ITEM 1. BUSINESS
(Dollars in thousands except per share data)
Description of Business
Borden Chemical, Inc. (which may be referred to as “we,” “us,” “our” or the “Company”) was incorporated on April 24, 1899. We are engaged primarily in the manufacturing and distribution of forest product and industrial resins, formaldehyde, oilfield products and other specialty and industrial chemicals worldwide. Our executive and administrative offices are located in Columbus, Ohio. Production facilities are located throughout the United States and in many foreign countries.
Our business consists of three reportable segments: North American Forest Products (“NAFORP”), North American Performance Resins Group (“NAPRG”) and International. See Note 19 to the Consolidated Financial Statements.
Historical Perspective
In 1995, when affiliates of Kohlberg Kravis Roberts & Co. (“KKR”) acquired control of the Company (then known as Borden, Inc.), our business consisted of the following business segments: Chemical, Foods, Other Consumer Products (including Consumer Adhesives), Decorative Products, Dairy and businesses held for sale. We sold all of these business segments by the end of 2001, except for the Chemical segment.
In 2001, we merged the Company with its subsidiaries, Borden Chemical Holdings, Inc. and Borden Chemical, Inc., executed certain financial transactions with our parent company, Borden Holdings, Inc. ("BHI"), and changed our name to Borden Chemical, Inc. (the “Corporate Reorganization”) to reflect the fact that the sole remaining business of the Company was the Chemical segment. The Corporate Reorganization simplified the legal structure, strengthened the capital structure and reduced costs of the Company. As part of the Corporate Reorganization, certain functions were downsized, eliminated or transferred to a separate legal entity, Borden Capital, Inc. (“Capital”), also owned by BHI.
Acquisitions and Divestitures
Following is a summary of acquisitions and divestitures we made in the past five years.
In the fourth quarter of 2003, we acquired Fentak Pty Ltd. (“Fentak”) in Australia and Malaysia, a producer of specialty chemical products for engineered wood, laminating and paper impregnation markets. We also acquired the business and technology assets of Southeastern Adhesives Company (“SEACO”), a domestic producer of specialty adhesives.
In 2001, through a series of transactions with affiliates, we sold Consumer Adhesives for total proceeds of $94,120 (the “Consumer Adhesives sale”). Consequently, Consumer Adhesives is reported as a discontinued operation in our financial statements in 2001. We retained continuing investments in Consumer Adhesives in the form of preferred stock and notes receivable. We sold the notes receivable to BHI in the fourth quarter of 2001 for their carrying value of $57,691. The preferred stock, with a carrying value of $110,000, was redeemed during the first quarter of 2002 for a $110,000 note receivable from Consumer Adhesives, which we subsequently sold to BHI for face value plus accrued interest and used the proceeds repay affiliated debt.
Also in 2001, we merged our North American foundry resins and coatings businesses with similar businesses of Delta-HA, Inc. to form HA-International, LLC (“HAI”), in which we have a 75% interest.
In 2000, the Company acquired the formaldehyde and certain other assets from Borden Chemicals and Plastics Operating Limited Partnership (“BCPOLP”), which was an affiliate of the Company, and acquired East Central Wax, a wax emulsions producer for the forest products business.
In 1999, we acquired Blagden Chemicals, Ltd. (“Blagden”) in the U.K. and Spurlock Industries, Inc. (“Spurlock”) in the U.S. Blagden produces formaldehyde, forest products and industrial resins. Spurlock produces formaldehyde and forest products resins.
Business Realignment and Corporate Reorganization
In addition to the acquisitions and divestitures discussed above, we have undertaken numerous plant consolidations and other business realignment initiatives. These initiatives are designed to improve efficiency and to focus resources on our core strengths. The associated business realignment charges consist primarily of employee severance, plant consolidation and related environmental remediation costs and asset write-offs. Following is a brief overview of our significant business realignment activities since 2001:
In June 2003, we initiated a realignment program designed to reduce operating expenses and increase organizational efficiency. To achieve these goals, we are reducing our workforce, streamlining processes, consolidating manufacturing processes and reducing general and administrative expenses. We anticipate the program will be completed in 2004.
In 2001, we recorded $126,408 of business realignment and impairment charges related primarily to the closures of our melamine crystal business (“Melamine”) and two forest products plants in the U.S., realignment of our North American workforce organization, reorganization of our corporate headquarters and the discontinuation of a plant construction project. The largest component of the 2001 charge is a $98,163 impairment of Melamine fixed assets, goodwill and spare parts that was the result of our strategic decision late in 2001 to sell or close this business and to enter into a long-term contractual arrangement with a supplier for our future melamine crystal needs.
As part of the Corporate Reorganization, in 2001, we also completed a significant capital restructuring, which consisted primarily of a capital contribution by BHI of $614,369 of preferred stock held by BHI. The significant impact of this transaction was to eliminate future required annual preferred dividend payments of $73,724. Also as part of the capital restructuring, BHI made a capital contribution of cash and purchased certain financial assets from us at their estimated fair values. The cash contribution and the cash received from sale of assets allowed us to substantially repay our affiliated debt as of December 31, 2001. See Note 3 to the Consolidated Financial Statements.
Products
The product lines included in our NAFORP operating segment are formaldehyde and forest product resins. The products in our NAPRG operating segment are oilfield, foundry and specialty resins. The products of our International operating segment are formaldehyde, forest product and performance resins and consumer products.
We are the leading global producer of thermosetting resins for the forest products industry and a leading producer of thermosetting resins for industrial and foundry applications in North America. Our resins are used to bind or coat other materials during the manufacturing process. Our resins are provided to a wide variety of customers for use in the manufacture of structural building panels, medium density fiberboard, particle board, laminate veneers, insulation binders, automotive brakes, and to coat cores and molds in the metal casting process.
We are also the world’s largest producer of formaldehyde. Approximately 50% of the formaldehyde produced by us is consumed internally to produce thermosetting resins, with the remainder sold to third parties.
We manufacture and distribute our products worldwide with the most significant markets being North America, Western Europe, Latin America, Australia, and Malaysia, and we generally hold a leading market position in the areas in which we compete.
Marketing and Distribution
Products are sold in the U.S. primarily through our sales force to industrial users. To the extent practicable, our international distribution techniques parallel those used in the U.S. However, raw materials, production considerations, pricing competition, government policy toward industry and foreign investment, and other factors may vary substantially from country to country.
Competition
Our major competitors are Dynea International OY, Georgia Pacific Corporation, Ashland Specialty Chemical Company and several regional domestic and international competitors. Price, customer service and product performance are the primary focus of competition.
Manufacturing and Raw Materials
The primary raw materials used in our manufacturing processes, for all of our operating segments, are methanol, phenol and urea. Raw materials are available from numerous sources in sufficient quantities but are subject to price fluctuations that cannot always be passed on to customers. We use long-term purchase agreements for our primary and certain other raw materials in certain circumstances to assure availability of adequate supplies at specified prices. These agreements generally do not have minimum purchase requirements.
Customers
Our business does not depend on any single customer nor are any of our operating segments limited to a particular group of customers, the loss of which would have a material adverse effect on the operating segment. Our primary customers consist of manufacturers, and the demand for our products is generally not seasonal.
Patents and Trademarks
We own various patents, trademark registrations, patent and trademark applications and technology licenses in our operating segments around the world which are held for use or currently used in our operations, including the Bordenâ and Elsieâ trademarks. We license the use of these two trademarks to third parties for use on non-chemical products. A majority of our patents relate to the development of new products and processes for manufacturing and use thereof and will expire at various times between 2004 and 2013. Other than the Bordenâ and Elsieâ trademarks, no individual patent or trademark is considered to be material.
Environmental Regulations
Our operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials and are subject to extensive environmental regulation at the Federal, state and international level and are exposed to the risk of claims for environmental remediation or restoration. In addition, our production facilities require operating permits that are subject to renewal or modification. Violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on our business, financial condition, results of operations or cash flows.
Accruals for environmental matters are recorded when it is probable that a liability has been incurred, the amount of the liability can be estimated and in accordance with the guidelines of Statement of Position 96-1, “Environmental Remediation Liabilities”. Although environmental policies and practices are designed to ensure compliance with Federal and state laws and environmental regulations, future developments and increasingly stringent regulation could require us to make additional unforeseen environmental expenditures. In addition, our former operations, including our ink, wallcoverings, film, phosphate mining and processing, thermoplastics, food and dairy operations, pose additional uncertainties for claims relating to our period of ownership. There can be no assurance that, as a result of former, current or future operations, there will not be some future impact on us relating to new regulations or additional environmental remediation or restoration liabilities.
We are actively engaged in complying with environmental protection laws, including various Federal, state and foreign statutes and regulations relating to manufacturing, processing and distributing its many products. We anticipate incurring future costs for capital improvements and general compliance under environmental laws, including costs to acquire, maintain and repair pollution control equipment. We incurred related capital expenditures of $5,234 in 2003, $3,641 in 2002 and $1,190 in 2001. We estimate that $5,400 will be spent for capital expenditures in 2004 for environmental controls at our facilities. This estimate is based on current regulations and other requirements, but it is possible that material capital expenditures in addition to those currently anticipated could be required if regulations and requirements change.
Research and Development
Our research and development and technical services expenditures were $17,998, $19,879 and $21,210 in 2003, 2002 and 2001, respectively. Development and marketing of new products are carried out by our operating segments and are integrated with quality control for existing product lines.
Employees
At December 31, 2003, we had approximately 2,400 employees. Relationships with our union and non-union employees are generally good.
Where You Can Find More Information
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports are available to the public through our internet website at www.bordenchem.com/home.asp under “About Us”, from the Securities and Exchange Commission at its website www.sec.gov or free of charge from Investor Relations at our administrative offices in Columbus, Ohio.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2003, we operated 27 domestic production and manufacturing facilities in 16 states, the most significant being a plant in Louisville, Kentucky. In addition, we operated 21 foreign production and manufacturing facilities primarily in Canada, South America, Europe, Australia and Malaysia.
Our manufacturing and processing facilities are generally well maintained and effectively utilized. Substantially all of our manufacturing facilities are owned. We lease our executive and administrative offices in Columbus, Ohio.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Environmental Proceedings
We have been notified that the Company is or may be responsible for environmental remediation at 30 sites in the U.S. Five of these sites, located in four states, involve active proceedings brought under state or Federal environmental laws: Geismar, Louisiana; Fairlawn, New Jersey; Fremont, California; Lakeland, Florida and Newark, California. The most significant of these sites is the site formerly owned by the Company in Geismar, Louisiana. While we cannot predict with certainty the total cost of such cleanups, we have recorded liabilities of approximately $23,400 and $27,100 at December 31, 2003 and 2002, respectively, for environmental remediation costs related to these five sites.
For the remaining 25 sites, we have been notified that the Company is or may be a potentially responsible party (“PRP”) in active proceedings in 15 states brought under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) or similar state “superfund” laws. While we cannot predict with certainty the total cost of such cleanup, we have recorded liabilities of approximately $7,600 and $7,000 at December 31, 2003 and 2002, respectively, for environmental remediation costs related to these 25 sites. The Company generally does not bear a significant level of responsibility for these sites and has little control over the costs and timing of cash flows. At 16 of the 25 sites, our share is less than 1%. At the remaining nine sites, the Company has a share of up to 8.8% of the total liability. The Company’s ultimate liability will depend on many factors including: its volumetric share of waste, the financial viability of other PRPs, the remediation methods and technology used, the amount of time necessary to accomplish remediation and the availability of insurance coverage. Our insurance provides very limited, if any, coverage for environmental matters.
In addition to the 30 sites referenced above, we are conducting voluntary remediation at 25 other locations. We have recorded liabilities of approximately $7,600 and $9,900 at December 31, 2003 and 2002, respectively, for remediation and restoration liabilities at these locations. See Note 22 to the Consolidated Financial Statements.
The Company is one of over 200 defendants in a private toxic tort action pending in U.S. District Court in Baton Rouge, Louisiana, alleging personal injuries and property damage in connection with two Iberville Parish waste disposal sites in Louisiana. No personal injuries have been specified. Settlement negotiations are near completion, and we expect to be dismissed from the case in exchange for a settlement of a de minimus amount. As with any litigation, the ultimate outcome is uncertain until a final settlement is consummated.
