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New Jersey |
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13-0511250 |
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(State of incorporation) |
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(I.R.S. Employer Identification No.) |
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180 East Broad St., Columbus, OH 43215 |
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614-225-4000 |
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(Address of principal executive offices) |
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(Registrant’s telephone number) |
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: | ||
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Title of each class |
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Name of each exchange on which registered |
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8 3/8% Sinking Fund Debentures |
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New York Stock Exchange |
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE | ||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in any amendment to this Form 10-K. [x].
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes __ No__X__
Aggregate market value in thousands of the voting stock held by nonaffiliates of the Registrant based upon the average bid and asked prices of such stock on March 19, 2004: $0.
Number of shares of common stock, par value $0.01 per share, outstanding as of the close of business on March 19, 2004: 200,895,628
DOCUMENTS INCORPORATED BY REFERENCE
Document Incorporated
none none
The Exhibit Index is Located herein at sequential pages 81 through 84.
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BORDEN CHEMICAL, INC.
INDEX
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PART I |
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Item 1 – Business |
3 |
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Item 2 – Properties |
6 |
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Item 3 – Legal Proceedings |
6 |
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Item 4 – Submission of Matters to a Vote of Security Holders |
8 |
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PART II |
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Item 5 – Market for the Registrant's Common Equity and Related Stockholder Matters |
8 |
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Item 6 – Selected Financial Data |
9 |
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Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations |
10 |
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Item 7A – Quantitative and Qualitative Disclosures about Market Risk |
27 |
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Item 8 – Financial Statements and Supplementary Data |
28 |
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Borden Chemical, Inc. Consolidated Financial Statements |
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Consolidated Statements of Operations, years ended December 31, 2003, 2002 and 2001 |
28 |
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Consolidated Balance Sheets, December 31, 2003 and 2002 |
30 |
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Consolidated Statements of Cash Flows, years ended December 31, 2003, 2002 and 2001 |
32 |
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Consolidated Statements of Shareholders’ Deficit, years ended December 31, 2003, 2002 and 2001 |
34 |
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Notes to Consolidated Financial Statements |
36 |
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Independent Auditors' Report |
72 |
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Item 9 – Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
73 |
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Item 9A – Controls and Procedures |
73 |
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PART III |
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Item 10 – Directors and Executive Officers of the Registrant |
73 |
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Item 11 – Executive Compensation |
76 |
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Item 12 – Security Ownership of Certain Beneficial Owners and Management |
80 |
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Item 13 – Certain Relationships and Related Transactions |
81 |
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Item 14 – Principal Accountant Fees and Services |
81 |
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PART IV |
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Item 15 – Exhibits, Financial Statement Schedules and Reports on Form 8-K |
81 |
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Signatures |
87 |
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Part I
ITEM 1. BUSINESS
(Dollars in thousands except per share data)
Description of Business
Borden Chemical, Inc. (which may be referred to as “we,” “us,” “our” or the “Company”) was incorporated on April 24, 1899. We are engaged primarily in the manufacturing and distribution of forest product and industrial resins, formaldehyde, oilfield products and other specialty and industrial chemicals worldwide. Our executive and administrative offices are located in Columbus, Ohio. Production facilities are located throughout the United States and in many foreign countries.
Our business consists of three reportable segments: North American Forest Products (“NAFORP”), North American Performance Resins Group (“NAPRG”) and International. See Note 19 to the Consolidated Financial Statements.
Historical Perspective
In 1995, when affiliates of Kohlberg Kravis Roberts & Co. (“KKR”) acquired control of the Company (then known as Borden, Inc.), our business consisted of the following business segments: Chemical, Foods, Other Consumer Products (including Consumer Adhesives), Decorative Products, Dairy and businesses held for sale. We sold all of these business segments by the end of 2001, except for the Chemical segment.
In 2001, we merged the Company with its subsidiaries, Borden Chemical Holdings, Inc. and Borden Chemical, Inc., executed certain financial transactions with our parent company, Borden Holdings, Inc. ("BHI"), and changed our name to Borden Chemical, Inc. (the “Corporate Reorganization”) to reflect the fact that the sole remaining business of the Company was the Chemical segment. The Corporate Reorganization simplified the legal structure, strengthened the capital structure and reduced costs of the Company. As part of the Corporate Reorganization, certain functions were downsized, eliminated or transferred to a separate legal entity, Borden Capital, Inc. (“Capital”), also owned by BHI.
Acquisitions and Divestitures
Following is a summary of acquisitions and divestitures we made in the past five years.
In the fourth quarter of 2003, we acquired Fentak Pty Ltd. (“Fentak”) in Australia and Malaysia, a producer of specialty chemical products for engineered wood, laminating and paper impregnation markets. We also acquired the business and technology assets of Southeastern Adhesives Company (“SEACO”), a domestic producer of specialty adhesives.
