prices in the first half of 2002 compared to 2001. A portion of the Segment's sales are sold under contracts that provide for monthly or quarterly selling price adjustments based on published cost indices for the Company's primary raw materials (i.e., methanol, phenol and urea). In addition, competitive pricing pressures negatively impacted the renewal of two large long-term customer contracts in 2002. Sales were also negatively impacted by foreign currency translation due to the weaker US dollar in relation to the Canadian dollar in 2002 versus 2001.
The decreases were partially offset by increased volumes which had a 6.9% positive impact on sales. Share gains and strong demand driven by a strong housing sector were the drivers of the volume increase.
EBITDA decreased by $11,948 or 11.5% versus 2001. Decreased margins due to competitive pressures, increasing raw material costs in the second half of the year and increased insurance and benefit costs were the principal causes of the EBITDA decrease. Although raw material price increases can contractually be passed on to customers, in periods of rising prices there can be a negative lag effect due to matching in timing of the cost increases and contract pricing trigger points. In addition, 2002 was negatively impacted by $1,107 of demolition and site cleanup costs related to previously closed facilities and $250 of severance related to a headcount reduction program, while 2001 included a positive impact from business realignment activities of $1,854, as a $10,500 gain on the sale of a closed facility more than offset costs related to the closure of facilities and severance related to headcount reductions.
North American Performance Resins - ------------------------------------
North American Performance Resin sales decreased by $68,290, or 16.7% in 2002 versus 2001 due to volume mix and lower selling prices. While absolute volumes increased, a decrease in specialty oilfield and UV coatings volumes led to a 13.9% decrease in sales. The volume decline in oilfield products is due to reduced drilling activity in 2002 compared to 2001. The UV coatings products volume decline is a result of significantly lower demand for fiber optic cable in 2002 compared to 2001. The expected demand outlook for UV coatings products remains flat through 2003 consistent with the demand for fiber optic cable. Lower selling prices also negatively impacted sales by 2.8% due to lower raw material costs in the first half of the year that were passed on to customers under raw material based contracts.
EBITDA declined by $29,202 or 41% in 2002 due primarily to the decrease in specialty oilfield and UV coatings 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 foundry acquisition.
International - -------------
International sales decreased $18,088 or 6.4% in 2002 due primarily to lower selling prices and volumes in Europe and Asia, the absence of sales from a business in Ecuador sold in the third quarter of 2001 and foreign currency translation in Latin America. The lower selling prices were the result of lower average raw material costs compared to the same period of 2001 and competitive pressures in Europe.
EBITDA from International businesses improved $27,598 in 2002 due to a decrease in costs related to plant restructurings and impairments and improved operational results in all regions. Plant closure costs and impairments decreased by $14,366 in 2002 compared to 2001 as 2001 plant consolidations in the UK and Latin America were completed in 2002. The remaining improvements in EBITDA were primarily attributable to improved margins relating to the positive spread between selling prices and raw material costs for the first half of the year and improved processing costs in Europe due to the plant consolidations.
Corporate and Other - ---------------------
Corporate and Other expenses decreased by $11,917 to a loss of $67,429 in 2002. The improvement is driven by the absence of $7,691 of severance and other charges related to the corporate reorganization in 2001, a $2,700 reduction in pension settlement charges related to divested businesses and the positive effect of the 2001 and 2002 headcount and cost reduction measures. These improvements were partially offset by increased management fees of $5,500 which reflect severance and wind down costs related to the phase out of Capital.
Businesses sold, distributed or closed - ------------------------------------------
The businesses sold, distributed or closed classification represents the Company's infrastructure management services business, printing inks and melamine business results as well as changes in estimates or costs related to businesses previously divested. The distribution of the infrastructure management services business occurred in the first quarter of 2000, the sale of the printing inks business occurred in the fourth quarter of 2000 and the closure of the melamine business occurred in January of 2002. The decrease in losses attributed to businesses sold, distributed or closed is due to the absence in 2002 of an impairment charge of $98,163 related to the melamine crystal fixed assets, spare parts and goodwill recorded in 2001 and a $19,028 charge that reflects management's estimate of probable environmental remediation costs that the Company incurred related to a previously owned business.
2001 VS. 2000
North American Forest Products - ---------------------------------
North American Forest Product sales increased $46,511 or 7.6% in 2001 driven by increased prices and the full year impact of two acquisitions made in the second half of 2000. The higher average selling prices reflect significantly higher raw material costs during the first half of the year. A portion of the Segment's sales are sold under contracts that provide for monthly or quarterly selling price adjustments based on published cost indices for the Company's primary raw materials (i.e., methanol, phenol and urea). The acquisition of a formaldehyde plant and certain other assets of Borden Chemicals and Plastic Operating Limited Partnership in the third quarter of 2000 and the acquisition of East Central Wax in the fourth quarter of 2000 provided incremental sales of approximately $35,000.
These increases were partially offset by decreased volumes as slowdowns in housing starts and the general chemical sector negatively impacted demand. Sales were also negatively impacted by increased competition and foreign currency translation. The translation impact was a result of a weakened US dollar versus the Canadian dollar in 2002 compared to 2001.
EBITDA increased $46,548 or 81.7% in 2001 principally due to a decrease of $19,395 relating to plant closure costs and the absence of a $25,330 charge taken in 2000 to exit certain long term raw material purchase contracts in order to take advantage of more favorable pricing opportunities. Excluding these charges, EBITDA increased 1.9% as the impacts of decreasing raw material prices in the second half of the year and the full year effect of the acquisitions more than offset the volume declines and the effects of higher energy prices.
North American Performance Resins - ------------------------------------
North American Performance Resins sales increased $22,894 or 5.9% in 2001 due to improved mix and the acquisition of a foundry resin business in the second quarter of 2001. The improved mix was the result of a larger proportion of higher priced specialty oilfield product sales in 2001 due to increased drilling activity. The increase in drilling activity was driven by the significantly higher natural gas prices in the first quarter of the year. Partially offsetting these increases were decreased sales due to volume declines in the foundry, industrial resin and UV coatings businesses resulting from declines in auto production, generally weaker industrial construction and electronics market conditions and declines in fiber optic cable demand.
EBITDA decreased by $22,708 or 24.2% in 2001 driven by the volume decrease, increased energy costs and manufacturing and SG&A costs related to the formation and integration of the HA-International joint venture.
International - -------------
Sales from International businesses declined $32,223 or 10.2% in 2001. The decline was driven by volume declines in Latin America, Asia and Europe and the negative impact of foreign currency translation due to a weaker US dollar in 2001 compared to 2000 versus the Brazil Real, UK pound and Australian dollar.
EBITDA declined $9,329 in 2001 compared to 2000 principally due to the volume declines and the foreign currency translation impact discussed above. In both 2000 and 2001 EBITDA was negatively impacted by approximately $20,000 of plant closure costs related to manufacturing restructurings in the UK and Latin America.
Corporate and Other - ---------------------
Corporate expenses increased $19,283 to a loss of $79,346 in 2001. The increase reflects settlement and curtailment charges of $16,300 in 2001 related to the sale of Foods and the absence of a 2000 gain of $10,500 on the sale of certain rights to harvest shellfish. A gain of $4,400 on the sale of a common stock equity investment held by the Company and the absence of 2000 pension settlement and curtailment charges of $8,858 related to the sale of Wise partially negated these declines. Also in 2001, $7,763 of charges related to severance and other charges related to the corporate reorganization and headcount reduction program contributed to the decline.
NON-OPERATING EXPENSES AND INCOME TAX EXPENSE: - ---------------------------------------------------
2002 vs. 2001 - ---------------
Non-Operating Expenses - -----------------------
Non-operating expenses decreased $49,214 in the year ended December 31, 2002 compared to the year ended December 31, 2001. Interest expense and affiliated interest expense decreased in 2002 by $4,298 and $10,086 respectively due to lower average borrowing levels. Other non-operating income of $5,989 in 2002 included a gain on an interest rate swap of $1,722, interest income of $2,269 and a $2,741 gain on the repurchase of debt in the open market. The non-operating loss in 2001 of $1,841 consisted primarily of a $1,762 loss incurred on an interest rate swap. Also included in 2001 non-operating expenses was $27,000 of investment write-downs. This amount consisted of a $10,000 charge related to the write-down of the Company's investment in BCPM (See Note 24 to the Consolidated Financial Statements) and $17,000 of charges related to the write-down of a receivable and preferred stock investment in WKI.
2001 vs. 2000
Non-operating expenses decreased by $31,457 in the year ended December 31, 2001 compared to the year ended December 31, 2000. Interest expense and affiliated interest expense decreased in 2001 by $11,041 and $7,658, respectively due to lower average borrowings. Other non-operating (income) was $26,370 in 2000 versus an expense of $1,841 in 2001. The 2000 income amount of $26,370 included $12,884 of interest income, $6,435 of preferred stock dividends from an affiliate, and $4,902 of a gain on an interest rate swap that settled in September 2000. Also included in 2000 non-operating expenses was $67,969 of investment write-downs which consisted of a $20,000 charge related to the write-down of the Company's investment in BCPM (See Note 24 to the Consolidated Financial Statements) and $47,969 of write-downs of the preferred stock investment in WKI Holding Company, Inc. (WKI) (See Note 11 to the Consolidated Financial Statements).
- ---- The 2002 consolidated tax rate reflects a valuation allowance recorded against the deferred benefit of certain deferred interest expense deductions in the amount of $16,672 that is no longer likely to be utilized due to usage limitations imposed by the Internal Revenue Code. This expense is offset by the reversal of a $20,000 reserve that had been related to U.S. Federal and state income tax audits that have since been resolved.
- ---- The 2001 consolidated tax rate reflects a write-down of the fixed assets and non-deductible goodwill of $31,692 related to a melamine plant due to its indefinite shut-down. The rate also reflects the impact of earnings related to the expected sale of a foreign business that are not expected to be permanently reinvested in foreign locations and the inability to utilize foreign tax credits associated with those earnings due to usage limitations. These expenses are offset by the reversal of a $14,388 reserve that had been related to U.S. Federal and state income tax audits that have since been resolved.
- ---- The 2000 income tax rate reflects a settlement reached with the Internal Revenue Service ("IRS") and the impact of usage limitations on foreign tax credits. As a result of a settlement reached with the IRS, the Company recorded net tax expense of $5,000 consisting of valuation reserves recorded on foreign tax credits of $30,000 that are no longer likely to be utilized, substantially offset by a $25,000 reduction of amounts established for tax issues related to the divestiture of certain segments of the Company's business that are no longer considered necessary. In addition, approximately $10,000 of income tax expense was recorded on foreign source income because related foreign tax credits are not expected to be utilized within the expiration period.
CASH FLOWS: - ------------
OPERATING - ---------
2002 vs. 2001 - --------------- Operating activities provided cash of $10,360 in 2002 compared to $95,120 of cash provided in 2001. The decrease was due to decreases in earnings adjusted for non-cash items, tax refunds received and cash generated from net trading capital. In 2002 cash tax payments were $978 compared to a net refund received of $36,186 in 2001. Cash from net trading capital decreased by $44,494 in 2002 due to higher sales volumes and comparisons against an abnormally high 2001 level of inventory and receivable reductions. In addition 2002 included $25,054 of cash restructuring payments which was an increase of $846 from 2001. Partially offsetting this was a decrease in net cash interest paid in 2002 of $23,330.
2001 vs. 2000 - --------------- Operating activities provided cash of $95,120 in 2001 compared to $22,944 of cash provided in 2000, an improvement of $72,176. The most significant components of this improvement are cash taxes received of $36,186 in 2001 compared to cash taxes paid of $19,175 in 2000, increased cash flows in accounts receivable of $59,348 due to improved collection efforts and collection of higher raw material costs passed through to customers in the first half of the year, the absence of a 2000 payment of $25,330 to exit certain raw material supply contracts and improved cash flows in inventory of $27,193 due to lower raw material costs and a $12,302 cash receipt from Foods to assume the liability for claims under certain employee benefit plans. Partially offsetting these improvements were a $49,122 increase in outflows in trade payables due to reduced payment terms with new raw material suppliers and lower raw material costs, increased cash restructuring payments in 2001 of $15,861, increased net interest paid of $6,363 and the absence of 2000 cash receipts from CCPC Acquisition Corp. and Wise (see below).
INVESTING
2002 vs. 2001 - --------------- Net cash provided by investing activities in 2002 was $81,464 compared with $210,981 in 2001. The 2002 cash inflow was provided by selling a note receivable from Elmer's of $110,000 to the Company's parent, and selling other assets for $10,237 to unrelated parties, offset by capital expenditures of $38,773. In comparison, in 2001 cash of $160,888 was received related to selling certain non-operating assets to the Company's parent and $96,977 of cash was received primarily from the sale of the common stock of Elmer's to an affiliate. These inflows were offset by capital expenditures of $47,408. In 2003, the company expects to incur capital expenditures of approximately $45,000.
2001 vs. 2000 - --------------- Investing activities provided cash of $210,981 in 2001 compared to cash used of $195,746 in 2000. The $406,727 improvement is primarily due to increased proceeds from the sale of assets of $150,978, the absence of 2000 acquisitions for $118,148, increased proceeds from the divestiture of businesses of $86,031 and reduced capital expenditures of $57,141. The increased proceeds from the sale of assets were due to the sale of loans receivable from affiliates at managements estimate of their fair value of $75,747, the sale of a common stock equity investment held by the Company for the market value of $64,141 and the sale of land and other assets associated with closed plants of $14,000. The loans to affiliates and $55,187 of the common stock equity investment held by the Company were sold to the Company's parent. The absence of acquisitions made by Consumer Adhesives and Chemical in 2000 improved cash flows by $118,148 in 2001. Divestiture proceeds of $96,977, primarily from the sale of Consumer Adhesives, exceeded 2000 proceeds of $10,946, which relate primarily to the sale of the printing inks business. Further contributing to the improvement was a reduction in capital expenditures of $57,141 primarily due to reduced plant expansion projects.
FINANCING ACTIVITIES
2002 vs. 2001 - --------------- In 2002 the Company had financing cash outflows of $101,716 compared to 2001 outflows of $308,403. The 2002 outflows are primarily due to the $66,165 increase in restricted cash and the payment of a $31,581 note due to BCPM. The 2001 outflows are primarily the result of repaying affiliated loans of $212,432 and preferred dividend payments of $73,724.
The Company cancelled its preferred stock in 2001 and does not expect to pay common stock dividends during 2003. Additionally, the Company expects to repay outstanding affiliated borrowings as restricted cash balances become unrestricted throughout 2003.