Subsidiary Bankruptcy Proceedings
The Company’s former subsidiary, BCP Management, Inc. (“BCPM”) filed for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware on March 22, 2002. BCPM served as the general partner and held a 1% interest in Borden Chemicals and Plastics Operating Limited Partnership, which was created in November 1987 and operated as a commodity chemicals producer. On April 3, 2001, BCPOLP filed for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. On February 5, 2003, the U.S. Bankruptcy Court approved a Joint Plan of Liquidation for BCPOLP and BCPM which provided for the transfer of the remaining assets of both entities, including preference, avoidance and other claims against third parties (including the Company) to separate liquidating entities for liquidation and distribution to their creditors. The transfer of the remaining assets of both entities to the liquidating agents was effective March 13, 2003. Our ownership interest in BCPM was extinguished, and no distributions from BCPM to the Company are anticipated.
On March 19, 2004, BCPM Liquidating LLC (“BCPM Liquidating”), the successor in interest to BCPM, and the Company reached a tentative agreement providing for the settlement of all claims for a payment by the Company of $6,000. The Company has entered into an Agreement with BCPM Liquidating extending the period within which either party may file claims against the other until May 14, 2004, during which period the terms of the settlement agreement will be finalized and submitted to the bankruptcy court for approval.
In addition, on March 19, 2004, the Company and BCP Liquidating LLC (“BCP Liquidating”), the successor in interest to BCPOLP, also reached a tentative agreement providing for the settlement of all claims for a payment by the Company of $1,050. The Company has entered into an Agreement with BCP Liquidating extending the period within which either party may file claims against the other until June 15, 2004, during which period the terms of the settlement agreement will be finalized and submitted to the bankruptcy court for approval.
No assurance can be given that these settlements will be finalized and approved, and absent such approval, these and other claims could be filed against the Company.
Imperial Home Décor Group
In 1998, pursuant to a merger and recapitalization transaction sponsored by The Blackstone Group ("Blackstone") and financed by Chase Manhattan Bank ("Chase"), Borden Decorative Products Holdings, Inc. (“BDPH”), a wholly owned subsidiary of the Company, was acquired by Blackstone and subsequently merged with Imperial Wallcoverings to create Imperial Home Décor Group (“IHDG”). Blackstone provided $84,500 in equity, and Chase provided $295,000 in senior financing. We received approximately $314,400 in cash and 11% of IHDG common stock for our interest in BDPH. On January 5, 2000, IHDG filed for reorganization under Chapter 11 of the U. S. Bankruptcy Code. The IHDG Litigation Trust (the “Trust”) was created pursuant to the plan of reorganization in the IHDG bankruptcy to pursue preference and other avoidance claims on behalf of the unsecured creditors of IHDG. In November 2001, the Trust filed a lawsuit against the Company and certain of its affiliates seeking to have the IHDG recapitalization transaction voided as a fraudulent conveyance and asking for a judgment to be entered against the Company for $314,400 plus interest, costs and attorney fees. Discovery is proceeding and is currently scheduled to conclude by November 2004. The parties are discussing alternatives to litigation.
We have accrued legal expenses for scheduled depositions related to this matter. To the extent that additional depositions or legal work is required, legal defense costs will increase. We have not recorded a liability for any potential losses because a loss is not considered probable based on current information. We believe we have strong defenses to the Trust’s allegations, and we intend to defend the case vigorously if a satisfactory alternative to litigation is not achieved.
Brazilian Excise Tax Administrative Appeal
In 1992, the State of Sao Paolo Tax Bureau issued an assessment against our primary Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes, characterized by the Tax Bureau as intercompany sales. Since that time, we have held discussions with the Tax Bureau, and our subsidiary has filed an administrative appeal seeking cancellation of the assessment. In December 2001, the Administrative Court upheld the assessment in the amount of R$52,000, or approximately US$18,000, including tax, penalties, monetary correction and interest. In September 2002, our subsidiary filed a second appeal with the highest level administrative court, again seeking cancellation of the assessment on the grounds that it was unlawfully issued. We believe we have a strong defense against the assessment and will pursue the appeal vigorously; however, no assurance can be given that the assessment will not be upheld.
HAI Grand Jury Investigation
HAI, a joint venture in which the Company has a 75% interest, received a grand jury subpoena dated November 5, 2003 from the U.S. Department of Justice Antitrust Division relating to a Foundry Resins Grand Jury investigation. HAI has provided documentation in response to the subpoena, is cooperating with the Department of Justice and has heard nothing further.
Other Legal Proceedings
The Company is involved in various product liability, commercial and employment litigation and other legal proceedings throughout the United States which are not discussed in its periodic filings and are considered to be in the ordinary course of business. There has been increased publicity about asbestos liabilities faced by manufacturing companies. As a result of the bankruptcies of many asbestos producers, plaintiffs' attorneys are increasing their focus on peripheral defendants, including the Company. We believe we have adequate reserves and insurance and do not believe we have a material asbestos exposure.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2003, no matters were submitted to a vote of our security holders.
Part II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Our authorized common stock consists of 300,000,000 shares with a par value of $0.01 per share. As of December 31, 2003, 200,895,628 common shares were issued and outstanding, of which 99.0% are controlled by affiliates of KKR with the remainder held by two members of management. No shares of such common stock trade on any exchange. We declared no dividends on common stock in 2003 or 2002. Our ability to pay dividends on its common stock is restricted by our Credit Facility (see Note 10 to the Consolidated Financial Statements).
The following table contains certain information regarding our Amended and Restated 1996 Stock Purchase and Option Plan for Key Employees, which is administered by the Compensation Committee of our Board of Directors and which provides for the purchase or grant of stock and stock-based awards to employees or other persons having a unique relationship with the Company or its subsidiaries. (See Note 15 to the Consolidated Financial Statements).
Equity Compensation Plan Information
Plan Category
Number of securities to be issued upon exercise of outstanding options, warrants and rights
Weighted-average exercise price of outstanding options, warrants and rights
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(a)
(b)
(c)
Equity compensation plans approved by security holders
5,532,360
$2.42
4,017,639
Equity compensation plans not approved by security holders
N/A
N/A
N/A
Total
5,532,360
$2.42
4,017,639
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Five Year Selected Consolidated Financial Data
The following summarizes our selected financial data for the past five years. See pages 16 through 18 for items impacting comparability between 2003, 2002 and 2001.
For the years
(1) 2001
(2) 2000
(3) 1999
Summary of Earnings
Net sales
Income (loss) from continuing operations
Net income (loss) applicable to common stock
$ 1,434,813
22,976
22,976
$ 1,247,885
(6,758)
(36,583)
$ 1,372,141
(136,604)
(186,646)
$ 1,377,845
(72,259)
(39,750)
$ 1,274,740
44,547
(20,778)
Basic and diluted income (loss) per common share from continuing operations
Basic and diluted income (loss) per common share
$ 0.11
0.11
$ (0.03)
(0.18)
$ (0.69)
(0.94)
$ (0.36)
(0.20)
$ 0.22
(0.10)
Dividends per share
Common share
Preferred series A
$ -
-
$ -
-
$ 0.18
2.52
$ 0.31
3.00
$ 0.32
3.00
Average number of common shares outstanding during the year-basic
200,898
200,458
198,997
198,975
198,975
Average number of common shares outstanding during the year-dilutive
200,924
200,458
198,997
198,975
198,975
Financial Statistics
Total assets
Long-term debt
$993,866
529,966
$ 1,011,780
523,287
$ 1,123,278
532,497
$ 1,520,597
530,530
$ 1,737,906
541,074
(1) In 2001, we sold Consumer Adhesives, closed Melamine and impaired the related assets and sold a common stock equity investment. Additionally, in 2001, our prepaid pension asset was reclassified to equity as a minimum pension adjustment.
(2) In 2000, we acquired a formaldehyde operation from BCPOLP and East Central Wax, a wax emulsions producer.
(3) In 1999, we acquired Blagden Chemical, Ltd. in the U.K. and Spurlock Industries, Inc. in the U.S.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands)
Forward-Looking and Cautionary Statements
As management of the Company, we may, from time to time, make written or oral statements regarding the future performance of the Company, including statements contained in this report and our other reports filed with the Securities and Exchange Commission. Investors should be aware that these statements, which may include words such as “believe,” “expect,” “anticipate,” “estimate” or “intend,” are based on our currently available financial, economic, and competitive data and on current business plans. Such statements are inherently uncertain, and investors should recognize that events could cause our actual results to differ materially from those projected in forward-looking statements made by us on behalf of the Company. Such risks and uncertainties are primarily in the areas of results of operations by business unit, liquidity, legal and environmental liabilities and industry and economic conditions.
Overview
We are a leading producer of resins, adhesives and binders for the global wood and industrial markets and are the world’s largest producer of formaldehyde. The majority of our businesses are market leaders, with a number one or number two share in North American or global markets.
Our strategic vision is to become the leading supplier of binders, adhesives and coating resins by providing technical solutions to the global wood and industrial markets. We expect to achieve this by leveraging our core businesses through product extensions, geographic expansion, acquisitions or strategic partnerships; developing innovative products; expanding our technology portfolio and investing in operational excellence through efforts such as Six Sigma.
Our business is managed as three operating segments: North American Forest Products (“NAFORP”), North American Performance Resins Group (“NAPRG”) and International. Our results also include general corporate and administrative expenses disclosed as “Corporate and other” and activities related to Melamine which was shut down in 2002 disclosed as “Divested business.” These are also presented to provide a complete picture of our results.
NAFORP’s product lines include formaldehyde and forest product resins. The key business drivers for NAFORP are housing starts, furniture demand, panel production capacity and consumption, and general chemical sector operating conditions.
NAPRG’s product lines include oilfield, foundry and specialty resins. NAPRG’s key business drivers are housing starts, auto builds, active gas drilling rigs and the general industrial sector performance.
International includes our operations in Latin America, Europe and Asia Pacific, primarily concentrated in Brazil, the U.K., Australia and Malaysia. International product lines include formaldehyde, forest product and performance resins and consumer products. The key business drivers for International are export levels, panel production capacity, housing starts, furniture demand and the local political and general economic environments.
Corporate and other represents ongoing general and administrative expenses, and income and expenses related to liabilities retained from businesses sold in previous years.
Industry Conditions
As is true for many industries, our results are impacted by the effect on our customers of economic upturns or downturns, as well as the impact on our own costs to produce, sell and deliver our products. Most of our products are used by our customers in their production processes; therefore, factors impacting their industries could significantly affect our results.
In 2003, we were positively impacted by the strong U.S. housing market. According to Resource Information Systems, Inc. (“RISI”), housing starts were up 8% in 2003 compared to 2002, driving a 3.5% increase in structural panel consumption. The mix in the structural panel consumption increase also benefited us, as oriented strand board (“OSB”) consumption, which on a per square foot basis uses more of our resins, was up 6.2%, while plywood consumption was essentially flat.
Higher natural gas prices, while hurting us from a processing cost perspective, increased the demand for our oilfield proppants used in the gas drilling industry. North American gas drilling rigs in active production increased 25% in 2003 driving a 43% increase in sales in our oilfield products. We believe continued elevated natural gas prices should continue to drive strong demand for these products in 2004.
The U.S. furniture production sector was down 3.3% in 2003, according to RISI, negatively impacting the demand for our resins used in particleboard and medium density fiberboard (“MDF”). U.S. particleboard consumption was down 2.2% in 2003 due to increased imports and the decrease in furniture production. Current forecasts for 2004 by RISI are predicting that particleboard and MDF consumption will increase in 2004, as the weakened U.S. dollar will decrease the amount of imported products and the continued stable housing market and low interest rates will increase the demand for furniture.
Raw Material Costs
Raw material costs make up approximately 60% of our product costs. The primary raw materials that we use are methanol, phenol and urea. During the past three years, the price of these materials has been volatile. In 2003, for example, the average prices of methanol, phenol and urea increased by 42%, 22% and 50% respectively. To help mitigate this volatility, we have purchase and sale contracts with our vendors and customers with periodic price adjustment mechanisms. Due to differences in timing of the pricing mechanism trigger points between our sales and purchase contracts there is often a “lead-lag” impact during which margins are negatively impacted for the short term in periods of rising raw material prices and positively impacted in periods of falling raw material prices. In addition, the pass through of raw material price changes can result in significant variances in sales comparisons from year to year. In 2003, we had a favorable impact as raw material price increases late in 2002 and 2003 were passed through to customers, having a significant impact on 2003 sales versus 2002.
Regulatory Environment
Various government agencies are conducting formaldehyde health research and evaluating the need for additional regulations. We understand that the International Agency for Research on Cancer has scheduled formaldehyde for an update review of its cancer classification in June 2004. The recently formed Formaldehyde Council, Inc. (“FCI”), of which we are a member, believes that any adverse findings would not be supported by the weight of most scientific evidence and epidemiology studies. Nonetheless, further regulation of formaldehyde could follow over time, from such a determination. We believe that we will be able to comply with any likely regulatory impact.
