**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549**

 

**FORM 10-K**

 

**ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**
| **For the  fiscal year ended December 31, 2004** | ** ** | **Commission  file number 1-496** |
|-------------------------------------------------------|------------|-----------------------------------|

 

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**HERCULES INCORPORATED**

 

**A DELAWARE CORPORATION**

**I.R.S. EMPLOYER IDENTIFICATION NO. 51-0023450**

**HERCULES PLAZA**

**1313 NORTH MARKET STREET**

**WILMINGTON, DELAWARE 19894-0001**

**TELEPHONE: 302-594-5000**

**www.herc.com**

 

Securities registered pursuant to Section 12(b) of the Act

(Each class is registered on the New York Stock Exchange, Inc.)

 

Title of each class

**Common Stock ($25/48 StatedValue)**

**8% Convertible Subordinated Debentures due August 15,2010**

 

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý   No o.

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K o.

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Act).  Yes ýNo o.

 

Theaggregate market value of registrant’s common stock, $25/48stated value (“Common Stock”) held by non-affiliates based on the closing priceon the last business day of the Company’s most recently completed second fiscalquarter, or June 30, 2004, was approximately $1.3 billion.

 

As of February 28,2005, registrant had 112,950,778 shares of Common Stock outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portionsof the registrant’s definitive Proxy Statement for its 2005 Annual Meeting ofShareholders (the “Proxy Statement”), when filed, will be incorporated byreference in Part III of this report.  

 

 

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**PART I**

 

#### **Forward-Looking Statements**

#### ** **

This Annual Report on Form 10-K includesforward-looking statements, as defined in the Private Securities LitigationReform Act of 1995, reflecting management’s current analysis and expectations,based on what management believes to be reasonable assumptions.  Forward-looking statements may involve knownand unknown risks, uncertainties and other factors, which may cause the actualresults to differ materially from those projected, stated or implied, dependingon such factors as: ability to generate cash, ability to raise capital, abilityto refinance, ability to execute productivity improvements and reduce costs,ability to raise product prices, business climate, business performance,changes in tax laws or regulations and related liabilities, economic andcompetitive uncertainties, higher manufacturing costs, reduced level ofcustomer orders, changes in strategies, risks in developing new products andtechnologies, environmental and safety regulations and clean-up costs, foreignexchange rates and exchange control regulations, foreign investment laws, theimpact of changes in the value of pension fund assets and liabilities, changesin generally accepted accounting principles, legislative changes, adverse legaland regulatory developments, including increases in the number or financialexposures of claims, lawsuits, settlements or judgments, the financial capacityof settling insurers, the impact of increased accruals and reserves for suchexposures, and adverse changes in economic and political climates around theworld, including terrorist activities, international hostilities, governmentalinstabilities and potential natural disasters. Accordingly, there can be no assurance that the Company will meet futureresults, performance or achievements expressed or implied by suchforward-looking statements.  Asappropriate, additional factors are contained in other reports filed by theCompany with the Securities and Exchange Commission.  The words or phrases “will likely result,” “areexpected to,” “will continue,” “is anticipated,” “estimate,” “project” orsimilar expressions identify forward-looking statements.  This paragraph is included to provide safe harborfor forward-looking statements, which are not generally required to be publiclyrevised as circumstances change, and which the Company does not intend toupdate except as may be required by law.

 
| **ITEM 1.** | **BUSINESS** |
|-------------|--------------|

 

Hercules Incorporated (“Hercules” or the “Company”) isa Delaware Corporation formed in 1912. The Company is a leading manufacturer and marketer of specialtychemicals and related services for a broad range of business, consumer andindustrial applications.  The Company isfocused on maximizing cash flows and delivering shareholder value byconcentrating on managed growth in its core businesses as well as continuousimprovement in its operations.  Herculesoperates on a global scale, with significant operations in North America,Europe, Asia and Latin America.  Productsales occur in over 125 countries with significant revenue streams generated onfive continents.

 

The Company’s principal products are chemicals used bythe paper industry to increase paper and paperboard performance and enhance themanufacturing process; water-soluble polymers; polypropylene andpolypropylene/polyethylene bicomponent fibers; and specialty resins.  These products impart such qualities asdurability, water-resistance and improved aesthetics for everyday consumergoods ranging from paper and packaging to toothpaste and diapers.  The primary markets the Company servesinclude pulp and paper; paints and adhesives; construction materials; food,pharmaceutical and personal care; and industrial specialties, including oilfield,textiles and general industrial.

 

While the Company’s products comprise a relativelyminor component of its end customers’ total product cost, they frequentlypossess characteristics important to the functionality and aesthetics of thefinished product or the efficient operation of the manufacturing process.  Examples of the Company’s products inconsumer end-uses include strength additives for tissue and toweling, sizingagents for milk and juice cartons, fibers that comprise the inner and outer liningsof disposable diapers and feminine hygiene products, thickeners in productssuch as toothpaste, shampoos and water-based paints, and water controladditives for building products such as tile cements, grouts, stuccos, plastersand joint compounds.  The Company alsooffers products and related services that improve and reduce the cost of thepaper manufacturing processes, including water management programs that aredesigned to protect and maintain equipment and reduce operating costs.

 

Although the performance and quality of its productsand high quality service are important to the Company’s competitive strategy,other important factors such as lower manufacturing cost and improvedreliability are becoming increasingly important.  The Company strives to continually improveits products and manufacturing processes by investing in technology.  The Company has committed substantialresources to its research and development efforts, including expenditures whichtotaled approximately $43 million in 2004. Such efforts enable the Company to consistently bring products to marketthat improve functional properties or that offer similar properties at a lowercost.  Functional properties have becomeincreasingly important, as customers have come to rely more on the Company toprovide new solutions to improve their product offerings and processes.  Additionally, the Company strives to make itsproducts more cost-competitive by effectively managing production costs andadvancing its application development with customers.

 

The Company’s strategy is to focus on meetingcustomers needs and adding value to their businesses; continuously improving toextend competitive advantages; maximizing cash flows; reducing financialleverage and returning to investment grade; growing profitability andincreasing return on invested capital; and mitigating and reducing legacyliabilities.

 

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Pursuant to this strategy, on December 1, 2003,Hercules completed the acquisition of Jiangmen Quantum Hi-Tech BiochemicalEngineering Co. Ltd. (“Jiangmen”) and on February 12, 2004, the Companycompleted the sale of its minority ownership in CP Kelco ApS to a subsidiary ofJ. M. Huber Corporation for $27 million in cash.  Jiangmen is a leading producer ofcarboxymethylcellulose (CMC) products in China. Located in Jiangmen City, Guangdong Province, the plant has currentproduction capacity in excess of 8,000 metric tons with room for expansion.  Jiangmen’s key markets include food,toothpaste, ceramics and paper, with 2004 sales of approximately $14 million.

 

**Reportable Segments**

 

The Company operates through two reportable segmentsand four divisions.  The Pulp and Paperand the Aqualon divisions comprise the Performance Products segment and the FiberVisionsand Pinova divisions comprise the Engineered Materials and Additivessegment.  The financial informationregarding these segments, which includes net sales and profit from operationsfor each of the three years ended December 31, 2004, 2003 and 2002 andcapital employed as of December 31, 2004, 2003 and 2002, is provided inNote 23 to the Consolidated Financial Statements.

 

**Performance Products**

 

Products and services offered by Pulp and Paper aredesigned to enhance customers’ profitability by improving production yields andoverall product quality, and to better enable customers to meet theirenvironmental objectives and regulatory requirements.

 

Pulp and Paper is one of the largest suppliers offunctional, process and water management chemicals for the pulp and paperindustry.  The division offers a wide andhighly sophisticated range of technology and applications expertise within-mill capabilities which run from influent treatment through the paper makingprocess to paper finishing.  The divisionis a broad-based global supplier able to offer a complete portfolio of productsto its paper customers.

 

Products offered by Aqualon are designed to manage theproperties of aqueous (water-based) systems. Most of the products are derived from renewable natural raw materialsand are sold as key ingredients to other manufacturers where they are used assmall-quantity additives to provide functionality such as thickening, waterretention, film formation, emulsifying action and binding power.  Major end uses for Aqualon products includepersonal care products, food additives, pharmaceutical products, constructionmaterials, paints, coatings and oil recovery, where polymers are used to modifyviscosity, gel strength and/or fluid loss.

 

At December 31, 2004, the principal products andprimary markets of this segment were:

 
| **Division**          | ** **                                                                                                                                                                                 | **Principal Products**                                                                                                                                                                 | ** **                                                      | **Primary Markets**                                                                                                                                                                                                                                                 |
|-----------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ***Pulp  and Paper*** | * *                                                                                                                                                                                   | *Functional performance chemicals:*Sizing (improving printability), strength, tissue creping  and coatings additives.                                                                  |                                                            | Large, multinational manufacturers of tissues, paper  towels, packaging, beverage containers, newsprint, papers for magazines and  books, printing and writing paper and other stationery items such as labels  and envelopes.                                      |
|                  | *Process treatment chemicals:*Deposit, contaminant, microbiological and foam control,  clarification, retention, drainage, felt conditioning, deinking, fiber  recovery and water closure. |                                                                                                                                                                                   |                                                            |
|                  | *Water treatment chemicals:*Utility systems, cooling water and water clarification.                                                                                                        |                                                                                                                                                                                   |                                                            |
| *** ***          | * *                                                                                                                                                                                   | * *                                                                                                                                                                               |                                                            |                                                                                                                                                                                                                                                                |
| ***Aqualon***         | * *                                                                                                                                                                                   | *Water-soluble polymers:*Hydroxyethylcellulose (HEC), Carboxymethylcellulose (CMC),  Methylcellulose (MC) and derivatives, Hydroxypropylcellulose (HPC) and Guar  and its derivatives. |                                                            | Manufacturers of interior and exterior architectural  paints, oilfield service companies for oil and gas drilling and recovery,  paper mills, construction material manufacturers and makers of oral hygiene  products, personal care products and pharmaceuticals. |
|                  | *Solvent-soluble polymers:*Pentaerythritol (PE) and Ethylcellulose (EC).                                                                                                                   |                                                                                                                                                                                   | Producers of coating resins, printing inks and aviation fluids. |

 

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**Engineered Materials and Additives**

 

FiberVisions is one of the largest manufacturers ofpolyolefin staple fibers used in disposable products like diapers andwipes.  FiberVisions producesmonocomponent polypropylene fibers and bicomponent fibers comprised of apolypropylene core and a polyethylene sheath. FiberVisions also produces polyolefin fiber and yarn for the industrialand textile markets used in concrete and asphalt, wipes, upholstery andautomotive fabrics, geotextile fabrics and filtration products.

 

Pinova consists of the rosin and terpenes specialtybusiness.  Pinova manufactures wood andgum rosin resins and terpene specialties and is the world’s only producer ofpale wood rosin derivatives.  Productapplications and markets include adhesives, rubber and plastic modifiers, foodand beverages, flavor and fragrances and construction specialties.

 

At December 31, 2004, the principal products andprimary markets of this segment were:
| **Division**       | ** **                                                                   | **Principal Products**                                                   | ** ** | **Primary Markets**                                                                                                                                                                       |
|--------------------|------------------------------------------------------------------------------|--------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ***FiberVisions*** | * *                                                                     | *Staple fibers:*For hygiene products, wipes, geotextiles and filtration. |       | Makers of nonwoven and woven fabrics for  applications including baby care, feminine care, adult incontinence, wipes,  geotextile, construction and upholstery.                           |
|               | *Filament yarns:*For upholstery and  automotive fabrics.                     |                                                                     |       |
|               |                                                                         | * *                                                                 |       |                                                                                                                                                                                      |
| ***Pinova***       | * *                                                                     | *Rosin resins*:  For adhesives, flavors and fragrances.                  |       | Makers of consumer and industrial products such as  masking, packaging, arts and duct tape, construction materials, beverages,  chewing gum, plastics, adhesives, fragrances and flavors. |
|               | *Terpene specialties*:  For flavors, fragrances, disinfectants and plastics. |                                                                     |

 

**Raw Materials and Energy Supply**

 

Raw materials and supplies are purchased from avariety of industry sources, including the agricultural, forestry, mining,petroleum and chemical industries.

 

Important raw materials for Pulp and Paper arecationic and anionic polyacrylamides and emulsions, biocides, amines,surfactants, rosin, adipic acid, epichlorohydrin, fumaric acid, stearic acid,diethylenetriamine, phosphorous trichloride and starch.

 

Raw materials important to Aqualon are cellulose pulp(derived from wood and cotton linters) and guar splits, both renewableresources, ethylene oxide and caustic. Other commodity and specialty chemical inputs include acetaldehyde,fatty acids, methanol, ethyl chloride, propylene oxide, chlorine, monochloroaceticacid, methyl chloride and inorganic acids.

 

The important raw materials for the EngineeredMaterials and Additives segment are polypropylene, polyethylene, pine woodstumps, limonene, gum rosin and crude sulfate turpentine.

 

FiberVisions purchases polypropylene resins from anumber of the major global producers. FiberVisions has undertaken initiatives to expand and fully qualifyalternative suppliers, which allows for greater flexibility and reliability ofsupply.

 

Major requirements for key raw materials and fuels aretypically purchased pursuant to contracts. The Company is not dependent on any one supplier for a material amountof its raw material or fuel requirements, but certain important raw materials,such as cotton linters, are obtained from a sole-source or a few major suppliers.  Except for polypropylene, which representedapproximately 11% of 2004 cost of goods sold, no single raw material accountsfor more than 4% of total current year cost of goods sold.

 

While temporary shortages of raw materials and fuelsmay occur occasionally, these items are currently readily available.  However, their continuing availability andprice are subject to domestic and world market and political conditions as wellas to the direct or indirect effect of governmental action or regulations.  The impact of any future raw material andenergy shortages on the Company’s business as a whole or in specific worldareas cannot be accurately predicted. Operations and products may, at times, be adversely affected bygovernmental action, shortages or international or domestic events.

 

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**Competition**

 

The specialty chemicals industry is highly fragmentedand its participants offer a broad array of product lines representing manydifferent products designed to meet specific customer requirements.  Individual product and portfolio offeringscompete on a global, regional and/or local level subject to the nature of thebusinesses and products, as well as the end-markets and customers served.  The industry has become increasingly globalas participants focus on establishing and maintaining leadership positions inrelatively narrow market niches.  Many ofthe Company’s product lines face competitive domestic and internationalpressures, including industry consolidation, pricing pressures and competingtechnologies.  In Pulp and Paper,customers and competitors are consolidating to enhance market positions andproduct offerings on a worldwide basis. Aqualon is facing competitive threats from emerging Asianproducers.  To address this threat,Aqualon continues to pursue a lower cost strategy, which includes addingproduction capacity in the growing, low-cost Asian region, as evidenced by its December 2003acquisition of Jiangmen, a Chinese manufacturing company, and reducing costs inexisting facilities.  In addition,certain of the Company’s businesses are subject to intense competition from newtechnologies, such as FiberVisions in its hygiene products line.  FiberVisions, as a fibers manufacturer forcarded non-woven hygienic applications, faces competition from spunbond (SB)and spunbond/melt blown/spunbond (SMS) technologies.  SB/SMS products may offer strength-drivencost savings compared to the products of FiberVisions in specific applications;however, FiberVisions believes that its carded products provide improvedsoftness, uniformity, stretch and liquid management properties preferred inwipes and by certain segments of the disposable diaper market and other hygieneproducts markets.  The threat of newproducers in the thermal-bonded hygienic product line is relatively low due tothe fact that the production process involves significant investments in plant,equipment and application know-how.

 

**Patents and Trademarks**

 

Patents covering a variety of products and processeshave been issued to the Company and its subsidiaries.  The Company is licensed under certain otherpatents held by other parties covering its products and processes.  The Company’s rights under these patents andlicenses constitute a valuable asset.

 

The Company and its wholly-owned subsidiaries alsohave many global trademarks covering their products.  Some of the more significant trademarksinclude: AquaCatTM clear cationic solution, Aquapel® sizing agent, Hercon®sizing emulsions, Aqualon® water-soluble polymers, Natrosol®hydroxyethylcellulose, Culminal® methylcellulose, Klucel®hydroxypropylcellulose, Natrosol FPS® water-soluble polymer suspension, Precis®sizing agent, Kymene® resin, Herculon® fiber, Presstige® deposit controladditives, Spectrum® microbiocides, Ultra-pHase® sizing agent, Hercobond® drystrength resin, Chromaset® surface size, ProSoft® tissue softeners and Zenix®contaminant control.

 

The Company does not consider any individual patent,license or trademark to be of material importance to Hercules taken as a whole.

 

**Research and Development**

 

The Company is heavily focused on product innovationas one of its key growth strategies. Research and development efforts are directed toward the discovery anddevelopment of new products and processes, the improvement and refinement ofexisting products and processes, the development of new applications forexisting products and cost improvement initiatives.  Hercules spent $43 million on research and developmentactivities in 2004, as compared to $39 million in 2003 and $42 million in2002.  The increase in spending forresearch and development activities is principally due to an expansion in thenumber and scope of research trials in support of new product initiatives.  Technology resources were allocated to thoseprograms according to the selection methods developed in 2003 and 2002 whichevaluates each project by assessing its strategic alignment, value, platformleverage and balance.  The decrease in spendingfor research and development activities in 2003 from 2002 was primarily due toefficiencies gained in the redesign of work processes.