2001 vs. 2000 - --------------- Financing activities used cash of $308,403 in 2001 compared to cash provided of $5,006 in 2000. The $313,409 increase in cash used is primarily due to net repayments of affiliate loans of $212,432 in 2001 compared to net borrowings of $86,703 in 2000, 2001 net short-term debt repayments of $41,763 compared to 2000 net short-term debt borrowings of $33,269 and a reduction in 2001 long-term debt borrowings of $64,600. Affiliate activity in 2001 is comprised primarily of repayments to Foods of $125,050 and BWHLLC of $73,355 and additional loans to WKI of $18,900. These increased uses were partially offset by reduced long-term debt repayments of $86,000, lower 2001 common stock dividends paid of $13,000, the absence of a $10,242 distribution to the Company's parent made in 2000 and a 2001 cash capital contribution from the Company's parent of $17,000.
LIQUIDITY AND CAPITAL RESOURCES: - -----------------------------------
In the third quarter of 2002, the Company entered into a new three-year asset based revolving credit facility dated September 23, 2002 (the "New Credit Facility") which provides for a maximum borrowing of $175,000. The New Credit Facility replaces the uncommitted letter of credit facility (discussed below) and the prior $250,000 Credit Facility that expired on July 13, 2002. The New Credit Facility is secured with inventory and accounts receivable in the United States, Canada and the United Kingdom and a portion of property and equipment in Canada and the United Kingdom. The New Credit Facility contains restrictions on dividends, limitations of borrowings from affiliates, limitations on capital expenditures ($65,000 in 2003) and payment of management fees ($5,000 per year in 2003 and beyond) in addition to a minimum trailing twelve-month fixed charge coverage ratio of 1.5 to 1.0 if aggregate availability is less than $25,000.
Under the uncommitted letter of credit facility, the Company provides cash collateral equivalent to 101% of letters of credit outstanding, or $67,049 at December 31, 2002. This amount was classified as restricted cash on the Consolidated Balance Sheet as of December 31, 2002. The letters of credit under this facility are in the process of being cancelled and reissued under the New Credit Facility. As the cash collateral becomes unrestricted, the Company plans to use the cash to repay borrowings from Foods.
Currently, the Company has borrowed $84,680 from Foods at an interest rate of 1.3125% as of December 31, 2002. When all letters of credit under the uncommitted letter of credit facility have been cancelled, the New Credit Facility limits the borrowings from affiliates to a maximum of $30,000 and the reissued letters of credit ($66,385 at December 31, 2002) will reduce the borrowing availability. As of December 31, 2002, the maximum borrowing allowable under the New Credit Facility was $137,127 of which $123,836 was unused and available. Thus, if the letters of credit had been reissued under the New Credit Facility and the newly unrestricted cash collateral were used to pay down the Foods debt, at December 31, 2002, the availability under the New Credit Facility would have been $57,451 and additional allowable borrowings from affiliates would have been $12,369.
Additional credit agreements are executed by the Company's international locations. As of December 31, 2002, these locations had credit facilities totaling $22,032. Of this amount $17,614 (net of a $2,126 term loan and $2,292 of other draws on the lines of credit) was available to fund working capital needs and capital expenditures.
With the expiration of the $250,000 Credit Facility in July 2002, Foods was automatically released from its obligation to guarantee the payment of the Company's outstanding publicly held debt. On March 1, 2002, the Company redeemed its investment in Consumer Adhesives preferred stock for a $110,000 note receivable. Subsequently, the note receivable was sold to the Company's parent for cash of $110,000 plus accrued interest with the proceeds being used to repay affiliated debt.
In the fourth quarter of 2001, the Company's parent contributed all of the outstanding shares of preferred stock, plus accrued dividends, to the Company as a capital contribution, thereby eliminating future annual preferred dividend payments of $73,724.
In the fourth quarter of 2002, the Company repurchased $7,368 of its outstanding publicly held bonds for $4,510 plus fees. A $2,741 gain on the extinguishment of the bonds was recognized. The Company and or affiliates of the Company, including entities controlled by KKR, may in the future, depending on market conditions, purchase additional senior unsecured notes of the Company in the open market or by other means.
In connection with the recent performance of equity markets in which assets supporting the U.S. pension benefit obligations of the Company's defined benefit plans are invested, the Company has projected the minimum annual funding requirements imposed by Federal laws and regulations. In preparing the projections, assumptions included an 8.5% annual rate of return on assets for the years 2003 through 2006 and that there were no other changes in the law or plan provisions. Minimum annual funding requirements under these assumptions ranged from a low of $0 in 2003 to a high of $21,900 in 2006 with a total funding requirement for the five years ended in 2007 of $65,100.
The Company has net operating loss carryforwards and alternative minimum tax credits for U.S. Federal tax purposes which can offset $154,920 of future taxable income. The Company, therefore, does not expect to have to pay any U.S. Federal income taxes over the next several years.
The Company's planned 2003 capital expenditures are approximately $45,000 and include plans to continue to increase plant production capacity as necessary. Capital expenditures will be financed through operations and, if necessary, available lines of credit or borrowings from affiliates.
The Company expects to have enough liquidity to fund working capital requirements and support capital expenditures over the three year term of the New Credit Facility with cash received from operations and amounts available under the New Credit Facility and from affiliates. However, there is no assurance that borrowings from affiliates will be available in future periods.
A summary of the Company's obligations at December 31, 2002 is contained in Note 12 to the Consolidated Financial Statements.
RISK MANAGEMENT
The Company enters into various financial instruments, primarily to hedge interest rate risk and foreign currency exchange risk. The Company also enters into raw materials purchasing contracts and contracts with customers to mitigate commodity price risks.
FOREIGN EXCHANGE RISK
In 2002 and 2001, international operations accounted for approximately 35% and 34% of the Company's sales. As a result, there is exposure to foreign exchange risk on transactions that are denominated in a currency other than the business unit's functional currency. Such transactions include foreign currency denominated imports and exports of raw materials and finished goods (both intercompany and third party), and loan payments (both intercompany and third party). In all cases, the functional currency is the unit's local currency.
It is the Company's policy to reduce foreign currency cash flow exposure due to exchange rate fluctuations by hedging firmly committed foreign currency transactions wherever economically feasible. The use of forward and option contracts protects cash flows against unfavorable movements in exchange rates, to the extent of the amount under contract. The Company does not 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. The Company does not speculate in foreign currency and does not hedge foreign currency translation or foreign currency net assets and liabilities. The counterparties to the forward contracts are financial institutions with investment grade credit ratings.
Foreign exchange risk is also mitigated because the Company operates in many foreign countries, reducing the concentration of risk in any one currency. In addition, 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 operating results or cash flow. Although considered unlikely, an average 10% foreign exchange increase or decrease in all countries may materially impact operating results of the Company.
In accordance with current accounting standards, the Company recognizes gains and losses arising from forward and option contracts on a quarterly basis through the Consolidated Statement of Operations.
A summary of forward currency and option contracts outstanding as of December 31, 2002 and 2001 follows. Fair values are determined from quoted market prices at December 31, 2002 and 2001.
INTEREST RATE RISK
The Company has utilized interest rate swaps to lower funding costs or to alter interest rate exposures between fixed and floating rates on long-term debt. The Company does not enter into speculative swaps or other financial contracts. As of December 31, 2002 there were no interest rate swaps outstanding. As of December 31, 2001, one interest rate swap was outstanding with a notional value of $24,286.
Fair values of the swaps are independently provided using estimated mid-market levels. Under interest rate swaps, the Company agrees 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. The Company paid 13.7% and received 1.86% in 2002 and paid 13.7% and received 4.5% in 2001. The remaining outstanding swap as of December 31, 2001 matured on December 1, 2002.
The interest rate on most debt agreements is fixed. A 10% increase or decrease in the interest rate of the variable debt agreements would have an immaterial effect on the Company's net income. The fair value of publicly held debt is based on the price at which the bonds are trading at December 31, 2002 and 2001. All other debt fair values are determined from quoted market interest rates at December 31, 2002 and 2001.
A summary of the Company's outstanding debt as of December 31, 2002 and 2001 follows:
The Company does not use derivative financial instruments in investment portfolios. Cash equivalent investments are placed with instruments that meet credit quality standards. These standards are established within the Company's investment policies, which also limit the exposure to any one issue. At December 31, 2002, the Company had $70,133 invested primarily in time deposits with average maturity periods of 7 days and average rates at 1.2%. At December 31, 2001, the Company had $6,920 invested primarily in marketable securities with average maturity periods of 43 days and average rates of 6.4%. Due to the short maturity of the Company's cash equivalents and restricted cash investments, the carrying value on these investments approximates fair value and the interest rate risk is not significant. A 10% increase or decrease in interest returns on invested cash would have an immaterial effect on the Company's net income and cash flow at December 31, 2002 and 2001.
COMMODITY RISK
The Company is exposed to price risks associated with raw material purchases, most significantly with methanol, phenol and urea. For the commodity raw materials, the Company has purchase contracts, with periodic price adjustment provisions. In 2002, suppliers were committed under contract to provide 100% of the Company's estimated methanol and urea requirements. Phenol suppliers were committed to providing up to 100% of estimated requirements and provided the flexibility to purchase a certain percentage of the Company needs in the spot market. For 2003, the Company has negotiated stronger competitive price clauses in certain contracts, which will allow it to buy outside the contract if market pricing falls below contract pricing and other contracts have min-max monthly volume commitments which will allow the Company to take further advantage of spot pricing. The commodity risk also is moderated through use of customer contracts with selling price provisions that are indexed to publicly available indices for these commodity raw materials as discussed on pages 15 and 16. Any commodity futures that the Company may enter into are approved by the Board of Directors.
The Company has entered into a long-term contractual arrangement with the leading global melamine crystal producer to supply a minimum of 70% of the Company's worldwide melamine crystal requirements. The melamine crystal to be purchased under the 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 the Company's ability to satisfy its melamine crystal needs.
In the fourth quarter of 2000, the Company entered into fixed rate, fixed quantity contracts to secure a portion of future natural gas usage at certain of the Company's facilities. The contracts were entered into to partially hedge the Company's risk associated with natural gas price fluctuations in peak usage months through March 2003. Gas purchases under these contracts totaled $671 and $853 in 2002 and 2001, with $402 and $1,073 future commitments at December 31, 2002 and 2001, respectively.
Additionally, the Company expanded its natural gas hedging activities in June 2001 to hedge a portion of natural gas purchases for all of North America. The Company entered into futures contracts with varying settlement dates through November 2002 to purchase natural gas. The contracts are settled for cash each month based on the closing market price on the last day the contract trades on the New York Mercantile Exchange. Commitments settled under these contracts totaled $1,210 and $1,716 in 2002 and 2001, respectively and related losses were $264 and $610 in 2002 and 2001. There were no future commitments under these contracts at December 31, 2002 and $520 of future commitments at December 31, 2001.
Gains and losses on commodity futures contracts are recognized each month as gas is used. Future commitments are marked to market on a quarterly basis. The Company also recorded a gain of $16 and a loss $545 for the difference between the fair value and carrying value of future natural gas commitments at December 31, 2002 and 2001, respectively.
EQUITY PRICE RISK
At December 31, 2001, the Company held a preferred stock investment of $110,000 in Consumer Adhesives. Subsequently, on March 1, 2002, the Consumer Adhesives preferred stock was redeemed for a $110,000 note receivable from Consumer Adhesives. On March 12, 2002, the note receivable was sold to the Company's parent for cash of $110,000 plus accrued interest. During 2001, a common stock equity investment of the Company was sold for $64,141. Of the $64,141, sales to third-party investors totaling $8,954 were made in 2001 resulting in a pre-tax gain of $3,772 ($2,780 after-tax). The remaining $55,187 of the sale was made to the Company's parent as part of the Corporate Reorganization (see Note 5 to the Consolidated Financial Statements). In addition, the remaining $10,000 investment in preferred stock of WKI was written-off during the year and transferred to the Company's parent at its fair value.
The Company reviews the carrying value of investments in accordance with existing accounting guidance that requires investments to be adjusted to fair value if the decline in value is considered to be "other than temporary" based on certain criteria. The Company recorded investment write downs of $10,000 and $47,969 in 2001 and 2000, respectively.
A summary of investments as of December 31, 2002 and 2001 follows. Fair value is based on the market stock price as of December 31, 2002 and 2001 for publicly traded common stock. Fair value for other investments is based on other similar financial instruments.
Readers are cautioned that forward-looking statements contained under the heading of "Risk Management" should be read in conjunction with the disclosure under the heading: "Forward-Looking and Cautionary Statements".
RECENTLY ISSUED ACCOUNTING STANDARDS - ---------------------------------------
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Under this Statement, an asset retirement obligation is recognized at its fair value in the period in which it is incurred. Asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and a related amortization expense is recognized in future periods. This Statement is effective for the Company for financial statements issued for fiscal years beginning after January 1, 2003. The Company does not expect implementation of SFAS No. 143 to have a significant impact on its result of operation or financial condition.
In January 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 specifies that goodwill and certain intangibles with indefinite lives no longer be amortized but instead be subject to periodic impairment testing. (See Note 6 to the Consolidated Financial Statements).
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction". This statement rescinds the aforementioned Statements and amends SFAS No. 13. The provisions of this Statement related to SFAS No. 4 "Reporting Gains and Losses from Extinguishment of Debt" are effective for fiscal years beginning after May 15, 2002 but early application is encouraged. The Company has adopted SFAS No. 145 and has reported a gain related to the repurchase of its publicly held bonds (See Note 12 to the Consolidated Financial Statements).
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement nullifies Emerging Issue Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principle difference between this Statement and EITF 94-3 relates to the requirements for recognition of the liability for costs associated with exit or disposal activities. Specifically, the liability for a cost associated with an exit or disposal activity is no longer recognized at the commitment date. Instead, the liability is recognized when the liability is incurred as defined by FASB Concept Statement No. 6, Elements of Financial Statements. The provisions of this Statement are effective for exit or disposal activities initiated after December 31, 2002, with early application encouraged. Retroactive application of this Statement is prohibited. Any exit and disposal activities initiated under EITF 94-3 shall continue to be accounted for under the provisions of this EITF. The Company will follow the guidelines set forth in SFAS No. 146.
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. The Company has provided additional disclosure with respect to guarantees in Note 23 to the Consolidated Financial Statements and has not yet determined if the adoption of the liability recognition provision will have any material impact on the Company's results of operations or financial condition.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123. The transition provisions of this SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The Company has elected not to voluntarily change to the fair value based method of accounting for stock-based compensation at this time. The Company has included the additional disclosure requirements in Notes 3 and 17 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. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003 and to older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company does not expect the implementation of FIN 46 to have a significant impact on its results of operations and financial condition.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS - --------------------------------------------
The Company and its officers may, from time to time, make written or oral statements regarding the future performance of the Company, including statements contained in this report and the Company's other reports filed with the Securities and Exchange Commission. Investors should be aware that these statements, which may include words such as "expects" or "outlook", are based on 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 the Company's actual results to differ materially from those projected in forward-looking statements made by or on behalf of the Company. Such risks and uncertainties are primarily in the areas of results of operations by business unit, including decreases in the level of housing starts and auto builds, the impact of imports of wood products and furniture to the United States, and the impact of raw material price increases on the Company's operations, liquidity, legal and environmental liabilities.