We support appropriate scientific research and risk-based policy decision-making, and we are working with industry groups, including the FCI, to ensure that governmental assessments and regulations are based on sound scientific information. We believe that we have credible stewardship programs and processes in place to provide compliant and cost-effective resin systems to our customers. However, as the world’s largest producer of formaldehyde, and due to the significance of formaldehyde as a raw material in our manufacturing processes, we cannot provide any assurance that future unanticipated regulatory changes relating to formaldehyde would not have a material impact on our business.
Competitive Environment
The chemical industry has been historically competitive, and we expect this competitive environment to continue in the foreseeable future. We compete with companies of varying size, financial strength and availability of resources. Price, customer service and product performance are the primary areas in which we compete.
Other Factors Impacting Our Results
Other pressures on our profit margins include rising utility costs and increasing benefit, general insurance and legal costs. We are taking a number of steps to control these costs, including the difficult decision to modify our postretirement medical benefits plan. In addition, we are continuing to analyze our business structure, consolidating plants and functions where we can realize significant cost savings and productivity gains. These consolidations have resulted in asset impairment charges and severance costs, which are more specifically discussed in the following sections and in Note 6 to Consolidated Financial Statements. Future consolidations or productivity initiatives may include additional asset impairment charges and severance costs.
We believe that these factors will continue in the foreseeable future. These market dynamics will require us to continue to focus on productivity improvements and risk mitigation strategies to enhance and protect our margins. In the Risk Management section of our report, you will see how we are taking other steps to manage factors impacting our margins through hedges of natural gas and foreign exchange exposures.
Overview of Results
Our consolidated net sales increased $186,928, or 15.0%, in 2003 versus 2002. This increase was primarily a result of the pass through of raw material cost increases. In addition, sales benefited from favorable currency translation in Canada, Latin America and Australia and increased demand for NAPRG oilfield products and NAFORP formaldehyde. Slightly offsetting these increases were declines in NAFORP resins volumes in products servicing the furniture markets due to continued production declines in the North American furniture market and customer inventory reductions.
We reported net income of $22,976 for 2003 versus a net loss of $36,583 for 2002. Of the $59,559 improvement, income from operations increased $32,834 reflecting decreased general and administrative, business realignment, impairment and management fee expenses. In addition, in 2002, we recognized a $29,825 charge taken for goodwill impairments upon the adoption of new accounting rules, which is reflected in the Cumulative effect of change in accounting principle in our 2002 Consolidated Statement of Operations (see Note 4 to the Consolidated Financial Statements).
Critical Accounting Policies:
In preparing our financial statements in conformity with generally accepted accounting principles, we have to make estimates and assumptions about future events that affect the amounts of reported assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities in the financial statements and accompanying notes. Some of these accounting policies require the application of significant judgment by management in the selection of appropriate assumptions for determining these estimates. By their nature, these judgments are subject to an inherent degree of uncertainty; therefore, we cannot assure you that actual results will not differ significantly from estimated results. We base these judgments on our historical experience, advice from experienced consultants, forecasts and other available information, as appropriate. Our significant accounting policies are more fully described in Note 2 to the Consolidated Financial Statements.
Our most critical accounting policies, which reflect significant management estimates and judgment in determining reported amounts in the Consolidated Financial Statements and the related Notes, are as follows:
Environmental remediation and restoration liabilities
Accruals for environmental matters are recorded when we believe it is probable that a liability has been incurred and we can reasonably estimate the amount of the liability. Our accruals are established following the guidelines of Statement of Position 96-1, “Environmental Remediation Liabilities.” We have accrued approximately $38,600 and $44,000 at December 31, 2003 and 2002, respectively, for all probable environmental remediation and restoration liabilities, which is our best estimate of these liabilities. Based on currently available information and analysis, we believe that it is reasonably possible that the costs associated with such liabilities may fall within a range of $24,200 to $73,600. This estimate of the range of reasonably possible costs is less certain than the estimates upon which reserves are based, and in order to establish the upper limit of this range, we used assumptions that are less favorable to the Company among the range of reasonably possible outcomes, but we did not assume we would bear full responsibility for all sites, to the exclusion of other PRPs.
Factors influencing the possible range of costs for environmental remediation include:
- The success of the selected method of remediation / closure procedures
- The development of new technology and improved procedures
- The possibility of discovering additional contamination during monitoring / remediation process
- The financial viability of other PRPs, if any, and their potential contributions
- The time period required to complete the work, including variations in anticipated monitoring periods
- For projects in their early stages, the outcome of negotiations with governing regulatory agencies regarding plans for remediation
Income tax assets and liabilities
Deferred income taxes represent the tax effect of temporary differences between amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We have business strategies that we would execute before any material deferred tax assets would go unused. The Company reviews income tax reserves on a quarterly basis. Management believes the reserves established for probable tax liabilities are appropriate at December 31, 2003.
In estimating accruals necessary for tax exposures, including estimating the outcome of audits by governing tax authorities, we apply the guidance of Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” as well as SFAS No. 109, “Accounting for Income Taxes.” These estimates require significant judgment and, in the case of audits by tax authorities, may often involve negotiated settlements.
Factors influencing the final determination of tax liabilities include:
- Future taxable income
- Execution of business strategies
- Negotiations of tax settlements with taxing authorities
Pension and postretirement assets and liabilities
The amounts recognized in our financial statements related to pension and postretirement (“OPEB”) benefit obligations are determined from actuarial valuations. Inherent in these valuations are certain assumptions including:
- Rate to use for discounting the liability (average weighted rates (“AWR”) were 5.8% for 2003 and 6.5% for 2002)
- Expected long-term rate of return on pension plan assets (AWR were 8.2% for 2003 and 8.3% for 2002)
- Health care cost trend rates (used for OPEB, due to our 2003 plan amendment, this assumption is no longer material to the determination of our liability)
- Rate of salary increases (AWR were 4.2% for 2003 and 4.5% for 2002)
- Mortality rate table (used 1983 GAM Table)
The most significant of these estimates is the expected long-term rate of return on pension plan assets. The actual return of our domestic pension plan assets in 2003 was 22%. Future returns on plan assets are subject to the strength of the financial markets, which we cannot predict with any accuracy.
These assumptions are updated annually. Actual results that differ from our assumptions are accumulated and amortized over future periods; therefore, these variances affect our expenses and obligations recorded in future periods. Future pension expense will also depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in our pension plans.
In 2003, we amended our OPEB plan such that, effective September 1, 2003, medical benefits are no longer provided to our retirees and their dependents who are over age 65. We estimate that our liability related to providing OPEB medical benefits will be reduced by approximately $88,000 and annual cash outlays anticipated under the pre-amended retiree medical benefit plan will be decreased by approximately $10,000 on an ongoing basis. This amendment has reduced the potential for changes in health care cost trends to materially impact our financial statements.
Results of Operations by Segment:
Following is a comparison of net sales and earnings before interest, taxes, depreciation and amortization adjusted for business realignment, impairments, non-operating income (expense) and certain other operating income (expense) items (“Adjusted EBITDA”) by segment and for Corporate and other and Divested business. Adjusted EBITDA is the measure used by our chief operating decision maker in the evaluation of our operating results and in determining allocations of capital resources among the business segments.
Net Sales to Unaffiliated Customers:
North American Forest Products
$ 755,767
$634,619
$656,694
North American Performance Resins
364,347
340,791
409,081
International
314,693
264,541
282,629
Divested business
7,934
23,737
$1,434,813
$1,247,885
$1,372,141
Adjusted EBITDA:
North American Forest Products
$ 92,548
$ 92,918
$101,655
North American Performance Resins
46,661
45,127
74,321
International
32,250
28,630
17,595
Corporate and other
(43,713)
(44,949)
(54,356)
$127,746
$121,726
$139,215
Reconciliation of Adjusted EBITDA to Income (Loss) from Continuing Operations Before Income Tax:
Adjusted EBITDA
$127,746
$121,726
$139,215
Depreciation and amortization
(47,319)
(47,947)
(59,361)
Adjustments to EBITDA (see pages 16 - 17)
(13,885)
(40,071)
(155,349)
Interest expense
(46,138)
(47,315)
(51,613)
Affiliated interest expense
(558)
(1,402)
(11,488)
Other non-operating (expense) income
(1,529)
5,989
(1,841)
Investment write-downs
-
-
(27,000)
Income (loss) from continuing operations before income tax
$18,317
$ (9,020)
$(167,437)
2003 vs. 2002
North American Forest Products (NAFORP)
Our NAFORP net sales increased $121,148, or 19.1%, in 2003 compared to 2002. Higher selling prices resulting from the pass through of raw material price increases was the primary reason for the increase. Favorable currency translation also contributed to the sales improvement as the Canadian dollar strengthened versus the U. S. dollar throughout 2003. These improvements were partially offset by a slight decline in volumes. Softer market conditions in the North American furniture sector during the year led to a decrease in demand for MDF and particleboard which are made with our urea formaldehyde based (“UF”) resins. Volume for UF resins was also impacted by increased competitive pressures. This decline in UF resin volumes was largely offset by improved formaldehyde volumes due to demand from the general chemical sector and increased volumes in the phenolic-based (“PF”) resins driven by the strong housing market and demand for plywood and OSB, which are made with PF resins.
Adjusted EBITDA for NAFORP decreased $370, or 0.4%, in 2003 compared to 2002, primarily due to increased processing and freight costs and the volume decline. Our processing costs increased because of higher energy and insurance costs in 2003. The mix of our formaldehyde product sales changed during 2003, resulting in increased freight costs. Freight costs per pound vary depending on whether product is shipped via pipeline, rail or tanker. These negative factors were largely offset by margin improvements, driven primarily by resins product formulation initiatives and purchasing productivity.
North American Performance Resins (NAPRG)
Our NAPRG net sales increased $23,556, or 6.9%, in 2003 compared to 2002, primarily due to overall higher selling prices and increased volumes. Higher selling prices, primarily in specialty resins and oilfield products, were a result of the pass through of raw material price increases and an improved mix of oilfield products. Improvements in volumes, primarily for oilfield products, also contributed to the increase in sales. The improvement in our oilfield products’ volumes resulted from increased demand due to an expansion in natural gas exploration and drilling activity in 2003, as previously discussed. Volume declines in our foundry and specialty resins products reflected continuing weak market conditions in the automotive, felt bonding, laminated flooring and furniture markets, as well as competitive pressures.
Adjusted EBITDA for NAPRG increased $1,534, or 3.4%, in 2003 compared to 2002. This improvement is primarily due to improved volumes and reduced selling, general and administrative expenses. Improved oilfield volumes, although partially offset by volume declines in foundry and specialty resins, positively impacted Adjusted EBITDA. Reduced general and administrative expenses were a result of workforce reductions, open positions and a reduction in bad debt expense in 2003 versus 2002, when we experienced several customer bankruptcies. These improvements were partially offset by higher distribution and processing costs. Distribution costs increased because of fuel surcharges and higher freight costs due to shipping oilfield products over a wider geographic area. Higher processing costs were a result of increased energy, equipment repair and insurance costs and the cost of operating a second oilfield products plant to meet customer demand.
International
Our International net sales for 2003 increased by $50,152, or 19.0%, compared to 2002, with our Latin American, Asia Pacific and European businesses all contributing to the sales increase. Latin American sales increased by $15,802 due to favorable currency translation and strong price improvements, slightly offset by a decline in volumes due to adverse market conditions, competitive pressures and market share losses in the consumer products market. Asia Pacific’s $17,000 increase in sales reflected favorable currency translation and improvements in pricing and volumes. Europe’s sales increase of $17,350 was due to strong price improvements, partially offset by unfavorable currency translation and a reduction in volumes due to the difficult market environment. For all three markets, the pricing improvements were a result of the pass through of raw material price increases.
International Adjusted EBITDA increased $3,620, or 12.6%, in 2003 compared to 2002. This improvement was essentially related to a $2,345 gain from the favorable settlement of a Brazilian foreign exchange claim and a $1,100 reserve reduction due to a revised estimate of a potential liability related to an excess duty imposed on the importation of inventory in Brazil. Also contributing to the improvement were productivity improvements in Europe and favorable currency translation in Asia Pacific and Latin America. These improvements were substantially offset by unfavorable product mix and reduced volumes in Latin America and Europe and increased processing costs in Latin America and Asia Pacific due to increased energy and equipment repair costs.