 

Pulp and Paper currently focuses its technologyefforts on innovative high-value product development, incremental improvementsto existing products and services and cost reduction programs to meet diversecustomer needs worldwide.  The divisioncurrently operates three state-of-the-art facilities located in Europe and theU.S. that include large and sophisticated research and development laboratorieswith pilot plant capabilities that simulate actual operating conditions in acustomer’s facilities.  This allows anaccurate assessment of the potential impact of new products on plantperformance.

 

The division’s scientists conduct research andcustomer optimization studies focused on solving water and process treatmentchallenges by using sophisticated techniques and equipment to provide highlevel analytical testing and advanced technical support to customers worldwide.

 

Aqualon focuses its research and development effortson market oriented product development, manufacturing process improvement andresponsive technical service to customers. New product development is focused on products which manage the physicalproperties of water based systems, such as latex paint, construction mortarsand personal care products, to meet customer demand for improved performanceand efficiency.

 

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Aqualon has application and development laboratoriesin Europe, Asia and the Americas that provide technical service tocustomers.  At these laboratories, teamswork in a network to develop products, identify new applications and solvecustomer problems.

 

Research and development efforts in FiberVisions areprimarily focused on developing new and novel polyolefin fibers around four keyplatforms: high tenacity for industrial applications; dyeable fibers forapparel and upholstery; wetability for wipes; and shaped fibers for improvedadhesion, wicking, coverage and visual appearance.  A continued hygiene focus is to improve fiberstrength while enhancing hygiene product properties for loft, softness andstretch, thereby creating a platform to better compete with SB/SMSproducts.  The industrial and textileproduct units are investigating the use of specific fibers for new applicationsin the upholstery, wipes, geotextiles and construction applications.

 

FiberVisions has research and development facilitiesin the U.S. and Europe designed to serve the business needs of itscustomers.  Pilot spinning and processinglines are used to examine new polymers and processing concepts such asmonocomponent or bicomponent fibers from single filament spinning to full-scaleproduction facilities.

 

Pinova, whose research facilities are located in theU.S., focuses its efforts on market driven product development and costimprovement techniques in its production processes.

 

**Environmental Matters**

 

The Company is subject to numerous environmental lawsand regulations.  The Company believes itis in compliance, in all material respects, with applicable federal, state andlocal environmental laws and regulations. Expenditures relating to environmental cleanup costs have not materiallyaffected, and are not expected to materially affect, capital expenditures orcompetitive position.  Additionalinformation regarding environmental matters is provided in Notes 11 and 12 tothe Consolidated Financial Statements and is incorporated herein by reference.

 

**Employees**

 

As of December 31, 2004, the Company hadapproximately 4,950 employees worldwide. Approximately half of the worldwide employees were located in the UnitedStates, of which approximately 23% were represented by various local ornational unions.  As of December 31,2003, the Company had approximately 5,100 employees worldwide.

 

**International Operations**

 

Information on net sales and capital employed bygeographic area for each of the three years ended December 31, 2004, 2003and 2002 appears in Note 23 to the Consolidated Financial Statements.  Direct export sales from the United States tounaffiliated customers were $119 million, $122 million and $110 million for2004, 2003 and 2002, respectively.  TheCompany’s operations outside the United States are subject to the usual risksand limitations related to investments in foreign countries, such asfluctuations in currency values, exchange control regulations, wage and pricecontrols, employment regulations, foreign investment laws, governmentalinstability (including expropriation or confiscation of assets) and otherpotentially detrimental domestic and foreign governmental policies affectingU.S.-based companies doing business abroad, including risks related toterrorism and international hostilities.

 

**Available Information**

 

Herculesfiles its annual report on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K and any amendments to those reports with the Securities andExchange Commission (SEC).  Herculesprovides access to its SEC filings via a hyperlink to the SEC’s website on itscorporate website, www.herc.com.  Thesefilings may also be read and copied at the SEC’s Public Reference Room which islocated at 450 Fifth Street, N.W., Washington, DC 20549. Information about theoperation of the Public Reference Room can be obtained by calling the SEC at1-800-SEC-0330.

 

The Company’s Directors Code of Business Conduct andEthics and its Business Practices Policy, as well as the charters of theCorporate Governance, Nominating and Ethics Committee, Audit Committee andHuman Resources Committee, are available on the Company’s website at www.herc.com.

 

These documents are also available in print to anyshareholder who requests them in writing from Israel J. Floyd, Esq., CorporateSecretary, Hercules Incorporated, Hercules Plaza, 1313 North Market Street,Wilmington, Delaware 19894-0001.

 
| **ITEM 2.** | **PROPERTIES** |
|-------------|----------------|

 

The Company’s corporate headquarters and majorresearch center are located in Wilmington, Delaware.  The Company also owns a number of plants andfacilities worldwide, in locations strategic to the sources of raw materials orto customers.  All of the Company’sprincipal properties are owned by the Company, except for its corporateheadquarters office building, which is leased. The following are the locations of the Company’s worldwide plants:

 

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Performance Products

 

**Pulp and Paper** – Beringen,Belgium; Burlington, Ontario, Canada; Busnago, Italy; Chicopee, Massachusetts,U.S.; Franklin, Virginia, U.S.; Hattiesburg, Mississippi, U.S.; Helsingborg, Sweden;Kim Cheon, Korea; Macon, Georgia, U.S.; Mexico City, Mexico; Milwaukee,Wisconsin, U.S.; Nantou, Taiwan; Pandaan, Indonesia; Paulinia, Brazil;Pendlebury, United Kingdom; Portland, Oregon, U.S.; Savannah, Georgia, U.S.;Shanghai, China (60% joint venture interest); Sobernheim, Germany; Tampere,Finland; Tarragona, Spain; Voreppe, France; and Zwijndrecht, The Netherlands.

 

The division also owns amanufacturing facility in Pilar, Argentina, that has been leased to a majorU.S. company under a five-year lease. The Company purchases its products for sale in Argentina from this plantunder a five-year supply and distribution agreement which ends in 2009.

 

**Aqualon** – Alizay, France; Doel,Belgium; Hopewell, Virginia, U.S.; Jiangmen City, China; Kenedy, Texas, U.S.;Louisiana, Missouri, U.S.; Parlin, New Jersey, U.S.; and Zwijndrecht, TheNetherlands.

 

Engineered Materials and Additives

 

**FiberVisions** – Athens, Georgia,U.S.; Covington, Georgia, U.S.; Suzhou, China; and Varde, Denmark.

 

**Pinova** – Brunswick, Georgia,U.S.; Hattiesburg, Mississippi, U.S.; and Savannah, Georgia, U.S.

 

The Company’s plants and facilities, many of which arecontinually upgraded and modernized, are generally considered to be in goodcondition with adequate capacity for projected business operations.  From time to time, the Company discontinuesoperations at, or disposes of, facilities that have for one reason or anotherbecome unsuitable.

 
| **ITEM 3.** | **LEGAL PROCEEDINGS** |
|-------------|-----------------------|

 

Information regarding legal proceedings is included inthe Notes to Consolidated Financial Statements (see Note 12) and isincorporated herein by reference.

 
| **ITEM 4.** | **SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS** |
|-------------|----------------------------------------------------------|

 

No matter was submitted to a vote of security holdersduring the fourth quarter of 2004 through the solicitations of proxies orotherwise.

 

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**EXECUTIVEOFFICERS OF THE REGISTRANT**

 

Thename, age and current position of each executive officer of Hercules as of February 28,2005 is listed below.  There are no familyrelationships among executive officers.

 
| **Name**               | ** ** | **Age ** | ** ** | **Current  Position**                                               |
|------------------------|------------|---------------|------------|---------------------------------------------------------------------|
| Craig A.  Rogerson     |       | 48            |       | President, Chief  Executive Officer and Director                    |
| Fred G. Aanonsen       |       | 57            |       | Vice President  and Controller                                      |
| Edward V.  Carrington  |       | 62            |       | Vice President,  Human Resources                                    |
| Marco F. Cenisio       |       | 44            |       | Vice President  and President, FiberVisions Division                |
| Richard G.  Dahlen     |       | 65            |       | Chief Legal  Officer                                                |
| Kathryn  Fialkowski    |       | 40            |       | President,  Pinova Division and Director, Project Management Office |
| Israel J. Floyd        |       | 58            |       | Corporate  Secretary and General Counsel                            |
| Hanna M.  Lukosavich   |       | 48            |       | Vice President  and Chief Information Officer                       |
| Paul C. Raymond,  III. |       | 42            |       | Vice President  and President, Pulp and Paper Division              |
| Vincenzo M.  Romano    |       | 51            |       | Vice President,  Taxes                                              |
| Stuart C. Shears       |       | 54            |       | Vice President  and Treasurer                                       |
| Allen A. Spizzo        |       | 47            |       | Vice President  and Chief Financial Officer                         |
| Thomas H. Strang       |       | 54            |       | Vice President,  SHERA and Manufacturing Excellence                 |
| John Y.  Televantos    |       | 52            |       | Vice President  and President, Aqualon Division                     |
| Charles H.  Wardlaw    |       | 50            |       | Vice President  and Chief Procurement Officer                       |

 

*Craig A.Rogerson* joined Hercules in 1979 and has held his currentposition since December 2003.  Hehad been Vice President and General Manager, FiberVisions and Pinova since April 2002.  Prior to that, he had been Vice President andGeneral Manager of BetzDearborn since August 2000 and Vice President ofBusiness Operations for BetzDearborn Division since May 2000.  He was President and CEO of Wacker SiliconesCorporation from 1997 to 2000.

 

*Fred G.Aanonsen* joined Hercules in July 2001.  Prior to joining Hercules, he spent 25 yearsat Union Carbide Corporation, where most recently he had been the Director ofAccounting and Financial Processing since 1998 and Business Director for theFinance SAP Design and Implementation Team from 1995 to 1998.  Mr. Aanonsen is a Certified Public Accountantand a member of the American Institute of Certified Public Accountants, the NewYork State Society of Certified Public Accountants and the Financial ExecutivesInstitute.

 

*Edward V.Carrington* originally joined Hercules when it acquiredRadiant Color in 1969 and assumed his current position in June 2001.  Prior to that, he had served in a consultingrole since October 2000.  From 1997until 2000, he was Vice President of Buttonwood Cottages, Inc., a vacationresort complex, and President of Rentals in Paradise, Inc., a vacation homerental business.  From 1992 until hisretirement from Hercules in 1997, he was Vice President, Human Resources.  Mr. Carrington is a trustee of ChristianaCare.

 

*MarcoF. Cenisio* joinedHercules in 1980 and has held his current position since March 2004.  From June 2002 through March 2004,Mr. Cenisio was Vice President, Europe and Global Strength, Pulp and PaperDivision.  From 1998 through June 2002,Mr. Cenisio was Global Business Director for Strength and Tissue Paper.

 

*Richard G. Dahlen* originallyjoined Hercules in 1996.  Mr. Dahlenassumed his current position in June 2001. Prior to that, he had served in a consulting role since October 2000.  From 1999 until 2000, he was retired and from1996 until his retirement in 1999, he served as Vice President, Law and GeneralCounsel.

 

*KathrynFialkowski* assumedher current position in January 2005.  In March 2004, she was appointedDirector, Hercules Project Management Office. From February 2003 to March 2004 she was Director, WorkProcess Redesign.  From 2001 to 2002, shewas Vice President, International Business Development with PartechInternational, a venture capital firm.  Priorto that, she served as Vice President, Customer Services with UUNETTechnologies, where she worked between 1997 and 2001.

 

*Israel J.Floyd* joined Hercules in 1973 and has held his currentposition since 2001.  He had been VicePresident, Secretary and General Counsel since 1999 and, prior to that wasSecretary and Assistant General Counsel from 1992 to 1999.

 

*Hanna M. Lukosavich* joined Hercules in August 2004.  She had been Vice President and ChiefInformation Officer at Resolution Performance Products (formerly part of ShellChemicals) from 2001 to 2004.  From 2000to 2001 she was Chief

 

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Information Officer atFerrostaal Incorporated.  Prior to thatshe was Director of Information Technology for Mannesmann Pipe & SteelCorp. from 1995 to 2000.

 

*Paul C. Raymond, III* joined Hercules in February 2005.  From 2002 to 2005 he was Vice President andGeneral Manager of Honeywell Electronic Materials.  From 2000 to 2002, he was Vice President,Global Operations of Honeywell Electrical Materials.

 

*VincenzoM. Romano*joinedHercules in**March 2003 as Director,Federal Tax and has held his current position since July 2004.  He was self-employed as a tax consultant fromSeptember 2001 until March 2003. Prior to that, he was a Tax Director for PricewaterhouseCoopers from January 1999to August 2001.

 

*Stuart C.Shears* joined Hercules in 1978 and has held his currentposition since 1999.

 

*Allen A.Spizzo* joined Hercules in 1979 and has held his currentposition since March 2004.  He hadbeen Vice President, Corporate Affairs, Strategic Planning and CorporateDevelopment from July 2002 to March 2004.  Prior to that, Mr. Spizzo had been VicePresident, Investor Relations and Strategic Planning since 2000.  Prior to that, he was Director for CorporateDevelopment since 1997.

 

*Thomas H.Strang* joined Hercules in 1982 and has held his currentposition since January 2004.  He hadheld the positions of Director, Supply Chain for FiberVisions and Pinova andPlant Manager for the Brunswick, Georgia, facility from 2002 to January 2004.  Prior to that, he was Plant Manager at theBrunswick, Georgia, facility since 1998.

 

*John Y.Televantos* joined Hercules in April 2002 as President ofthe Aqualon Division and Vice President of Hercules.  He had been President and Chief ExecutiveOfficer, and prior to that Chief Operating Officer, of Foamex Internationalduring the period of time June 1999 through December 2001.  Prior to that, he was Vice President,Development Businesses and Research at Lyondel Chemical Company since 1998.

 

*Charles H. Wardlaw* joined Hercules in August 2004.  He had been Vice President, StrategicSourcing for Tyco International since 2001. Previously he was Global Sourcing Director for DuPont Dow Elastomerssince 1997.

 

9

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**PART II**

 
| **ITEM 5.** | **MARKET FOR HERCULES’ COMMON STOCK AND RELATED  STOCKHOLDER MATTERS** |
|-------------|-----------------------------------------------------------------------------|

 

The Company’s common stock is listed on the New YorkStock Exchange (ticker symbol HPC) and the Swiss Stock Exchange.  It is also traded on the Philadelphia,Midwest and Pacific Stock Exchanges.

 

The approximate number of holders of record of itscommon stock ($25/48 stated value) as of February 28, 2005 was 15,573.

 

The following table sets forth, for the periodsindicated, the high and low closing price per share of the Company’s commonstock, as reported on the New York Stock Exchange:

 
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| 2004           |       |     |       |    |       |
| First Quarter  |       | $        | 13.18      |    | $          | 10.81 |   |
| Second Quarter |       | $        | 12.19      |    | $          | 9.99 |   |
| Third Quarter  |       | $        | 14.25      |    | $          | 11.21 |   |
| Fourth Quarter |       | $        | 15.09      |    | $          | 13.97 |   |
|           |       |     |       |    |       |
| 2003           |       |     |       |    |       |
| First Quarter  |       | $        | 9.69       |    | $          | 7.40 |   |
| Second Quarter |       | $        | 10.54      |    | $          | 8.06 |   |
| Third Quarter  |       | $        | 12.18      |    | $          | 9.55 |   |
| Fourth Quarter |       | $        | 12.50      |    | $          | 9.77 |   |

 

On December 31, 2004, the closing price of thecommon stock was $14.85.

 

The payment of quarterly dividends was suspended inthe fourth quarter of 2000, subject to reconsideration by the Board ofDirectors in its discretion, when warranted under appropriate circumstances andsubject to restrictions in the indentures governing the Company’s 11.125%senior notes due 2007, the 6.75% senior subordinated notes due 2029 and theSenior Credit Facility.