ITEM 7A:
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.
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
1. BACKGROUND
The Company, Borden Chemical, Inc. (formerly Borden, Inc.) was incorporated on April 24, 1899. After the sale of the Consumer Adhesives business segment in 2001 to an affiliate, the sole remaining business of the Company is the Chemical business, which is engaged primarily in manufacturing, processing, purchasing and distributing forest products and industrial resins, formaldehyde, coating and other specialty and industrial chemicals worldwide. The Company's executive and administrative offices are located in Columbus, Ohio. Chemical production facilities are located throughout the United States and in many foreign countries.
On March 14, 1995, affiliates of Kohlberg Kravis Roberts & Co. ("KKR") acquired control of the Company. In late 1995, the Company began the process of redesigning its operating structure in order to maximize value for its owners and determined that certain businesses did not fit into its long-term strategic plan. At the end of 1995, the Company consisted of the following business segments: Chemical, Food, Other Consumer Products, Decorative Products, Dairy and businesses held for sale. A group of centralized corporate departments located in Columbus, Ohio provided certain governance and other administrative services to all the Company's operating business units and businesses held for sale. As of the end of 2000, all business segments had been divested except the Chemical and Consumer Adhesives segments. In 2001 the Consumer Adhesives segment was divested (see below), leaving the Chemical segment as the Company's sole remaining business.
The Company's immediate parent is Borden Holdings, Inc. ("BHI"), which is a wholly owned subsidiary of BW Holdings, LLC ("BWHLLC"), an entity controlled by KKR.
Beginning in the third quarter of 2002, the Company reports three operating segments rather than one, as in the prior 2002 interim period reports, to better reflect the ongoing internal organization (See Note 21). Prior periods operating segment information has been restated to reflect this change.
In the fourth quarter of 2001, the Company merged with its subsidiaries Borden Chemical Holdings, Inc. ("BCHI") and Borden Chemical, Inc. ("BCI"), executed certain financial transactions with its parent and changed its name to Borden Chemical, Inc. (the "Corporate Reorganization") reflecting the fact that the only remaining business of the Company is the Chemical business (see Note 5). The Corporate Reorganization was undertaken to simplify the legal structure and strengthen the capital structure of the Company and to reduce overhead 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 the Company's parent. 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 the other entities for these services.
During the 2002 year, BHI decided to completely wind down Capital's operations, with the cessation of operations expected to occur during the first half of 2003. Certain management, consulting and board services previously provided to the Company by Capital will be assumed by the Company, while other such services will continue to be provided to the Company by KKR for an annual fee of $3,000.
On August 13, 2001, an option sold to BWHLLC in 1996 to purchase 74% of the common shares of Consumer Adhesives was exercised for $54,120. Also, on August 13, 2001, a company controlled by BWHLLC purchased the remaining 26% of Consumer Adhesives' common shares for $40,000 (collectively "the Consumer Adhesives Sale"). In addition to the cash proceeds received, the Company retained continuing investments in Consumer Adhesives in the form of notes receivable and preferred stock. Prior to the Consumer Adhesives Sale, these investments were eliminated in the Consolidated Financial Statements. The notes receivable from Consumer Adhesives were sold to the Company's parent on November 19, 2001 for $57,691 (see Note 5). The carrying value of the preferred stock was $110,000 at December 31, 2001. The preferred stock was redeemed on March 1, 2002 for a $110,000 note receivable from Consumer Adhesives. On March 12, 2002, the note receivable was sold to BHI for cash of $110,000 plus accrued interest. As a result of the Consumer Adhesives Sale and subsequent sale of the preferred stock, Consumer Adhesives is reflected as a discontinued operation in the Consolidated Financial Statements for all periods presented. During 2001, a pre-tax gain of $132,275 ($94,847 after-tax) was recognized in equity due to the affiliated nature of the transaction.
2. NATURE OF OPERATIONS
The Company is engaged primarily in manufacturing, processing, purchasing and distributing forest products and industrial resins, formaldehyde, coatings and other specialty and industrial chemicals worldwide. Prior to the Consumer Adhesives Sale, the Company also manufactured, processed, purchased and distributed consumer glues and adhesives in North America (see Note 1).
Domestic products are sold by in-house sales forces throughout the United States to industrial users. To the extent practicable, international distribution techniques parallel those used in the United States and are concentrated in Canada, Western Europe, Latin America, Australia and Malaysia.
At December 31, 2002, 27 of a total 48 manufacturing and processing facilities are located in the United States and in 2002 approximately 65% of the Company's sales were generated in the United States.
3. 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 asset impairments, environmental remediation liabilities, related party transactions, deferred tax assets and liabilities and related valuation allowances and other tax accruals, and pension and post-retirement assets and liabilities. Other estimates include valuation allowances for accounts receivable and inventories and general insurance liabilities. Actual results could differ from these estimated amounts.
CASH AND EQUIVALENTS - The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Included in the Company's cash equivalents and restricted cash are interest bearing time deposits of $70,133 in 2002 and $6,920 in 2001. 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 6%). Major renewals and betterments are capitalized. Maintenance, repairs and minor renewals are expensed as incurred.
INTANGIBLES - The excess of purchase price over net tangible and identifiable intangible assets of businesses acquired is carried as Goodwill in the Consolidated Balance Sheet. Prior to January 1, 2002, it was the Company's policy to carry goodwill arising prior to November 1, 1970, at cost, while goodwill arising after that date 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 in the Consolidated Balance Sheet. These intangible assets were amortized on a straight-line basis over the shorter of the legal or useful life of the asset.
As of January 1, 2002, the Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets". (See Note 6)
IMPAIRMENT - The Company periodically evaluates the recoverability of long-lived assets by assessing whether the carrying value can be recovered over its remaining useful life 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 asset to operating cash flows on a discounted basis. The Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", as of January 1, 2002 (See Note 8).
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.
REVENUE RECOGNITION - Revenues are recognized when products are shipped and title and risk of loss transfers to the buyer.
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 $61,927 in 2002, $63,929 in 2001 and $63,776 in 2000. 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.
In addition, the Company incurred realized and unrealized net foreign transaction losses (gains) aggregating $1,307 in 2002, $912 in 2001 and ($200) in 2000.
INCOME TAXES - The Company files a consolidated U.S. Federal Income Tax return with its parent, 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 (which effectively convert a portion of the Company's variable rate obligations to fixed), forward exchange contracts (which reduce the Company's cash flow exposure to changes in foreign exchange rates) and natural gas futures (which 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 has not elected hedge accounting for any derivatives; consequently, all derivatives 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.
STOCK-BASED COMPENSATION - The Company accounts for stock-based compensation under APB 25 and has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123" ("SFAS No. 148").
The following table sets forth the required annual reconciliation of reported and Pro Forma Net Income and EPS under SFAS No. 148:
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. 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. Prior to 2001, options issued by subsidiaries that enabled the holder to obtain stock of the subsidiary were assumed to be exercised if they were dilutive. As of December 31, 2001, as a result of the Consumer Adhesives Sale (see Note 1) and the Corporate Reorganization (see Note 5), there were no options to purchase subsidiary stock outstanding. At December 31, 2000, there were 5,488,750 options to purchase subsidiary stock outstanding, of which 1,106,250 were in the money but anti-dilutive due to the net loss for the year.
The Company's diluted EPS is calculated as follows:
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 July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations", which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Under this Statement, an asset retirement obligation is recognized at its fair value in the period in which it is incurred. Asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and, as such, a related amortization expense is recognized in future periods. This Statement is effective for financial statements issued for fiscal years beginning after January 1, 2003. The Company does not expect implementation of SFAS No.143 to have a significant impact on its results of operation or financial condition.
In January 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 specifies that goodwill and certain intangibles with indefinite lives no longer be amortized but instead be subject to periodic impairment testing. See Note 6.
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This statement rescinds the aforementioned Statements and amends SFAS No. 13. The provisions of this Statement related to SFAS No. 4 "Reporting Gains and Losses from Extinguishment of Debt" are effective for fiscal years beginning after May 15, 2002 but early application is encouraged. The Company has adopted SFAS No. 145 and has reported a gain related to the repurchase of publicly held bonds. See Note 12.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement nullifies Emerging Issue Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principle difference between this Statement and EITF 94-3 relates to the requirements for recognition of the liability for costs associated with exit or disposal activities. Specifically, the liability for a cost associated with an exit or disposal activity is no longer recognized at the commitment date. Instead, the liability is recognized when the liability is incurred as defined by FASB Concept Statement No. 6, "Elements of Financial Statements". The provisions of this Statement are effective for exit or disposal activities initiated after December 31, 2002, with early application encouraged. Retroactive application of this Statement is prohibited. Any exit and disposal activities initiated under EITF 94-3 shall continue to be accounted for under the provisions of this EITF. The Company will follow the guidelines set forth in SFAS No. 146.
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. The Company has provided additional disclosure with respect to guarantees in Note 23 and has not yet determined if the adoption of the new rules will have any material impact on the Company's results of operations or financial condition.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123. The transition provisions of this SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The Company has elected not to voluntarily change to the fair value based method of accounting for stock-based compensation at this time. The Company has included the additional disclosure requirements in Notes 3 and 17.
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. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003 and to older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company does not expect the implementation of FIN 46 to have a significant impact on its results of operations and financial condition.
RECLASSIFICATION - Certain prior year amounts have been reclassified to conform with the 2002 presentation.
4. CHANGE IN REPORTING ENTITY
The Company's 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 has served as the general partner of Borden Chemicals and Plastics Operating Limited Partnership ("the Partnership") which was created in November 1987 and operated as a commodity chemicals producer. On April 3, 2001 the Partnership 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 the Partnership and BCPM (the "Joint Plan") which provides 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 agents for liquidation and distribution to their creditors. The Company's ownership interest in BCPM will be extinguished and no distributions from BCPM to the Company are anticipated. The Company recorded charges totaling $30,000 for calendar years 2000 and 2001 to reduce the value of the Company's investment in BCPM to zero. No claims have been filed against the Company in connection with these bankruptcy proceedings; however, no assurance can be given that such claims will not be made in the future.
As a result of the bankruptcy of BCPM, the Company no longer consolidates BCPM in its Financial Statements but rather accounts for BCPM under the equity method of accounting for all periods presented. There is no impact on previously reported amounts of net (loss) income as a result of the deconsolidation, while the impact on the Consolidated Balance Sheet at December 31, 2001 is to reduce both total assets and liabilities by $6,167. The Company's equity-method investment in BCPM was written down to $0 in 2001.
5. CORPORATE REORGANIZATION
In the fourth quarter of 2001, the Company merged with its subsidiaries BCHI and BCI, executed certain financial transactions with its parent and changed its name to Borden Chemical, Inc. reflecting the fact that the only remaining business of the Company is the Chemical business. The Corporate Reorganization was undertaken to simplify the legal structure and strengthen the capital structure of the Company and to reduce overhead costs. As part of the Corporate Reorganization, certain functions were downsized, eliminated or transferred to a separate legal entity, Capital, also owned by the Company's parent. 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 the other entities for these services. The Company provides 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 the services.
In 2001, the Company's parent contributed all of the outstanding Series A Cumulative Preferred Stock ("Preferred Stock") plus accumulated dividends of $6,553 to the Company as a capital contribution. Prior to this, the Company had 24,574,751 shares of Preferred Stock outstanding with a total of 100,000,000 shares authorized. Each share had a liquidation preference of $25 and was entitled to cumulative dividends at an annual rate of 12% payable quarterly in arrears. The significant impact of this transaction was to eliminate required annual future preferred dividend payments of $73,724.
In 2001, as part of the Corporate Reorganization, 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, impairments and other in the Consolidated Statements of Operations.
In conjunction with the Corporate Reorganization in the fourth quarter of 2001, the Company sold certain assets to its parent for cash. The Company sold a common stock equity investment for $55,187 resulting in a pre-tax gain of $15,797 ($10,197 after-tax) 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") (see Note 22) 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 which is included in investment writedowns and other charges to reflect the decline in fair value of the WKI loan receivable. On March 12, 2002, the Company used the proceeds of $110,000 from the sale to the Company's parent of its remaining investment in Consumer Adhesives, to further repay its affiliated debt. All assets sales were sold at management's best estimate of fair value at the date of sale.
In 2001, 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.
In 2002, the Company's parent decided to completely wind down Capital's operations, with the cessation of operations expected to occur during the first half of 2003. Certain management, consulting and board services previously provided to the Company by Capital will be assumed by the Company, while other such services will continue to be provided to the Company by KKR for an annual fee of $3,000. The Company recorded a charge of $5,500 related to costs allocable to the Company in connection with the cessation of Capital's operations.
Beginning in 1996, key subsidiaries of the Company issued stock options under their individual Stock Purchase and Option Plans for Key Employees. The options held by Chemical employees became options of the Company effective with the 2001 Corporate Reorganization (see Note 17). In addition, the Company settled the minority interest liability related to the ownership of shares in BCHI by management of 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 book value of the liability which approximates fair value.
6. GOODWILL AND INTANGIBLE ASSETS
As of January 1, 2002 the Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets". Consequently, subsequent to January 1, 2002, goodwill and identifiable intangible assets with indefinite useful lives are no longer amortized and identifiable assets with finite useful lives are amortized over their respective useful lives.
The Company's recorded goodwill of $71,399 as of December 31, 2001 had been recorded in conjunction with numerous business acquisitions. In accordance with the implementation of SFAS No. 142, the Company tested goodwill for impairment as of January 1, 2002. As required by the new accounting principle, to perform the goodwill impairment test the Company identified the appropriate reporting units, assigned assets and liabilities (including goodwill) to the reporting units, 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. As a result of this 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 which represents 100% of the January 1, 2002 carrying amount. There was no tax benefit recognized in conjunction with the impairment charge. This impairment charge is reported as the cumulative effect of change in accounting principle in the Consolidated Statements of Operations and the goodwill amount at December 31, 2002 has been reduced by this amount.
To determine estimated fair values of the Company's reporting units, the Company engaged mergers and acquisition professionals employed by Capital, an affiliate of the Company. The 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.
The following table provides a comparison of 2002, 2001 and 2000 as if the new accounting principle were applied to the prior year periods:
The changes in the carrying amount of goodwill for the year ended December 31, 2002 are as follows:
Intangible assets, which will continue to be amortized, consist of the following:
The impact of foreign currency translation adjustments is included in accumulated amortization.