Corporate and other
Our Corporate and other expenses decreased $1,236 in 2003 compared to 2002. Contributing to this net decline in expenses were the following factors: we amended our OPEB medical benefit plan during 2003, resulting in a reduction in plan expenses of approximately $11,500; we settled a Brazilian foreign exchange claim relating to a sold business for a gain of $2,826 and we recognized a $2,355 gain on the sale of the Company’s airplane. In addition, salary and benefit costs were lower in 2003 due to a reduction in workforce. Offsetting these reductions in expense were increased insurance and legal costs of approximately $13,100, and the absence of a 2002 adjustment that reduced our allowance for doubtful accounts.
Divested business
Amounts reported as Divested business in both years represents the disposition of remaining inventory and other assets of Melamine, which was closed in early 2002. We sold this business to a third party in the second quarter of 2003.
2002 vs. 2001
North American Forest Products (NAFORP)
Net sales for our NAFORP business declined by $22,075, or 3.4%, in 2002, as decreasing prices due to the pass through of lower raw material prices more than offset volume increases. In addition, competitive pricing pressures negatively impacted the renewal of two large long-term customer contracts in 2002. NAFORP’s 2002 sales were also negatively impacted by foreign currency translation due to the weaker Canadian dollar. Increased volumes were driven by gains in market share and strong demand due to a healthy housing sector.
NAFORP’s Adjusted EBITDA decreased by $8,737, or 8.6%, from prior year. Competitive pressures, a negative lead-lag impact in the second half of the year and increased insurance and benefit costs were the principal causes of the decline.
North American Performance Resins (NAPRG)
Our NAPRG net sales decreased by $68,290, or 16.7%, in 2002, due to volume, mix and lower selling prices. While absolute volumes increased, a decrease in specialty oilfield and coatings volumes led to a decline in sales. The volume decline in oilfield products is due to reduced drilling activity in 2002. The coatings products volume decline is a result of significantly lower demand for fiber optic cable in 2002. Lower selling prices in other specialty resins were the result of competitive pressures and the pass through of raw material price decreases.
Adjusted EBITDA for NAPRG declined by $29,194, or 39.3%, in 2002, relating to the decrease in coatings and oilfield volumes discussed above. This decrease was partially offset by improved processing costs related to decreased energy costs and synergies realized as a result of the 2001 formation of HAI.
International
Our International net sales decreased $18,088, or 6.4%, in 2002, due chiefly to lower selling prices and volumes in Europe and Asia, the 2001 sale of our business in Ecuador and unfavorable foreign currency translation in Latin America. The lower selling prices resulted from the pass through of raw material price decreases in 2002 and competitive pressures in Europe.
Adjusted EBITDA from our International businesses increased $11,035, or 62.7%, in 2002 due to improved operational results in all regions. We attribute these improvements to improved margins relating to a positive lead-lag for the first half of the year and improved processing costs in Europe due to plant consolidations.
Corporate and other
Our Corporate and other expenses decreased by $9,407 compared to 2001. The improvement was driven by the benefits realized from the 2001 Corporate Reorganization and other workforce and cost reduction measures we made in 2002 and 2001.
Divested business
The divested business activity in 2002 and 2001 represents Melamine. Results for 2002 primarily related to the disposition of remaining inventory and other assets following its closure early in the year.
Adjustments To EBITDA
Our chief operating decision maker relies primarily on Adjusted EBITDA in the evaluation of operating results and the allocation of capital resources. This table details items not included in Adjusted EBITDA for purposes of this evaluation of our operating segments. We monitor these activities separately from our operating results. These (expenses) income primarily relate to our realignment programs, pension and legal settlement charges and impairment charges:
Year Ended December 31, 2003
Plant Closure
Severance
Impairment
Other
Total
North American Forest Products
$ (932)
$ (1,125)
$ -
$ (90)
$(2,147)
North American Performance Resins
(397)
(1,000)
-
(1,303)
International
(7,720)
(643)
(2,183)
11,692
1,146
Corporate and other
(146)
(4,672)
-
(8,732)
(13,550)
Divested business
1,716
-
-
1,969
Total
$(6,988)
$(6,837)
$(3,183)
$3,123
$(13,885)
As part of our ongoing realignment program designed to improve productivity and reduce our costs, we recorded 2003 plant closure costs of $6,988 consisting of plant employee severance of approximately $3,900, asset impairments related to the closure and consolidation of plants of approximately $3,200, environmental remediation costs relating to plant closures in Brazil of approximately $800 and other costs of approximately $700. These costs were partially offset by a net reduction of reserves of approximately $1,600 no longer required for Melamine due to its sale in the second quarter of 2003.
We also recorded severance costs of $6,837 in 2003 related principally to administrative workforce reduction programs, primarily for the June 2003 realignment program.
The impairment charges we recorded in 2003 relate to a reduction in our estimate of net realizable value for a facility held for sale, the impairment of goodwill related to our Malaysian operations resulting from our year-end analysis of goodwill and the recognition of fixed asset impairments at several international manufacturing facilities.
Other income not reflected in 2003 Adjusted EBITDA primarily represent gains of $12,260 on the sale of a former plant site in the U.K. and on the sale of Melamine, both of which were closed as part of our realignment programs. These gains were offset by a $5,929 charge related to tentative legal settlements reached with BCPM Liquidating and BCP Liquidating (see Note 22 to the Consolidated Financial Statements) and severance expense included in general and administrative expense relating to positions to be replaced as part of the June 2003 realignment program.
Year Ended December 31, 2002
Plant Closure
Severance
Impairment
Other
Total
North American Forest Products
$ (1,107)
$ (250)
$ -
$ -
$(1,357)
North American Performance Resins
(1,950)
(102)
(1,040)
-
(3,092)
International
(2,844)
(795)
(5,275)
2,465
(6,449)
Corporate and other
-
(2,118)
-
(19,850)
(21,968)
Divested business
(6,683)
-
-
(522)
(7,205)
Total
$(12,584)
$(3,265)
$(6,315)
$(17,907)
$(40,071)
Plant closure costs recorded in 2002 as part of our realignment programs totaled $12,584 and consisted of plant employee severance of $2,721 and demolition, environmental and other costs relating to plant closure and consolidations of $9,863, including the closure of Melamine.
Our 2002 severance costs of $3,265 related primarily to administrative workforce reduction programs.
The impairment charges we recorded in 2002 pertain to a reduction in net realizable value for a facility held for sale and to fixed assets at several international manufacturing facilities.
Other expenses not reflected in 2002 Adjusted EBITDA primarily represent a pension settlement charge of $13,600 triggered by lump sum settlements paid to participants. In addition, we recorded additional management fees of $5,500 related to the wind-down of Capital. These expenses were partially offset by a $2,465 gain recognized on the sale of land associated with a closed plant in Spain.
Year Ended December 31, 2001
Plant Closure
Severance
Impairment
Other
Total
North American Forest Products
$ (6,573)
$ (2,080)
$ -
$10,507
$ 1,854
North American Performance Resins
2,433
(2,632)
(2,885)
-
(3,084)
International
(20,020)
(179)
-
(2,303)
(22,502)
Corporate and other
(7,691)
-
(37,202)
(44,018)
Divested business
-
-
(98,163)
10,564
(87,599)
Total
$(23,285)
$(12,582)
$(101,048)
$(18,434)
$(155,349)
In 2001, we recorded plant closure costs totaling $23,285 relating to our realignment program. These costs consisted of fixed asset write-offs of $11,863, plant employee severance of $1,862 and demolition, environmental and other costs for plant closure and consolidations of $9,560.
In addition, we recorded severance costs of $12,582 related to consolidation of general administrative functions including $3,265 related to the 2001 Corporate Reorganization.
We recorded significant impairment charges in 2001, primarily related to our decision to close Melamine. Of the $101,048 impairment charge, $98,163 related to this shut-down. This charge included the impairment of fixed assets, goodwill and spare parts of $62,527, $32,701 and $2,935, respectively. The remaining $2,885 of the impairment charge was for a domestic plant facility for which construction was discontinued in 2001.
Other expenses not reflected in 2001 Adjusted EBITDA primarily include a charge for environmental remediation of $19,028 relating to a former business. In addition, we recorded a pension settlement charge of $15,813 and a loss of $2,303 on the divestiture of our operations in Ecuador. These other expenses were partially offset by a $10,507 gain we recorded on the sale of land associated with a closed plant and earnings of $10,564 from Melamine, which was closed in early 2002.
Non-Operating Expenses and Income Tax Expense:
Non-operating expense
Interest expense
$46,138
$47,315
$51,613
Affiliated interest expense, net
1,402
11,488
Other non-operating expense (income)
1,529
(5,989)
1,841
Investment write-downs and other charges
-
-
27,000
$48,225
$42,728
$91,942
In 2003, our interest and net affiliated interest expense decreased $2,021 versus 2002 due to lower debt balances and lower interest rates. Other non-operating expenses increased $7,518. We incurred a $1,367 loss on the settlement of an intercompany loan resulting from foreign currency translation. In addition, interest income declined by $1,409 in 2003 due to lower interest rates and lower average cash balances. The remainder of the variance is primarily related to gains realized in 2002 on interest rate swaps and debt buybacks (see below).
In 2002, our affiliated interest expense declined by $10,086 versus 2001 due to lower affiliate borrowings after repayments of debt made with cash received from BHI in connection with the Corporate Reorganization. In addition, our non-affiliated interest expense declined by $4,298 due to lower average borrowings. We also recognized a gain of $2,741 on the repurchase of debt in the open market and recorded a gain on an interest rate swap of $1,722.
In 2001, we recorded $27,000 of investment write-downs. Of this amount $17,000 related to the write-down of a receivable from and preferred stock investments in WKI Holding Company, Inc., an affiliate. In addition, we wrote-off our remaining investment in BCPM of $10,000. Our 2001 other non-operating expense also included a loss on an interest rate swap of $1,841.
Income tax benefit
Income tax benefit
$(4,659)
$(2,262)
$(30,833)
Effective tax rate
N/M
25%
18%
Our 2003 consolidated rate reflects a benefit of $19,936 from the sale of the stock of Melamine in 2003. The tax basis of the stock exceeded the tax basis of the assets and we could not recognize this additional basis until the stock sale was completed in 2003. This benefit is a capital loss carryforward that can only be used against capital gains; therefore, we established a valuation reserve for the full amount of this benefit. Other 2003 activities reflected in the 2003 consolidated rate include a reduction of a valuation reserve in the amount of $14,534 related to tax assets we believe we are more likely than not to realize. Our 2003 tax rate also reflects the elimination of $1,624 of deferred tax liabilities associated with the BCPM bankruptcy. In addition, we reduced reserves for prior years’ Canadian and U.S. tax audits by $3,997 as a result of preliminary settlements of certain matters in the fourth quarter of 2003. The effective rate also reflects additional income tax expense of $9,324 on foreign dividend income and on deemed dividend income related to loans and guarantees from foreign subsidiaries.
Our 2002 consolidated tax rate reflects a valuation allowance recorded against the deferred benefit of interest expense deductions in the amount of $16,672 that are no longer more likely than not to be used due to limitations imposed by the Internal Revenue Service (“IRS”). During 2002, we reached preliminary settlement with the IRS regarding tax years 1998 and 1999. The outcome of this settlement was favorable to us, and as a result, we were able to reduce our accruals related to these years by $20,000.
Our 2001 consolidated tax rate reflects the non-deductible impairment of $31,692 on the fixed assets and goodwill related to the shut-down of Melamine. This rate also reflects $12,397 for the impact of foreign earnings that we expect to repatriate due to the anticipated sale of a foreign business, as well as our inability to use foreign tax credits associated with these earnings due to usage limitations. In early 2001, the IRS completed its final computation of the tax due for tax matters dating back to 1996. This computation was complex and involved multiple years and multiple adjustments. The final resolution resulted in an additional benefit included in our 2001 income tax benefit totaling $14,388.
Cash Flows:
Cash provided by (used in):
Operating activities
$34,026
$ 10,360
$ 95,120
Investing activities
(42,314)
81,464
210,981
Financing activities
21,710
(101,716)
(308,403)
Net change in cash and cash equivalents
$13,422
$(9,892)
$(2,302)
Operating Activities
Our 2003 operating activities provided cash of $34,026. This included the generation of $10,006 for net trading capital, an increase of $28,353 versus 2002, and reductions in realignment expenditures of $13,253 and in interest payments of $1,462. This improvement in net trading capital, which consists of accounts receivable, inventory and accounts payable, resulted from our continued focus on working capital management during 2003. We focused on reducing days outstanding for accounts receivable, increasing inventory turns and improving the timing of payments of our accounts payable. Realignment expenditures of $11,801 declined from 2002 due to reduced levels of activity. Our cash interest payments were lower than prior year as a result of lower interest rates. These favorable events were partially offset by higher tax payments of $18,390 in 2003 due primarily to international taxes.