 

10

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| **ITEM 6.** | **SELECTED FINANCIAL DATA** |
|-------------|-----------------------------|

 

A summary of the selected financial data for Hercules forthe years ended and as of the end of the years specified is set forth in thetable below.  Pursuant to Statement ofFinancial Accounting Standards No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets” (“SFAS 144”), the BetzDearborn Water TreatmentBusiness has been treated as a discontinued operation as of February 12,2002.  See Note 25 in the Notes to theConsolidated Financial Statements for a summary of divestitures that haveoccurred in the last three years.

 
| ** **                                                                                                                             | ** ** | **(Dollars in millions, except per share data)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2004**                                         | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                                                                                                   |       |                                             |       |   |   |   |   |   |   |   |   |
| Net sales                                                                                                                              |       | $                                                | 1,997      |   | $ | 1,846 |   | $ | 1,705 |   | $ | 1,776 |   | $ | 2,303 |   |
| Profit from operations                                                                                                                 |       | 227                                              |       | 255 |   | 220 |   | 184 |   | 366 |   |
| Net income (loss) from continuing operations before  discontinued operations and cumulative effect of changes in accounting  principle |       | $                                                | 27         |   | $ | 74 |   | $ | (47 | ) | $ | (109 | ) | $ | 60 |   |
| Net income (loss) on discontinued operations, net of  tax                                                                              |       | —                                           |       | 4 |   | (196 | ) | 56 |   | 40 |   |
| Net income (loss) before cumulative effect of  changes in accounting principle                                                         |       | 27                                               |       | 78 |   | (243 | ) | (53 | ) | 100 |   |
| Cumulative effect of changes in accounting  principle, net of tax                                                                      |       | —                                           |       | (33 | ) | (368 | ) | — |   | — |   |
| Net income (loss)                                                                                                                      |       | $                                                | 27         |   | $ | 45 |   | $ | (611 | ) | $ | (53 | ) | $ | 100 |   |
| Dividends                                                                                                                              |       | $                                                | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 66 |   |
|                                                                                                                                   |       |                                             |       |   |   |   |   |   |   |   |   |
| Per share of common stock                                                                                                              |       |                                             |       |   |   |   |   |   |   |   |   |
| Basic earnings (loss) per share                                                                                                        |       |                                             |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                                                  |       | $                                                | 0.25       |   | $ | 0.69 |   | $ | (0.44 | ) | $ | (1.04 | ) | $ | 0.58 |   |
| Discontinued operations                                                                                                                |       | —                                           |       | 0.04 |   | (1.85 | ) | 0.53 |   | 0.39 |   |
| Cumulative effect of changes in accounting principle                                                                                   |       | —                                           |       | (0.31 | ) | (3.47 | ) | — |   | — |   |
| Net income (loss)                                                                                                                      |       | $                                                | 0.25       |   | $ | 0.42 |   | $ | (5.76 | ) | $ | (0.51 | ) | $ | 0.97 |   |
| Diluted earnings (loss) per share                                                                                                      |       |                                             |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                                                  |       | $                                                | 0.25       |   | $ | 0.69 |   | $ | (0.44 | ) | $ | (1.04 | ) | $ | 0.58 |   |
| Discontinued operations                                                                                                                |       | —                                           |       | 0.04 |   | (1.85 | ) | 0.53 |   | 0.38 |   |
| Cumulative effect of changes in accounting principle                                                                                   |       | —                                           |       | (0.31 | ) | (3.47 | ) | — |   | — |   |
| Net income (loss)                                                                                                                      |       | $                                                | 0.25       |   | $ | 0.42 |   | $ | (5.76 | ) | $ | (0.51 | ) | $ | 0.96 |   |
| Dividends declared                                                                                                                     |       | $                                                | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | 0.64 |   |
|                                                                                                                                   |       |                                             |       |   |   |   |   |   |   |   |   |
| Total assets                                                                                                                           |       | $                                                | 2,710      |   | $ | 2,711 |   | $ | 2,759 |   | $ | 4,938 |   | $ | 5,463 |   |
|                                                                                                                                   |       |                                             |       |   |   |   |   |   |   |   |   |
| Total debt                                                                                                                             |       | $                                                | 1,240      |   | $ | 1,348 |   | $ | 882 |   | $ | 2,201 |   | $ | 2,485 |   |
| Company-obligated preferred securities of subsidiary  trusts                                                                           |       | —                                           |       | — |   | 624 |   | 624 |   | 622 |   |
| Total debt and preferred securities                                                                                                    |       | $                                                | 1,240      |   | $ | 1,348 |   | $ | 1,506 |   | $ | 2,825 |   | $ | 3,107 |   |

 

11

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

 

Thefollowing discussion should be read in connection with the informationcontained in the Consolidated Financial Statements and Notes thereto.  All references to individual Notes refer toNotes to the Consolidated Financial Statements.

 

**Overview**

 

Herculesis a leading global manufacturer and marketer of specialty chemicals andrelated services for a broad range of business, consumer and industrialapplications.  The Company’s principalproducts are chemicals used by the paper industry to improve performance andenhance the manufacturing process; water-soluble polymers; polypropylene andpolyethylene fibers; and specialty resins. Key markets for the Company’s products as a percentage by end market inthe years ended December 31, 2004 and 2003 were:

 
| ** **                                                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Pulp and Paper                                                                |       | 48         | %          | 49         | %          |
| Regulated (including food, pharmaceutical and  personal care)                 |       | 20         | %          | 20         | %          |
| Industrial Specialties (including oilfield, textiles  and general industrial) |       | 13         | %          | 12         | %          |
| Paints and Adhesives                                                          |       | 10         | %          | 10         | %          |
| Construction Materials                                                        |       | 9          | %          | 9          | %          |
| Consolidated                                                                  |       | 100        | %          | 100        | %          |

 

Morethan 50% of the Company’s revenues are generated outside of North America.  Net sales by region expressed as a percentageof all sales for the years ended December 31, 2004 and 2003 were:

 
| ** **    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------|------------|------------|------------|------------|------------|
| ** **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America |       | 46         | %          | 48         | %          |
| Europe        |       | 38         | %          | 38         | %          |
| Asia Pacific  |       | 11         | %          | 9          | %          |
| Latin America |       | 5          | %          | 5          | %          |
| Consolidated  |       | 100        | %          | 100        | %          |

 

TheCompany operates through two reportable segments and four divisions:Performance Products (Pulp and Paper and Aqualon) and Engineered Materials andAdditives (FiberVisions and Pinova).  Netsales for the years ended December 31, 2004 and 2003 as a percent of totalsales, by division, were:

 
| ** **     | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------|------------|------------|------------|------------|------------|
| ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Pulp and Paper |       | 47         | %          | 48         | %          |
| Aqualon        |       | 34         | %          | 32         | %          |
| FiberVisions   |       | 14         | %          | 15         | %          |
| Pinova         |       | 5          | %          | 5          | %          |
| Consolidated   |       | 100        | %          | 100        | %          |

 

Operatingresults for the year ended December 31, 2004 were positively impacted byincreased sales volumes in the Aqualon, Pulp and Paper and Pinova divisions,coupled with the continued strength of the Euro, which has appreciatedapproximately 10% on average against the U.S. dollar from the year ended December 31,2003.  These gains were offset by highercosts, primarily for energy and energy-related raw materials, non-cash pensioncharges and freight.

 

Increasedenergy and natural gas/crude oil feedstock costs impacted many raw materials,particularly those derived from chlor-alkali, ethylene, benzene andpropylene.  Strong demand from China formany basic materials and the strengthening global economy also exerted upwardpressure on the price of raw materials. The Company has initiated a number of programs to mitigate thesenegative effects, including product substitution, exploration of new sourcingopportunities and price increases for our products that use these rawmaterials.

 

12

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InPulp and Paper, production of paper and paperboard in North America improvedthroughout the year, consistent with improved economic conditions.  European paper and paperboard production alsoincreased as compared to 2003.  Improvedfourth quarter net sales results for both regions reflected the improvingdemand in the tissue and towel and process chemical segments.  This favorable trend for paper and paperboardproduction is anticipated to continue into 2005, consistent with currenteconomic forecasts.  Sales in emergingmarkets remained strong in the quarter and for the year ended December 31,2004.  Net sales for the year ended December 31,2004 increased 30% in China, 24% in Brazil and 30% in Eastern Europe, excludingRussia, as compared to 2003.  Thesedeveloping regions are important growth areas for the Pulp and Paper divisionas it is anticipated that economic development will increase per capita paperconsumption and industrial demand for paper and paperboard products.

 

Marketconditions affecting Aqualon remain favorable. Volume growth was fueled by strong personal care, pharmaceutical, paint,oil field and polyols markets.  Volumeand net sales also benefited from the Company’s December 2003 acquisitionof Jiangmen Quantum Hi-Tech BioChemical Engineering Co. Ltd. (“Jiangmen”).  Unfavorable mix, reflecting increased salesof lower priced products, regional and industry mix, and lower pricing incertain mature product lines in order to retain market share, has partiallyoffset the positive volume growth.

 

InFiberVisions, margins were under pressure due to unprecedented highpolypropylene resin prices and continued competitive activity.  Polypropylene resin prices, as reported bythe Chemical Data Inc. Index (“Index”), increased to $0.657 per pound for thefourth quarter of 2004, up 51% compared to the same period in 2003.  The Index for the year was $0.557 per poundas compared to an average of $0.434 per pound for 2003.  FiberVisions has contractual arrangementswith many of its customers that enable it to pass through higher polypropylenecosts on a delayed basis.  Sales continueto be adversely impacted by substitution in the baby diaper coverstock marketand slower than anticipated sales growth into the disposable wipe marketsegments and other applications.

 

In thePinova business, 2004 sales volumes were 29% higher than the prior year, butincreases in raw material, energy and non-cash pension costs and lower tollingincome negatively impacted profits.  Thebusiness has been successful in regaining volume through increased sales toexisting customers and the addition of new customers, albeit at lower pricingthan the prior year.

 

Inaddition to these factors, results for the year ended December 31, 2004were influenced by a number of other events, as discussed below.

 

On February 12,2004, the Company completed the sale of its minority interest in CP Kelco ApS,realizing a pre-tax gain of $27 million. The Company completed the refinancing of its Senior Credit Facility on April 8,2004 and redeemed its 9.42% debentures on May 10, 2004.  As a result of the refinancing andredemption, $14 million in non-cash expense related to the write-off ofunamortized debt issuance costs was recognized in Other expense, net.  Also in April 2004, the Company reacheda settlement agreement in the lawsuit captioned Douglas C. Smith, Individuallyand on Behalf of All Others Similarly Situated v. Hercules Incorporated andThomas Gossage, resulting in the recognition of a charge of $6 million inthe first quarter.  The Company, asdiscussed below in “Financial Condition,” continued to repurchase its 11.125%senior notes due 2007, resulting in a $34 million loss on the repurchases forthe year that includes the write-off of $4 million of unamortized debt issuancecosts.  All of these items were includedin Other expense, net.

 

TheCompany recognized a $41 million non-cash tax expense during the third quarter2004 to establish a valuation allowance for impaired foreign tax creditcarryforwards.  This charge was theresult of lower actual and forecasted U.S. taxable income and the inability to executecertain tax initiatives.  As a result ofthe October 2004 enactment of the American Jobs Creation Act of 2004 (the “Act”)and progress in implementing a structure to reduce future foreign taxes, theCompany expects to be able to utilize available foreign tax credits within theten-year carryforward period provided by the Act and therefore reversed thepreviously recognized $41 million non-cash valuation allowance in the fourthquarter 2004.  The planning structureinvolves a reorganization of the European business around a new Europeanheadquarters to be located in Switzerland.

 

DuringSeptember and October 2004, the Company reached settlement agreementswith all of its insurers regarding coverage for the Company’s asbestos-relatedclaims.  The settlements provide for cashpayments and trust funding totaling $225 million (with a net present value of$218 million when discounted) over the next several years, subject in somecases to repayment of residual trust balances in the event that federal asbestosreform legislation is enacted. Concurrent with the completion of these settlements, the Company updatedthe analysis of its estimated asbestos claims exposure.  Based upon the results of that analysis and asubsequent analysis as of December 31, 2004, the Company recordedadditional reserves to recognize an estimated potential liability of $260million as of December 31, 2004 for asbestos-related claims.  As a result, the Company recorded a charge of$34 million for the year ended December 31, 2004, reflecting an $80million increase in asbestos reserves, a $49 million increase inasbestos-related insurance receivables and $3 million of fees incurred inreaching the settlements.

 

13

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OnFebruary 14, 2005, the Company received a Revenue Agent Report (“RAR”)from the Internal Revenue Service pertaining to the Company’s tax returns for1999 through 2001.  Pursuant to itsreconciliation and analysis of the proposed tax adjustments contained in theRAR, the Company recognized a net tax benefit of approximately $14 million in2004 primarily reflecting its ability to utilize additional capital losses forwhich a full valuation allowance had been established.

 

OnFebruary 25, 2005, the Company reached a settlement in principle with theplaintiffs in the Thomas & Thomas Rodmakers v. Newport Adhesives andComposites litigation, resulting in the recognition of a charge of $11.25million in the fourth quarter of 2004.

 

**CriticalAccounting Estimates**

 

TheCompany’s discussion and analysis of its financial condition and results ofoperations is based on its consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States.  The preparation of thesefinancial statements requires Hercules to make estimates and assumptions thataffect the amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities.  Hercules evaluates its estimates on a regularbasis, including those related to sales returns and allowances, bad debts,inventories, impairments of long-lived assets, income taxes, restructuring,contingencies, including litigation and environmental, and pension and otherbenefit obligations.  Hercules bases itsestimates on various factors including historical experience, consultation andadvice from third party subject matter experts and various assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  Actual results may differ from theseestimates.

 

Herculesbelieves that the following accounting estimates are critical due to the significantsubjectivity and judgment necessary to account for the matters or thesusceptibility of such matters to change and the effect of the estimates andassumptions on its consolidated financial statements.

 

TheCompany maintains allowances for doubtful accounts.  The recorded amount reflects various factors,including accounts receivable aging, customer-specific risk issues, countryrisk and historical write-off experience. It includes, but is not limited to, a formula driven calculation appliedto the aging of trade accounts receivable balances.  When a specific accounts receivable balanceis deemed uncollectible, a charge is taken to this reserve.  Recoveries of balances previously written offare also reflected in this reserve.

 

Herculesadopted the provisions of Statement of Financial Accounting Standards No.142 “Goodwilland Other Intangible Assets” (“SFAS 142”) effective January 1, 2002.  As of December 31, 2004, Herculesrecognized the following reporting units: Pulp and Paper, Aqualon, FiberVisionsand Pinova.  Pursuant to SFAS 142, theCompany is required to perform an annual assessment of its reporting units forimpairment.  To assess impairment, theCompany compares the reporting unit’s book value of net assets, includinggoodwill, to its fair value.  Fair valueis estimated using a combination of valuation approaches including the marketvalue and income approaches.  In theevent that the book value exceeds the fair value, the Company recognizes animpairment to the extent the book value of goodwill exceeds the implied fairvalue of goodwill for any reporting unit, calculated by determining the fairvalue of the assets and liabilities for the reporting unit.  Deterioration in future economic conditions,poor operating results in the reporting units, new or stronger competitors, orchanges in technology could result in an inability to recover the carryingvalue of the goodwill and intangible assets, thereby requiring an impairment inthe future.

 

TheCompany tests other long-lived assets for impairment based on the guidanceprovided in Statement of Financial Accounting Standards No. 144, “Accountingfor the Impairment or Disposal of Long-lived Assets” (“SFAS 144”) which wasadopted January 1, 2002.  If theCompany determines that an impairment loss has occurred, the loss is recognizedin the income statement.  Deteriorationin future economic conditions, poor operating results in a business, thedetermination that the long-lived asset is unsuitable for one reason oranother, new or stronger competitors, or changes in technology, could result inan inability to recover the carrying value of the asset, thereby requiring animpairment in the future.

 

Herculesrecords a valuation allowance to reduce its deferred tax assets to an amountthat is more likely than not to be realized after consideration of futuretaxable income and reasonable tax planning strategies.  In the event that Hercules were to determinethat it would not be able to realize all or part of its deferred tax assets forwhich a valuation allowance had not been established, or is able to utilizecapital and/or operating loss carryforwards for which a valuation allowance hasbeen established, an adjustment to the deferred tax asset will be reflected inincome in the period such determination is made.

 

Herculeshas and will continue to record charges for the estimated costs of employeeseverance and other exit costs pursuant to the Company’s strategy tocontinuously improve return on capital, streamline organizational structure,improve work processes and consolidate manufacturing and non-manufacturingresources.  In the event that it isdetermined that additional employees must be involuntarily terminated, or thatadditional manufacturing or non-manufacturing facilities must be closedpursuant to work process redesign or other cost reduction initiatives,supplemental reserves would be required, which would result in an incrementalcharge against earnings.

 

14

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Herculesestablishes reserves for environmental matters, litigation and othercontingencies when it is probable that a liability has been incurred and theamount of the liability is reasonably estimable.  At December 31, 2004, the Company had$117 million accrued for contingencies and asset retirement obligations inaccordance with Statement of Financial Accounting Standards No. 5, “Accountingfor Contingencies” (“SFAS 5”) and Statement of Financial Accounting StandardsNo. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”).  The actual costs will depend upon numerousfactors, including the number of parties found responsible at eachenvironmental site and their ability to pay, the actual methods of remediationrequired or agreed to, outcomes of negotiations with regulatory authorities,outcomes of litigation, changes in the timing of required remedial activities,changes in environmental laws and regulations, technological developments, theyears of remedial activity required and changes in the number or financialexposures of claims, lawsuits, settlements or judgments, or in the ability toreduce such financial exposures by collecting indemnity payments frominsurers.  If the contingency is resolvedfor an amount greater or less than has been accrued, Hercules’ share of thecontingency increases or decreases, or other assumptions relevant to thedevelopment of the estimate were to change, Hercules would recognize anadditional expense or benefit in income in the period such determination wasmade.

 

Herculeshas established reserves for asbestos-related personal injury lawsuits andclaims.  The Company’s estimates arebased on a number of assumptions including the number of future claims, thetiming and amount of future payments, disease, venue, and the dynamic nature ofasbestos litigation and other circumstances. At December 31, 2004, the Company had a gross accrued liability of$260 million for present and future potential asbestos claims.  The Company had $169 million ofasbestos-related receivables pertaining to the aforementioned lawsuits andclaims at December 31, 2004.