Aggregate intangible amortization expense for the year ended December 31, 2002 and 2001 was $ 1,555 and $ 1,653 respectively.
Estimated annual intangible amortization expense for 2003 through 2007 is as follows:
7. BUSINESS 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.
In 2001, the Company and Delta-HA, Inc. merged their North American foundry resins and coatings businesses. In conjunction with the merger the Company recognized an accrual of approximately $7,000 to restructure operations of the acquired entity, minority interest liability of $4,500 to recognize the 25% minority interest, and recorded goodwill of approximately $9,000.
In 2000, the Company acquired the formaldehyde and certain other assets from BCPOLP, an affiliate of the Company, for $23,764 and acquired East Central Wax, Inc., a manufacturer of wax emulsions for the wood products industry, for $2,900. Both acquisitions were for cash. No goodwill was recorded with the BCPOLP asset acquisition and $1,894 was recorded with the East Central Wax acquisition.
Also in 2000, the Company acquired certain assets and liabilities of a Canadian based Consumer Adhesives business for $91,484 in cash. The business manufactured glue, glue sticks, paints, tapes and craft/stationery products at its manufacturing facility in Ontario, Canada. Goodwill recorded with the acquisition was $16,254. This business was sold in conjunction with the 2001 Consumer Adhesives Sale (see Note 9).
8. DIVESTITURES, BUSINESS REALIGNMENT AND ASSET IMPAIRMENTS
In 2002, management continued to review and adjust its structure to streamline its operations in order to improve business financial results and maximize returns to owners of the Company. As a result of this process, the Company committed to certain business realignment activities. Management of the Company expects to continue to review its operating structure and strategic options in 2003.
Divestitures - ------------
The following schedule summarizes the net cash proceeds, pre-tax and after-tax gains and losses associated with business divestiture activities over the last three years.
In 2001, the Company divested its chemical operation in Ecuador. Proceeds from the sale of the Ecuador chemical business were $5,275, resulting in a pre-tax loss of $2,303 ($2,839 after-tax).
In 2000, the Company sold its chemical printing inks business for $10,330, resulting in a pre-tax loss of $3,561 ($2,172 after-tax), and distributed 100% of its ownership in its infrastructure management services business to its parent, which was treated as a dividend at the recorded net book value of $16,277.
Also in 2000, gains on divestitures prior to 2000 of $2,616 were recognized.
Business Realignment, Impairments and Other - -------------------------------------------
During 2002, the Company recorded business realignment, impairments and other expense of $19,699, consisting of business realignment expense of $13,384 and non-cash asset impairment charges of $6,315. Of the total $19,699 of expense recorded in 2002, $7,557 was recorded in the fourth quarter, $2,082 in the third quarter, $5,401 in the second quarter and $4,659 in the first quarter.
Provided below is a rollforward of business realignment reserve activity for 2002:
Plant closure expense in 2002 of $10,119 consists of $12,584 of plant closure costs primarily related to the closure of the melamine crystal business facility, partially offset by a pre-tax gain on the sale of land associated with a previously closed plant of $2,465 ($1,602 after-tax). The $12,584 plant closure costs include plant employee severance of $2,721 and demolition, environmental and other costs of $9,863. Additionally, included in plant closure costs is a $1,099 increase to the reserve related to revised estimates of environmental clean-up and demolition for several locations closed in previous years.
In fourth quarter 2002, the Company recorded an expense of $5,275 related to the impairment of fixed assets of international manufacturing facilities in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". Also in the fourth quarter, the Company increased its impairment charge by $1,040 related to a new plant facility for which construction was discontinued in 2001. This impairment charge was required to reflect the current estimated net recoverable value of the land and building.
During 2001, the Company recorded business realignment, impairments and other expense of $126,408, consisting of business realignment expense of $25,360 and non-cash asset impairment charges of $101,048.
Provided below is a rollforward of business realignment reserve activity for 2001:
Business realignment expense in 2001 of $25,360 consists of $12,778 of plant closure costs and $12,582 of severance and other employee costs. Plant closure costs include fixed asset write-offs of $11,863, plant employee severance of $ 1,862, and demolition, environmental and other costs of $9,560, offset by a pre-tax gain on the sale of land associated with a closed plant of $10,507 ($6,515 after-tax).
In fourth quarter 2001, the Company announced that it had decided to offer for sale its wholly owned subsidiary, Melamine Chemicals, Inc. ("MCI"), which manufactured melamine crystal at a plant in Louisiana. For economic and strategic purposes, the Company has entered into a long-term contractual arrangement, which took effect January 1, 2002, with a major supplier for a substantial portion of its future melamine crystal needs. As of the end of 2001 no sale had been negotiated and in January 2002, the plant was shut-down indefinitely. 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 expense of $98,163 for impairment of melamine fixed assets, spare parts and goodwill of $62,527, $2,935 and $32,701, respectively. The Company incurred additional employee and environmental costs in the first quarter 2002 related to the MCI closure, as discussed above. Also in fourth quarter 2001, the Company discontinued construction of a new plant and recorded a charge of $2,885 of engineering, construction and other costs to reflect estimated net recoverable value of the land and building.
9. DISCONTINUED OPERATIONS
The summary of discontinued operations below includes Consumer Adhesives' results through August 2001, the date of the Consumer Adhesives Sale:
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 ($94,847 after-tax), which was recorded in Paid-in-Capital due to the affiliated nature of the transaction. In addition to the amounts shown above, gains and losses (net of tax) recognized on the sale of discontinued operations are included separately in the Consolidated Statements of Operations.
The Company recognized $93,000 as a gain on disposal of discontinued operations in 2000. As a result of a settlement reached with the Internal Revenue Service in the second quarter of 2000, amounts established for tax issues related to the prior divestiture of certain segments of the Company's business were no longer considered necessary. A portion of these amounts was classified as gain on the sale of discontinued operations in 2000, consistent with the classification of these amounts when established.
10. OTHER COMPREHENSIVE INCOME
Other comprehensive income includes the following items:
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 represents the impact of the adoption of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," on January 1, 2001. The Company recorded a pre-tax initial transition adjustment to Other Comprehensive Income of $5,200 ($3,300 net of tax) of which $1,131 ($730 net of tax) and $3,870 ($2,570 net of tax) 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, 2002 and 2001 are as follows:
11. INVESTMENTS IN AFFILIATES
Investment in affiliates at December 31, 2001 represents the Company's investment in Consumer Adhesives preferred stock. In March 2002, the preferred stock was redeemed for a note receivable, which was then sold to the Company's parent, along with accrued interest, at what management believes to be fair value (see Note 5).
The Company sold a common stock equity investment in 2001 for $64,141. Of the total proceeds, $8,954 was received from sales to third parties and $55,187 was received from the Company's parent as part of the Corporate Reorganization (see Note 5). Because the sale was to a related party, the gain of $15,797 ($10,197 net of tax) on the sale to its parent is included in shareholders' equity.
The Company continuously reviews the carrying value of investments in accordance with accounting guidance that requires investments to be adjusted to fair value if the decline in value is considered to be "other than temporary" based on certain criteria. In 2001, the Company wrote-off the remaining $10,000 investment in WKI Holding Company, Inc. (WKI) preferred stock, wrote-off $7,000 of a loan receivable from WKI and wrote-off the remaining $10,000 investment in BCPM. In 2000, the Company wrote-off $47,969 of investment in WKI preferred stock and $20,000 of investment in BCPM. The write-offs are reflected in Investment write-downs and other charges in the Consolidated Statements of Operations.
12. DEBT, LEASE OBLIGATIONS, UNCONDITIONAL PURCHASE OBLIGATIONS AND RELATED COMMITMENTS
Debt outstanding at December 31, 2002 and 2001 is as follows:
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 the fourth quarter and is included in other non-operating income.
In the third quarter of 2002, the Company entered into a new three-year asset based revolving credit facility dated September 23, 2002 (the "New Credit Facility") which provides for a maximum borrowing of $175,000, including letters of credit. The New Credit Facility replaces the uncommitted letter of credit facility (discussed below) and the prior $250,000 Credit Facility that expired on July 13, 2002. The New Credit Facility is secured with inventory and accounts receivable in the United States, Canada and the United Kingdom and a portion of property and equipment in Canada and the United Kingdom. The New Credit Facility contains restrictions on dividends, limitations on borrowings from affiliates ($30,000 after letters of credit are reissued under this facility), capital expenditures ($65,000 in 2003) and payment of management fees ($5,000 per year in 2003 and beyond) in addition to a minimum trailing twelve-month fixed charge coverage ratio of 1.5 to 1.0 if aggregate availability is less than $25,000. The credit facility will be used to fund short-term working capital needs and capital improvements. As of December 31, 2002, the maximum borrowing allowable under this credit facility was $137,127 of which $123,836 was unused and available. If the letters of credit had been reissued under the New Credit Facility and the newly unrestricted cash collateral (discussed below) were used to pay down the affiliate debt, at December 31, 2002, the availability under the New Credit Facility would have been $57,451 and additional allowable borrowings from affiliates would have been $12,369.
Under the terms of the New Credit Facility the Company has the ability to borrow funds at either the prime rate plus an applicable margin 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, 2002 there are no borrowings outstanding under either option. For letters of credit issued under the New 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 letters of credit.
The uncommitted letter of credit facility mentioned above, initially in the amount of $45,000, was increased in second quarter 2002 to $85,000. The Company was required to provide cash collateral equivalent to 101% of the letters of credit outstanding under this facility. The fees under this facility were 1/2% per annum of the amount of the letters of credit outstanding. The letters of credit are in the process of being cancelled and reissued under the New Credit Facility. As the letters of credit are cancelled and cash is no longer restricted as collateral, the Company plans to use the cash to pay-down its loans payable to affiliates.
As mentioned above, the Company's prior credit facility in the amount of $250,000 expired July 13, 2002. Under the terms of that facility, the Borden Foods affiliate guaranteed the payment of amounts due under the credit facility. Upon the expiration of the facility, the Foods guarantee obligation was released, which automatically released Foods from the corresponding obligation to guarantee the payment of the Company's outstanding publicly held debt.
Additional credit agreements are executed for the Company's international locations. As of December 31, 2002, these locations had credit facilities totaling $22,032. Of this amount $17,614 (net of $2,126 in a term loan and $2,292 in other draws on the line of credit) was available for borrowing under these credit agreements. The Company's international units incurred no commitment fees in 2002.
Purchase Obligations - --------------------- In fourth quarter 2000, the Company entered into fixed rate, fixed quantity contracts to secure a portion of future natural gas usage at certain facilities. The contracts were entered into to partially hedge the Company's risk associated with natural gas price fluctuations in peak usage months. Contracts covered the period from October 2000 through March 2003. Gas purchases under these contracts totaled $671 and $853 in 2002 and 2001, with $402 and $1,073 of future commitments at December 31, 2002 and 2001, respectively. These contracts covered approximately 86% in 2002 and between 75% and 85% of 2001 natural gas usage during the periods of the contracts at those facilities.
Due to a sharp increase in natural gas prices in 2000, the Company expanded its natural gas hedging activities in June 2001 to hedge a portion of natural gas purchases for all of North America. The Company entered into futures contracts with varying settlement dates through November 2002. The contracts were settled for cash each month based on the closing market price on the last day the contract trades on the New York Mercantile Exchange. The Company used futures contracts to hedge 43% of its 2002 North American natural gas usage. Approximately 24% of the Company's 2001 North American natural gas usage from June through December was hedged through futures contracts. Commitments settled under these contracts totaled $1,210 and $1,716 in 2002 and 2001, respectively. There were no future commitments under these contracts at December 31, 2002 and $520 of future commitments at December 31, 2001.
Aggregate maturities of total debt, minimum annual rentals under operating leases and unconditional purchase obligations for natural gas at December 31, 2002, for the Company is as follows:
Rental expense amounted to $14,399, $19,566 and $22,941 in 2002, 2001 and 2000, respectively.
13. INCOME TAXES
Comparative analysis of the Company's income tax expense (benefit) related to continuing operations follows:
The Company's income tax expense (benefit) related to discontinued operations was $0, $5,500 and $5,781 in 2002, 2001 and 2000, respectively. 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). The Company's income tax (benefit) related to the disposal of discontinued operations was $93,000 in 2000.
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:
The 2002 consolidated tax rate reflects a valuation allowance recorded against the deferred benefit of certain deferred interest expense deductions in the amount of $16,672 that is no longer likely to be utilized due to usage limitations imposed by the Internal Revenue Code. This expense is offset by the reversal of a $20,000 reserve that had been related to U.S. Federal and state income tax audits that have since been resolved.
The 2001 consolidated tax rate reflects a write-down of the fixed assets and non-deductible goodwill of $31,692 related to a melamine plant due to its indefinite shut-down. The rate also reflects the impact of earnings related to the expected sale of a foreign business that are not expected to be permanently reinvested in foreign locations and the inability to utilize foreign tax credits associated with those earnings due to usage limitations. These expenses are offset by the reversal of a $14,388 reserve that had been related to U.S. Federal and state income tax audits that have since been resolved.
The 2000 income tax rate reflects a settlement reached with the Internal Revenue Service ("IRS") and the impact of usage limitations on foreign tax credits. As a result of a settlement reached with the IRS, the Company recorded net tax expense of $5,000 consisting of valuation reserves recorded on foreign tax credits of $30,000 that are no longer likely to be utilized, substantially offset by a $25,000 reduction of amounts established for tax issues related to the divestiture of certain segments of the Company's business that are no longer considered necessary. In addition, approximately $10,000 of income tax expense was recorded on foreign source income because related foreign tax credits are not expected to be utilized within the expiration period.
The domestic and foreign components of the Company's (loss) income from continuing operations before income taxes, and the effect of change in accounting principle of $29,825, are as follows:
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, 2002 and 2001, are as follows:
The Company's net deferred tax asset at December 31, 2002 was $145,856. Of this amount, $146,790 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 $79,981. This is comprised primarily of net operating loss carryforwards of $21,090 for U.S. federal tax purposes, which will begin expiring in 2021; foreign tax credit carryovers of $12,054, which were generated in 1998 and will expire in 2004; minimum tax credits of $33,132, available indefinitely; and other carryforwards of $13,705. Realization of the entire net domestic deferred tax asset is dependent on generation of approximately $419,400 of future taxable income.
Since 1995, the Company has generated taxable losses from operations offset in some years by substantial taxable gains from the sales of operating businesses. These sales have occurred as a result of the business strategy to streamline the organization and focus its business on Chemical related products. Management believes the expectation of future gains from dispositions will fully utilize the Company's deferred tax assets.