Our 2002 operating activities provided cash of $10,360 in 2002. Cash generated from earnings of approximately $77,000 was substantially offset by interest payments of $46,928, net trading capital outflows of $18,347 and taxes paid of $978. Cash generated by net trading capital decreased by $44,494 versus the prior year. This decline essentially related to higher accounts receivable at year-end 2000, which were collected in 2001, resulting in inflated inflows for 2001. Favorable timing of payments on accounts payable versus 2001 was offset by unfavorable variances on inventory. Realignment expenditures in 2002 totaled $25,054, which was in line with 2001 spending levels. Our interest payments in 2002 were $46,928, a decrease of $23,330 from the prior year, due to debt repayments made late in 2001 and reduced interest rates in 2002.
Our 2001 operating activities provided cash of $95,120. In addition to cash generated by net income, our net trading capital generated $26,147 of cash related to decreases in accounts receivable and lower inventory levels, partially offset by unfavorable timing of accounts payable payments. We also received net tax refunds totaling $36,186, primarily due to favorable settlements of income tax audits. These cash inflows were partially offset by interest payments of $70,258.
Investing Activities
Our 2003 net investing activities used cash of $42,314. We spent $41,820 for capital expenditures, primarily for plant expansions and improvements. We also made two acquisitions in 2003: Fentak and the business and technology assets of SEACO for cash of $14,691 plus deferred payments totaling about $4,550 over the next five years. We realized proceeds of $14,197 from the sale of land associated with a closed plant in the U.K. and other miscellaneous assets.
Our 2002 cash inflow for investing activities of $81,464 primarily related to the sale of a note receivable from Consumer Adhesives of $110,000 to BHI and to other assets sales to unrelated parties for $10,237. Our 2002 capital expenditures totaled $38,773 and related primarily to plant expansions and improvements.
Our 2001 investing activities generated cash of $210,981. During 2001, we sold cash certain non-operating assets to BHI for cash of $160,888 as a part of the Corporate Reorganization. In addition, we received $96,977 from business divestitures, primarily from the Consumer Adhesives sale, with the remainder generated from the sale of our business in Ecuador. These 2001 inflows were partially offset by capital expenditures of $47,408, primarily for plant improvements and expansion.
Financing Activities
Our 2003 financing activities provided cash of $21,710. Capital contributions from affiliates of $9,300 and net external borrowings primarily related to the Fentak acquisition accounted for the cash inflow. Early in the third quarter of 2003, we completed the process of converting letters of credit from our uncommitted letter of credit (“LOC”) facility to our Credit Facility (see Liquidity and Capital Resources) resulting in the release of restricted cash of $67,049, most of which was used to repay borrowings from affiliates; thus these net transactions had little impact on total financing cash generated.
Our 2002 financing activities used cash of $101,716. The 2002 activities included an increase in restricted cash of $66,165 relating to our establishment of a temporary uncommitted LOC facility, a repayment of a $31,581 note due to a former subsidiary and net repayments of borrowings of $3,379.
In 2001, we used cash of $308,403 for financing activities. These expenditures are primarily related to the repayment of affiliated loans of $212,432 and preferred dividend payments of $73,724 using the cash we generated from investing activities previously discussed. We cancelled our preferred stock in 2001 and have not paid common stock dividends since 2001.
Liquidity and Capital Resources:
We have significant available borrowing capacity to augment cash generated by our operations. We expect to have adequate cash available from these sources throughout their duration to fund our cash requirements for operating our business and meeting our cash obligations. The table and related disclosures on pages 21 & 22 indicate our more significant contractual cash obligations. We are confident we will be able to obtain new financing arrangements as needed to replace our existing facilities upon their expiration in future years.
We entered into a three-year asset based revolving credit facility in the third quarter of 2002 (our "Credit Facility"), under which we can borrow up to $175,000. This Credit Facility replaced a temporary uncommitted LOC facility established in 2002 (discussed below) and our previous $250,000 credit facility that expired in the third quarter of 2002.
Our Credit Facility is secured with inventory and accounts receivable in the U.S., Canada and the U.K., a portion of property and equipment in Canada and the U.K. and the stock of certain subsidiaries. Our maximum borrowing allowable under the Credit Facility is calculated monthly and is based upon specific percentages of eligible accounts receivable, inventory and fixed assets. This Credit Facility contains restrictions on dividends, limitations on borrowings from our affiliates ($30,000), capital expenditures ($68,000 in 2004) and on the payment of management fees ($5,000 per year). It also includes a minimum trailing twelve-month fixed charge coverage ratio of 1.5 to 1.0 if aggregate availability is less than $25,000, 1.25 to 1.0 if aggregate availability is between $25,000 and $50,000 and 1.1 to 1.0 if aggregate availability is between $50,000 and $75,000. However, these requirements do not apply when aggregate availability exceeds $75,000. As of December 31, 2003, our maximum borrowing allowable under the Credit Facility was $144,000, of which $98,000, after outstanding LOCs, was unused and available. As a result, we had no fixed charge coverage ratio requirements at year-end 2003.
We established an uncommitted LOC facility in 2002 to transition our LOC requirements during the last year of operation of our previous credit facility. Under this LOC facility, we were required to provide cash collateral equivalent to 101% of letters of credit outstanding. This amount was classified as Restricted cash on our 2002 Consolidated Balance Sheet. In early July 2003, we completed the process of transferring all the LOCs under this facility to our Credit Facility, resulting in the removal of the restrictions on the cash collateral.
Our U.S. entity and HAI had separate borrowing arrangements with an affiliate, Borden Foods Holdings Corporation (“Foods”), evidenced by demand promissory notes bearing interest at variable rates. We reported these loans, which totaled $18,260 at year-end 2003 and $84,680 at year-end 2002, as Loans payable to affiliates on our Consolidated Balance Sheets. The $30,000 limit on borrowings from affiliates under our Credit Facility became effective following the termination of our uncommitted LOC facility in 2003. Of the total loans outstanding, HAI owed $6,000 at December 31, 2003 and had $4,000 available for additional borrowings. The remainder of the loans related to our U.S. entity. Interest rates on these loans ranged from 1.0% to 4.75%, and interest expense totaled $558, $1,857 and $14,538 for the years ended December 31, 2003, 2002 and 2001, respectively. In early 2004, our U.S. entity entered into a similar affiliated borrowing agreement with another affiliate, BW Holdings, LLC (“BWHLLC”), and cancelled its arrangement with Foods.
HAI replaced its loan agreement with Foods on January 28, 2004, when they entered into a three-year asset based revolving credit facility, which provides for a maximum borrowing of $20,000 (the “HAI facility”). The HAI facility is secured with the assets of HAI. Maximum borrowing allowable under this facility is based upon specific percentages of eligible accounts receivable and inventory. The HAI facility restricts HAI on the payment of dividends, affiliate transactions, additional debt, minimum availability ($2,000) and capital expenditures ($2,000 in 2004). In addition, HAI must maintain a minimum trailing twelve-month debt coverage ratio of 1.5 to 1.0.
Our Australian subsidiary entered into a five-year asset-backed credit facility in the fourth quarter of 2003 (the "Australian facility"), which provides for a maximum borrowing of AUD$19,900, or approximately $15,000. The Australian facility provided the funding for our Fentak acquisition (See Note 5 to the Consolidated Financial Statements for additional information on the acquisition), and it is secured by mortgages on the fixed assets of the Australian business and the stock of Australian subsidiaries. This facility includes a fixed rate component used for the acquisition, as well as a revolver and LOC facility. This facility restricts the Australian subsidiaries on the payment of dividends, the sale of assets and additional borrowings by the Australian businesses outside of this facility. This facility also contains financial covenants applying to the Australian subsidiaries including current ratio, interest coverage, debt service coverage and leverage. The fixed portion of the Australian facility requires minimum quarterly principal reductions totaling AUD$450 (approximately $330). The revolving facility component requires semi-annual principal reductions based on a portion of excess cash as defined in the agreement. At year-end 2003, our Australian subsidiary had AUD$3,178 (approximately $2,400) available under this facility.
We have additional international credit facilities that provide availability to these businesses totaling approximately $29,900. Of this amount, approximately $15,900 (net of letters of credit and other guarantees of $7,700 and $2,300 of other draws) was available to fund working capital needs and capital expenditures. There is an additional $4,000 available for which usage is restricted to capital investments and for foreign currency hedging. While these facilities are primarily unsecured, portions of the lines are secured by equipment and with $1,442 of cash. Our U.S. business guarantees up to $6,700 of the debt of one of our Brazilian subsidiaries, included in these facilities.
In the fourth quarter of 2003, we exercised our option to redeem, at par, the remaining $885 of County of Maricopa Industrial Revenue Bonds ("IRBs"). Also in the fourth quarter of 2003, we converted our remaining IRB issue, the $34,000 Parish of Ascension IRB, to a fixed interest rate, and, by doing so, we were able to eliminate the requirement to maintain a backup letter of credit for approximately $34,500. This increased our availability under the Credit Facility and provided us with additional borrowing capacity.
Effective December 1, 2003, we entered into a $34,000 interest rate swap agreement structured for the Parish of Ascension IRBs. Under this agreement, we receive a fixed rate of 10% and pay a variable rate equal to the 6-month LIBOR plus 630 basis points. At December 31, 2003, this equates to a rate of 7.6%.
Previous buybacks of our senior unsecured notes will allow us to fulfill our sinking fund requirements through 2013 for our 8-3/8% debentures and our 9-1/4% debentures. In the future, we, or our affiliates, including entities controlled by KKR, may purchase our senior unsecured notes in the open market or by other means, depending on market conditions.
In June 2003, we announced a realignment plan from which we expect annualized savings of approximately $20,000 when the program is fully implemented in 2004. We are taking the following measures to achieve these goals: reducing our workforce, streamlining our processes in manufacturing as well as administration, consolidating manufacturing processes and targeting reductions of general and administrative expenses. We are combining jobs where practical and we have eliminated over 200 positions as of the end of 2003 related to this program. As a result of consolidating manufacturing processes, we closed our North Bay, Ontario plant as of the end of 2003 and shifted the manufacturing to another facility. We are executing a similar consolidation in Europe. Our facility in France has been converted into a distribution center, and the manufacturing transitioned to the U.K. To further decrease targeted general and administrative expenses, we have reduced contract work, consolidated and eliminated positions and streamlined the administration of medical benefits and other post-retirement benefits. We anticipate completing this program in 2004. We expect to incur additional costs in 2004 related to this program. (See Note 6 to the Consolidated Financial Statements for additional information on our realignment programs).
We plan to spend about $40,000 in 2004 for capital expenditures, including plans to continue increasing plant production capacity as necessary to meet demand. We plan to fund capital expenditures through operations and, if necessary, through available lines of credit or borrowings from affiliates.
The following table summarizes our contractual cash obligations at December 31, 2003 and the effect we expect these obligations to have on our future cash requirements. Our contractual cash obligations consist of legal commitments at December 31, 2003, requiring us to make fixed or determinable cash payments, regardless of the contractual requirements of the vendor to provide future goods or services. This table does not include information on our recurring purchases of materials for use in production, as our raw materials purchase contracts do not meet this definition because they do not require fixed or minimum quantities. Contracts with cancellation clauses are not included, unless such cancellation would result in major disruption to our business. For example, we have contracts for information technology support that are cancelable, but this support is essential to the operation of our business and administrative functions; therefore, amounts payable under these contracts are included.
(1) This table excludes payments relating to income tax, pension and OPEB benefits and environmental obligations due to the fact that, at this time, we cannot determine either the timing or the amounts of payments for all periods beyond 2004 for certain of these liabilities. In addition, loans payable to affiliates are not included in this table because they are demand instruments, and repayments are not predictable, as we use this to fund our daily cash requirements. See Notes 11, 12, 13 and 22 to the Consolidated Financial Statements and the following discussions on minimum pension funding requirements, environmental, taxes and OPEB for more information on these obligations. Our capital lease obligations are not material.