 

In theUnited States, the Company provides defined benefit pension plan coverage foreligible employees hired prior to January 1, 2005 and postretirementwelfare benefit plan coverage to eligible employees hired prior to January 1,2003.  Similar plans are provided outsidethe United States in accordance with local practice.  Pension and other postretirement benefitobligations and the related expense (income) are determined based uponactuarial assumptions regarding mortality, medical inflation rates, discountrates, long-term return on assets, salary increases, Medicare availability andother factors.  Changes in theseassumptions can result in changes to the recognized pension expense andrecorded liability.  At December 31,2004, the accumulated benefit obligation (“ABO”) of the Company’s U.S. andcertain foreign defined benefit pension plans, on a consolidated basis,exceeded their funded basis.  The Companyis required to recognize an additional liability equal to the sum of suchexcess plus the prepaid pension asset balance, with a corresponding after-taxcharge to other comprehensive income in stockholders’ equity.  For the year ended December 31, 2004 theCompany increased its additional minimum liability (“AML”) to $578 million(pre-tax) by recording an additional minimum liability of $23 million(pre-tax).  The Company also reduced itspreviously deferred pension asset by $20 million resulting in an after taxcharge of $30 million to other comprehensive income (see Note 16).  The increase to the AML primarily was aresult of changes to discount rate and other assumptions that caused the ABO tobe higher than the fair value of the plan assets.  At the present time, the U.S. defined benefitpension plan is at a sufficient funding level as to not require ERISA mandatedcontributions.  The Company hasdetermined, however, that it is in the best interests of the Company and itspension plan participants to make voluntary contributions to the plan.  If the U.S. qualified pension plan performsin accordance with actuarial assumptions, the Company presently anticipatesmaking voluntary cash contributions of approximately $40 million per year overthe next few years, including $40 million contributed to the U.S. defined benefitplan in January 2005.

 

15

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**Resultsof Operations**

 

**2004 vs.2003**

 

Thetables below reflect Net sales and Profit from operations for the years ended December 31,2004 and 2003.  Substantially all reconcilingitems have been allocated to the segments.

 
| ** **                         | ** ** | **Year Ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------------------|------------|------------|------------|------------|------------|
| **(Dollars in millions)**          | ** ** | **2004**                         | ** ** | **2003**   | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| ** **                         |       |                             |       |       |       |       |       |   |   |
| **Net sales:**                     |       |                             |       |       |       |       |       |   |   |
| Performance Products               |       | $                                | 1,617      |       | $          | 1,483      |       | $ | 134 |   | 9 | % |
| Engineered Materials and Additives |       | 380                              |       | 363        |       | 17         |       | 5 | % |
| Consolidated                       |       | $                                | 1,997      |       | $          | 1,846      |       | $ | 151 |   | 8 | % |
|                               |       |                             |       |       |       |       |       |   |   |
| **Profit (loss) from operations:** |       |                             |       |       |       |       |       |   |   |
| Performance Products               |       | $                                | 248        |       | $          | 262        |       | $ | (14 | ) | (5 | )% |
| Engineered Materials and Additives |       | (15                              | )          | 9          |       | (24        | )          | (267 | )% |
| Corporate Items                    |       | (6                               | )          | (16        | )          | 10         |       | 63 | % |
| Consolidated                       |       | $                                | 227        |       | $          | 255        |       | $ | (28 | ) | (11 | )% |

 

Thetable below reflects Net sales percentage changes for the year ended December 31,2004 when compared with the year ended December 31, 2003:

 
| ** **                         | ** ** | **Net Sales Percentage Increase  (Decrease) from prior year due to** | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Year Ended**                     | ** ** | ** **                                                           | ** ** | **Product** | ** ** | ** ** | ** ** | **Rates of** | ** ** | ** ** | ** ** |
| **December 31, 2004**         | ** ** | **Volume**                                                           | ** ** | **Mix** | ** ** | **Price** | ** ** | **Exchange** | ** ** | **Total** | ** ** |
| Pulp and Paper                     |       | 5                                                                    | %          | (2 | )% | (1 | )% | 4 | % | 6 | % |
| Aqualon                            |       | 18                                                                   | %          | (7 | )% | (1 | )% | 4 | % | 14 | % |
| Performance Products               |       | 11                                                                   | %          | (5 | )% | (1 | )% | 4 | % | 9 | % |
|                               |       |                                                                 |       |   |   |   |   |   |   |   |   |
| FiberVisions                       |       | (6                                                                   | )%         | (2 | )% | 5 | % | 4 | % | 1 | % |
| Pinova                             |       | 28                                                                   | %          | (7 | )% | (5 | )% | — |   | 16 | % |
| Engineered Materials and Additives |       | 2                                                                    | %          | (3 | )% | 3 | % | 3 | % | 5 | % |
| Consolidated                       |       | 8                                                                    | %          | (4 | )% | — |   | 4 | % | 8 | % |

 

16

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Thetables below reflect Net sales per region and percentage change from the yearended December 31, 2003.

 
| **(Dollars  in millions)****Region** | ** ** | **Year Ended  December 31,  2004** | ** ** | **Year Ended  December 31,  2003** | ** ** | **%****Change** | ** ** | **%****Change  Net of  Rate of  Exchange  Benefit** | ** ** |
|--------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------|------------|-----------------------------------------------------|------------|
| North America                        |       | $                                       | 921        |                                    | $          | 885             |       | 4                                                   | %          | 4 | % |
| Europe                               |       | 762                                     |       | 693                                     |       | 10              | %          | 1                                                   | %          |
| Asia Pacific                         |       | 215                                     |       | 174                                     |       | 24              | %          | 23                                                  | %          |
| Latin America                        |       | 99                                      |       | 94                                      |       | 5               | %          | 2                                                   | %          |
| All regions                          |       | $                                       | 1,997      |                                    | $          | 1,846           |       | 8                                                   | %          | 4 | % |

 

Consolidatednet sales were $1,997 million for the year ended December 31, 2004, anincrease of $151 million, or 8%. Compared to 2003, volumes generated an 8%improvement, mix had a negative impact of 4%, the effect of price changes wasminimal and rates of exchange had a 4% positive effect.

 

Forthe year ended December 31, 2004, regional sales were up 4% in NorthAmerica, 5% in Latin America, 24% in Asia Pacific and 10% in Europe (1%excluding the stronger Euro).  TheEuropean region remained challenging most of the year due to the competitivePulp and Paper market and substitution of competitors’ product taking volumesfrom FiberVisions in the diaper coverstock market.  North America sales improved in allbusinesses.  The Pulp and Paper marketfor containerboard and packaging materials in this region has improved.  Sales in Asia Pacific have increasedprimarily as a result of the acquisition of Jiangmen in China and strongereconomic conditions in Asia.

 

Profitfrom operations for the year ended December 31, 2004 was $227 million, adecrease of $28 million or 11% as compared to 2003.  Improved volume growth and a $12 millionbenefit from favorable rates of exchange was more than offset by highernon-cash pension charges, raw material, freight and insurance costs across allbusinesses; non-cash asset impairment charges in Aqualon and Pulp and Paper;and bad debt and severance accruals related to our Pulp and Paperdivision.  Additionally, profit fromoperations in 2003 benefited from income recognized as a result of a favorablelegal settlement and the receipt of insurance demutualization proceeds.

 

Duringthe year ended December 31, 2004, Performance Products net sales grew $134million, or 9%, and profit from operations decreased by $14 million.

 

In thePulp and Paper Division, net sales for the year ended December 31, 2004grew $52 million or 6%, with 5% resulting from higher volumes and a 4% benefitfrom favorable rates of exchange, partially offset by 1% lower pricing and 2%unfavorable product mix.  The highervolumes were primarily a result of increased sales under our supply agreementwith G.E. Water Technologies and the improving North American market forcontainerboard.  Europe remainedchallenging as volume growth was offset by competitive price pressure andunfavorable mix.  Price erosion occurredin both functional and process chemicals.

 

Pricingin Pulp and Paper deteriorated from 2003 levels as a result of competitivepressures.  Pricing was down in NorthAmerica and Europe, our two largest markets. The division initiated two price increases with a combined increase of11% to 19% on all process and functional products late in the second half of2004, which is expected to benefit 2005 results.  Profit from operations was $22 million or 21%lower than the prior year.  Highervolumes and favorable rates of exchange were more than offset by lower pricing,higher energy, raw materials, and non-cash pension expense, as well as sellingexpenses associated with new product growth. Raw material costs were higher in the fourth quarter than in previousquarters reflecting increases in adipic acid and epichlorohydrin prices.  Additionally, during 2004 severance chargesof approximately $8 million were incurred for headcount reductions in thegeneral and administrative functions.

 

Aqualonnet sales for the year ended December 31, 2004 increased $82 million or14% compared to 2003.  The growth wasdriven by 18% higher volumes and a 4% benefit from higher rates of exchange,partially offset by negative mix of 7% and 1% lower prices.  Volume improvements were made in many of ourmarkets including personal care, pharmaceutical, paint, oilfield, lubricants,adhesives and coatings.  Volumes alsocontinued to benefit from our Jiangmen acquisition completed in the fourthquarter of 2003 which accounted for approximately 40% of the increase.  The unfavorable product mix reflected highersales of lower priced products, primarily related to CMC sales in China, and

 

17

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unfavorable regional andindustry mix.  Price increases announcedand implemented in the fourth quarter resulted in pricing being flat in theaggregate for the quarter and down only 1% for the year.  The continued competitive pricing in oneproduct line due to temporary industry overcapacity was offset by price increasesin other product lines.  The U.S. CMCbusiness continues to be under pressure due to aggressive behavior of severalforeign producers that are exporting into the U.S. market.  The Company is seeking governmental remediesto address such behavior.

 

Profitfrom operations for the year ended December 31, 2004 improved $8 million,or 5%, as compared to 2003, as increased volumes, favorable rates of exchange,higher plant utilization rates and lower raw material costs in the aggregatewere partially offset by higher non-cash pension, freight, plant maintenance,utilities and increased selling, general and administrative costs.  Raw material costs were higher in the fourthquarter than the previous three quarters reflecting increases in ethyleneoxide, caustic and methanol.  Inaddition, an asset impairment charge of $4 million was incurred in the firstquarter of 2004 as a result of the closure of a raw material production line.

 

In theEngineered Materials and Additives segment, net sales for the year ended December 31,2004 increased $17 million, or 5%.  Thesegment had a loss from operations of $15 million compared with a profit fromoperations of $9 million in 2003 primarily due to the results of theFiberVisions division’s operations.

 

FiberVisionsnet sales for the year ended December 31, 2004 increased $3 million or 1%when compared with 2003.  The growth insales resulted from improved pricing of 5%, higher rates of exchange of 4%,partially offset by 6% lower volumes and a 2% unfavorable mix.  Volumes in the fourth quarter were up 2%, reflectinggains in wipes and other applications markets, offsetting the lossesexperienced in diaper coverstock applications from the prior year.  Results of operations for the year ended December 31,2004 decreased by $17 million.  Improvedpricing, rates of exchange and lower management fees charged by our ESFiberVisions joint venture partner were more than offset by higher polymercosts and lower plant utilization. Polypropylene costs increased 28% year over year.  In addition, the Division recognized legalcosts associated with the now terminated Meraklon S.p.A. acquisition.

 

Netsales in Pinova increased $14 million or 16% in 2004 as compared to 2003.  Sales benefited from significantly highervolumes of 28%, partially offset by 5% lower pricing and unfavorable mix of7%.  The increase in volumes was relatedto recapturing lost market share in the highly competitive chewing gum,adhesives and other industrial markets. The lower pricing and unfavorable product mix was related to theseefforts to regain lost business and a strategic shift into lower pricedindustrial segments aimed at reducing inventory and increasing sales volumes,thereby generating positive cash flow. Losses from operations of  $11million and $4 million were recorded in 2004 and 2003, respectively.  Improved plant utilization rates associatedwith higher volumes were offset by lower pricing, higher raw materials, energyand non-cash pension costs and lower tolling fees.

 

Corporateitems included net operating charges and benefits that were not directlyrelated to the business segments.  Thecharges typically appear in Other operating expense, net, although a portionwas included in Cost of sales.  The tablebelow reflects the components of Corporate items.

 
| ** **                                | ** ** | **Year  Ended  December 31,** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|
| **(Dollars in millions)**                 | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| Reductions in insurance claims  reserves  |       | $                                  | (3         | ) | $ | — |   |
| Severance and restructuring  costs        |       | —                             |       | 5 |   |
| Nitrocellulose facility  shutdown costs   |       | 7                                  |       | 1 |   |
| Special executive pension  adjustments    |       | 1                                  |       | 7 |   |
| Proxy costs                               |       | —                             |       | 4 |   |
| Other miscellaneous charges  (gains), net |       | 1                                  |       | (1 | ) |
| Corporate items - net expense             |       | $                                  | 6          |   | $ | 16 |   |

 

Corporateitems for the year ended December 31, 2004 resulted in a net expense of $6million versus $16 million net expense in 2003. The results for the year ended December 31, 2004 included chargesof $7 million related to the shutdown of the former Nitrocellulose facility and$1 million for a special executive pension adjustment, offset by a $3 millionreduction in insurance claims reserves. The comparable 2003 period included a $1 million charge related to theshutdown of the former Nitrocellulose facility, a $7 million special executivepension adjustment, $5 million in corporate severance and restructuringcharges, $4 million in proxy costs and $1 million of other gains, net.

 

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Interestand debt expense for the year ended December 31, 2004 was $109 million, or$22 million lower than the $131 million incurred in 2003, reflecting loweroutstanding debt balances, improved debt mix and reduced rates on the Company’sbank debt.  The April 2004refinancing of the Term B loan, combined with a third quarter amendment to thecredit agreement resulted in a 150 basis point rate reduction on the bankdebt.  In addition to the repurchase of$150 million of its 11.125% senior notes during 2004, the Company also repaidits 9.42% trust preferred securities in May 2004 with the proceeds of the April 2004private placement of $250 million 6.75% senior subordinated debt and a portionof the proceeds of the new Senior Credit Facility.

 

Otherexpense, net, was $116 million for the year ended December 31, 2004, anincrease of $87 million compared to $29 million of expense for 2003.  The increase was primarily attributable tothe net $34 million adjustment related to the asbestos litigation consisting ofan $80 million increase in the asbestos reserves, a $49 million increase in theinsurance receivables and $3 million in fees incurred in reaching thesettlements with the insurance carriers. Additionally, the Company wrote off $14 million of debt issuance costsassociated with its April 2004 debt refinancing and paid premiums of $30million and wrote off $4 million of debt issuance costs associated with theCompany’s open market repurchase of its 11.125% senior notes throughout2004.  Legal settlements of $19 millionin 2004 exceeded 2003 levels of $8 million primarily due to the recentsettlement of the Thomas & Thomas Rodmakers v. Newport Adhesives andComposites litigation (see Note 12 to the Consolidated FinancialStatements).

 

Theprovision for income taxes on continuing operations reflected effective taxrates of 7% in 2004 and 22% in 2003.  Theeffective tax rate in 2004 reflected the benefit of the CP Kelco ApS gain andthe reduction of the valuation allowance related to capital losses partiallyoffset by an increase in tax reserves. The effective tax rate for 2003 reflected the tax benefit from thedonation of intellectual property to qualified organizations and the use ofprior year capital losses.

 

**2003 vs.2002**

 

Thetables below reflect Net sales and Profit from operations for the years ended December 31,2003 and 2002.  Substantially allreconciling items have been allocated to the segments.

 
| ** **                         | ** ** | **Year Ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------------------|------------|------------|------------|------------|------------|
| **(Dollars in millions)**          | ** ** | **2003**                         | ** ** | **2002**   | ** ** | **Change** | ** ** | **%****Change** | ** ** |
| **Net sales:**                     |       |                             |       |       |       |       |       |   |   |
| Performance Products               |       | $                                | 1,483      |       | $          | 1,385      |       | $ | 98 |   | 7 | % |
| Engineered Materials and Additives |       | 363                              |       | 320        |       | 43         |       | 13 | % |
| Consolidated                       |       | $                                | 1,846      |       | $          | 1,705      |       | $ | 141 |   | 8 | % |
|                               |       |                             |       |       |       |       |       |   |   |
| **Profit (loss) from operations:** |       |                             |       |       |       |       |       |   |   |
| Performance Products               |       | $                                | 262        |       | $          | 243        |       | $ | 19 |   | 8 | % |
| Engineered Materials and Additives |       | 9                                |       | 18         |       | (9         | )          | (50 | )% |
| Corporate Items                    |       | (16                              | )          | (41        | )          | 25         |       | 61 | % |
| Consolidated                       |       | $                                | 255        |       | $          | 220        |       | $ | 35 |   | 16 | % |

 

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Thetable below reflects Net sales percentage changes for the year ended December 31,2003 when compared with the year ended December 31, 2002:

 
| ** **                         | ** ** | **Net Sales Percentage Increase  (Decrease) from  prior year due to** | ** ** |
|------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **Year Ended**                     | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Rates of** | ** ** | ** ** | ** ** |
| **December 31,  2003**        | ** ** | **Volume(1)**                                                         | ** ** | **Price** | ** ** | **Exchange** | ** ** | **Total** | ** ** |
| Pulp and Paper                     |       | (1                                                                    | )%         | (1 | )% | 6 | % | 4 | % |
| Aqualon                            |       | 3                                                                     | %          | — |   | 8 | % | 11 | % |
| Performance Products               |       | 1                                                                     | %          | — |   | 6 | % | 7 | % |
|                               |       |                                                                  |       |   |   |   |   |   |   |
| FiberVisions                       |       | 14                                                                    | %          | 3 | % | 9 | % | 26 | % |
| Pinova                             |       | (15                                                                   | )%         | 1 | % | — |   | (14 | )% |
| Engineered Materials and Additives |       | 5                                                                     | %          | 3 | % | 6 | % | 14 | % |
| Consolidated                       |       | 2                                                                     | %          | — |   | 6 | % | 8 | % |

 

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(1) Includes the effectof the consolidation of ES FiberVisions in 2003 in accordance with FASBInterpretation No. 46 (R) “Consolidation of Variable Interest Entities” (“FIN 46R”).  FiberVisions volume improvement without ESFiberVisions was 1%.