Loss and credit carryforwards as well as the related valuation allowance have both decreased from 2001 principally due to the decision by the Company to deduct certain Foreign tax credits rather than treat them as credits available to offset future U.S. Income Tax. In addition, the Company has determined that it's ability to utilize a deferred tax asset for deferred interest expense is not, "more likely than not" realizable due to limitations on utilization for this specific asset. As such, the Company recorded a valuation reserve on this asset of $16,672 in the fourth quarter of 2002.
The Company has not recorded income taxes applicable to undistributed earnings of foreign subsidiaries that are indefinitely reinvested in foreign operations. Undistributed earnings permanently reinvested amounted to $150,101 at December 31, 2002.
14. 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.
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 2002, 2001 and 2000 amounted to $5,647, $5,289 and $6,159, respectively.
The Company's funding of its pension plans equals or exceeds the minimum funding requirements imposed by Federal and foreign laws and regulations.
Former associates of Foods and current and former associates of Consumer Adhesives continue to participate in the U.S. Plan, which is sponsored by BWHLLC. The U.S. Plan remains the liability of the Company, and Foods and Consumer Adhesives reimburse the Company for the annual expense associated with their respective participants in this plan. Therefore, the following tables summarizing the pension activities for the Company's defined benefit pension plans include the liabilities and assets relating to these affiliates. However, the expense table excludes the expense relating to Foods, for all years presented, and to Consumer Adhesives for 2002. The expense for Foods was $624, $952 and $2,086 for 2002, 2001 and 2000, respectively. The Consumer Adhesives expense for 2001 and 2000 is insignificant.
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 2000 a settlement charge of $8,858 was recorded relating to the settlement of the liability for Wise Holdings, Inc., as well as other lump sum settlements made during 2000.
Following is a rollforward of the assets and benefit obligations of the Company's defined benefit plans for the years ended December 31, :
The year end obligations were calculated using a 6.5% and 7.2% rate at December 31, 2002 and 2001, respectively.
Amounts recognized in the balance sheets, after reclassification of the prepaid pension asset to reflect a minimum pension liability adjustment, consist of:
Plan assets consist primarily of equity securities and corporate obligations.
Following are the components of net pension expense recognized by the Company for the years ended December 31,:
The weighted average rates used to determine net pension expense for the Company were as follows:
Most employees not covered by the Company's plans are covered by collectively bargained 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 $504, $367 and $244 in 2002, 2001 and 2000, respectively, for payments to pension trusts on behalf of employees not covered by the Company's plans.
15. 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 provided with the same medical benefits as active employees, while those who are eligible for Medicare are provided with supplemental benefits. The Company has reserved the right to amend or terminate the plans under which medical benefits are provided to domestic retirees. 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.
Following is a rollforward of the changes in the Non-Pension Postretirement Benefit Obligations of the Company for the years ended December 31,:
Also included in the Consolidated Balance Sheets at December 31, 2002 and 2001 are other post-employment benefit obligations of $6,065 and $6,966, respectively.
The Company assumed the remaining domestic post-retirement benefit liability of $8,141 from Foods in December 2001. In 2002, Foods reimbursed the Company $509 for the expense related to Foods' participants.
A 6.5% and 7.25% weighted average discount rate was used in determining the postretirement benefit obligation at December 31, 2002 and 2001, respectively. For measurement purposes, health care costs are assumed to increase 5.25% for pre-65 benefits and 8.25% for post-65 benefits in 2002 grading down gradually to a constant 5.25% annual increase by the year 2008 for post-65 benefits. The comparable assumptions for the prior year were 8.75% and 5.25% by the year 2008.
The net postretirement (benefit) expense table excludes the expense related to Foods, for all years presented, and to Consumer Adhesives from date of sale in 2001. Following are the components of net postretirement (benefit) expense recognized by the Company for 2002, 2001 and 2000:
Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one-percentage-point change in the assumed health care cost trend rates would have the following effects:
16. SHAREHOLDERS' (DEFICIT) EQUITY
Common Stock and Warrants - ---------------------------- The Company has 200,923,628 shares of $0.01 par value common stock issued and outstanding and 300,000,000 shares authorized. At December 31, 2002, management held a total of 1,948,634 common shares of the Company, including 1,587,301 shares of restricted stock granted during 2002. 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 - ---------------- On November 19, 2001, the Company's parent contributed all of the outstanding Preferred Stock plus accumulated dividends of $6,553 to the Company as a capital Contribution (See Note 5). The Company declared preferred stock cash dividends of $0, $61,846 and $73,724 in 2002, 2001 and 2000, respectively.
Other Shareholders' Equity - ---------------------------- The Company declared common stock cash dividends of $0, $36,434 and $61,578 during 2002, 2001 and 2000, respectively. The dividends were recorded as a charge to paid-in capital to reflect a return of capital to the Company's parent.
At December 31, 2002, 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 of the Company's parent as proceeds from the 1996 sales of Wise and Foods and from the issuance of options on the common stock of the Consumer Adhesives business and of Borden Decorative Products Holdings, Inc. Receivable from Parent (shown as a reduction in the Consolidated Statements of Shareholders' (Deficit) Equity) includes accrued interest of $58,699, $0 and $10,120 related to these notes receivable at December 31, 2002, 2001 and 2000. Paid-in Capital includes the related net of tax interest income of $38,154, $24,674 and $31,090 for the years ended December 31, 2002, 2001 and 2000. 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, and 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.
During 2002 the Company granted 1,587,301 shares of restricted stock to certain management members. The shares become unrestricted on the third anniversary of the grant date. Deferred compensation expense of $3,571 related to this grant is being amortized over the three-year vesting period. At December 31, 2002, the unamortized deferred compensation was $2,679.
BHI contributed tax benefits to the Company of $20,890, $21,038 and $44,045 during 2002, 2001 and 2000, respectively. The Company is included in its parent's tax return and the deductible interest expense on the parent's notes payable reduces the Company's tax liability. 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 has no responsibility to fund (see Note 22).
In addition to the contribution of the tax benefits, discussed above, during 2001 the Company's parent contributed Preferred Stock and accumulated dividends totaling $620,922 and $17,000 of cash as a capital contribution in conjunction with the Corporate Reorganization.
During 1996 the Company sold an option to BWHLLC to purchase what was then all of the common stock of the Consumer Adhesives business for $54,120, which was 110% of the August 16, 1996 fair market value of the common stock. The option was issued at fair value with a five-year expiration. During 2000, the Company made a capital contribution to the Consumer Adhesives business in exchange for additional shares of stock. On August 13, 2001, the option was exercised and an affiliate of the Company purchased the remaining 26% of Consumer Adhesives' common shares issued in 2000, for $40,000. The related pre-tax gain of $132,275 ($94,847 after-tax) was recorded in paid-in capital as of December 31, 2001 (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 for $1,236, the value of the minority interest liability that represented their previous interest in BCHI.
During 2000, the Company distributed 100% of its ownership in the infrastructure management services business to the Company's parent. The distribution was recorded at net book value of $16,277, including $8,557 owed by the Company to the infrastructure management services business in accordance with a tax sharing agreement. Subsequent to the distribution, substantially all of the assets of the infrastructure management services business were sold to a subsidiary of Interliant, Inc. Subsequent to this sale, the remaining assets of the infrastructure management services business, with a net book value of $307, were contributed back to the Company from the Company's parent.
The Company recorded a net of tax minimum pension liability adjustment of $17,075, $66,580 and ($1,779) for 2002, 2001 and 2000, respectively, relating to underfunded pension plans, which is reflected in accumulated other comprehensive income.
17. STOCK OPTION PLANS AND OTHER STOCK BASED COMPENSATION
Stock Options - -------------- Beginning in 1996, key subsidiaries of the Company issued stock options under their individual Stock Purchase and Option Plans for Key Employees. Under these plans, equity in the Chemical and infrastructure management services business units was sold to key management personnel. Fixed stock options were granted to purchase additional shares at exercise prices between $5.00 and $7.50. In addition, each company granted fixed stock options to employees under their respective broad-based option plans. The options were issued with exercise prices at or above fair market value, with vesting over five years.
The options granted to Chemical employees became options of the Company effective with the Corporate Reorganization. The conversion of Chemical shares and options provided Chemical management with equivalent intrinsic value in the Company at the new measurement date. Accordingly, no compensation expense was recorded. The strike prices of these options have a range of $4.13 to $5.00, which exceeds estimated fair market value.
During 2002, an additional 1,492,000 options were granted to key employees, including 1,176,000 performance options. The 2002 options have an exercise price of $2.25 per share, and were granted at estimated fair market value. The performance options vest after the fifth anniversary of the grant date, however, vesting is accelerated upon the achievement of certain EBITDA targets. The remaining options vest ratably over five years. In accordance with FASB Interpretation No. 44 ("FIN44") options granted after July 1, 2001 require variable accounting. The expense relating to these options for 2002 was $14. As of December 31, 2002 there are 3,426,040 options outstanding on the Company's common stock and 5,897,559 shares available for future grants.
The liability for options relating to the infrastructure management services business was included in the distribution of this business, and these options were subsequently exercised upon the sale of that business by the Company's parent.
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". To determine compensation cost for 2002 option grants according to SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes options pricing model with a risk-free weighted average interest rate of 5.0% and expected lives of five years. The 2001 Corporate reorganization resulted in a new measurement date for the options outstanding at that time for purposes of measuring compensation expense. To determine compensation cost according to SFAS No. 123, the fair value of each option was estimated as of the measurement date using the Black-Scholes option-pricing model with a risk free weighted average interest rate of 4.37% and expected lives of five years (See Note 3).
Information regarding the management stock option plans for the Company is as follows:
The option conversion relates to the increase in options as a result of the Corporate Reorganization (see Note 5). Options relating to distributed business represents options for the infrastructure management services business which was distributed to the Company's parent during 2000 (see Note 22).
At December 31, 2002 there were 1,472,824 options exercisable, with a range of exercise prices of $4.13 to $5.00, a weighted average exercise price of $4.51 and a weighted average remaining life of 4 years. At December 31, 2001 there were 5,213,104 options exercisable, with a range of exercise prices of $4.13 to $5.00, a weighted average exercise price of $4.26 and a weighted average remaining life of 5 years.
Unit Appreciation Rights - -------------------------- Certain current and former employees of the Company hold unit appreciation rights ("UAR's") granted by the Company in BWHLLC during the years 1996 - 2000. The UAR's have a ten-year life with vesting periods ranging from 4 to 5 years. The UAR's are accounted for under the liability method as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), and any compensation expense incurred in conjunction with the UAR's will be reflected in the Statements of Operations for the Company. For 2002, 2001 and 2000, the Company has not recorded any compensation expense attributable to the UAR's. There were 13,383,461 UAR's outstanding at December 31, 2002 and no UAR's available for future grants.
18. DERIVATIVE FINANCIAL INSTRUMENTS
The effect on the Company's other Comprehensive income from adoption of SFAS No. 133 as of January 1, 2001 was a charge of $5,200 ($3,300 net of tax), as discussed further in Note 10. As of December 31, 2002, the Company had derivative liabilities of $402 classified as other current liabilities and derivative gains of $16 classified as other assets.
Interest Rate Swaps - --------------------- The Company enters into interest rate swaps to alter interest rate exposures between fixed and floating rates on long-term debt. Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts calculated by reference to an agreed notional principal amount. The notional amount of interest rate swaps was $0 at December 31, 2002 and $24,286 at December 31, 2001. The remaining swap at December 31, 2001 matured on December 1, 2002. The net impact of interest rate swaps was an increase in the Company's interest expense of $2,566 in 2002, $2,215 in 2001 and $6,663 in 2000. The year-end fair value of the interest rate swap was a loss of $2,711 at December 31, 2001.
The following table summarizes the weighted average interest rates for the swaps used by the Company. Variable rates change with market conditions and may vary significantly in the future.
An interest rate swap, having a notional amount of $200,000, no longer met the criteria for hedge accounting and was marked to market prior to termination on September 1, 2000. On that date the Company recognized a gain of $4,902 in the Consolidated Statement of Operations.
Foreign Exchange - ----------------- International operations account for a significant portion of the Company's revenue and operating income. It is the policy of the Company to reduce foreign currency cash flow exposure due to exchange rate fluctuations by hedging anticipated and firmly committed transactions wherever economically feasible (within the risk limits established in the Company's policy). The Company enters into forward and option contracts to buy and sell foreign currencies only to reduce foreign exchange exposure and protect the U.S. dollar value of such transactions to the extent of the amount under contract. These contracts are part of a worldwide program to minimize foreign currency exchange operating income and balance sheet exposure.
Gains and losses arising from contracts are recognized on a quarterly basis through the Consolidated Statement of Operations (see Note 3). The Company does not hold or issue derivative financial instruments for trading purposes.
At December 31, 2002 and 2001, the Company had $60,079 and $50,987, respectively, of notional value of forward foreign currency exchange contracts outstanding. The unsecured contracts mature within 12 months and are principally with banks. The Company is exposed to credit loss in the event of non-performance by the other parties to the contracts. The Company evaluates the credit worthiness of the counterparties' financial condition and does not expect default by the counterparties.
Option and Commodity Future Contracts - ----------------------------------------- The Company is exposed to price fluctuations associated with raw materials purchases, most significantly with methanol, phenol and urea. For these commodity raw materials, the Company has purchase contracts, with periodic price adjustment provisions. The Company also adds selling price provisions that are indexed to publicly available indices on customer contracts for these commodity raw materials. The Board of Directors approves all commodity futures and commodity commitments.
In the fourth quarter of 2000, the Company entered into fixed rate, fixed quantity contracts to secure a portion of future natural gas usage at certain of the Company's facilities. The contracts were entered into to partially hedge the Company's risk associated with natural gas price fluctuations in peak usage months through March 2003. Gas purchases under these contracts totaled $671 and $853 in 2002 and 2001, with $402 and $1,073 future commitments at December 31, 2002 and 2001, respectively.
Additionally, the Company expanded its natural gas hedging activities in June 2001 to hedge a portion of natural gas purchases for all of North America. The Company entered into futures contracts with varying settlement dates through November 2002 to purchase natural gas. The contracts are settled for cash each month based on the closing market price on the last day the contract trades on the New York Mercantile Exchange. Commitments settled under these contracts totaled $1,210 and $1,716 in 2002 and 2001, respectively and related losses were $264 and $610 in 2002 and 2001. There were no future commitments under these contracts at December 31, 2002 and $520 of future commitments at December 31, 2001.
Gains and losses on commodity futures contracts are recognized each month as gas is used. Future commitments are marked to market on a quarterly basis. The Company also recorded a gain of $16 and a loss $545 for the difference between the fair value and carrying value of future natural gas commitments at December 31, 2002 and 2001, respectively.
19. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying or notional amounts and fair values of the Company's financial instruments at December 31, 2002 and 2001. The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair values are determined from quoted market prices where available or based on other similar financial instruments.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and other accruals are considered reasonable estimates of their fair values. The carrying value of the loans receivable from and payable to affiliates approximates fair values as management believes the loans bear interest at market interest rates.