In 2001, through a series of transactions with affiliates, we sold Consumer Adhesives for total proceeds of $94,120 (the “Consumer Adhesives sale”). Consequently, Consumer Adhesives is reported as a discontinued operation in our financial statements in 2001. We retained continuing investments in Consumer Adhesives in the form of preferred stock and notes receivable. We sold the notes receivable to BHI in the fourth quarter of 2001 for their carrying value of $57,691. The preferred stock, with a carrying value of $110,000, was redeemed during the first quarter of 2002 for a $110,000 note receivable from Consumer Adhesives, which we subsequently sold to BHI for face value plus accrued interest and used the proceeds repay affiliated debt.
Also in 2001, we merged our North American foundry resins and coatings businesses with similar businesses of Delta-HA, Inc. to form HA-International, LLC (“HAI”), in which we have a 75% interest.
In 2000, the Company acquired the formaldehyde and certain other assets from Borden Chemicals and Plastics Operating Limited Partnership (“BCPOLP”), which was an affiliate of the Company, and acquired East Central Wax, a wax emulsions producer for the forest products business.
In 1999, we acquired Blagden Chemicals, Ltd. (“Blagden”) in the U.K. and Spurlock Industries, Inc. (“Spurlock”) in the U.S. Blagden produces formaldehyde, forest products and industrial resins. Spurlock produces formaldehyde and forest products resins.
Business Realignment and Corporate Reorganization
In addition to the acquisitions and divestitures discussed above, we have undertaken numerous plant consolidations and other business realignment initiatives. These initiatives are designed to improve efficiency and to focus resources on our core strengths. The associated business realignment charges consist primarily of employee severance, plant consolidation and related environmental remediation costs and asset write-offs. Following is a brief overview of our significant business realignment activities since 2001:
In June 2003, we initiated a realignment program designed to reduce operating expenses and increase organizational efficiency. To achieve these goals, we are reducing our workforce, streamlining processes, consolidating manufacturing processes and reducing general and administrative expenses. We anticipate the program will be completed in 2004.
In 2001, we recorded $126,408 of business realignment and impairment charges related primarily to the closures of our melamine crystal business (“Melamine”) and two forest products plants in the U.S., realignment of our North American workforce organization, reorganization of our corporate headquarters and the discontinuation of a plant construction project. The largest component of the 2001 charge is a $98,163 impairment of Melamine fixed assets, goodwill and spare parts that was the result of our strategic decision late in 2001 to sell or close this business and to enter into a long-term contractual arrangement with a supplier for our future melamine crystal needs.
As part of the Corporate Reorganization, in 2001, we also completed a significant capital restructuring, which consisted primarily of a capital contribution by BHI of $614,369 of preferred stock held by BHI. The significant impact of this transaction was to eliminate future required annual preferred dividend payments of $73,724. Also as part of the capital restructuring, BHI made a capital contribution of cash and purchased certain financial assets from us at their estimated fair values. The cash contribution and the cash received from sale of assets allowed us to substantially repay our affiliated debt as of December 31, 2001. See Note 3 to the Consolidated Financial Statements.
Products
The product lines included in our NAFORP operating segment are formaldehyde and forest product resins. The products in our NAPRG operating segment are oilfield, foundry and specialty resins. The products of our International operating segment are formaldehyde, forest product and performance resins and consumer products.
We are the leading global producer of thermosetting resins for the forest products industry and a leading producer of thermosetting resins for industrial and foundry applications in North America. Our resins are used to bind or coat other materials during the manufacturing process. Our resins are provided to a wide variety of customers for use in the manufacture of structural building panels, medium density fiberboard, particle board, laminate veneers, insulation binders, automotive brakes, and to coat cores and molds in the metal casting process.
We are also the world’s largest producer of formaldehyde. Approximately 50% of the formaldehyde produced by us is consumed internally to produce thermosetting resins, with the remainder sold to third parties.
We manufacture and distribute our products worldwide with the most significant markets being North America, Western Europe, Latin America, Australia, and Malaysia, and we generally hold a leading market position in the areas in which we compete.
Marketing and Distribution
Products are sold in the U.S. primarily through our sales force to industrial users. To the extent practicable, our international distribution techniques parallel those used in the U.S. However, raw materials, production considerations, pricing competition, government policy toward industry and foreign investment, and other factors may vary substantially from country to country.
Competition
Our major competitors are Dynea International OY, Georgia Pacific Corporation, Ashland Specialty Chemical Company and several regional domestic and international competitors. Price, customer service and product performance are the primary focus of competition.
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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.
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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 t
rademark 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.
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ITEM 2. PROPERTIES
As of December 31, 2003, we operated 27 domestic production and manufacturing facilities in 16 states, the most significant being a plant in Louisville, Kentucky. In addition, we operated 21 foreign production and manufacturing facilities primarily in Canada, South America, Europe, Australia and Malaysia.
Our manufacturing and processing facilities are generally well maintained and effectively utilized. Substantially all of our manufacturing facilities are owned. We lease our executive and administrative offices in Columbus, Ohio.