 

Thetables below reflect Net sales per region and percentage change from the yearended December 31, 2002:

 
| **(Dollars in millions)  Region** | ** ** | **Year Ended  December 31,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** | **%****Change** | ** ** | **%****Change  Net of  Rate of  Exchange  Benefit** | ** ** |
|-----------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------|------------|-----------------------------------------------------|------------|
| North America                     |       | $                                       | 885        |                                    | $          | 870             |       | 2                                                   | %          | 1 | % |
| Europe                            |       | 693                                     |       | 586                                     |       | 18              | %          | 11                                                  | %          |
| Asia Pacific                      |       | 174                                     |       | 160                                     |       | 9               | %          | 9                                                   | %          |
| Latin America                     |       | 94                                      |       | 89                                      |       | 6               | %          | —                                              |       |
| All regions                       |       | $                                       | 1,846      |                                    | $          | 1,705           |       | 8                                                   | %          | 2 | % |

 

Net sales in 2003 increased 8% from 2002.  Growth in sales for 2003 compared to 2002 wasdriven by a 6%, or $110 million, benefit from rate of exchange and a 2%, or $29million, benefit from the consolidation of ES FiberVisions pursuant to FIN46R.  The Euro appreciated approximately20% in 2003 from 2002 levels.  Volume andprice in the aggregate were flat compared to 2002.  Volumes were essentially flat in Pulp andPaper, with declines in the weak North American and European markets offset bystrong sales growth in the emerging regions of China, Brazil and Russia.  Volume growth in Aqualon was a result ofstronger demand in the oil and gas drilling and recovery markets.  FiberVisions volume growth principallyreflected the consolidation of ES FiberVisions. Lower volumes in the Pinova business were driven by lost business in itschewing gum and adhesives markets.

 

Profit from operations improved 16% compared to2002.  Higher costs in 2003 for energy,raw materials and pension were more than offset by productivity improvementsand the positive effect of the stronger Euro. Worldwide non-cash pension expense was approximately $28 million in2003, an increase of $22 million versus 2002.

 

In the Performance Products segment, net salesincreased $98 million, or 7%.  Net saleswere positively impacted 6%, or $91 million, by rates of exchange.  Profit from operations in the segmentimproved $19 million, or 8%, equal to the benefit from favorable rates ofexchange.  Cost increases in energy, rawmaterials and non-cash pension expense were offset by productivityimprovements.

 

In Pulp and Paper, net sales increased $37 million, or4%, reflecting a $48 million positive impact from rates of exchange,principally the Euro, and strong growth in emerging markets.  Net sales increased 29% in China, 40% inBrazil

 

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and 17% in Russia. Net sales were negatively impacted by $11 million as a result of priceerosion and unfavorable mix.  Globalvolumes were essentially flat reflecting the impact of weak market conditionsin North America.  For 2003, paper andpaperboard production was down 2% in North America.  Office paper production in Europe, a keymarket for Hercules, was also down 2%. Factors impacting the North American industry included a decliningmanufacturing base as more production shifted off-shore to countries such asChina, lower classified advertising (newsprint), lower weight magazines and aslowdown in print advertising and plastics substitutes for liquid packaging.  Profit from operations was essentially flat,down $1 million versus 2002.  Profit fromoperations was negatively impacted by higher energy and energy related rawmaterials in addition to non-cash pension expense.  These higher costs, in part, were offset by supplychain improvements and lower selling, general and administrative expense.

 

Aqualon’s net sales grew $61 million, or 11% comparedto 2002.  Rate of exchange, principallythe Euro, had a $43 million, or 8%, favorable impact and volume/mix had an $18million, or 3%, favorable impact.  Volumegrowth was fueled by an increase in the construction, oil field and personalcare businesses.  Global price increaseswere implemented in the first half of 2003, partially offsetting higher rawmaterial and energy costs.  Profit fromoperations improved $20 million, or 14%, compared to 2002, driven by positiverate of exchange impact ($11 million or 8%) and volume increases even as thebusiness experienced higher costs for energy, raw material and non-cash pensionexpense.

 

In the Engineered Materials and Additives segment, netsales increased $43 million, or 13%.  Theconsolidation of the ES FiberVisions joint ventures contributed $29 million, or9%, to the improvement.  Favorableimpacts due to rate of exchange contributed $19 million, or 6%.  Lower volumes in Pinova due to the lostbusiness in its chewing gum and adhesives markets negatively impacted thesegment’s net sales.  Profit fromoperations decreased $9 million, or 50%, from 2002.  Improvement in FiberVisions profit fromoperations was more than completely offset by Pinova’s losses from operations.

 

FiberVisions net sales increased $57 million, or 26%from 2002, reflecting the positive impacts from the consolidation of the ESFiberVisions joint ventures of $29 million or 13%, favorable rates of exchangeof $19 million or 9%, and pricing and volume/mix totaling $9 million or4%.  FiberVisions’ contractualarrangements with many of its customers enable it to pass through higherpolypropylene costs on a delayed basis. Lower volumes for fibers used in diapers were partially offset by highervolumes in the wipes markets.  New wipesproducts generated approximately $23 million and new bicomponent productsgenerated approximately $10 million in net sales, respectively.  Profit from operations improved $3 million,or 30% as compared to 2002, primarily as a result of the consolidation of theES FiberVisions joint ventures.

 

Pinova net sales decreased $14 million, or 14%, from2002 reflecting a 13% decrease in volumes due to the lost business in itschewing gum and adhesives markets.  Lossfrom operations was $4 million compared to an $8 million profit from operationsin 2002.  The business has a significantfixed cost structure that is not easily reduced.  The business has been successful in regainingmost of the lost volumes through increased sales to existing customers and theaddition of new customers.

 

Corporate items included net operating charges andbenefits that were not directly related to the business segments.  The charges typically appear in Otheroperating expense, net, although a portion was also included in Cost ofsales.  The table below reflects thecomponents of Corporate items. 
| ** **                                | ** ** | **Year  Ended December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                 | ** ** | **2003**                          | ** ** | **2002** | ** ** |
| Severance and restructuring  costs        |       | $                                 | 5          |   | $ | 22 |   |
| Environmental                             |       | —                            |       | 12 |   |
| Nitrocellulose facility  shutdown costs   |       | 1                                 |       | — |   |
| Special executive pension  adjustments    |       | 7                                 |       | — |   |
| Proxy costs                               |       | 4                                 |       | — |   |
| Other miscellaneous (gains)  charges, net |       | (1                                | )          | 7 |   |
| Corporate items - net expense             |       | $                                 | 16         |   | $ | 41 |   |

 

Corporateitems for the year ended December 31, 2003 resulted in a net expense of$16 million versus $41 million of net expense in 2002.  The results for the year ended December 31, 2003included a charge of $1 million related to the shutdown of the formerNitrocellulose facility, $5 million for severance charges, $7 million forspecial executive pension adjustments, $4 million for proxy expenses and $1million in other gains, net, whereas the comparable 2002 period included $22 millionfor severance and restructuring charges, $12 million in environmental chargesand $7 million of other charges, net.

 

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Interestand debt expense for the year ended December 31, 2003 was $131 million, representinga $26 million decrease from the combined $157 million in interest, debt expenseand preferred security distributions of subsidiary trusts recognized in2002.  This reduction was a reflection oflower outstanding debt balances, improved debt mix and lower interest rates onthe Company’s bank debt.  In June 2003,upon its maturity, the Company paid $125 million to settle its 6.625%notes.  Additionally, interest rates weredecreased in the December 2002 refinancing of the Senior Credit Facilityand the Company repurchased $24 million (book value) of 11.125% senior notesduring the fourth quarter of 2003.

 

Otherexpense, net was $29 million for the year ended December 31, 2003, adecrease of $86 million compared to the $115 million expense for 2002.  Other expense, net for the year ended December 31,2003 included asbestos related accruals and costs of $13 million, a $2 millionnet gain on debt settlements and $18 million in other costs and expenses.  Other expense, net for the year ended December 31,2002 included $68 million in asbestos related accruals and costs, a $44 millioncharge for debt extinguishment expenses and $3 million in other costs andexpenses.

 

Theprovision for income taxes on continuing operations reflected effective taxrates of 22% in 2003 and 6% in 2002. The effective tax rate for 2003 reflectedthe tax benefit from the donation of intellectual property to qualifiedorganizations and the use of prior year capital losses.  The effective tax rate for 2002 reflected thetax benefit of the pre-tax loss partially offset by the effect of increases totax reserves related to anticipated tax assessments and other provisions.

 

**FinancialCondition**

 

Liquidityand financial resources: Net cash provided by (used in) operations was $121million, $23 million, and $(215) million for 2004, 2003, and 2002,respectively.  The improvement inoperating cash flows in 2004 as compared to previous years reflected theinsurance settlements related to asbestos, the favorable impact of reducedpayments for interest and income taxes, decreased contributions to definedbenefit pension plans, and the lower debt repayment penalties andpremiums.  By the end of October 2004,the Company had reached agreement with each of its insurance carriers toreimburse certain costs incurred by Hercules in defending and resolving itsasbestos-related matters.  As a result ofthese settlements, the Company recorded additional receivables totaling $49million and during 2004 received cash payments totaling $50 million as comparedto $17 million in 2003.  During 2004, theCompany recognized $80 million of additional asbestos-related charges in orderto re-establish its total accrual to $260 million at December 31, 2004,based on the results of updated studies of its asbestos-relatedliabilities.  Total asbestos claimpayments made during 2004 of $41 million have decreased from the 2003 paymentswhich totaled $50 million.  The Companyprojects asbestos-related settlement payments of approximately $47 million in2005; however, it is anticipated that these amounts as well as legal feesincurred, will be fully reimbursable via the funding provided by the insurancecarriers which is held in trust. Interest and preferred security payments were reduced to$97 million in 2004 compared with $122 million and $153 million,respectively, for 2003 and 2002.  Thedecrease in interest payments was primarily due to the Company’s repurchase ofapproximately $174 million of its 11.125% senior notes since October 2003.  Interest rates were reduced by 150 basispoints through the April 2004 refinancing of the Term B loan and the August 2004amendment to the Senior Credit Facility. The decrease in net income tax payments was primarily due to the $20million federal tax refund received during 2004.  The large amount of tax payments in 2002 wasa result of the sale of the Company’s BetzDearborn Water Treatment Business (“WaterTreatment Business”).  Additionally, as aresult of the settlement of debt obligations with the proceeds from the sale ofthe Water Treatment Business, the Company incurred considerable prepayment feesduring 2002.  Similarly, during 2004 theCompany had to pay more than the face value of its debt in order to repurchaseits high yield notes.  During 2004, theCompany contributed $43 million to its defined benefit pension plans comparedto contributions of $55 million and $92 million in 2003 and 2002, respectively.

 

Othersignificant cash flow changes as compared to previous years resulted from theCompany’s severance, restructuring and other exit costs.  The majority of current severance paymentswere related to activity under the Company’s Dismissal Salary and DismissalWage Plans.  Severance and restructuringpayments have been reduced to $10 million in 2004 as compared to $21 million in2003 and $39 million in 2002 as the majority of payments related to thesignificant workforce reduction plan authorized by management in late 2001 havebeen made.

 

Netcash (used in) provided by investing activities was $(49) million, $49 million,and $1,659 million for 2004, 2003, and 2002, respectively.  Capitalexpenditures of $77 million during the year ended December 31, 2004 werepartially offset by $27 million of gross proceeds from the sale of the Company’sminority interest in CP Kelco ApS.  During2003, the Company used the $125 million in escrowed funds from its December 2002refinancing to redeem its 6.625% notes. The positive cash flow from the release of the escrowed funds waspartially offset by $48 million of capital expenditures, $9 million forthe acquisition of Jiangmen, and the recording of a $27 million investment inCRESTS Units preferred securities.  Asnoted in further detail in Note 5 to the Consolidated Financial Statements, the$27 million investment resulted from the Company’s de-consolidation of HerculesTrust II pursuant to FIN 46R.  Hercules’significant cash provided by investing activities in 2002 was due to receipt of$1.8 billion of proceeds from the sale of its Water Treatment Business,partially offset by $43 million of capital expenditures and by the escrow of$125 million of funds to redeem the 6.625% notes due June 2003.

 

22

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Netcash used in financing activities was $74 million, $171 million, and $1,334million for 2004, 2003, and 2002, respectively. The Company used the cash provided by operations in 2004 and 2003 to paydown its long-term debt.  Funding for thepay down of indebtedness during 2002 resulted from cash provided via theCompany’s refinancing and business divestitures.  During 2004 and 2003 the Company repurchased $150 million and $24 million, respectively of its11.125% senior notes.  The 2004 usage ofcash for these payments was partially offset by the net proceeds of the Company’srefinancing of its Senior Credit Facility and the private placement of the6.75% senior subordinated notes during the second quarter of 2004.  Additional cash used during 2003 was theresult of the Company repaying its $125 million 6.625% notes which came due in June 2003.  Cash used in 2002 is primarily due to theCompany’s use of approximately $1.8 billion of net proceeds from the sale ofits Water Treatment Business to permanently reduce long-term debt, repaying infull several outstanding borrowings. These payments were partially offset by $450 million of additionalborrowings under new refinanced agreements.

 

On April 8,2004, the Company completed the refinancing of its existing Senior CreditFacility with a new $400 million term loan (the “Term B Loan”) and a new $150million committed revolving credit facility (the “Revolving Facility”).  The Company also has the ability under itsnew Senior Credit Facility, subject to lender approval, to borrow an additional$250 million in the form of an incremental term note.  The Term B Loan matures October 8, 2010and the Revolving Facility matures April 8, 2009 unless accelerated.  Borrowings under the Term B Loan bearinterest at LIBOR + 1.75% (weighted-averaged rate of 4% at December 31,2004) with the Company holding the option to reset interest rates for one, two,three or six month periods.  The newSenior Credit Facility is secured by liens on the Company’s assets (includingreal, personal and intellectual properties) and is guaranteed by substantiallyall of the Company’s current and future wholly owned domesticsubsidiaries.  The Company also completeda private placement of $250 million aggregate principal amount of 6.75% seniorsubordinated notes due 2029.  These noteswere exchanged for similar notes registered with the Securities and ExchangeCommission on October 21, 2004.

 

Proceedsfrom the refinancing were used in part to fully repay the outstanding Term Bloan.  On May 10, 2004, proceedsfrom the refinancing and the issuance of the 6.75% senior subordinated noteswere also used to fully redeem the Company’s 9.42% junior subordinateddeferrable interest debentures due 2029 distributed to the holders of the 9.42%trust preferred securities of Hercules Trust I (the “Trust”) upon dissolutionof the Trust.  As a result of the debtrepayment and redemption, the Company recognized approximately $14 million ofnon-cash expense during the second quarter of 2004 for the write-off ofunamortized debt issuance costs.

 

During 2003, the Board of Directors authorized theCompany, from time to time, subject to market conditions and provisions of theCompany’s credit agreements and indentures, to repurchase up to $200 million ofits outstanding indebtedness. During 2003 the Company repurchased $24 million (book value) of its11.125% senior notes for $29 million and recorded a $5 million loss in Otherexpense, net.  The Company repurchased anadditional $131 million (book value) of its 11.125% senior notes through September 30,2004 for $157 million.  In October 2004,the Board terminated the unused portion of the initial debt repurchase program,concurrently authorizing a new $200 million debt repurchase program.  During the remainder of 2004 the Companyrepurchased $19 million (book value) of 11.125% senior notes for $23 millionunder this new program.  The Companyrecognized a $30 million loss as a result of its 2004 repurchases of debt andrecorded a non-cash expense of $4 million for the write-off of the unamortizeddebt issuance costs related to the repurchased debt.  These charges were reflected in Otherexpense, net.  In January and March 2005,the Company acquired an additional $14 million (book value) for $17 million.

 

As of December 31, 2004, $81 million of the $150million Revolving Facility under the Company’s Senior Credit Facility wasavailable for use.  The Company had $69million of outstanding letters of credit associated with its Senior CreditFacility at December 31, 2004.

 

Capital Structure and Commitments

 

Total capitalization (stockholders’ equity and debt)was $1.337 billion and $1.359 billion at December 31, 2004 and 2003,respectively.  Total debt was $1.240billion at December 31, 2004, a decrease of $108 million from December 31,2003.  The decrease reflects the $363million repayment of the 9.42% junior subordinated deferrable interestdebentures in April 2004, the repayment of the old Term B loan of $198million, the repurchase of $150 million of the 11.125% senior notes throughout2004, the net retirement of the $33 million of the 6.5% junior subordinateddebentures and a reduction of $14 million for payments on term notes and otherdebt instruments and current amounts due on the new Term B Loan.  These reductions were partially offset by the$250 million proceeds from the private placement of the 6.75% senior subordinateddebentures and the $400 million net proceeds of the new Term B Loan.  Total capitalization at December 31,2003 increased $23 million from December 31, 2002 principally fromimprovements in the components of Accumulated other comprehensive losses.  The current ratio decreased to 1.62 at December 31,2004 compared to 1.82 at December 31, 2003.  The quick ratio decreased to 1.22 at December 31,2004 compared to 1.41 at December 31, 2003.

 

Capitalexpenditures are expected to be between $70 and $80 million per year in 2005and 2006.