The following table includes financial instrument carrying and fair values for the Company.
20. SUPPLEMENTAL INFORMATION
21. SEGMENT AND GEOGRAPHIC DATA
Beginning in 2002, the Company reports three operating segments rather than one, as previously reported, to better reflect the ongoing internal organization. Prior years have been restated to reflect this change. The three segments reported are North American Forest Products, North American Performance Resins Group and International. In addition, Corporate and Other is reported separately. The product lines included in the North American Forest Products segment are formaldehyde and forest products resins. The key business drivers in the North American Forest Products segment are housing starts, furniture demand, panel production capacity and chemical sector operating conditions. The North American Performance Resins Group includes specialty, oilfield, industrial, nonwoven, laminate and foundry resins, and UV coatings. In the North American Performance Resins Group segment, the key business drivers are housing starts, auto builds, active gas drilling rigs, fiber optic demand and the general industrial sector. The International segment consists of operations in Latin America, Europe and Asia Pacific. Principal countries of operation are Brazil, the United Kingdom, Malaysia and Australia. Product lines include forest product and performance resins. In the International segment, the key business drivers are export levels, panel production capacity, housing starts, furniture demand and the local political environment. Corporate and Other represents general and administrative expenses and income and expenses related to divested businesses.
In the consolidated financial information that follows, the businesses sold, distributed or discontinued classification includes the Company's melamine crystal business, which facility was closed on January 11, 2002. Operating results subsequent to the closure date represent revenue and related expenses from the sale of inventory. The classification also includes the Company's printing inks business through the date of its sale in 2000 and the infrastructure management services business prior to its distribution to the Company's parent in 2000.
EBITDA information is presented with the Company's segment disclosures because it is a primary measure used by the Company to evaluate operating results. EBITDA represents the sum of Operating Income (loss) and depreciation and amortization presented in the tables below.
OPERATING SEGMENTS: - --------------------
The Company reports and manages its business through three operating segments which do cross geographic boundaries. The following tables reflect sales and long-lived assets by major geographic area:
22. RELATED PARTY TRANSACTIONS
Corporate Reorganization Transactions - ---------------------------------------
The Corporate Reorganization included certain financial transactions between the Company and its parent (see Note 5).
Financing and Investing Arrangements - ---------------------------------------
Borden Foods Holding Corporation ("Foods"), an affiliate of the Company, loans cash to the Company, under an Affiliate Borrowing Agreement. The loans are evidenced by a demand promissory note with interest at a variable rate per year equal to the daily operating Fed Funds Rate as reported by "Telerate" (or an agreed upon alternative reporting system) on each day the note remains outstanding. Interest is calculated on the daily unpaid principal balance and is paid on Friday of each week and on the last day of each month. These loans are recorded as loans payable to affiliates in the Consolidated Balance Sheets. Foods had $84,680 at an interest rate of 1.3125% and $78,550 at an interest rate of 2.125% loaned to the Company at December 31, 2002, 2001 and 2000, respectively. The Company recorded affiliated interest expense of $1,857, $14,538 and $20,963 related to amounts loaned by affiliates for the years ended December 31, 2002, 2001 and 2000, respectively. The significant reduction in affiliated interest expense is due to lower average borrowings by the Company in 2002.
As a guarantor of the Company's debt, Foods received an annual fee from the Company of $1,050 in 2001 and 2000. Under the terms of the guarantee agreement between Foods and the Company, Foods was automatically released from the obligation to guarantee the payment of the Company's outstanding publicly held debt upon Foods being released from the obligation to guarantee the payment of amounts due under the Company's $250,000 Credit Agreement that expired on July 13, 2002.
In the first quarter of 2002, the Company settled in full its note payable to BCPM (the "Note") in the form of cash payments of $31,581 and $2,600 of certain set-offs asserted by the Company against amounts due under the Note. BCPM acknowledged the validity and enforceability of certain set-offs asserted against amounts due under the Note by the Company; the Company waived the right to assert certain other set-offs against amounts due under the Note; and BCPM and the Company exchanged mutual releases with respect to the Note. A committee comprised solely of independent directors of BCPM, represented and advised by separate and independent counsel, reviewed and agreed to the above provisions (See Note 4).
In the Company's 2001 Annual Report on Form 10-K, the Company expressed that it intended to cancel a $404,817 note receivable (plus accrued interest) from its parent, BHI, which is accounted for as a reduction from equity. In the third quarter of 2002, the Company decided to defer canceling this note receivable. Historically, BHI funded the interest due the Company on the note through common dividends received from the Company. The Company continues to accrue interest on the note receivable, however, quarterly interest has not been paid, since October 15, 2001.
At December 31, 2001, the Company had a $110,000 preferred stock investment in Consumer Adhesives, an affiliate of the Company. The preferred stock was redeemed on March 1, 2002 for a $110,000 note receivable from Consumer Adhesives. On March 12, 2002, the note receivable was sold to BHI, the Company's parent, for cash proceeds of $110,000 plus accrued interest of $455.
In the third quarter 2000 the Company entered into a $40,000 credit facility with WKI maturing on December 31, 2000. This facility was extended through a series of amendments through April 16, 2001. Effective April 12, 2001 this facility was amended and restated extending the maturity date to March 31, 2004. The facility was further amended effective July 2, 2001 to increase the amount available to $50,000. In accordance with the terms of the restated and amended agreement, the facility was reduced to $25,000 on August 12, 2001 with the perfection of certain pledged collateral. The Company received a second priority lien on that same collateral. On September 25, 2001 the Company extended an additional $3,000 unsecured credit facility to WKI maturing on October 25, 2001. That facility was increased to $13,000 effective October 26, 2001 maturing on December 28, 2001. No borrowings occurred under the unsecured facilities and the facility was transferred to the Company's parent in conjunction with the Corporate Reorganization (See Note 5).
Administrative Service, Management and Consulting Arrangements - -------------------------------------------------------------------
Prior to the Corporate Reorganization, KKR rendered management, consulting and board services to the Company for an annual fee of $10,000, payable quarterly in arrears. The 2001 fee through the date of the Corporate Reorganization was $9,167. At December 31, 2001, $1,667 is included in accounts payable to Capital for the two months of fourth quarter 2001 fees prior to the Corporate Reorganization. Effective with the Corporate Reorganization, the Company was no longer charged directly for any KKR fees. However, with the cessation of operations by Capital (discussed below), in 2003 KKR will provide certain management, consulting and board services directly to the Company for an annual fee of $3,000.
As a result of the Corporate Reorganization in 2001, Capital provided management, consulting and board services to the Company, and the Company provided certain administrative services to Capital. Capital charged the Company an annual fee of $9,000, payable quarterly in arrears, which represents the net amount of Capital's services less the Company's cost of providing administrative services to Capital. Charges incurred for one month of such services in 2001 subsequent to the Corporate Reorganization were $750. Included in accounts payable was $2,250 and $1,711 at December 31, 2002 and 2001 respectively for the annual fee due to Capital under this arrangement. During 2002 the Company's parent made a decision to cease the operations of Capital by the end of the first half of 2003. This decision resulted in the immediate recognition by Capital of incremental expenses and liabilities related primarily to severance and rent obligations. These incremental expenses are the legal obligation of Capital and will be funded by Capital and the Company is not responsible for settling these liabilities. The Company's allocated portion of Capital's incremental costs is $5,500 and has been recognized by the Company as additional management fee for financial reporting purposes with the offset recorded as a capital contribution to the Company, by BHI.
The Company incurs certain costs on Capital's behalf and is reimbursed by Capital for 100% of these costs. Included in accounts receivable at December 31, 2002 and 2001 is a $2,298 and $554 receivable for these expenses.
The Company provides administrative services to Foods under a revised agreement effective for 2002. The total fee under this agreement is based on the level of services provided, which was significantly reduced from those services provided in 2001. Additionally, the Company also provided services to Wise prior to its sale by BWHLLC in 2000. Fees received for these services are offset against the Company's general and administrative expenses, and totaled $120, $1,000 and $1,167 for the years ended December 31, 2002, 2001 and 2000, respectively.
In 2001 and 2000, the Company rendered management, consulting and financial services to World Kitchen Holding Company, Inc. ("WKI"), an affiliate of the Company, for an annual fee of $2,500 depending upon WKI reaching certain operating criteria. In addition, WKI also reimbursed the Company for certain expenses paid on its behalf. In November 2001, Capital purchased the management fee receivable of $1,667 from the Company plus receivables for expenses paid on WKI's behalf in the amount of $1,927. Total fees received under this arrangement were $0 and $2,500 for 2001 and 2000, respectively and are offset against the Company's general and administrative expenses.
Other Transactions and Arrangements - --------------------------------------
Prior to Consumer Adhesives Sale (See Note 1), the Company and Consumer Adhesives were parties to a tax sharing agreement. Under this agreement, Consumer Adhesives paid income taxes to the Company as if Consumer Adhesives filed stand-alone federal and state income tax returns. At December 31, 2002, Consumer Adhesives had no liability to the Company for unpaid federal and state income tax.
During 2001, the Company received payments of $ 11,802 from Foods for its calculated portion of the Company's net pension liability. In the fourth quarter of 2001, the Company received $12,302 from Foods to assume the liability for payment of claims made under essentially all of Foods' employee benefit plans. As of December 31, 2001, the Company owed $106 to Foods for reimbursement of payments made on its behalf. No amounts were owed to Foods at December 31, 2002.
As described in Note 8, the Company acquired certain assets from BCP in 2000. A wholly owned subsidiary of the Company serves as the general partner of BCP (See Note 4). The purchase price of these assets is considered to be at fair value as determined by an independent appraisal. During 2002, 2001 and 2000, the Company purchased $2,012, $11,026 and $102,540 of raw materials from BCP. In addition, the Company paid $25,330 in 2000 to BCP to exit certain raw material purchase contracts.
In February 2000, the Company distributed 100% of its ownership in the infrastructure management services business to the Company's parent. The distribution was recorded at net book value of $16,277, including $8,557 owed by the Company to the infrastructure management services business in accordance with a tax sharing agreement. Subsequent to the distribution, substantially all of the assets of the infrastructure management services business were sold to a subsidiary of Interliant, Inc. in exchange for $2,500 in cash and 1,041,179 shares of Interliant, Inc. stock. In June 2000, the remaining net assets of the infrastructure management services business, with a net book value of $307, were contributed back to the Company from the Company's parent.
23. GUARANTEES AND INDEMNIFICATIONS
Standard Guarantees / Indemnifications - -----------------------------------------
In the ordinary course of business, the Company enters into numerous agreements that contain standard guarantees and indemnities whereby the Company indemnifies another party for, among other things, breaches of representations and warranties. Such guarantees or indemnifications are granted under various agreements, including those governing (i) purchases and sales of assets or businesses, (ii) leases of real property, (iii) licenses of intellectual property and (iv) long-term supply agreements. The guarantees or indemnifications issued are for the benefit of the (i) buyers in sale agreements and sellers in purchase agreements, (ii) landlords in lease contracts, and (iii) licensees in license agreements and (iv) customers in long-term supply agreements.
In addition, these parties may also be indemnified against any third party claim resulting from the transaction that is contemplated in the underlying agreement. While some of these guarantees extend only for the duration of the underlying agreement, many survive the expiration of the term of the agreement or extend into perpetuity (unless subject to a legal statute of limitations). There are no specific limitations on the maximum potential amount of future payments that the Company could be required to make under these guarantees, nor is the Company able to develop an estimate of the maximum potential amount of future payments to be made under these guarantees as the triggering events are not subject to predictability. With respect to certain of the aforementioned guarantees, the Company has reimbursement agreements from its parent entity, or maintains insurance coverage that mitigates any potential payments to be made.
In addition the Company has agreed to indemnify KKR for any claims resulting from its services to the Company. The indemnification does not expire and the Company is not able to determine a maximum exposure under the agreement. However, the Company does have an indemnification agreement from its parent for any amounts that it must pay under the KKR indemnity relating to WKI.
Subsidiary Guarantees - ----------------------
The Company guarantees the bank debt of one of its Brazilian subsidiaries at Banco Itau S.A. up to a maximum U.S. equivalent of US $6,700.
Warranties - ----------
The Company does not make express warranties on its products, other than that they comply with the Company's specifications, and therefore does not record a warranty liability. Adjustments for product quality claims in general are handled through routine procedures and charged against sales revenues upon occurrence.
24. COMMITMENTS AND CONTINGENCIES
ENVIRONMENTAL MATTERS - The Company like others in similar businesses, is subject to extensive Federal, state and local environmental laws and regulations. Although environmental policies and practices are designed to ensure compliance with these laws and regulations, future developments and increasingly stringent regulation could require the Company to make additional unforeseen environmental expenditures. Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Environmental accruals are routinely reviewed on an interim basis as events and developments warrant and are subjected to a comprehensive review annually during the fiscal fourth quarter.
In 1987, under an Environmental Indemnity Agreement (EIA) between the Company and BCP, the Company agreed, subject to certain conditions and limitations, to indemnify BCP from certain environmental liabilities incurred at BCP facilities, which were previously owned by the Company, on or before November 30, 1987 and share on an equitable basis those arising from facts or circumstances existing and requirements in effect both prior to and after such date. On October 22, 2002 the United States Bankruptcy Court for the District of Delaware approved a Settlement Agreement among the Company, BCPOLP, BCPM, the United States Environmental Protection Agency and the Louisiana Department of Environmental Quality, where the company agreed to perform certain of BCPOLP's obligations with respect to environmental conditions at BCPOLP's Geismar, Louisiana site.
The Company has accrued approximately $44,000 and $43,400 at December 31, 2002 and 2001, respectively, for all probable environmental remediation, indemnification and restoration liabilities at approximately 55 locations, 35 of which are active proceedings brought under CERCLA or similar state environmental laws. Of these amounts, $5,400 and $2,400 at December 31, 2002 and December 31, 2001, respectively, relate to environmental remediation and restoration liabilities that are included in the Company's business realignment reserve (See Note 8). This is management's best estimate of these liabilities. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such liabilities may exceed current reserves by amounts that may prove insignificant, or by amounts, in the aggregate, of up to approximately $39,000.
Because the Company's operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials, the Company is subject to extensive environmental regulation at the Federal and State level and is exposed to the risk of claims for environmental remediation or restoration as well as claims of injury from direct exposure to such materials or products produced by the Company and from indirect exposure when such materials or its products are incorporated into other companies' products. In addition, the Company's former ink, wallcoverings, film, phosphate mining and processing, thermoplastics, food, dairy and other manufacturing operations, were also subject to environmental regulations and posed similar risks for claims. There can be no assurance that, as a result of former, current or future operations, there will not be additional environmental remediation or restoration liabilities or claims of personal injury by employees or members of the public due to exposure or alleged exposure to such materials or to the Company's products.