Based on our current projections of the minimum annual funding requirements imposed by Federal laws and regulations with regard to our U.S. pension plan, our projected minimum annual funding requirements range from $0 in 2004 to approximately $25,800 in 2006, with a total funding requirement for the five years ended in 2008 of $73,200. The assumptions used by our actuaries in calculating these projections included an 8.0% annual rate of return on assets for the years 2003 through 2008 and the continuation of current law and plan provisions.
We expect to spend approximately $5,400 for capital expenditures in 2004 related to capital improvements and compliance under environment laws. Of this amount, approximately $2,300 are included in the above table as unconditional purchase obligations, with the remainder being voluntary capital improvement projects. We expect other environmental expenditures for 2004 - 2008 to total approximately $17,700, with approximately $32,700 paid over the next 25 years beginning in 2009.
We have net operating loss carryforwards, future tax deductions and alternative minimum tax credits that can offset approximately $75,000 of future taxes for U.S. federal income tax purposes. We estimate we will pay cash taxes totaling approximately $22,000 in 2004 for state, local and international liabilities.
Effective September 1, 2003, we amended our OPEB medical benefit plan to eliminate medical benefits for our retirees and their dependents who are over age 65. We have arranged with a major benefits provider to offer affected retirees and their dependents continued access to medical and prescription drug coverage, including coverage for pre-existing conditions. We are currently subsidizing a portion of the cost of coverage for affected retirees and their dependents through December 2004 to assist our retirees’ transition to alternative medical coverage and reserve the right to continue, terminate or reduce the subsidy provided to our affected retirees and their dependents for periods after December 2004. As a result of these actions, we estimate that our liability related to providing OPEB medical benefits will be reduced by approximately $88,000. Our primary benefit from this amendment was a reduction of future annual cash outlays related to OPEB benefits by approximately $10,000 annually, as compared to the cash outlays we anticipated under the pre-amended retiree medical benefit plan.
We expect to have adequate liquidity to fund working capital requirements, contractual obligations and capital expenditures over the remainder of the three year term of our Credit Facility with cash received from operations, amounts available under the Credit Facility and amounts available under our subsidiaries’ separate credit facilities. In addition, we have the affiliate borrowing facility, which gives us further flexibility and capacity. However, there is no assurance that borrowings from affiliates will be available in future periods.
Risk Management:
We use various financial instruments, including some derivatives to help us hedge our foreign currency exchange risk and interest rate risk. We also use raw material purchasing contracts and pricing contracts with customers to mitigate commodity price risks. These contracts generally do not contain minimum purchase requirements.
Foreign Exchange Risk
Our international operations accounted for approximately 37% of our sales in 2003 and 35% in 2002. As a result, we have exposure to foreign exchange risk on transactions potentially denominated in many foreign currencies. These transactions include foreign currency denominated imports and exports of raw materials and finished goods (both intercompany and third party) and loan repayments. In all cases, the functional currency is the business unit’s local currency.
It is our policy to reduce foreign currency cash flow exposure due to exchange rate fluctuations by hedging firmly committed foreign currency transactions wherever economically feasible. Our use of forward and option contracts is designed to protect our cash flows against unfavorable movements in exchange rates, to the extent of the amount under contract. We do not attempt to hedge foreign currency exposure in a manner that would entirely eliminate the effect of changes in foreign currency exchange rates on net income and cash flow. We do not speculate in foreign currency nor do we hedge the foreign currency translation of our international businesses to the U.S. dollar for purposes of consolidating our financial results or other foreign currency net asset or liability positions. The counter-parties to our forward contracts are financial institutions with investment grade credit ratings.
Our foreign exchange risk is also mitigated because we operate in many foreign countries, reducing the concentration of risk in any one currency. In addition, our foreign operations have limited imports and exports, reducing the potential impact of foreign currency exchange rate fluctuations. With other factors being equal, such as the performance of individual foreign economies, an average 10% foreign exchange increase or decrease in any one country would not materially impact our operating results or cash flow. However, an average 10% foreign exchange increase or decrease in all countries may materially impact our operating results.
As required by current accounting standards, our Consolidated Statements of Operations includes any gains and losses arising from forward and option contracts.
The following table summarizes forward currency and option contracts outstanding as of December 31, 2003 and 2002. Fair values are determined from quoted market prices at these dates.
(1) Forward contracts
(2) Calls sold
(3) Puts purchased
Interest Rate Risk
We use interest rate swaps to minimize our interest rate exposures between fixed and floating rates on long-term debt. We do not enter into speculative financial contracts of any type. The fair values of the swaps are determined using estimated market levels. Under interest rate swaps, we agree with other parties to exchange at specified intervals the difference between the fixed rate and floating rate interest amounts calculated by reference to the agreed notional principal amount.
As of December 31, 2003, we had one interest rate swap outstanding with a notional value of $34,000 and a fair value of $(483). Under this arrangement, we paid 7.6% and received 10.0% in 2003. We had a $24,286 swap outstanding during 2002 that matured on December 1, 2002. In 2002, we paid 13.7% and received 1.9% on this swap.
The interest rates on most of our debt agreements are fixed. A 10% increase or decrease in the interest rates of the variable debt agreements would be immaterial to our net income. The fair value of our publicly held debt is based on the price at which the bonds are traded or quoted at December 31, 2003 and 2002. All other debt fair values are determined from quoted market interest rates at December 31, 2003 and 2002.
Following is a summary of our outstanding debt as of December 31, 2003 and 2002 (see Note 10 to the Consolidated Financial Statements for additional information on our debt):
We do not use derivative financial instruments in our investment portfolios. We place any cash equivalent investments in instruments that meet the credit quality standards established within our investment policies, which also limit the exposure to any one issue. At December 31, 2003, we had no material investments in cash equivalent instruments. At December 31, 2002, we had $70,133 invested primarily in time deposits with average maturity periods of 7 days and average rates at 1.2%. Due to the short maturity of our cash equivalents and restricted cash investments, the carrying value on these investments approximates fair value and our interest rate risk is not significant. A 10% increase or decrease in interest returns on invested cash would not have a material effect on our net income and cash flows at December 31, 2003 and 2002.
Commodity Risk
We are exposed to price risks associated with raw material purchases, most significantly with methanol, phenol and urea. For our commodity raw materials, we have purchase contracts, with periodic price adjustment provisions. In 2003, our suppliers were committed under these contracts to provide 100% of our estimated methanol requirements. Commitments with our phenol and urea suppliers provide up to 100% of our estimated requirements and also provide the flexibility to purchase a certain percentage of our needs in the spot market, when favorable to us. We expect these arrangements for raw materials to continue throughout 2004. Our commodity risk also is moderated through our use of customer contracts with selling price provisions that are indexed to publicly available indices for these commodity raw materials. All commodity futures that we enter into are approved by our Board of Directors.
We have a long-term contractual arrangement with the leading global melamine crystal producer to supply a minimum of 70% of our worldwide melamine crystal requirements. The melamine crystal we purchase under this agreement will be sourced from numerous supplier production sites and the temporary or permanent loss of any individual site would not likely have a material adverse impact on our ability to satisfy our melamine crystal requirements. We have no minimum purchase requirements under this contract.
Natural Gas Futures - Natural gas is essential in our manufacturing processes, and its cost can vary widely and unpredictably. In order to control our costs for natural gas, we hedge a portion of our natural gas purchases for all of North America. In 2003, we hedged approximately 69% of our actual natural gas usage. During 2003, we entered into futures contracts for natural gas usage through June 2004. The contracts are settled for cash each month based on the closing market price on the last day the contract trades on the New York Mercantile Exchange. Our commitments settled under these contracts totaled $4,866 and our related losses were $224 in 2003. At December 31, 2003, we had future commitments under these contracts of $1,359.
We were in previous natural gas futures contracts with varying settlement dates during 2001and 2002. Commitments settled under these contracts totaled $1,210 and our related losses were $264 in 2002. These contracts terminated prior to December 31, 2002.
We recognize gains and losses on commodity futures contracts each month as gas is used. Our future commitments are marked to market on a quarterly basis. We recorded a gain of $11 at December 31, 2003 related to our natural gas futures contracts.
Natural Gas Commitments - In 2000, we entered into fixed rate, fixed quantity contracts to secure a portion of future natural gas usage for certain facilities. We entered into these contracts to partially hedge our risk of natural gas price fluctuations in peak usage months. Our gas purchases under these contracts totaled $402 and $671 in 2003 and 2002, respectively. We recorded a gain of $16 at December 31, 2002 and a loss of $545 at December 31, 2001 for the difference between the fair value and the carrying value of our future natural gas commitments. These contracts expired early in 2003, and we have no natural gas purchase commitments at year-end 2003.
Other Matters
Our operations are subject to the usual hazards associated with chemical manufacturing and the related storage and transportation of feedstocks, products and wastes, including, but not limited to, combustion, inclement weather and natural disasters, mechanical failure, unscheduled downtime, transportation interruptions, remediation, chemical spills, discharges or releases of toxic or hazardous substances or gases and other environmental risks. These potential hazards could cause personal injury or loss of life, severe damage to or destruction of property and equipment and environmental damage and could result in suspension of our operations and the imposition of civil or criminal penalties. We have significant operational management systems, preventive procedures and protective safeguards to minimize the risk of an incident and to ensure the safe continuous operation of our facilities. In addition, we maintain property, business interruption and casualty insurance that we believe is in accordance with customary industry practices, but we are not fully insured against all potential hazards incidental to our business.
Due to the nature of our business and the current litigious climate, product liability litigation, including class action lawsuits claiming liability for death, injury or property damage caused by our products, or by other manufacturers’ products that include our components, is inherent to our business but historically has been immaterial. However, our current product liability claims and any future lawsuits, could result in damage awards against us, which in turn could encourage additional litigation.
Recently Issued Accounting Standards
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires a guarantor to recognize a liability, at the inception of the guarantee, for the fair value of obligations it has undertaken in issuing the guarantee and also include more detailed disclosures with respect to guarantees. FIN 45 is effective for guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN 45 are effective for financial statements for interim or annual periods ending after December 15, 2002. We have adopted FIN 45 and included the additional requirements with respect to guarantees in Note 21 to the Consolidated Financial Statements.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” ("FIN 46”) to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements, the assets, liabilities and activities of another entity. FIN No. 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. In December 2003, the FASB issued a revision of FIN 46 deferring the effective date for implementation. We have no variable interest entities; therefore, the implementation of FIN 46 will not have an impact on our results of operations and financial condition.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The clarification provisions of this statement require that contracts with comparable characteristics be accounted for similarly. This statement is effective for any new derivative instruments entered into after June 30, 2003. We adopted SFAS No. 149 on July 1, 2003, and the adoption did not have an impact on our financial statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement addresses the accounting for certain financial instruments that, under previous guidance, could be accounted for as equity. SFAS No. 150 requires that those instruments be classified as liabilities in the statement of financial position. This statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Our adoption of SFAS No. 150 on July 1, 2003 did not have a material impact on our financial statements.
In December 2003, the FASB issued SFAS No. 132 (as revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB Statement No. 132.” The new rules require additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. This Statement is effective for our fiscal years ending after December 15, 2003, except for certain disclosures on foreign plans, which are effective for fiscal years ending after June 15, 2004. We have adopted SFAS No. 132 (as revised 2003) and included the additional disclosures in Notes 12 and 13 to the Consolidated Financial Statements. We elected to include the disclosures for our foreign plans in 2003.
ITEM 7A:
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
We have established and maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our SEC filings reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of the end of the period covered by this Annual Report on Form 10-K, we carried out an evaluation, under the supervision and with the participation of our Disclosure Committee and our management, including our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e). Based on that evaluation, the President and Chief Executive Officer and Executive Vice President and Chief Financial Officer concluded that our disclosure controls and procedures were effective in timely alerting them to material information required to be included in our SEC filings. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out our evaluation.
Part III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Set forth below are the names and ages of the Directors and Executive Officers of the Company as of March 1, 2004, and the positions and offices 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.