 

23

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The Company’s contractual commitments as of December 31,2004 are summarized as follows:

 
| ** **                                                                                   | ** ** | **(Dollars in millions)**     | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                   | ** ** | **Payments Due by Period(2)** | ** ** |
| ** **                                                                                   | ** ** | ** **                    | ** ** | **Less than** | ** ** | **1 - 3** | ** ** | **4 - 5** | ** ** | **After 5** | ** ** |
| ** **                                                                                   | ** ** | **Total**                     | ** ** | **1 year** | ** ** | **years** | ** ** | **years** | ** ** | **years** | ** ** |
| Debt Obligations                                                                             |       | $                             | 1,240      |   | $ | 30 |   | $ | 239 |   | $ | 9 |   | $ | 962 |   |
| Operating Lease Obligations                                                                  |       | 131                           |       | 20 |   | 34 |   | 39 |   | 38 |   |
| Purchase Obligations                                                                         |       | 7                             |       | 7 |   | — |   | — |   | — |   |
| Other Long-term Liabilities Reflected on the Registrant’s  Balance Sheet under GAAP (1) |       | 494                           |       | 89 |   | 78 |   | 63 |   | 264 |   |
| Total Contractual Cash Obligations                                                           |       | $                             | 1,872      |   | $ | 146 |   | $ | 351 |   | $ | 111 |   | $ | 1,264 |   |

 

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| (1)    |   | Includes amounts pertaining to asbestos-related  matters, asset retirement obligations, post-employment and post-retirement  obligations and workers compensation claims. Due to the dynamic nature of  asbestos litigation, it is impractical to determine the anticipated payments  in any given year. Therefore, the non-current asbestos-related liability of  $213 million has been reflected in the after five years column.                                                                                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (2)    |   | Does not include the anticipated future interest  payments to be made under the Company’s current debt agreements; however,  based upon current indebtedness and interest rates at December 31, 2004,  such obligations would be approximately $87 million in 2005, $86 million in  2006, $85 million in 2007, $62 million in 2008, $61 million in 2009 and $868  million thereafter. A one percent increase or decrease in the LIBOR rate  would have an impact of approximately plus or minus $4 million on the  Company’s interest payments in years 2005 through 2009 and $3 million in  2010. |

 

The Company had the following commercial commitmentsat December 31, 2004: lines of credit of $20 million outstanding and lettersof credit of $69 million, both of which may require payments in thefuture.  If required, these commitmentswould be funded from general corporate funds.

 

The Company projects cash flow from operations will besufficient to meet its investing and financing requirements in the next severalyears.

 

**Risk Factors**

 

Indebtedness

 

As of December 31, 2004, the Company’s total debtwas approximately $1,240 million, of which 66% is fixed rate indebtedness.  The Company’s indebtedness has significantconsequences.  For example, it could:increase the Company’s vulnerability to economic downturns and competitivepressures; require the Company to dedicate a substantial portion of its cashflow from operations to payments on its indebtedness, thereby reducing the availabilityof its cash flow to fund working capital, capital expenditures, research anddevelopment efforts and other general corporate purposes; limit the Company’sflexibility in planning for, or reacting to, changes in its business and theindustries in which it operates or in pursuing attractive businessopportunities requiring debt financing; place the Company at a disadvantage toits competitors that have less debt; and limit the Company’s ability to borrowadditional funds due to restrictive covenants.

 

The Senior Credit Facility and the indenturesgoverning the 11.125% senior notes due 2007 and the 6.75% senior subordinatednotes due 2029, which together account for a large portion of the Company’sdebt, contain numerous restrictive covenants, including, among other things,covenants that limit the Company’s ability to: borrow money and incurcontingent liabilities; make dividend or other restricted payments; use assetsas security in other transactions; enter into transactions with affiliates;enter into new lines of business; issue and sell stock of restrictedsubsidiaries; sell assets or merge with or into other companies and makecapital expenditures.  In addition, theSenior Credit Facility requires the Company to meet financial ratios and tests,including maximum leverage and interest coverage levels.  These restrictions could limit the Company’sability to plan for or react to market conditions or meet extraordinary capitalneeds and could otherwise restrict corporate activities.

 

The Company’s ability to comply with the covenants andother terms of the Senior Credit Facility and the indentures governing thesenior notes and to satisfy these and other debt obligations will depend uponthe Company’s current and future performance. The Company’s performance is affected by general economic conditions andby financial, competitive, political, business and other factors, many of whichare beyond the Company’s control.  TheCompany believes that the

 

24

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cash generated from its businesses will be sufficientto enable the Company to comply with the covenants and other terms of theSenior Credit Facility and the indentures governing the senior notes and tomake debt payments as they become due.

 

The Company and its subsidiaries may incur additionalindebtedness in the future.  As of December 31,2004, the Company had a $550 million Senior Credit Facility with a syndicate ofbanks.  Under the Senior Credit Facility,the Company has a $150 million revolving credit agreement, which permitscertain additional borrowings.  Inaddition, the Company has the option to borrow an additional $250 million inthe form of a term note under the Senior Credit Facility.  If new indebtedness is added to the Company’scurrent indebtedness levels, the risks described above could increase.

 

Market Risk

 

Fluctuations in interest and foreign currency exchangerates affect the Company’s financial position and results of operations.  The Company has used several strategies toactively hedge interest rate and foreign currency exposure and minimize theeffect of such fluctuations on reported earnings and cash flow (see “ForeignCurrency Translation” and “Derivative Financial Instruments and Hedging” in theSummary of Significant Accounting Policies and Note 24 to the ConsolidatedFinancial Statements).  Sensitivity ofthe Company’s financial instruments to selected changes in market rates andprices, which are reasonably possible over a one-year period, are describedbelow.  The market values for interestrate risk are calculated by the Company utilizing a third-party software modelthat employs standard pricing models to determine the present value of theinstruments based on the market conditions as of the valuation date.

 

The Company’s derivative and other financialinstruments subject to interest rate risk consist substantially of debtinstruments (see Note 24 to the Consolidated Financial Statements).  At December 31, 2004 and 2003, netmarket value of these combined instruments was a liability of $1.265 billionand $1.386 billion, respectively.  Thesensitivity analysis assumes an instantaneous 100-basis point move in interestrates from their levels, with all other variables held constant.  A 100-basis point increase in interest ratesat December 31, 2004 and 2003 would result in a $70 million and an $85million decrease, respectively, in the net market value of the liability.  A 100-basis point decrease in interest ratesat December 31, 2004 and 2003 would result in a $74 million and a $68million increase, respectively, in the net market value of the liability.

 

Our financial instruments subject to foreign currencyexchange risk consist of foreign currency forwards and options and represent anet asset position of $0.6 million and $1.0 million at December 31, 2004and 2003, respectively.  The followingsensitivity analysis assumes an instantaneous 10% change in foreign currencyexchange rates from year-end levels, with all other variables held constant.  A 10% strengthening of the U.S. dollar versusother currencies at December 31, 2004 and 2003 would result in a $0.6million increase and a $0.1 million decrease, respectively, in the net assetposition, while a 10% weakening of the dollar versus all currencies wouldresult in a $0.8 million decrease and a $0.1 million increase, respectively, inthe net asset position.

 

Foreign exchange forward and option contracts havebeen used to hedge the Company’s firm and anticipated foreign currency cashflows.  Thus, there is either an asset orcash flow exposure related to all the financial instruments in the abovesensitivity analysis for which the impact of a movement in exchange rates wouldbe in the opposite direction and substantially equal to the impact on theinstruments in the analysis.  There arepresently no significant restrictions on the remittance of funds generated bythe Company’s operations outside the United States.

 

The Company has not designated any derivative as ahedge instrument under Statement of Financial Accounting Standards No. 133, “Accountingfor Derivative Instruments and Hedging Activities” (“SFAS 133”) and,accordingly, changes in the fair value of derivatives are recorded each periodin earnings.

 

Environmental

 

In the ordinary course of its business, the Company issubject to numerous environmental laws and regulations covering compliancematters or imposing liability for the costs of, and damages resulting from,cleaning up sites, past spills, disposals and other releases of hazardoussubstances.  Changes in these laws andregulations may have a material adverse effect on the Company’s financialposition and results of operations.  Anyfailure by the Company to adequately comply with such laws and regulationscould subject the Company to significant future liabilities.

 

Environmental remediation expenses are funded frominternal sources of cash.  Such expensesare not expected to have a significant effect on the Company’s ongoingliquidity.  Environmental cleanup costs,including capital expenditures for ongoing operations, are a normal, recurringpart of operations and are not significant in relation to total operating costsor cash flows (see Item 3, Legal Proceedings and Notes 11 and 12 to theConsolidated Financial Statements).

 

Litigation

 

Hercules is a defendant in numerous lawsuits arisingout of, or incidental to, the conduct of its business.  Such litigation typically falls within thefollowing broad categories: environmental (discussed above); antitrust; commercial; intellectualproperty; labor and employment; personal injury; property damage; productliability; and toxic tort.  While it isnot feasible to predict the outcome of all pending matters, the ultimateresolution of one or more of these matters could

 

25

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have a material effect upon the Company’s financialposition, results of operations and/or cash flows for any annual, quarterly orother period (see Item 3, Legal Proceedings and Note 12 to the ConsolidatedFinancial Statements).

 

Pension

 

Theassets and liabilities associated with the Company’s defined benefit plans aresubject to interest rate and market risk. A 100-basis point decrease or increase in the discount rate hasapproximately a plus or minus $157 million impact on the ABO.  A 100-basis point decrease or increase in thediscount rate has approximately a plus or minus $163 million impact on theprojected benefit obligation.  A100-basis point decrease or increase in the assumed rate of return hasapproximately a plus or minus $11 million impact on the U.S. pension andpostretirement expense estimated for 2005 (see Note 8 to the ConsolidatedFinancial Statements).

 

**Indemnifications**

 

Inconnection with the sale of certain assets or businesses, the Company hasindemnified respective buyers against certain liabilities that may arise inconnection with the sales transactions and business activities prior to theultimate closing of the sale.  Theseindemnifications typically pertain to environmental, tax, employee and/orproduct-related matters.  If the indemnifiedparty were to incur a liability or have a liability increase as a result of asuccessful claim, pursuant to the terms of the indemnification, the Companywould be required to reimburse the buyer. These indemnifications are generally subject to threshold amounts,specified claim periods and other restrictions and limitations.  As of December 31, 2004, the Company hasrecorded indemnifications totaling $40 million. Although it is possible that future payments may exceed amounts accrued,due to the nature of indemnified items, it is not possible to make a reasonableestimate of the maximum potential loss or range of loss.

 

Asdescribed in greater detail in Note 12 to the Consolidated FinancialStatements, the Company has entered into comprehensive settlement agreementswith each of its asbestos insurance carriers. Under the terms of these agreements and in exchange for payments madeand to be received from the insurance carriers, the Company has released and indemnifiedthe released insurers from any past, present and future claims asserted underits cancelled policies.

 

**Recent Accounting Pronouncements**

 

On October 22,2004, President Bush signed The American Jobs Creation Act of 2004 (the “Act”).  The Act included some of the most significantchanges to corporate taxation since 1996 and, among other things eliminates theExtraterritorial Income Regime (“ETI”) over a two-year phase out periodbeginning in 2005.  However, the phaseout will still allow the Company to obtain 80% of the ETI benefit for 2005 and60% for 2006.  The Act provides for aspecial one-time tax deduction of 85% of certain foreign earnings that arerepatriated in either an entity’s last tax year that began before the enactmentdate or the first tax year that begins during the one-year period beginning onthe date of enactment. Additionally, the Act provides for a deduction for U.S.domestic manufacturers beginning in 2005. This new deduction begins at 3% of the U.S. domestic manufacturer’sincome for 2005 and 2006, increasing to 6% for 2007 through 2009 and achievesits maximum rate of 9% after 2009.

 

As aresult of the accounting implications associated with the Act, the FASB issuedStaff Positions FAS 109-1, “Application of FASB Statement No. 109, Accountingfor Income Taxes, to the Tax Deduction on Qualified Production ActivitiesProvided by the American Jobs Creation Act of 2004” (“FSP 109-1”) and FAS109-2, “Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004” (“FSP109-2”) in December 2004.  FSP 109-1clarifies that the domestic manufacturing deduction should be accounted for asa special deduction to be recognized as earned, as opposed to a rate reduction,under Statement of Financial Accounting Standards No. 109, “Accounting forIncome Taxes.”  The Company is currentlyinvestigating the impact of FSP 109-1. Due to the complex nature of the ETI and foreign earnings repatriationprovisions of the Act, it is anticipated that Congress or the Treasury Departmentwill provide clarifying regulations in the near future.  Accordingly, FSP 109-2 allows entitiesadditional time beyond the financial reporting period in which the Act wasenacted to evaluate the impact upon their financial statements.  Both FSP 109-1 and FSP 109-2 became effectiveupon their issuance in December 2004. It is anticipated that FSP 109-2 will not have a material impact on theconsolidated financial position, results of operations or cash flows as theCompany currently repatriates all available foreign earnings.  Accordingly, the special one-time taxdeduction regarding certain foreign earnings, as referenced above, will not beavailable.

 

In November 2004,the FASB issued Statement of Financial Accounting Standards No. 151, “InventoryCosts — an amendment of ARB No. 43” (“SFAS 151”).  SFAS 151 was one of a number of projects bythe FASB to converge U.S. accounting standards to International AccountingStandards.  SFAS 151 requires abnormalamounts of idle facility expenses, freight, handling costs and spoilage to berecognized as current period charges.  Inaddition, the allocation of fixed manufacturing overhead costs to the costs ofconversion is required to be based on the normal capacity of the manufacturingfacilities.  SFAS 151 will be effectivefor inventory costs incurred during fiscal years beginning after June 15,2005.  The Company does not expect SFAS151 to have a material impact on its consolidated financial position, resultsof operations or cash flows as its current inventory and conversion costmethodologies are generally consistent with that required by the new standard.

 

26

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In December 2004,the FASB issued Statement of Financial Accounting Standards No. 153, “Exchangesof Nonmonetary Assets – an amendment of APB Opinion No. 29” (“SFAS 153”).  SFAS 153 was also a result of the FASB’sproject to converge U.S. accounting standards to International AccountingStandards.  The guidance in APB OpinionNo. 29, “Accounting for Nonmonetary Transactions,” includes certain exceptionsto the principle that exchanges of nonmonetary assets should be measured basedon the fair value of the assets exchanged. SFAS 153 eliminates the exceptionfor similar productive assets and replaces it with a general exception forexchanges on nonmonetary assets that do not have commercial substance.  SFAS 153 defines a nonmonetary exchange ashaving commercial substance if the future cash flows of the entity are expectedto change significantly as a result of the exchange.  SFAS 153 will be effective for fiscal periodsbeginning after June 15, 2005.  TheCompany does not expect SFAS 153 to have a material impact on its consolidatedfinancial position, results of operations or cash flows.

 

In December 2004,the FASB issued Statement of Financial Accounting Standards No. 123 (Revised2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” (“SFAS 123”).  SFAS 123Rsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, andamends Statement of Financial Accounting Standards No. 95, “Statement of CashFlows” (“SFAS 95”).  Generally, theapproach in SFAS 123R is similar to the approach described in SFAS 123.  However, SFAS 123R requires all share-basedpayments to employees, including grants of stock options, to be recognized inthe income statement based on their fair values.  The Company expects to adopt SFAS 123Reffective July 1, 2005, as required. SFAS 123R permits public companies to adopt its requirements using oneof two methods: (1) A “modified prospective” method in which compensation costis recognized beginning with the effective date (a) based on the requirementsof SFAS 123R for all share-based payments granted after the effective date and(b) based on the requirements of SFAS 123 for all awards granted to employeesprior to the effective date of SFAS 123R that remain unvested on the effectivedate; or (2) A “modified retrospective” method which includes the requirementsof the modified prospective method described above, but also permits entitiesto restate based on the amounts previously recognized under SFAS 123 forpurposes of pro forma disclosures either (a) all prior periods presented or (b)prior interim periods of the year of adoption. The Company plans to adopt SFAS 123R using the modified prospectivemethod.

 

TheCompany previously adopted the fair-value-based method of accounting forshare-based payments effective January 1, 2003 using the prospectivemethod described in Statement of Financial Accounting Standards No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure”.  Accordingly, the Company currently recognizescompensation cost associated with restricted stock awards and discloses the proforma compensation cost of stock option awards. As SFAS 123R must be appliednot only to new awards, but to previously granted awards, primarily stockoptions,  that are not fully vested onthe effective date, and because the Company adopted the prospective transitionmethod, compensation cost for those previously granted awards that were notrecognized under SFAS 123 will be recognized under SFAS 123R.  This results from the prospective adoption ofSFAS 123, which applied only to awards, principally restricted stock awards,granted, modified or settled after the adoption date of January 1, 2003.However, had the Company adopted SFAS 123R in prior periods, the impact wouldhave approximated the impact of SFAS 123 as described in the disclosure of proforma net income and earnings per share in the Summary of SignificantAccounting Policies.  Beyond thoserestricted stock and stock option awards previously granted, the Company cannotpredict with certainty the impact of SFAS 123R on the consolidated financialstatements as such awards are determined on an annual basis and encompass apotentially wide range depending upon the incentive compensation philosophyadvocated by the Human Resources Committee of the Company’s Board ofDirectors.  Compensation cost associatedwith previously granted stock option awards to be recognized in accordance withSFAS 123R during 2005 is expected to be less than $1 million.

 

SFAS123R also requires the benefits of tax deductions in excess of compensationcost recognized in the financial statements to be reported as a financing cashflow, rather than as an operating cash flow as currently required under SFAS95. This requirement, to the extent such benefits exist, will decrease netoperating cash flows and increase net financing cash flows in periodssubsequent to adoption.  The Companycannot estimate what those amounts will be in the future, because they dependon, among other things, when employees exercise stock options. The amount of operatingcash flows recognized in prior periods for such excess tax deductions was notmaterial for 2004, 2003 and 2002 respectively, due to the minimal amount ofoptions exercised during those periods.