LEGAL MATTERS - The Company has recorded $3,045 and $2,794 in liabilities at December 31, 2002 and 2001 respectively, for legal costs in amounts that management believes are probable and reasonably estimable. Actual costs are not expected to exceed these amounts. In addition, there has been increased publicity about asbestos liabilities faced by manufacturing companies. As a result of the bankruptcies of many asbestos producers, plaintiff attorneys are increasing their focus on peripheral defendants, including the Company. The Company believes it has adequate reserves and insurance and does not believe it has a material asbestos exposure.
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 merged with an acquisition vehicle created by Blackstone, which subsequently merged with Imperial Wallcoverings to create Imperial Home Decor Group ("IHDG"). Blackstone provided $84,500 in equity and Chase provided $295,000 in senior financing. Borden received approximately $314,400 in cash and 11% of IHDG common stock for its interest in BDPH. On January 5, 2000, IHDG filed for reorganization under Chapter 11 of the U. S. Bankruptcy Code. IHDG emerged from bankruptcy in April 2001. 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 pending in the case with a cut-off currently scheduled for December 2003. The Company believes it has strong defenses to the Trust's allegations and intends to defend the case vigorously. The Company believes, based upon the information it currently possesses, and taking into account its established reserves for estimated liability and its insurance coverage, that the ultimate outcome of the foregoing proceedings and actions is unlikely to have a material adverse effect on the Company's financial statements.
OTHER - The Company's 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 has served as the general partner of Borden Chemicals and Plastics Operating Limited Partnership ("the Partnership") which was created in November 1987 and operated as a commodity chemicals producer. On April 3, 2001 the Partnership 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 US Bankruptcy Court approved a Joint Plan of Liquidation for the Partnership and BCPM (the "Joint Plan") which provides 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 agents for liquidation and distribution to their creditors. The Company's ownership interest in BCPM will be extinguished and no distributions from BCPM to the Company are anticipated. The Company recorded charges totaling $30,000 for calendar years 2000 and 2001 to reduce the value of the Company's investment in BCPM to zero. No claims have been filed against the Company in connection with these bankruptcy proceedings; however, no assurance can be given that such claims will not be made in the future.
In 1992, the State of Sao Paolo Tax Bureau issued an assessment against the Company's primary Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes, characterized by the Tax Bureau as intercompany sales. Since that time the subsidiary and the Tax Bureau have held discussions and the subsidiary has filed an administrative appeal seeking cancellation of the assessment. In December 2001, the Administrative Court upheld the assessment in the amount of $R40,600, including tax, penalties, monetary correction and interest, or approximately $11,000. In September 2002, the subsidiary filed a second appeal with the highest level administrative court, again seeking cancellation of the assessment. The Company believes it has 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.
QUARTERLY FINANCIAL DATA (UNAUDITED)
The following represents Quarterly Financial Data for the Company:
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Borden Chemical, Inc.
We have audited the accompanying consolidated balance sheets of Borden Chemical, Inc. (a subsidiary of Borden Holdings, Inc.) and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, shareholders' (deficit) equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Borden Chemical, Inc. and subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets in 2002 to conform to Statement of Financial Accounting Standard No. 142.
DELOITTE & TOUCHE LLP
Columbus, Ohio March 12, 2003
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS - -------- -------------------------------------------------- ON ACCOUNTING AND FINANCIAL DISCLOSURE ------------------------------------------
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - --------- --------------------------------------------------------
Set forth below are the names and ages of the Directors and Executive Officers of the Company as of March 1, 2003, and the positions and offices with the Company currently held by each of them. Their terms of office extend to the next Annual Meeting of the Board of Directors or until their successors are elected.
Served in Age on Present Dec. 31, Position Name Position & Office 2002 Since ---------- ----------------------------- ----- -----
C. R. Kidder Chairman of the Board 58 1995 B. F. Carroll Director 31 2001 K. M. Kelley Director 44 2001 H. R. Kravis Director 58 1995 P. J. Norris Director 55 2001 G. R. Roberts Director 59 1995 J. K. Saer Director 46 2001 S. M. Stuart Director 43 1995 C. O. Morrison Director, 47 2002 President and Chief Executive Officer W. H. Carter Director, 49 1995 Executive Vice President and Chief Financial Officer W. F. Stoll, Jr. Director, 54 1996 Executive Vice President and General Counsel J. M. Kaestle Executive Vice President- 47 2001 Global Resins J. P. Bevilaqua Executive Vice President- 47 2002 Performance Resins E. G. Huller Vice President - 55 2001 Global Supply Chain Management R. H. Glaser Vice President - 42 2002 Strategy and Development A. J. Miles Vice President- 51 2001 Environmental Health & Safety J. A. Sonnett Vice President - 46 2001 Human Resources
C. Robert Kidder was elected a Director, Chairman of the Board and Chief Executive Officer of the Company on January 10, 1995. In November, 2001 he became an employee and President of Borden Capital, Inc., a subsidiary of the Company's parent, and continued to serve as the Company's Chief Executive Officer through March 2002. He is also a director of WKI Holding Company, Inc., Electronic Data Systems Corporation and Morgan Stanley. He is a member of the Executive, Nominating and Compensation Committees of the Board.
Brian F. Carroll was elected a Director of the Company November 20, 2001. He has been an executive with Kohlberg, Kravis, Roberts & Co., since July 1999. From September 1997 to June 1999 he attended the Stanford University Graduate School of Business. Before attending graduate school, from March 1995 to July 1997, he worked for Kohlberg Kravis Roberts & Co. He is also a director of AEP Industries, Inc. He is Chairman of the Compensation Committee and a member of the Audit Committee of the Board.
Kevin M. Kelley served as Executive Vice President, Corporate Strategy and Development of the Company from April 5, 1999 to November 24, 2001. Since November 24, 2001 he has been employed as Executive Vice President and Treasurer of Borden Capital, Inc., a subsidiary of the Company's parent. He was elected a director of the Company November 20, 2001. From April 1996 to March 1999, he was Managing Director of Ripplewood Holdings LLC. He is also a director of AEP Industries, Inc. He is a member of the Executive Committee of the Board.
Henry R. Kravis acted as Chairman of the Board of the Company from December 21, 1994, to January 10, 1995. He has been a member of KKR & Co., LLC since 1996, was a General Partner of Kohlberg, Kravis, Roberts & Co. from its establishment through 1995 and has been a General Partner of KKR Associates, L.P. since its establishment. He is also a Director of Accuride Corporation, Alliance Imaging, Inc., Amphenol Corporation, The Boyds Collection, Ltd., Evenflo Company Inc., KinderCare Learning Centers, Inc., KSL Recreation Corporation, PRIMEDIA Inc., Sotheby's Holdings, Inc., and Willis Group Holdings Limited. He is a member of the Executive Committee of the Board. Messrs. Kravis and Roberts are first cousins.
Paul J. Norris was elected a director of the Company November 20, 2001. He was elected President and Chief Executive Officer of W.R. Grace & Co. in November 1998 and became Chairman in January 1999. Prior to joining W.R. Grace & Co., he was Senior Vice President of Allied Signal Incorporated and served as President of its specialty chemicals business from January 1997 to November 1998. In addition to serving as a director of the Company, he performs advisory services for Kohlberg, Kravis, Roberts & Co. A significant portion of these advisory services relate to the investment by affiliates of Kohlberg, Kravis, Roberts & Co. in the Company. Mr. Norris is a member of the Audit and Executive Committees of the Board.
George R. Roberts has been a member of KKR & Co., LLC since 1996, was a General Partner of Kohlberg, Kravis, Roberts & Co. from its establishment through 1995, and has been a General Partner of KKR Associates, L.P. since its establishment. He is also a Director of The Boyds Collection, Ltd., DPL, Inc., KinderCare Learning Centers, Inc., KSL Recreation Corporation, Owens-Illinois, Inc., PRIMEDIA Inc., Safeway, Inc., and Willis Group Holdings Limited. Messrs. Kravis and Roberts are first cousins.
John K. Saer was elected a director of the Company November 20, 2001. He has been a director with Kohlberg, Kravis, Roberts & Co. since January 2001. Prior to that, from 1993 to December 2000 he was with KSL Recreation Corporation, serving as Chief Financial Officer beginning in December 1996. He is a member of the Executive, and Compensation Committees and is Chairman of the Audit and Nominating Committees of the Board. He is also a Director of KSL Recreation Corporation.
Scott M. Stuart has been a member of KKR & Co., LLC since 1996. He began his employment with Kohlberg, Kravis, Roberts & Co. as an Executive in 1986. He is also a Director of The Boyds Collection, Ltd., and DPL, Inc.(The Dayton Power & Light Co.). He is a member of the Executive Committee of the Board.
Craig O. Morrison was elected President and Chief Executive Officer of the Company effective March 25, 2002. Prior to joining the Company he served as President and General Manager of Alcan Packaging's Pharmaceutical and Cosmetic Packaging business from 1999 to 2002. From 1993 to 1998 he was President and General Manager for Van Leer Containers, Inc. He is a member of the Executive and Nominating Committees of the Board.
William H. Carter was elected Executive Vice President and Chief Financial Officer effective April 3, 1995 and a director November 20, 2001.
William F. Stoll, Jr. was elected Senior Vice President and General Counsel effective July 1, 1996 and promoted to Executive Vice President in December 2000. He was elected a director of the Company November 20, 2001. He is also a director of AEP Industries, Inc.
John M. Kaestle was elected an Executive Vice President of the Company November 24, 2001. He joined the Company's subsidiary, Borden Chemical, Inc., in March 2001 as Executive Vice President - Forest Products Group. Prior to joining the Company, he served as Vice President Containerboard Sales and Logistics, and Chief Financial Officer, Containerboard Packaging and Recycling Division of Weyerhauser Company, from 1981 to 2001.
Joseph P. Bevilaqua was elected a Vice President of the Company April 1, 2002 responsible for Corporate Strategy and Development. In September 2002 he became Vice President responsible for the Performance Resins Group. Prior to joining the Company, he served as Vice President & General Manager of Alcan Packaging's plastics packaging business from February 2000 to March 2002. From August 1998 to December 1999 he served as Vice President & General Manager of North American Plastics for Russell-Stanley Corporation. Prior to that he held various positions with Woodbridge Foam Corporation, from 1992-1997.
Edward G. Huller was elected a Vice President of the Company November 24, 2001. He served as Vice President -Global Supply Chain Management for the Company's subsidiary, Borden Chemical, Inc., beginning in May 1999. Prior to that, from 1991-1999, he held various positions at Dow Chemical, including Global Supply Chain Director for the Chlor-Alkali business.
Raymond H. Glaser was elected Vice President of Corporate Strategy & Development in August 2002. Prior to joining the Company he served as Director of Business Development for W.R. Grace & Co. from October 1999 to August 2002. Prior to that, he worked in several capacities from May 1996 to October 1999 for Allied Signal's Performance Polymers division, including as Director of New Ventures.
Andrew J. Miles was elected a Vice President of the Company November 24, 2001 responsible for Health, Safety and Environmental compliance. He served as Vice President- Health, Safety and Environmental (HS&E) for the Company's subsidiary Borden Chemical, Inc., beginning in November 2000. Prior to that he served as Director of HS&E for Great Lakes Chemical, from May 1998 to November 2000, and Vice President of HS&E for Dexter Packaging Products from October 1992 to March 1998.
Judy A. Sonnett was elected a Vice President of the Company November 24, 2001 responsible for Human Resources. She was Vice President of Human Resources for the Company's subsidiary, Borden Chemical, Inc., beginning in November 1998. From 1995 to November 1998, she worked in Human Resources for W.L. Gore and Associates.
ITEM 11. EXECUTIVE COMPENSATION - --------- -----------------------
During 2002, Mr. Kidder served as the Registrant's acting Chief Executive Officer until March 25 when Mr. Morrison joined the Company. Mr. Kidder's and Mr. Carter's compensation for the year was paid by Borden Capital, Inc., a subsidiary of the Registrant's parent. The Registrant paid a total of $9 million to Borden Capital, Inc. in 2002 for management services. The amounts shown in the following table as compensation to Mr. Kidder and Mr. Carter represent the portion of the Borden Capital fee related to services provided by Mr. Kidder as interim CEO and Chairman, and by Mr. Carter as Chief Financial Officer. In addition to Mr. Kidder, the following table provides certain summary information concerning compensation of the Company's current Chief Executive Officer and the next four most highly compensated Executive Officers as of December 31, 2002 (the "Named Executive Officers") for the periods indicated.
OPTION GRANTS IN LAST FISCAL YEAR ---------------------------------
RETIREMENT BENEFITS, COMPENSATION OF DIRECTORS, EMPLOYMENT, TERMINATION AND - -------------------------------------------------------------------------------- CHANGE IN CONTROL ARRANGEMENTS, COMPENSATION COMMITTEE INTERLOCKS AND INSIDER - -------------------------------------------------------------------------------- PARTICIPATION - -------------
The Long-Term Incentive Plans-Awards In Last Fiscal Year table is not included since the Registrant has no long-term incentive plan.
Retirement Benefits - -------------------- The Borden Employees Retirement Income Plan ("ERIP") for salaried employees was amended as of January 1, 1987, to provide benefit credits of 3% of earnings which are less than the Social Security wage base for the year plus 6% of earnings in excess of the wage base. Earnings include annual incentive awards paid currently but exclude any long-term incentive awards. Benefits for service through December 31, 1986, are based on the plan formula then in effect and have been converted to opening balances under the plan. Both opening balances and benefit credits receive interest credits at one-year Treasury bill rates until the participant commences receiving benefit payments. For the year 2002, the interest rate as determined in accordance with the plan language was 2.18%. Benefits vest after completion of five years of employment for employees hired on or after July 1, 1990.
The Company has supplemental plans which will provide those benefits which are otherwise produced by application of the ERIP formula, but which, under Section 415 or Section 401 (a)(17) of the Internal Revenue Code, are not permitted to be paid through a qualified plan and its related trust. The supplemental plan also provides a pension benefit using the ERIP formula based on deferred incentive compensation awards and certain other deferred compensation, which are not considered as part of compensation under the ERIP.
The total projected annual benefits payable under the formulas of the ERIP at age 65 without regard to the Section 415 or 401(a)(17) limits and recognizing supplemental pensions as described above, are as follows for the Named Executive Officers of the Company in 2002: C. R. Kidder - $175,893, C.O. Morrison - $78,112, W. H. Carter - $125,223, W.F. Stoll - $60,820 (not including the special employment contract benefit described below), J.M. Kaestle - $42,368, and Huller- $24,347.