Name
Position & Office
Age on Dec. 31, 2003
Served in Present Position Since
C. R. Kidder
Chairman of the Board
B. F. Carroll
Director
H. R. Kravis
Director
P. J. Norris
Director
G. R. Roberts
Director
J. K. Saer
Director
S. M. Stuart
Director
C. O. Morrison
Director, President and Chief Executive Officer
W. H. Carter
Director, Executive Vice President and
Chief Financial Officer
J. P. Bevilaqua
Executive Vice President
N. G. Brown
Vice President and General Counsel
R. H. Glaser
Vice President-Strategy and Development
R. L. Monty
Vice President-Environmental Health and Safety
C. H. Morton
Vice President-Global Operations
J. A. Sonnett
Vice President-Human Resources
C. Robert Kidder was elected a Director, Chairman of the Board and Chief Executive Officer of Borden, Inc. in January 1995, when Kohlberg Kravis Roberts & Co. acquired Borden. In 1996 he founded Borden Capital Management Partners which provided private equity investments, corporate governance functions, mergers and acquisitions expertise and strategic partnering across the Borden Family of Companies. Mr. Kidder continued to serve as Borden, Inc.’s Chief Executive Officer through March 2002. In 2003, Mr. Kidder liquidated and retired from Borden Capital. He is also a director of WKI Holding Company, Inc., Electronic Data Systems Corporation, and Morgan Stanley. He is a member of Borden’s Executive, Nominating, and Compensation Committees.
Henry R. Kravis acted as Chairman of the Board of Borden, Inc. 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 Alliance Imaging, Inc., Amphenol Corporation, The Boyds Collection, Ltd., KinderCare Learning Centers, Inc., KSL Recreation Corporation, Legrand SA, PRIMEDIA Inc., and Willis Group Holdings Limited. He is a member of the Executive Committee of the Board. Messrs. Kravis and Roberts are first cousins.
Brian F. Carroll was elected a Director 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., The Boyds Collection, Ltd. and Rockwood Specialties, Inc. He is Chairman of Borden’s Compensation Committee and a member of the Audit Committee.
Paul J. Norris was elected a director November 20, 2001. He is Chairman and Chief Executive Officer of W.R. Grace & Co. He served as President and Chief Executive Officer of W.R. Grace & Co. from November 1998 to November 2003 and has served as Chairman since January 1999. On April 2, 2001, W.R. Grace & Co. and sixty-one of its U.S. subsidiaries filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. 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 Borden, he is a senior advisor to Kohlberg Kravis Roberts & Co. A significant portion of his advisory services relate to Kohlberg Kravis Roberts & Co.’s investment in the Company. Mr. Norris is a member of Borden’s Audit and Executive Committees.
George R. Roberts was elected a director of Borden, Inc. in 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 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 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 also a Director of KSL Recreation Corporation. He is a member of Borden’s Executive and Compensation Committees and is Chairman of the Audit and Nominating Committees.
Scott M. Stuart has been a director since 1996 and a General Partner of KKR Associates, L.P. since 1995. He 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. He is a member of the Executive Committee.
Craig O. Morrison was elected President and Chief Executive Officer effective March 25, 2002. Prior to joining Borden 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.
William H. Carter was elected Executive Vice President and Chief Financial Officer effective April 3, 1995 and a director November 20, 2001. He was a director, and from January to June 2000 served as interim President and Chief Executive Officer, of Borden’s subsidiary, BCP Management, Inc., which voluntarily filed for protection under Chapter 11 of the United States Bankruptcy Code, on March 22, 2002. Mr. Carter also was a director of WKI Holding Company, Inc. and from August 2000 to May 2001 served as its interim Chief Financial Officer. WKI Holding Company filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on May 31, 2002.
Joseph P. Bevilaqua joined the Company as Vice President - Corporate Strategy and Development April 1, 2002. In September 2002 he assumed responsibility for the Performance Resins Group, and was elected an Executive Vice President in March 2003. In January 2004 he assumed additional operating responsibilities. Prior to joining Borden, 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.
Nancy G. Brown was elected a Vice President and General Counsel effective June 11, 2003. She served as Vice President, General Counsel and Secretary of Borden Foods Corporation from January 1996 to December 2001.
Raymond H. Glaser was elected Vice President - Corporate Strategy & Development in August 2002. Prior to joining Borden 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.
Richard L. Monty was elected Vice President - Environmental Health & Safety effective January 26, 2004. Prior to joining Borden, he was employed by Huntsman Corporation from July 1992 to January 2004 in various Environmental Health and Safety positions, ultimately serving as Director, Global Environmental Health & Safety from 2001 to January 2004.
C. Hugh Morton was elected Vice President - Global Operations effective January 19, 2004. Prior to joining Borden he served as Vice President of Operations for Thomson Consumer Electronics from January 2001 to December 2002. From July 1998 to September 2000 he was Executive Vice President of Great Lakes Chemical and President of the Polymer Additives Division.
Judith A. Sonnett was elected Vice President-Human Resources on November 24, 2001. She was Vice President of Human Resources for Borden, Inc.’s subsidiary, Borden Chemical, Inc., from November 1998 to November 2001. From 1995 to November 1998, she worked in Human Resources for W.L. Gore and Associates.
Audit Committee
Our Board of Directors has an Audit Committee consisting of three non-management Directors: Messrs. Saer, Carroll and Norris. The Board of Directors has determined that the Chairman of its Audit Committee, Mr. Saer, qualifies as an Audit Committee financial expert as defined in the Securities and Exchange Commission’s rules. The members of our Audit Committee are not independent, as independence for Audit Committee members is defined in Exchange Act Rule 10A-3 or in the New York Stock Exchange Listing standards.
Code of Ethics
We have a Code of Business Ethics that applies to all associates, including our Chief Executive Officer and senior financial officers. These standards are designed to deter wrongdoing and to promote the honest and ethical conduct of all associates. Excerpts from the Code of Business Ethics, which address the subject areas covered by the Securities and Exchange Commission’s rules, are posted on our website: www.bordenchem.com under “About Us”. Any substantive amendment to, or waiver from, any provision of the Code of Business Ethics with respect to any senior executive or financial officer shall be posted on this website.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table provides certain summary information concerning compensation of the Chief Executive Officer, the next four most highly compensated Executive Officers as of December 31, 2003 and one former Executive Officer (the "Named Executive Officers") for the periods indicated.
(1) Except as stated herein, amounts shown in this column for 2003 consist of matching company contributions to the Retirement Savings Plan and the executive supplemental benefit plans. The amount for Mr. Stoll also includes severance pay of $174,307. The amount shown for Mr. Glaser includes $11,000 for reimbursed moving expenses.
(2) Mr. Morrison’s restricted stock consists of 1,058,201 shares and Mr. Bevilaqua’s restricted stock consists of 529,100 shares. There is no published market value for Borden’s common shares at Dec. 31. Dividends are not payable on the restricted shares. See description in "Employment, Termination and Change in Control Arrangements" for other terms of Mr. Morrison’s and Mr. Bevilaqua’s restricted stock, which vests after three years of employment, unless the executive is terminated without cause, in which event vesting is accelerated.
(3) 100% of Mr. Carter’s 2002 salary was paid by Borden Capital funded by fees paid by the Company.
(4) A portion of the bonus payments made in 2002 to Messrs. Carter ($417,263) and Stoll ($225,000) relate to installments paid for a one-time retention bonus and were paid by Borden Capital, Inc., funded by fees paid by the Company. A portion of the bonus payment made in 2003 to Mr. Carter ($380,000) and all of Mr. Stoll’s 2003 bonus were funded by BHI and also relate to this retention bonus. See page 78 for additional information.
(5) Tax gross-up.
(6) Mr. Stoll was Executive Vice President and General Counsel through July 18, 2003.
Option Grants in Last Fiscal Year
The following table provides information on option grants during 2003 to the Named Executive Officers.
(1) The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with risk free interest rates of 2.910%, dividend rates of 0.0%, expected volatility of .01% and expected life of five years.
Option Exercises in Last Fiscal Year and FY-End Option Values
The following table provides information on options held by the Named Executive Officers and the value of their unexercised options at December 31, 2003.
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 we have 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 2003, the interest rate as determined in accordance with the plan language was 1.495%. Benefits vest after completion of five years of employment for employees hired on or after July 1, 1990.
We have a supplemental plan which provides 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 in 2003: C.O. Morrison-$82,142, W. H. Carter-$120,266, J.P. Bevilaqua-$43,865, J.A. Sonnett-$45,222, R. H. Glaser-$32,976 and W. F. Stoll-$57,263 (not including the special arrangement described below which is projected to be a one-time payment of $641,757).
We have a special retirement arrangement with Mr. Stoll, former 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 Borden as a non-qualified benefit. Special provisions also apply in the event of death or disability. The pension payment will be paid to Mr. Stoll at the time he reaches age 58.
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 defined basic contributions are provided under the supplemental plans. This benefit is not provided if the executive has any other pension benefit guarantee.
Compensation of Directors
In 2003, Messrs. Kravis and Stuart received Board fees totaling $15,000, Messrs. Roberts, Saer, Norris and Carroll received Board fees totaling $30,000 and Mr. Kidder received Board fees totaling $22,500. No additional compensation was paid for committee participation or special assignments. Directors who were also employees of the Company received no remuneration for serving as Directors.
Kohlberg Kravis Roberts & Co. received a fixed fee of $3 million from the Company in 2003. Messrs. Carroll, Kravis, Roberts, Saer and Stuart are directors of the Company and are affiliated with Kohlberg Kravis Roberts & Co.
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
We have 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 Borden’s common stock at $2.25 per share and received 210,667 options granted at $2.25 per share which vest over five years. 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 his fourth year 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 based on his length of employment. Dividends are not payable on the restricted shares. In the event that the return on Mr. Morrison’s equity investment in Borden is negative, due solely to certain specified circumstances, the arrangement requires us 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.
We have an arrangement with Mr. Bevilaqua that was effective March 2002. Under the terms of the agreement Mr. Bevilaqua was provided with relocation assistance, a bonus opportunity, an equity investment opportunity, and a 2001 incentive payment guarantee. Pursuant to this arrangement Mr. Bevilaqua purchased 111,111 shares of Borden’s common stock at $2.25 per share and received 105,333 options granted at $2.25 per share which vest over five years. Mr. Bevilaqua was also granted 529,100 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 his fourth year of employment. The value of the shares is to be determined based upon a formula, and is capped, under certain circumstances, at $1 million. In the event Mr. Bevilaqua’s employment is terminated without cause, the vesting of the restricted shares is accelerated based on his length of employment. Dividends are not payable on the restricted shares. In the event that the return on Mr. Bevilaqua’s equity investment in Borden is negative, due solely to certain specified circumstances, the arrangement requires us to purchase his investment at a price equal to his initial investment. The arrangement also entitles Mr. Bevilaqua to receive a perquisite payment in the amount of $25,000 annually, usual and customary health and pension benefits, and provides for twelve months severance based on monthly base salary in the event of termination of employment for reasons other than for cause.
Mr. Stoll, our former Executive Vice President and General Counsel, has an arrangement which provides him with certain benefits. Under the terms of the agreement, Mr. Stoll is entitled to receive twenty-four months of base-salary severance through July 16, 2005, and a retention bonus payable in installments from 2002-2005 or upon termination for reasons other than for cause. Upon Mr. Stoll’s termination in 2003, he received the remainder of the bonus due him, or $419,000, which was funded by our parent, BHI. The arrangement further provides for the payment of a special pension benefit at age 58, which is described under Retirement Benefits, above.
We have 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 retention bonus to be funded by our parent equal to $1,200,000 payable in installments 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, in the event of termination of employment for reasons other than for cause.
Compensation Committee Interlocks and Insider Participation
Messrs. Carroll and Saer are members of the Compensation Committee of the Board of Directors and both are employees of Kohlberg Kravis Roberts & Co. See "Certain Relationships and Related Transactions." Mr. Kidder, our Chairman and former Chief Executive Officer, is also a member of the Compensation Committee.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial ownership of our Common Stock as of March 1, 2004, by (a) persons known to us to be the beneficial owners of more than five percent of our outstanding voting stock, (b) each Director, (c) each of the Named Executive Officers during the 2003 fiscal year and (d) all Directors and Executive Officers 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.
* Beneficial ownership does not exceed 1.0% of the respective class of securities.
(1) The 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. Edward A. Gilhuly, Perry Golkin, James H. Greene, Jr., Henry R. Kravis, Michael W. Michelson, Alexander Navab, Paul E. Raether, 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) As of March 1, 2004, Mr. Morrison and Mr. Bevilaqua beneficially owned 1,280,423 and 640,211 shares of common stock, respectively, and had the right to acquire beneficial ownership within 60 days to an additional 84,267 and 42,133 shares of common stock, respectively, pursuant to the exercise of stock options.