 

Currently,the Company utilizes the Black-Scholes option pricing model to estimate thevalue of stock options granted to employees and expects to continue the use ofthis acceptable option valuation model upon the required adoption of SFAS 123R.

 

27

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| **ITEM 7A.** | **QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT  MARKET RISK** |
|--------------|-----------------------------------------------------------------|

 

For discussion of quantitative and qualitativedisclosures about market risk, see the caption “Risk Factors” under Item 7,Management’s Discussion and Analysis of Financial Condition and Results ofOperations.

 

28

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| **ITEM****8.** | **FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA** |
|----------------|-------------------------------------------------|

 

**INDEX TO CONSOLIDATED FINANCIALSTATEMENTS ANDREQUIRED SUPPLEMENTARY DATAHERCULES INCORPORATED**

 
| **CONSOLIDATED FINANCIAL STATEMENTS**                                                                                     |       |
|---------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                |       |
| Management’s Report on Internal Control  Over Financial Reporting                                                    |       |
| Report of Independent Registered Public  Accounting Firm                                                                  |       |
| Consolidated Statements of Operations for  the Years Ended December 31, 2004, 2003 and 2002                          |       |
| Consolidated Balance Sheets as of December 31, 2004 and 2003                                                         |       |
| Consolidated Statements of Cash Flows for  the Years Ended December 31, 2004, 2003 and 2002                          |       |
| Consolidated Statements of Stockholders’  Equity (Deficit) for the Years Ended December 31, 2004, 2003 and 2002 |       |
| Consolidated Statements of Comprehensive  Income (Loss) for the Years Ended December 31, 2004, 2003 and 2002         |       |
| Summary of Significant Accounting Policies  and Notes to Consolidated Financial Statements                                |       |
|                                                                                                                      |       |
| **SUPPLEMENTARY DATA**                                                                                                    | ** ** |
| ** **                                                                                                                | ** ** |
| Summary of Quarterly Results (Unaudited)                                                                                  |       |
| Valuation and Qualifying Accounts                                                                                         |       |

 

29

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**Management’sReport on Internal Control Over Financial Reporting**

 

The management of Hercules is responsible forestablishing and maintaining adequate internal control over financial reportingas defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Actof 1934, as amended.  Hercules’ internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles.

 

Because of the inherent limitations, internal controlover financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Hercules’ management assessed the effectiveness of theCompany’s internal control over financial reporting as of December 31,2004.  In making this assessment,management used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”) in *Internal Control-Integrated Framework*.  Based on this assessment, management hasconcluded that, as of December 31, 2004, the Company’s internal controlover financial reporting was effective based on those criteria.

 

Management’s assessment of the effectiveness of theCompany’s internal control over financial reporting as of December 31,2004 has been audited by PricewaterhouseCoopers LLP, the Company’s independentregistered public accounting firm, as stated in their report, which appearsherein.

 

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### **Reportof Independent Registered Public Accounting Firm**

### ** **

To****the Shareholders and Board ofDirectors

of Hercules Incorporated:

 

We have completed an integrated audit of Hercules Incorporated’s 2004consolidated financial statements and of its internal control over financialreporting as of December 31, 2004 and audits of its 2003 and 2002consolidated financial statements in accordance with the standards of thePublic Company Accounting Oversight Board (United States).  Ouropinions, based on our audits, are presented below.

 

Consolidated financial statements and financial statement schedule

 

In our opinion, the consolidated financial statements listed in theindex appearing under Item 15 (a) (1) present fairly, in all materialrespects, the financial position of Hercules Incorporated and its subsidiariesat December 31, 2004 and 2003, and the results of their operations andtheir cash flows for each of the three years in the period ended December 31,2004 in conformity with accounting principles generally accepted in the UnitedStates of America.  In addition, in ouropinion, the financial statement schedule listed in the index appearingunder Item 15 (a) (2) presents fairly, in all material respects, theinformation set forth therein when read in conjunction with the relatedconsolidated financial statements.  Thesefinancial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements and financial statement schedule based on our audits.  We conducted our audits of these statementsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit of financial statements includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

As discussed in Note 5 to the consolidated financial statements, theCompany adopted Statement of Financial Accounting Standards No. 150,“Accounting for Certain Financial Instruments with Characteristics of BothLiabilities and Equity” on July 1, 2003.

 

As discussed in the Summary of Significant Accounting Policies, theCompany adopted Statement of Financial Accounting Standards No. 148,“Accounting for Stock-Based Compensation — Transition and Disclosure” on January 1,2003.

 

As discussed in Note 11 to the consolidated financial statements, theCompany adopted Statement of Financial Accounting Standards No. 143,“Accounting for Asset Retirement Obligations” on January 1, 2003.

 

As discussed in Note 4 to the consolidated financial statements, theCompany changed its accounting for goodwill and indefinite-lived intangibleassets effective January 1, 2002, with the adoption of Statement ofFinancial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in Management’sReport on Internal Control Over Financial Reporting appearing under Item 8,that the Company maintained effective internal control over financial reportingas of December 31, 2004 based on criteria established in *Internal Control – Integrated Framework*issued by theCommittee of Sponsoring Organizations of the Treadway Commission (“COSO”), isfairly stated, in all material respects, based on those criteria. Furthermore,in our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2004, basedon criteria established in *Internal Control –Integrated Framework* issued by the COSO.  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financialreporting.  Our responsibility is toexpress opinions on management’s assessment and on the effectiveness ofthe Company’s internal control over financial reporting based on our audit. Weconducted our audit of internal control over financial reporting in accordancewith the standards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects.  An audit of internalcontrol over financial reporting includes obtaining an understanding ofinternal control over financial reporting, evaluating management’s assessment,testing and evaluating the

 

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design and operating effectiveness of internal control, and performingsuch other procedures as we consider necessary in the circumstances.  We believe that our audit provides areasonable basis for our opinions.

 

A company’s internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles.  A company’s internal control over financialreporting includes those policies and procedures that (i) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company;(ii) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (iii) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, ordisposition of the company’s assets that could have a material effect on thefinancial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

 

 
| /s/ PricewaterhouseCoopers LLP |   |
|--------------------------------|--------|
| Philadelphia, PA               |
| March 16, 2005            |

 

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**Hercules Incorporated**

**Consolidated Statements of Operations**

 
| ** **                                                                                                                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(Dollars in  millions, except per share)**                                                                                           | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales                                                                                                                              |       | $                                | 1,997      |   | $ | 1,846 |   | $ | 1,705 |   |
| Cost of  sales                                                                                                                         |       | 1,310                            |       | 1,167 |   | 1,040 |   |
| Selling,  general and administrative expenses                                                                                          |       | 382                              |       | 360 |   | 348 |   |
| Research and  development                                                                                                              |       | 43                               |       | 39 |   | 42 |   |
| Goodwill and  intangible asset amortization (Note 4)                                                                                   |       | 8                                |       | 8 |   | 9 |   |
| Other  operating expense, net (Note 19)                                                                                                |       | 27                               |       | 17 |   | 46 |   |
| Profit from  operations                                                                                                                |       | 227                              |       | 255 |   | 220 |   |
| Interest and  debt expense (Note 20)                                                                                                   |       | 109                              |       | 131 |   | 99 |   |
| Gain on sale  of CP Kelco ApS (Note 25)                                                                                                |       | (27                              | )          | — |   | — |   |
| Preferred  security distributions of subsidiary trusts                                                                                 |       | —                           |       | — |   | 58 |   |
| Other  expense, net (Note 21)                                                                                                          |       | 116                              |       | 29 |   | 115 |   |
| Income  (loss) before income taxes and equity income (loss)                                                                            |       | 29                               |       | 95 |   | (52 | ) |
| Provision  (benefit) for income taxes (Note 7)                                                                                         |       | 2                                |       | 21 |   | (3 | ) |
| Income  (loss) before equity income (loss)                                                                                             |       | 27                               |       | 74 |   | (49 | ) |
| Equity  income of affiliated companies, net of tax                                                                                     |       | —                           |       | — |   | 2 |   |
| Net income  (loss) from continuing operations before discontinued operations and  cumulative effect of changes in accounting principle |       | 27                               |       | 74 |   | (47 | ) |
|                                                                                                                                   |       |                             |       |   |   |   |   |
| Net income  (loss) on discontinued operations, net of tax (Note 25)                                                                    |       | —                           |       | 4 |   | (196 | ) |
| Net income  (loss) before cumulative effect of changes in accounting principle                                                         |       | 27                               |       | 78 |   | (243 | ) |
|                                                                                                                                   |       |                             |       |   |   |   |   |
| Cumulative  effect of changes in accounting principle, net of tax (Notes 4, 5 and 11)                                                  |       | —                           |       | (33 | ) | (368 | ) |
| Net income  (loss)                                                                                                                     |       | $                                | 27         |   | $ | 45 |   | $ | (611 | ) |
| Earnings  (loss) per share (Note 22)                                                                                                   |       |                             |       |   |   |   |   |
| Basic  earnings (loss) per share                                                                                                       |       |                             |       |   |   |   |   |
| Continuing  operations                                                                                                                 |       | $                                | 0.25       |   | $ | 0.69 |   | $ | (0.44 | ) |
| Discontinued  operations                                                                                                               |       | —                           |       | 0.04 |   | (1.85 | ) |
| Cumulative  effect of changes in accounting principle                                                                                  |       | —                           |       | (0.31 | ) | (3.47 | ) |
| Net income  (loss)                                                                                                                     |       | $                                | 0.25       |   | $ | 0.42 |   | $ | (5.76 | ) |
| Weighted  average number of shares (millions)                                                                                          |       | 107.3                            |       | 106.2 |   | 106.0 |   |
| Diluted  earnings (loss) per share                                                                                                     |       |                             |       |   |   |   |   |
| Continuing  operations                                                                                                                 |       | $                                | 0.25       |   | $ | 0.69 |   | $ | (0.44 | ) |
| Discontinued  operations                                                                                                               |       | —                           |       | 0.04 |   | (1.85 | ) |
| Cumulative  effect of changes in accounting principle                                                                                  |       | —                           |       | (0.31 | ) | (3.47 | ) |
| Net income  (loss)                                                                                                                     |       | $                                | 0.25       |   | $ | 0.42 |   | $ | (5.76 | ) |
| Weighted  average number of shares (millions)                                                                                          |       | 109.0                            |       | 107.2 |   | 106.0 |   |

 

*Theaccompanying accounting policies and notes are an integral part of theconsolidated financial statements.*

 

33

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**Hercules Incorporated**

**Consolidated Balance Sheets**

 
| ** **                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(Dollars in millions)**                                                               | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **ASSETS**                                                                              |       |                  |       |   |   |
| Current  assets                                                                         |       |                  |       |   |   |
| Cash and  cash equivalents                                                              |       | $                     | 127        |   | $ | 126 |   |
| Accounts  receivable, net (Note 1)                                                      |       | 347                   |       | 321 |   |
| Inventories  (Note 2)                                                                   |       | 189                   |       | 187 |   |
| Deferred  income taxes (Note 7)                                                         |       | 45                    |       | 93 |   |
| Asbestos-related  assets (Note 12)                                                      |       | 6                     |       | 7 |   |
| Other  current assets (Note 17)                                                         |       | 58                    |       | 95 |   |
| Total  current assets                                                                   |       | 772                   |       | 829 |   |
| Property,  plant and equipment, net (Note 17)                                           |       | 695                   |       | 677 |   |
| Intangible  assets, net (Note 4)                                                        |       | 162                   |       | 165 |   |
| Goodwill  (Note 4)                                                                      |       | 550                   |       | 518 |   |
| Deferred  income taxes (Note 7)                                                         |       | 122                   |       | 44 |   |
| Asbestos-related  assets (Note 12)                                                      |       | 163                   |       | 162 |   |
| Deferred  charges and other assets (Note 17)                                            |       | 246                   |       | 316 |   |
| Total assets                                                                            |       | $                     | 2,710      |   | $ | 2,711 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                           |       |                  |       |   |   |
| Current  liabilities                                                                    |       |                  |       |   |   |
| Accounts  payable                                                                       |       | $                     | 198        |   | $ | 182 |   |
| Accrued  expenses (Note 17)                                                             |       | 202                   |       | 207 |   |
| Asbestos-related liabilities (Note  12)                                                 |       | 47                    |       | 45 |   |
| Current debt  obligations (Note 5)                                                      |       | 30                    |       | 22 |   |
| Total  current liabilities                                                              |       | 477                   |       | 456 |   |
| Long-term  debt (Note 5)                                                                |       | 1,210                 |       | 1,326 |   |
| Deferred  income taxes (Note 7)                                                         |       | 77                    |       | 78 |   |
| Pension  liability (Note 8)                                                             |       | 241                   |       | 250 |   |
| Other  postretirement benefits (Note 8)                                                 |       | 81                    |       | 96 |   |
| Deferred  credits and other liabilities (Note 17)                                       |       | 314                   |       | 318 |   |
| Asbestos-related  liabilities (Note 12)                                                 |       | 213                   |       | 176 |   |
| Total  liabilities                                                                      |       | 2,613                 |       | 2,700 |   |
| Commitments  and contingencies (Note 12)                                                |       | —                |       | — |   |
| Stockholders’  equity                                                              |       |                  |       |   |   |
| Series  preferred stock (Note 14)                                                       |       | —                |       | — |   |
| Common  stock, $25/48 par value (Note 15)  (shares issued: 2004 and 2003 - 159,984,444) |       | 83                    |       | 83 |   |
| Additional  paid-in capital                                                             |       | 569                   |       | 603 |   |
| Unearned  compensation (Notes 9 and 10)                                                 |       | (78                   | )          | (87 | ) |
| Accumulated  other comprehensive losses (Note 16)                                       |       | (276                  | )          | (317 | ) |
| Retained  earnings                                                                      |       | 1,522                 |       | 1,495 |   |
|                                                                                    |       | 1,820                 |       | 1,777 |   |
| Reacquired  stock, at cost (shares: 2004 - 47,842,836 and 2003 - 48,992,628)            |       | (1,723                | )          | (1,766 | ) |
| Total  stockholders’ equity                                                        |       | 97                    |       | 11 |   |
| Total  liabilities and stockholders’ equity                                        |       | $                     | 2,710      |   | $ | 2,711 |   |

 

*Theaccompanying accounting policies and notes are an integral part of theconsolidated financial statements.*

 