The Company has a special retirement arrangement with Mr. Stoll, Executive Vice President and General Counsel. Under this arrangement, the Company will calculate the benefit Mr. Stoll would have received from his former employer, using predetermined assumptions, and deduct from this amount the retirement benefits accrued under the Borden Retirement Programs. Any shortfall in benefits will be paid by the Company as a non-qualified benefit. Special provisions also apply in the event of death or disability.
In addition, certain Executive Officers receive Company matching contributions on the first 7% of contributions to the Retirement Savings Plan. Company matching contributions on employee contributions in excess of 5% are provided under the supplemental plans. This benefit is not provided if the executive has any other pension benefit guarantee.
Compensation of Directors - --------------------------- In 2002, Messrs. Kravis, Roberts, Stuart, Saer and Carroll received Board fees ranging in the aggregate from $10,000 to $30,000. No additional compensation was paid for committee participation or special assignments. Fees for Messrs. Kelley's and Kidder's services as Directors were paid as part of a management fee paid by the Company to Borden Capital, Inc. as described under "Certain Relationships and Related Transactions". Directors who were also employees of the Company received no remuneration for serving as directors.
Directors who served prior to March 15, 1995 and who were not employees of the Company are provided, upon attaining age 70, annual benefits through a funded grantor trust equal to their final annual retainer if they served in at least three plan years. Such benefits can continue for up to 15 years.
Employment, Termination and Change in Control Arrangements - ---------------------------------------------------------------- The Company has an arrangement with Mr. Morrison that provides for his services as President and Chief Executive Officer beginning March 2002. Under the terms of the agreement Mr. Morrison was provided with relocation assistance, a bonus opportunity, an equity investment opportunity, and a 2001 incentive payment guarantee. Pursuant to this arrangement Mr. Morrison purchased 222,222 shares of the Company's common stock at $2.25 per share and received 210,667 options granted at $2.25 per share. Mr. Morrison also received 1,176,000 performance options at $2.25 per share which vest at the earlier of five years, or in 33% increments when the Company meets EBITDA targets of $170 million, $190 million and $210 million. In addition Mr. Morrison was granted 1,058,201 shares of restricted stock which vest after three years of employment, at which time one-half of the shares may be sold to the Company. The remaining shares may be sold to the Company after four years of employment. The value of the shares is to be determined based upon a formula, and is capped, under certain circumstances, at $2 million. In the event Mr. Morrison's employment is terminated without cause, the vesting of the restricted shares is accelerated. Dividends are not payable on the restricted shares. In the event that the return on Mr. Morrison's equity investment in the Company is negative, due solely to certain specified circumstances, the arrangement requires the Company to purchase his investment at a price equal to his initial investment. The arrangement also entitles Mr. Morrison to receive a perquisite payment in the amount of $40,000 annually, usual and customary health and pension benefits, and provides for eighteen months severance based on monthly base salary in the event of termination of employment for reasons other than for cause.
In March 2003, an agreement was reached with Mr. Kidder relating to his termination of employment with Borden Capital, Inc. Mr. Kidder will continue as Chairman of the Board of the Company. The agreement provides for two years severance pay totaling $2,565,888 and a stay bonus of $1,718,880, both of which will be paid in a lump sum on April 11, 2003. Under the terms of the agreement Mr. Kidder is provided with a country club golf membership, office space, outplacement services, pay for unused vacation, and continued COBRA healthcare coverage through March 2005 at rates charged to active employees. The agreement also provides that Mr. Kidder's investment in BW Holdings, LLC will be valued upon the wind-up of that entity.
The Company has an arrangement with Mr. Stoll relating to his employment as Executive Vice President and General Counsel. Under the terms of the agreement Mr. Stoll is entitled to a stay bonus equal to $644,000 payable from 2002-2005 or upon termination for reasons other than for cause. The agreement also provides for annual incentive plan participation, an annual perquisites payment of $30,000, five weeks vacation, and twenty-four months of base salary severance. In addition Mr. Stoll has a special pension arrangement pursuant to which the Company will calculate the pension benefit Mr. Stoll would have received from his former employer, using predetermined assumptions, and deduct from this amount the retirement benefits accrued under the Company's retirement programs. Any shortfall in benefits will be paid by the Company as a non-qualified benefit. Special provisions also apply in the event of death or disability.
The Company has an agreement with Mr. Carter relating to his employment as Executive Vice President and Chief Financial Officer. Under the terms of the agreement Mr. Carter is entitled to a stay bonus equal to $1,200,000 payable from 2002-2005 or upon termination for reasons other than for cause. The agreement also provides for annual incentive plan and management equity plan participation, an annual perquisites payment of $30,000, and twenty-four months of base salary severance.
The Company entered into an agreement effective Nov. 24, 2001 with Borden Capital, Inc., a subsidiary of the Company's parent, which is described in Item 13. Certain Relationships and Related Transactions. Certain fees paid by the Company under this agreement fund compensation arrangements described above with Messrs. Kidder, Carter and Stoll which entitle them to stay-bonus payments which total $1,718,880, $1,200,000 and $ 644,000 respectively over a four year time period from 2002-2005 or upon termination of employment without cause. In addition, in 2002, the Company's fee funded payments from Borden Capital, Inc. for the salaries of Messrs. Kidder and Carter and incentive payments to Messrs. Kidder and Stoll.
Compensation Committee Interlocks and Insider Participation - ---------------------------------------------------------------- Messrs. Carroll and Saer are members of the Company's Compensation Committee and both are employees of Kohlberg Kravis Roberts & Co. See "Certain Relationships and Related Transactions." Mr. Kidder, the former Chief Executive Officer of the Company, is also a member of the Compensation Committee.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND - --------- --------------------------------------------------------- MANAGEMENT - ----------
The following table sets forth certain information regarding the beneficial ownership of the Registrant's Common Stock and other equity securities issued by affiliated entities, as of March 1, 2003, by (a) persons known to the Registrant to be the beneficial owners of more than five percent of the outstanding voting stock of the Registrant, (b) each director of the Registrant, (c) each of the Named Executive Officers of the Registrant during the 2002 fiscal year of the Registrant and (d) all directors and executive officers of the Registrant as a group. Except as otherwise noted, the persons named in the table below have sole voting and investment power with respect to all securities shown as beneficially owned by them.
Name of Beneficial Ownership Beneficial Owner of Equity Securities ------------------- ------------------------------ Shares/Units Percent ------------ -------
KKR Associates (1) 198,974,994 99.0 9 West 57th Street New York, New York 10019 C. Robert Kidder 369,569 (2) * Henry R. Kravis (1) -0- * George R. Roberts (1) -0- * Scott M. Stuart (1) -0- * Brian F. Carroll -0- * John K. Saer -0- * Paul J. Norris -0- * Kevin M. Kelley -0- * Craig O. Morrison 1,322,556 (3) * William H. Carter -0- * William F. Stoll, Jr. -0- * John M. Kaestle -0- * Edward G. Huller -0- * All Directors and Executive Officers (4) * as a group
* Beneficial ownership does not exceed 1.0% of the respective class of securities. (1) The Registrant's Common Stock shown as beneficially owned by KKR Associates is directly held by Borden Holdings, Inc., a Delaware corporation which is wholly owned by BW Holdings, LLC, a Delaware limited liability company, the managing member of which is a limited partnership, of which KKR Associates is the sole general partner and as to which it possesses sole voting and investment power. KKR Associates is also the beneficial owner of 632,000,000 units of BW Holdings, LLC. KKR Associates is a limited partnership of which Messrs. Todd Fisher, Edward A. Gilhuly, Perry Golkin, James H. Greene, Jr., Johannes Huth, Henry R. Kravis, Robert I. MacDonnell, Michael W. Michelson, Alexander Navab, Paul E. Raether, Neil Richardson, George R. Roberts, and Scott M. Stuart are the general partners. Such persons may be deemed to share beneficial ownership of the shares shown as owned by KKR Associates. The foregoing persons disclaim beneficial ownership of any such shares. (2) Represents units in BW Holdings, LLC. (3) As of March 1, Mr. Morrison beneficially owned 1,280,423 shares of common stock of the Registrant, and 42,133 shares subject to currently exercisable stock options. (4) Equity securities beneficially owned by all directors and executive officers as a group consist of: 369,569 units of BW Holdings, LLC, 1,920,634 shares of the Registrant, and 63,199 shares of the Registrant subject to currently exercisable options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------- --------------------------------------------------
All of the Company's common stock is owned by a holding company which is owned by an affiliate of KKR Associates, a New York limited partnership of which Messrs. Todd Fisher, Edward A. Gilhuly, Perry Golkin, James H. Greene, Jr., Johannes Huth, Henry R. Kravis, Robert I. MacDonnell, Michael W. Michelson, Alexander Navab, Paul E. Raether, Neil Richardson, George R. Roberts, and Scott M. Stuart are the general partners. KKR Associates has sole voting and investment power with respect to such shares. Messrs. Kravis, Roberts and Stuart are directors of the Company.
The Company entered into an agreement effective Nov. 24, 2001 with Borden Capital, Inc. ("Capital") a subsidiary of the Company's parent, for the provision of management, consulting and board services by Capital to the Company and for the provision of administrative services by the Company to Capital. The cost of these services in 2002 was a net expense to the Company of $14.5 million. Included in this fee are fees for Mr. Kelley's and Mr. Kidder's services as directors of the Company, and certain compensation arrangements with Messrs. Kidder, Carter and Stoll which entitle them to payments totaling $ 1,718,880, $1,200,000 and $644,000 respectively over a four year period from 2002-2005, or upon termination of employment without cause. In addition, a portion of Mr. Kidder's salary and all of Mr. Carter's salary is included in the above mentioned fee. Mr. Kidder, Chairman of the Company, is an officer of Capital.
In 2000, the Company made a loan to Mr. Carter, Executive Vice President and Chief Financial Officer, in the amount of $375,000, of which $225,000 was secured with a mortgage on his residence. The interest rate applicable to the loan was prime less .25%. The full amount of the loan plus accrued interest as of May 31, 2002, totaling $417,263, has been repaid by Mr. Carter.
ITEM 14. CONTROLS AND PROCEDURES - ------------------------------------
ANNUAL EVALUATION OF OUR DISCLOSURE CONTROLS AND INTERNAL CONTROLS Within the 90 days prior to the date of this Annual Report on Form 10-K, management evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures and the internal controls and procedures for financial reporting. This controls evaluation was done under the supervision and with the participation of the Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Following are the conclusions of the CEO and the CFO about the effectiveness of our disclosure controls and internal controls as of March 13, 2003.
CEO AND CFO CERTIFICATIONS Appearing immediately following the Signatures section of this Annual Report on Form 10-K there are certifications of the CEO and the CFO. The certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. This section of the Annual Report is the information concerning the controls evaluation referred to in the Section 302 certifications and this information should be read in conjunction with the Section 302 certifications for a more complete understanding of the topics presented.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, or the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Internal controls are procedures which are designed with the objective of providing reasonable assurance that the Company's transactions are properly authorized, its assets are safeguarded against unauthorized or improper use and transactions are properly recorded and reported, all to permit the preparation of the Company's financial statements in conformity with generally accepted accounting principles.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS The Company's management, including the CEO and the CFO, does not expect that the disclosure controls or internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Additionally, controls can be circumvented by the acts of individuals or by collusion of two or more people. Because of the inherent limitations in all control systems, including the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.
SCOPE OF THE CONTROLS EVALUATION The evaluation of our disclosure controls and our internal controls by our CEO and our CFO included a review of all previously existing controls as well as those recently implemented by the Company and the effect of the controls on the information generated for use in this Annual Report on Form 10-K. In the course of the controls evaluation, management sought to identify data errors, controls problems or acts of fraud and to confirm that appropriate corrective action, including process improvements, were being undertaken. The internal controls are also evaluated on an ongoing basis by the internal audit department, by other personnel in the finance department and by the Company's independent auditors in connection with their audit and review activities. The overall goals of these various evaluation activities are to monitor the Company's disclosure controls and internal controls and to make modifications as necessary, with the intent being that the disclosure controls and the internal controls will be maintained as dynamic systems that change (including with improvements and corrections) as conditions warrant. Among other matters, management sought in its evaluation to determine whether there were any "significant deficiencies" or "material weaknesses" in the Company's internal controls, or whether any acts of fraud involving personnel who have a significant role in the internal controls were identified. This information was important both for the controls evaluation generally and because Items 5 and 6 in the Section 302 certifications of the CEO and the CFO require that the CEO and the CFO disclose such information to the Board's Audit Committee and to the independent auditors and to report on related matters in this section of the Annual Report on Form 10-K. In the professional auditing literature, "significant deficiencies" are referred to as "reportable conditions." These are control issues that could have a significant adverse effect on the ability to record, process, summarize and report financial data in the financial statements. A "material weakness" is defined in the auditing literature as a particularly serious reportable condition where the internal control does not reduce to a relatively low level the risk that misstatements caused by error or fraud may occur in amounts that would be material in relation to the financial statements and not be detected within a timely period by employees in the normal course of performing their assigned functions. Management also sought to deal with other controls matters in the controls evaluation and, in each case if a problem was identified, to consider what revision, improvement and/or correction to make in accordance with ongoing procedures.
CONCLUSIONS Based upon the controls evaluation, the CEO and CFO have concluded that, subject to the limitations noted above, the Company's disclosure controls are effective to ensure that material information relating to the Company is made known to management, including the CEO and the CFO, particularly during the period when the Company's periodic reports are being prepared, and that the Company's internal controls are effective to provide reasonable assurance that the Company's financial statements are fairly presented in conformity with generally accepted accounting principles. Further, since the date of the controls evaluation to the date of this Annual Report, there have been no significant changes in internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
CHIEF EXECUTIVE OFFICER'S SECTION 302 CERTIFICATION
I, Craig O. Morrison, Chief Executive Officer of Borden Chemical, Inc., certify that:
1. I have reviewed this Annual Report on Form 10-K of Borden Chemical, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrants and we have:
a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. Presented in this annual report our conclusions based upon the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls and b. Any fraud, whether or not material, that involved management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ Craig O. Morrison ------------------------- Craig O. Morrison Chief Executive Officer
CHIEF FINANCIAL OFFICER'S SECTION 302 CERTIFICATION
I, William H. Carter, Chief Financial Officer of Borden Chemical, Inc., certify that:
1. I have reviewed this Annual Report on Form 10-K of Borden Chemical, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrants and we have:
a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. Presented in this annual report our conclusions based upon the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls and b. Any fraud, whether or not material, that involved management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ William H. Carter -------------------------- William H. Carter Chief Financial Officer
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - --------- ------------------------------------------------------------------
(a) List of documents filed as part of this report ------------------------------------------------------
1. Financial Statements ---------------------
All financial statements of the registrant are set forth under Item 8