ITEM 3. LEGAL PROCEEDINGS
Environmental Proceedings
We have been notified that the Company is or may be responsible for environmental remediation at 30 sites in the U.S. Five of these sites, located in four states, involve active proceedings brought under state or Federal environmental laws: Geismar, Louisiana; Fairlawn, New Jersey; Fremont, California; Lakeland, Florida and Newark, California. The most significant of these sites is the site formerly owned by the Company in Geismar, Louisiana. While we cannot predict with certainty the total cost of such cleanups, we have recorded liabilities of approximately $23,400 and $27,100 at December 31, 2003 and 2002, respectively, for environmental remediation costs related to these five sites.
For the remaining 25 sites, we have been notified that the Company is or may be a potentially responsible party (“PRP”) in active proceedings in 15 states brought under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) or similar state “superfund” laws. While we cannot predict with certainty the total cost of such cleanup, we have recorded liabilities of approximately $7,600 and $7,000 at December 31, 2003 and 2002, respectively, for environmental remediation costs related to these 25 sites. The Company generally does not bear a significant level of responsibility for these sites and has little control over the costs and timing of cash flows. At 16 of the 25 sites, our share is less than 1%. At the remaining nine sites, the Company has a share of up to 8.8% of the total liability. The Company’s ult
imate 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 l
iquidating 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 assessm
ent and will pursue the appeal vigorously; however, no assurance can be given that the assessment will not be upheld.
HAI Grand Jury Investigation
HAI, a joint venture in which the Company has a 75% interest, received a grand jury subpoena dated November 5, 2003 from the U.S. Department of Justice Antitrust Division relating to a Foundry Resins Grand Jury investigation. HAI has provided documentation in response to the subpoena, is cooperating with the Department of Justice and has heard nothing further.
Other Legal Proceedings
The Company is involved in various product liability, commercial and employment litigation and other legal proceedings throughout the United States which are not discussed in its periodic filings and are considered to be in the ordinary course of business. There has been increased publicity about asbestos liabilities faced by manufacturing companies. As a result of the bankruptcies of many asbestos producers, plaintiffs' attorneys are increasing their focus on peripheral defendants, including the Company. We believe we have adequate reserves and insurance and do not believe we have a material asbestos exposure.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2003, no matters were submitted to a vote of our security holders.
Part II
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Our authorized common stock consists of 300,000,000 shares with a par value of $0.01 per share. As of December 31, 2003, 200,895,628 common shares were issued and outstanding, of which 99.0% are controlled by affiliates of KKR with the remainder held by two members of management. No shares of such common stock trade on any exchange. We declared no dividends on common stock in 2003 or 2002. Our ability to pay dividends on its common stock is restricted by our Credit Facility (see Note 10 to the Consolidated Financial Statements).
The following table contains certain information regarding our Amended and Restated 1996 Stock Purchase and Option Plan for Key Employees, which is administered by the Compensation Committee of our Board of Directors and which provides for the purchase or grant of stock and stock-based awards to employees or other persons having a unique relationship with the Company or its subsidiaries. (See Note 15 to the Consolidated Financial Statements).
Equity Compensation Plan Information
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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)) |
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(a) |
(b) |
(c) |
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Equity compensation plans approved by security holders |
5,532,360 |
$2.42 |
4,017,639 |
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Equity compensation plans not approved by security holders |
N/A |
N/A |
N/A |
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Total |
5,532,360 |
$2.42 |
4,017,639 |
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ITEM 6. SELECTED FINANCIAL DATA
Five Year Selected Consolidated Financial Data
The following summarizes our selected financial data for the past five years. See pages 16 through 18 for items impacting comparability between 2003, 2002 and 2001.
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For the years |
2003 |
2002 |
(1) 2001 |
(2) 2000 |
(3) 1999 |
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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) |
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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) |
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Dividends per share
Common share
Preferred series A |
$ -
- |
$ -
- |
$ 0.18
2.52 |
$ 0.31
3.00 |
$ 0.32
3.00 |
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Average number of common shares outstanding during the year-basic |
200,898 |
200,458 |
198,997 |
198,975 |
198,975 |
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Average number of common shares outstanding during the year-dilutive |
200,924 |
200,458 |
198,997 |
198,975 |
198,975 |
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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 |
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(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.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands)
Forward-Looking and Cautionary Statements
As management of the Company, we may, from time to time, make written or oral statements regarding the future performance of the Company, including statements contained in this report and our other reports filed with the Securities and Exchange Commission. Investors should be aware that these statements, which may include words such as “believe,” “expect,” “anticipate,” “estimate” or “intend,” are based on our currently available financial, economic, and competitive data and on current business plans. Such statements are inherently uncertain, and investors should recognize that events could cause our actual results to differ materially from those projected in forward-looking statements made by us on behalf of the Company. Such risks and uncertainties are primarily in the areas of results of operations by business unit, liquidity, legal
and environmental liabilities and industry and economic conditions.
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 s
ales 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 pol
icies are more fully described in Note 2 to the Consolidated Financial Statements.