(3) Equity securities beneficially owned by all Directors and Executive Officers as a group consist of: 1,920,634 common shares and 126,400 shares subject to currently exercisable options.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
99% of our 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. Edward A. Gilhuly, Perry Golkin, James H. Greene, Jr., Henry R. Kravis, Michael W. Michelson, Paul E. Raether, 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 on our Board of Directors.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees billed to us during the fiscal years ended December 31, 2003 and 2002 by our principal accounting firm, Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (collectively, “Deloitte”):
(a) Audit Fees. This category includes fees and expenses paid to Deloitte for the audit of our annual financial statements and for the reviews of the financial statements included in our Quarterly Reports on Form 10-Q. This includes audit fees for engagements performed at U.S. and international locations and at HAI, for the fiscal years ended December 31, 2003 and 2002.
(b) Audit-Related Fees. This category includes fees and expenses paid to Deloitte for a stand-alone audit of HAI, other audit-related accounting and SEC reporting services, consultations on Sarbanes-Oxley matters, and employee benefit plan audits for the year ended December 31, 2003. Audit-related fees and expenses for the year ended December 31, 2002 relate to a stand-alone audit of HAI, employee benefit plan audits, actuarial assistance and other accounting research.
(c) Tax Fees. This category includes fees and expenses paid to Deloitte for domestic and international tax compliance and planning services and tax advice.
Pre-Approval Policy and Procedures. Under a policy and procedures adopted by the Audit Committee, all audit and non-audit services provided by our principal accounting firm must be pre-approved by the Audit Committee or its designated member, Mr. Norris. All services pre-approved by Mr. Norris are reported to the full Audit Committee at its next regularly scheduled meeting. The pre-approval of audit and non-audit services may be given at any time up to a year before the commencement of the specified service. Under the policy, management is prohibited from using its principal accounting firm for certain non-audit services, the list of which is based upon the list of prohibited activities in the SEC’s rules and regulations.
Part IV
ITEM 15
ITEM 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Management contracts, compensatory plans and arrangements are listed herein at Exhibits (10)(iv) through (10)(xiii).
(3)(i) Restated Certificate of Incorporation dated March 14, 1995, and Certificate of Amendment of Restated Certificate of Incorporation dated June 23, 1995, both incorporated herein by reference from Exhibit (3) to the June 30, 1995 Form 10-Q.
(ii) Certificate of Merger of Borden Chemical Holdings, Inc. into Borden, Inc. November 21, 2001 incorporated by reference from Exhibit (10) (xvii) to the 2001 Form 10-K Annual Report.
(iii) By-Laws dated November 4, 2002, incorporated herein by reference from Exhibit (3)(ii) to the 2002 Annual Report on Form 10-K.
(4) (i) Form of Indenture between the Registrant and The First National Bank of Chicago, as Trustee, dated as of January 15, 1983, as supplemented by the First Supplemental Indenture dated as of March 31, 1986, and the Second Supplemental Indenture, dated as of June 26, 1996, relating to the $200,000,000 8-3/8% Sinking Fund Debentures due 2016, incorporated herein by reference from Exhibits (4)(a) and (b) to Amendment No. 1 to Registration Statement on Form S-3, File No. 33-4381 and Exhibit (4)(iv) to the June 30, 1996, Form 10-Q.
(ii) Form of Indenture between the Registrant and The Bank of New York, as Trustee, dated as of December 15, 1987, as supplemented by the First Supplemental Indenture dated as of December 15, 1987, and the Second Supplemental Indenture dated as of February 1, 1993, and the Third Supplemental Indenture dated as of June 26, 1996, incorporated herein by reference from Exhibits (4)(a) through (d) to Registration Statement on Form S-3, File No. 33-45770, and Exhibit (4)(iii) to the June 30, 1996, Form 10-Q, relating to the following Debentures and Notes:
(a) The $150,000,000 9-1/4% Sinking Fund Debentures due 2019.
(b) The $200,000,000 9-1/5% Debentures due 2021.
(c) The $250,000,000 7-7/8% Debentures due 2023.
(iii) Form of Indenture between the Registrant and The Chase Manhattan Bank, as Trustee, relating to Senior Securities, incorporated herein by reference from Exhibit 4.1 to the Company’s Registration Statement on Form S-3, File No. 33-57577.
(iv) Form of Indenture between the Registrant and The Bank of New York, relating to Subordinated Securities incorporated herein by reference from Exhibit 4.2 to the Company's Registration Statement on Form S-3, File No. 33-57577.
(10) (i) Loan and Security Agreement dated September 23, 2002 among Borden Chemical, Inc., Borden Chemical Canada, Inc., Borden Chemical UK Limited, Borden Chemical GB Limited, and Fleet Capital Corporation, as Lender and Agent for the other lenders thereto, incorporated herein by reference to Exhibit (10)(i) to the September 30, 2002 Form 10-Q.
(ii) Credit Agreement dated as of December 15, 1994 amended and restated as of July 14, 1997, incorporated herein by reference to Exhibit (10)(ii) to the June 30, 1997 Form 10-Q.
(iii) Stockholders Agreement, dated as of June 20, 1996, by and among Borden, Inc. and J. Brendan Barba, Paul M. Feeney, David MacFarland, Robert Cron, Kenneth J. Avia, Melanie K. Barba, John Powers, Lauren Powers, Carolyn Vegliante and Lawrence Noll, incorporated herein by reference to Exhibit 2 to Schedule 13D, dated July 1, 1996. File No. 005-37385.
(iv) Amended and Restated 1996 Unit Incentive Plan for Key Employees of Borden, Inc. and Associated Persons, dated as of December 31, 2000 incorporated herein by reference to Exhibit (10)(vi) to the 2000 Form 10-K Annual Report.
(v) Executive Supplemental Pension Plan Amended and Restated as of January, 1996 incorporated by reference to Exhibit (10)(xiii) to the 1998 Form 10-K Annual Report.
(vi) Advisory Directors Plan, incorporated herein by reference from Exhibit (10)(viii) to the 1989 Form 10-K Annual Report.
(vii) Management Agreements
(a) Employment Agreement with W. F. Stoll, Jr., dated June 6, 1996, incorporated by reference to Exhibit (10)(vi) to the June 30, 1996 Form 10-Q.
(b) Summary of Terms of Employment for Mr. Morrison incorporated by reference from Exhibit (10)(i) to the Form 10-Q for the period ended March 31, 2002.
(c) Summary Terms of Employment for Joseph P. Bevilaqua dated January 7, 2002, incorporated by reference from Exhibit (x)(d) to the 2002 Annual Report on Form 10-K.
(d) Summary Terms of Employment for C.R. Kidder dated March 2003, incorporated by reference from Exhibit (x) (e) to the 2002 Annual Report on Form 10-K.
(e) Summary Terms of Employment for W. H. Carter as of November 2001.
(viii) Amended and Restated 1996 Stock Purchase and Option Plan for Key Employees of Borden Chemical, Inc., and Subsidiaries dated September 2003, incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-8, File No. 333-109490.
(ix) Form of Management Stockholder Agreement incorporated by reference from Exhibit 4.4 to the Registration Statement on Form S-8, File No. 333-109490.
(x) Form of Non-Qualified Stock Option Agreement incorporated by reference from Exhibit 4.5 to the Registration Statement on Form S-8, File No. 333-109490.
(xi) Form of Sale Participation Agreement incorporated by reference from Exhibit 4.6 to the Registration Statement on Form S-8, File No. 333-109490.
(xii) Form of Registration Rights Agreement dated January 1, 2002 among Borden Chemical, Inc., Borden Holdings, Inc., and BDS Two, Inc., incorporated by reference from Exhibit 4.7 to the Registration Statement on Form S-8, File No. 333-109490
(xiii) Perquisite Benefits Policy, incorporated by reference to Exhibit (10)(xviii) to the 2001 Form 10-K Annual Report.
(xiv) Consulting Agreement with Kohlberg Kravis Roberts & Co., LP dated August 21, 1995, incorporated herein by reference to Exhibit 10 to the September 30, 1995 Form 10-Q, and amendment dated May 30, 2002, incorporated by reference to Exhibit (10) to the June 30, 2002 Form 10-Q.
(xv) Joint Management Services Agreement dated October 1, 2001 between Borden Chemical, Inc. and Borden Capital, Inc., incorporated by reference to Exhibit (10) (xiv) to the 2001 Form 10-K Annual Report.
(xvi) Pledge and Assignment Agreement, dated as of January 18, 2002, made by Borden Chemical, Inc. (formerly known as Borden, Inc.), a New Jersey Corporation (the “Pledgor”), to Credit Suisse First Boston, incorporated by reference to Exhibit (10) (xix) to the 2001 Form 10-K Annual Report.
(xvii) Reimbursement agreement for Uncommitted Letter of Credit Facility between Credit Suisse First Boston, New York Branch dated January 18, 2002, incorporated by reference to Exhibit (10)(xx) to the 2001 Form 10-K Annual Report.
(xviii) First Amendment, dated as of March 27, 2002, to the Reimbursement agreement for Uncommitted letter of Credit Facility between Credit Suisse First Boston, New York Branch dated January 18, 2002, incorporated by reference to Exhibit (10)(ii) to the March 31, 2002 Form 10-Q.
(xix) Second Amendment, dated as of April 30, 2002, to the Reimbursement agreement for Uncommitted letter of Credit Facility between Credit Suisse First Boston, New York Branch dated January 18, 2002, incorporated by reference to Exhibit (10)(iii) to the March 31, 2002 Form 10-Q.
(xx) Master Asset Conveyance and Facility Support Agreement dated as of December 20, 2002 between the Company and Borden Chemicals and Plastics Operating Limited Partnership, incorporated herein by reference from Exhibit (xxvi) to the 2002 Annual Report on Form 10-K.
(xxi) Environmental Servitude Agreement dated as of December 20, 2002 between the Company and Borden Chemicals and Plastics Operating Limited Partnership incorporated herein by reference from Exhibit (xxvii) to the 2002 Annual Report on Form 10-K.
(xxii) Settlement Agreement dated September 13, 2002 among the Company, Borden Chemicals and Plastics Operating Limited Partnership, BCP Management, Inc., the U.S. E.P.A., and the Louisiana Department of Environmental Quality.
(12) Ratio of Earning to Fixed Charges.
(21) Subsidiaries of Registrant.
(23)(i) Accountants’ Consent.
(31) Rule 13a-14 Certifications
(a) Certificate of the Chief Executive Officer
(b Certificate of the Chief Financial Officer
(32) Section 1350 Certifications
Item 15(b) Reports on Form 8-K
We filed a report on Form 8-K on October 9, 2003 to disclose the issuance of a Limited Reoffering Circular in connection with the conversion from a daily rate to a fixed rate and reoffering of our $34,000,000 aggregate principal amount of Parish of Ascension, State of Louisiana Pollution Control Revenue Refunding Bonds, Series 1982.
INDEPENDENT AUDITORS’ REPORT
To the Board of Directors
and Shareholders of Borden Chemical, Inc.
We have audited the consolidated financial statements of Borden Chemical, Inc. (a subsidiary of Borden Holdings, Inc.) and subsidiaries as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003, and have issued our report thereon dated March 19, 2004 (which report expresses an unqualified opinion and includes an explanatory paragraph regarding the Company’s adoption in 2002 of Statement of Financial Accounting Standard No. 142); such financial statements and report are included elsewhere in this Form 10-K. Our audits also included the financial statement schedule of Borden Chemical, Inc. and subsidiaries, listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Columbus, Ohio
March 19, 2004
Schedule II - Valuation and Qualifying Accounts
Balance 12/31/00
Charged to Expense
Write-offs
Balance 12/31/01
Allowance for doubtful accounts
$12,654
$5,175
$(1,170)
$ 16,659
Balance 12/31/01
Charged to Expense
Write-offs
Balance 12/31/02
Allowance for doubtful accounts
$16,659
$(690)
$(3,750)
$ 12,219
Balance 12/31/02
Charged to Expense
Write-offs
Balance 12/31/03
Allowance for doubtful accounts
$12,219
$2,526
$(286)
$14,459
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BORDEN CHEMICAL, INC.
By /s/ William H. Carter
William H. Carter
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: March 29, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated, on the date set forth above.
Signature
Title
Signature
Title
/s/ C. Robert Kidder
Chairman of the Board
/s/ Craig O. Morrison
Director
C. Robert Kidder
Craig O. Morrison
/s/ Henry R. Kravis
Director
/s/ Paul J. Norris
Director
Henry R. Kravis
Paul J. Norris
/s/ John K. Saer
Director
/s/ Brian F. Carroll
Director
John K. Saer
Brian F. Carroll
/s/ George R. Roberts
Director
/s/ William H. Carter
Director
George R. Roberts
William H. Carter
/s/ Scott M. Stuart
Scott M. Stuart
Director