34

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**Hercules Incorporated**

**Consolidated Statements of Cash Flows**

 
| ** **                                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(Dollars in millions)**                                                                      | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Cash Flow From Operating Activities:**                                                       |       |                             |       |   |   |   |   |
| Net income  (loss)                                                                             |       | $                                | 27         |   | $ | 45 |   | $ | (611 | ) |
| Net (income)  loss from discontinued operations                                                |       | —                           |       | (4 | ) | 196 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operations:      |       |                             |       |   |   |   |   |
| Depreciation                                                                                   |       | 75                               |       | 73 |   | 71 |   |
| Amortization                                                                                   |       | 26                               |       | 27 |   | 29 |   |
| Deferred  income tax provision                                                                 |       | (19                              | )          | 8 |   | 17 |   |
| Gain on  disposals                                                                             |       | (28                              | )          | (4 | ) | — |   |
| Impairment  charges                                                                            |       | 9                                |       | 2 |   | 375 |   |
| Write-off of  debt issuance costs                                                              |       | 18                               |       | — |   | — |   |
| Other  non-cash charges and credits                                                            |       | 1                                |       | 10 |   | (10 | ) |
| Affiliates’  earnings in excess of dividends received                                     |       | —                           |       | — |   | (2 | ) |
| Accruals and  deferrals of cash receipts and payments (net of acquisitions and  dispositions): |       |                             |       |   |   |   |   |
| Accounts  receivable                                                                           |       | (7                               | )          | 8 |   | (8 | ) |
| Inventories                                                                                    |       | 6                                |       | (7 | ) | (5 | ) |
| Asbestos-related  assets, current                                                              |       | 1                                |       | 2 |   | 6 |   |
| Other  current assets                                                                          |       | 21                               |       | 1 |   | (5 | ) |
| Asbestos  related assets - non-current                                                         |       | —                           |       | (49 | ) | (70 | ) |
| Accounts  payable and accrued expenses                                                         |       | 5                                |       | (37 | ) | (109 | ) |
| Income taxes  payable                                                                          |       | (25                              | )          | (88 | ) | (148 | ) |
| Pension and  postretirement benefits                                                           |       | (23                              | )          | (34 | ) | (74 | ) |
| Asbestos  liability                                                                            |       | 39                               |       | 19 |   | 129 |   |
| Non-current  assets and liabilities                                                            |       | (5                               | )          | 51 |   | 4 |   |
| Net cash  provided by (used in) operating activities from continuing operations                |       | 121                              |       | 23 |   | (215 | ) |
| **Cash Flow From Investing Activities:**                                                       |       |                             |       |   |   |   |   |
| Capital  expenditures                                                                          |       | (77                              | )          | (48 | ) | (43 | ) |
| Proceeds of  investment and fixed asset disposals                                              |       | 1                                |       | 10 |   | 1,816 |   |
| Proceeds  from sale of minority interest in CP Kelco ApS                                       |       | 27                               |       | — |   | — |   |
| Decrease  (increase) in restricted cash                                                        |       | —                           |       | 125 |   | (125 | ) |
| Acquisitions,  net of cash acquired                                                            |       | —                           |       | (9 | ) | — |   |
| Investment  in CRESTS Units preferred securities                                               |       | —                           |       | (27 | ) | — |   |
| Other, net                                                                                     |       | —                           |       | (2 | ) | 11 |   |
| Net cash  (used in) provided by investing activities                                           |       | (49                              | )          | 49 |   | 1,659 |   |
| **Cash Flow From Financing Activities:**                                                       |       |                             |       |   |   |   |   |
| Long-term  debt proceeds                                                                       |       | 650                              |       | — |   | 450 |   |
| Long-term  debt payments                                                                       |       | (730                             | )          | (165 | ) | (1,776 | ) |
| Change in  short-term debt                                                                     |       | 2                                |       | (1 | ) | (8 | ) |
| Payment of  debt issuance costs and underwriting fees                                          |       | (8                               | )          | — |   | (5 | ) |
| Repurchase  of CRESTS Units warrants                                                           |       | —                           |       | (7 | ) | — |   |
| Treasury  stock issued                                                                         |       | 6                                |       | 2 |   | 5 |   |
| Other                                                                                          |       | 6                                |       | — |   | — |   |
| Net cash  used in financing activities                                                         |       | (74                              | )          | (171 | ) | (1,334 | ) |
| Effect of  exchange rate changes on cash                                                       |       | 3                                |       | 16 |   | (2 | ) |
| Net cash  flow from discontinued operations (Note 25)                                          |       | —                           |       | — |   | 25 |   |
| Net increase  (decrease) in cash and cash equivalents                                          |       | 1                                |       | (83 | ) | 133 |   |
| Cash and  cash equivalents at beginning of year                                                |       | 126                              |       | 209 |   | 76 |   |
| Cash and  cash equivalents at end of year                                                      |       | $                                | 127        |   | $ | 126 |   | $ | 209 |   |
| ** **                                                                                     |       |                             |       |   |   |   |   |
| **Supplemental Disclosures of Cash Flow Information:**                                         |       |                             |       |   |   |   |   |
| Cash paid  during the period for:                                                              |       |                             |       |   |   |   |   |
| Interest                                                                                       |       | $                                | 97         |   | $ | 122 |   | $ | 96 |   |
| Preferred  security distributions of subsidiary trusts                                         |       | —                           |       | — |   | 57 |   |
| Income  taxes, net of refunds received                                                         |       | 41                               |       | 65 |   | 142 |   |
| Non-cash  investing and financing activities:                                                  |       |                             |       |   |   |   |   |
| Acquisition  of minority interest                                                              |       | $                                | —     |   | $ | 2 |   | $ | — |   |
| Incentive  and other employee benefit stock plan issuances                                     |       | 16                               |       | 19 |   | 7 |   |
| Elimination  of 6.5% junior subordinated deferrable interest debentures due 2029               |       | (34                              | )          | — |   | — |   |
| Elimination  of investment in Hercules Trust II upon its dissolution                           |       | 27                               |       | — |   | — |   |

 

*Theaccompanying accounting policies and notes are an integral part of theconsolidated financial statements.*

 

35

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**Hercules Incorporated**

**Consolidated Statements of Stockholders’ Equity (Deficit)**

 
| ** **                                                              | ** ** | ** ** | ** ** | ** **  | ** ** | ** **   | ** ** | **Accumulated** | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|-------------|------------|--------------|------------|-----------------|------------|--------------|------------|----------------|------------|------------|------------|
| ** **                                                              | ** ** | ** ** | ** ** | ** **  | ** ** | **Unearned** | ** ** | **Other**       | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                              | ** ** | **Common** | ** ** | **Paid-in** | ** ** | **Compen-**  | ** ** | **Comprehen-**  | ** ** | **Retained** | ** ** | **Reacquired** | ** ** | ** ** | ** ** |
| **(Dollars in millions)**                                               | ** ** | **Stock**  | ** ** | **Capital** | ** ** | **sation**   | ** ** | **sive Loss**   | ** ** | **Earnings** | ** ** | **Stock**      | ** ** | **Total**  | ** ** |
| Balances at December 31,  2001                                     |       | $          | 83         |        | $          | 685          |       | $               | (102       | )            | $          | (218           | )          | $          | 2,061      |   | $ | (1,845 | ) | $ | 664 |   |
| *(Common shares: issued, 159,984,444;  reacquired, 51,196,972)*         |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |   |   |   |   |   |   |   |
| Net loss                                                                |       | —     |       | —      |       | —       |       | —          |       | (611         | )          | —         |       | (611       | )          |
| Foreign  currency translation adjustment                                |       | —     |       | —      |       | —       |       | 15              |       | —       |       | —         |       | 15         |       |
| Release of  shares held by ESOP trust                                   |       | —     |       | (5          | )          | 11           |       | —          |       | —       |       | —         |       | 6          |       |
| Increase in  additional minimum pension liability, net of tax           |       | —     |       | —      |       | —       |       | (354            | )          | —       |       | —         |       | (354       | )          |
| Reclassification  adjustment relating to disposal of business           |       | —     |       | —      |       | —       |       | 103             |       | —       |       | —         |       | 103        |       |
| Purchase of  common stock, 16,960 shares                                |       | —     |       | —      |       | —       |       | —          |       | —       |       | —         |       | —     |       |
| Issuances of  common stock:                                             |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |
| Incentive  plans, net, 598,445 shares, from reacquired stock            |       | —     |       | (15         | )          | —       |       | —          |       | —       |       | 21             |       | 6          |       |
|                                                                    |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |
| Balances at December 31,  2002                                     |       | $          | 83         |        | $          | 665          |       | $               | (91        | )            | $          | (454           | )          | $          | 1,450      |   | $ | (1,824 | ) | $ | (171 | ) |
| *(Common shares: issued, 159,984,444; reacquired, 50,615,487)*          |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |   |   |   |   |   |   |   |
| Net income                                                              |       | —     |       | —      |       | —       |       | —          |       | 45           |       | —         |       | 45         |       |
| Foreign  currency translation adjustment                                |       | —     |       | —      |       | —       |       | 124             |       | —       |       | —         |       | 124        |       |
| Release of  shares held by ESOP trust                                   |       | —     |       | (5          | )          | 11           |       | —          |       | —       |       | —         |       | 6          |       |
| Debt  issuance costs on warrants issued with trust preferred securities |       | —     |       | (7          | )          | —       |       | —          |       | —       |       | —         |       | (7         | )          |
| Repurchase  of warrants                                                 |       | —     |       | (7          | )          | —       |       | —          |       | —       |       | —         |       | (7         | )          |
| Decrease in  additional minimum pension liability, net of tax           |       | —     |       | —      |       | —       |       | 13              |       | —       |       | —         |       | 13         |       |
| Issuances of  common stock:                                             |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |
| Incentive  plans, net, 1,622,859 shares, from reacquired stock          |       | —     |       | (43         | )          | (11          | )          | —          |       | —       |       | 58             |       | 4          |       |
| Amortization  of unearned compensation                                  |       | —     |       | —      |       | 4            |       | —          |       | —       |       | —         |       | 4          |       |
|                                                                    |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |
| Balances at December 31,  2003                                     |       | $          | 83         |        | $          | 603          |       | $               | (87        | )            | $          | (317           | )          | $          | 1,495      |   | $ | (1,766 | ) | $ | 11 |   |
| *(Common shares: issued, 159,984,444; reacquired, 48,992,628)*          |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |   |   |   |   |   |   |   |
| Net income                                                              |       | —     |       | —      |       | —       |       | —          |       | 27           |       | —         |       | 27         |       |
| Foreign  currency translation adjustment                                |       | —     |       | —      |       | —       |       | 71              |       | —       |       | —         |       | 71         |       |
| Release of  shares held by ESOP trust                                   |       | —     |       | (5          | )          | 14           |       | —          |       | —       |       | —         |       | 9          |       |
| Increase in  additional minimum pension liability, net of tax           |       | —     |       | —      |       | —       |       | (30             | )          | —       |       | —         |       | (30        | )          |
| Issuances of  common stock:                                             |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |
| Incentive  plans, net, 1,149,792 shares, from reacquired stock          |       | —     |       | (29         | )          | (8           | )          | —          |       | —       |       | 43             |       | 6          |       |
| Amortization  of unearned compensation                                  |       | —     |       | —      |       | 3            |       | —          |       | —       |       | —         |       | 3          |       |
|                                                                    |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |
| Balances at December 31,  2004                                     |       | $          | 83         |        | $          | 569          |       | $               | (78        | )            | $          | (276           | )          | $          | 1,522      |   | $ | (1,723 | ) | $ | 97 |   |
| *(Common shares: issued, 159,984,444; reacquired, 47,842,836)*          |       |       |       |        |       |         |       |            |       |         |       |           |       |       |       |   |   |   |   |   |   |   |
|                                                                         |            |            |            |             |            |              |            |                 |            |              |            |                |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Theaccompanying accounting policies and notes are an integral part of theconsolidated financial statements.*

 

36

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**Hercules Incorporated**

**Consolidated Statements of ComprehensiveIncome (Loss)**

 
| ** **                                                               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(Dollars in millions)**                                                | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income  (loss)                                                       |       | $                                | 27         |   | $ | 45 |   | $ | (611 | ) |
| Foreign  currency translation                                            |       | 71                               |       | 124 |   | 118 |   |
| (Increase)  decrease in additional minimum pension liability, net of tax |       | (30                              | )          | 13 |   | (354 | ) |
| Comprehensive  income (loss)                                             |       | $                                | 68         |   | $ | 182 |   | $ | (847 | ) |

 

*The accompanying accountingpolicies and notes are an integral part of the consolidated financialstatements.*

 

37

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**Hercules Incorporated**

**Summary of Significant Accounting Policies**

 

**Principles of Consolidation**

 

The Consolidated Financial Statements include theaccounts of Hercules, all majority-owned subsidiaries where control exists, anyother subsidiaries which it controls and variable interest entities (“VIEs”) inwhich Hercules is the primary beneficiary. All significant intercompany transactions and profits have beeneliminated.  Investments in affiliatedcompanies, where Hercules has a 20% to 50% interest and where the entity iseither not a VIE or Hercules is not the primary beneficiary, are accounted forusing the equity method of accounting and, accordingly, consolidated incomeincludes Hercules’ share of their income. Subsidiaries of the Company (Hercules Trust I and Hercules Trust II)that were VIEs and with respect to which Hercules is not the primary beneficiaryhave been de-consolidated as of December 31, 2003.  Hercules Trust I and Hercules Trust II wereliquidated and dissolved in 2004.

 

**Use of Estimates**

 

Preparation of financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the amountsreported in the Consolidated Financial Statements and the accompanyingNotes.  Actual results could differ fromthese estimates.

 

**Revenue Recognition**

 

The Company recognizes revenue when the earningsprocess is complete.  This generallyoccurs when products are shipped to the customer or services are performed inaccordance with terms of the agreement, title and risk of loss have beentransferred, collectibility is probable and pricing is fixed ordeterminable.  Revenue arrangements withmultiple deliverables are reported separately for deliverables that havestand-alone value when there is objective and reliable evidence as to the fairvalue of the deliverable and the delivery of any undelivered item is probableand substantially controlled by the Company. Approximately 13%, 12% and 12% of the Company’s revenues for the yearsended December 31, 2004, 2003 and 2002, respectively, are from consignmentinventory.  For consignment inventory,title and risk of loss are transferred when the earnings process is consideredcomplete, which generally occurs when the Company’s products have been consumedor used in the customer’s production process. Accruals are made for sales returns and other allowances based on theCompany’s experience.  The correspondingshipping and handling costs are included in cost of sales.

 

**Allowance for Doubtful Accounts Receivable**

 

Theallowance for doubtful accounts represents an estimate of uncollectibleaccounts receivable.  The recorded amountreflects various factors, including accounts receivable aging,customer-specific risk issues, country risk and historical write-offexperience.  It includes, but is notlimited to, a formula driven calculation applied to the aging of trade accountsreceivable balances.  When a specificaccounts receivable balance is deemed uncollectible, a charge is taken to thisreserve.  Recoveries of balancespreviously written off are also reflected in this reserve.

 

**Research and Development Expenditures**

 

Research and development expenditures are expensed asincurred.

 

**Environmental Expenditures**

 

The Company has ongoing expenditures forenvironmental related projects at current and former operating facilities.  Accruals for environmental remediationmatters are expensed when it is probable that a liability has been incurred andthe amount of the liability is reasonably estimable.  The Company capitalizes environmental expendituresfor projects that extend the life, increase the capacity or improve the safetyor efficiency of its facilities.  Inaddition, the Company capitalizes asset retirement obligations relating toenvironmental remediation liabilities that result from the normal operation ofCompany facilities.  The Companycapitalized environmental related expenditures totaling $3 million, $2 millionand $1 million for the years ended December 31, 2004, 2003 and 2002,respectively.

 

**Cash and Cash Equivalents**

 

Cash in excess of operating requirements is investedin short-term, income-producing instruments. Cash equivalents include commercial paper and other securities withoriginal maturities of 90 days or less at the time of purchase.  Book value approximates fair value because ofthe short maturity of those instruments.

 

**Inventories**

 

Inventories are stated at the lower of cost ormarket.  Foreign and certain domesticinventories, which in the aggregate represented 89% and 84% of totalinventories at December 31, 2004 and 2003, respectively, are valuedprincipally on the average-cost method. A portion of domestic inventories are valued on the last-in, first-out(“LIFO”) method.  Elements of costs ininventories include raw materials, direct labor and manufacturing overhead.

 

38

----

 

**Property, Plant and Equipment and Depreciation**

 

Property, plant and equipment are stated at cost.  The Company changed to the straight-linemethod of depreciation, effective January 1, 1991, for newly acquiredprocessing facilities and equipment. Assets acquired before then continue to be depreciated by acceleratedmethods.  The Company believesstraight-line depreciation provides a better matching of costs and revenuesover the lives of the assets.  Theestimated useful lives of depreciable assets are as follows: buildings – 30years; plant machinery and equipment – 15 years; other machinery and equipment –3 to 15 years.

 

Maintenance, repairs and minor renewals are expensedas incurred; major renewals and improvements that extend the lives or increasethe capacity of plant assets are capitalized. Upon normal retirement or replacement, the net book value of property(less proceeds of sale or salvage) is charged to income.

 

**Goodwill and Other Intangible Assets**

 

Pursuant to Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),beginning January 1, 2002, goodwill is not amortized but is tested forimpairment at least annually with any necessary adjustment charged toexpense.  The Company has selected November 30as the date for performing the annual impairment test.  Other intangible assets have been amortizedon a straight-line basis over the estimated future periods to be benefited,generally 40 years for customer relationships, trademarks and tradenames and 5to 15 years for other intangible assets. Intangible assets with finite lives are amortized over their usefullives.

 

**Investments**

 

Investments in affiliated companies in which theCompany has a 20% to 50% interest and where the entity is not a variableinterest entity for which Hercules is the primary beneficiary are accounted forusing the equity method of accounting. Accordingly, these investments are included in deferred charges andother assets on the Company’s Consolidated Balance Sheets and the income orloss from these investments is included in equity income (loss) of affiliatedcompanies in the Company’s Consolidated Statements of Operations.

 

Investments in affiliated companies in which theCompany does not have a controlling interest, or an ownership and votinginterest so large as to exert significant influence, are accounted for usingthe cost method of accounting. Accordingly, these investments are also included in deferred charges andother assets on the Company’s Consolidated Balance Sheets.

 

Other investments include non-current marketablesecurities whose value approximates market value.

 

**Investments in Subsidiary Trusts**

 

The Company had twosubsidiary trusts, Hercules Trust I and Hercules Trust II (the “Trusts”), thatwere variable interest entities for which the Company was not the primarybeneficiary.  The Company utilized thecost method to account for its investments in the subsidiary trusts at December 31,2003.  Both Trusts were liquidated anddissolved during 2004.****

 

**Long-lived Assets**

 

The Company reviews its long-lived assets, includingother intangible assets, for impairment on an exception basis whenever eventsor changes in circumstances indicate carrying amounts of the assets may not berecoverable through undiscounted future cash flows.  If an impairment loss has occurred based onexpected future cash flows (undiscounted), the loss is recognized in the incomestatement.  The amount of the impairmentloss is the excess of the carrying amount of the impaired asset over the fairvalue of the asset.  The fair valuerepresents expected future cash flows from the use of the assets, discounted atthe rate used to evaluate potential investments.  The Company reviews its long-lived assets inaccordance with Statement of Financial Accounting Standards No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”).

 

**Computer Software Development Costs**

 

The Company follows the American Institute ofCertified Public Accountants Statement of Position 98-1, “Accounting for theCost of Computer Software Developed or Obtained for Internal Use” (“SOP98-1”).  These assets are included indeferred charges and other assets in the Company’s Consolidated Balance Sheets.  Computer software development costs are beingamortized over a period of 5 to 10 years. Amortization expense was $15 million, $13 million and $11 million in2004, 2003 and 2002, respectively.

 

**Deferred Financing Costs**

 

The Company capitalizescosts associated with the issuance of debt (deferred financing costs),including bank, legal, investment advisor and accounting fees and otherexpenses.  Deferred financing costs areamortized over the term of the related financing transaction using theeffective interest rate method and are included in interest and debtexpense.  Amortization of deferredfinancing costs for 2004, 2003 and 2002 was $3 million, $6 million and $9million, respectively.

 

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**Income Taxes**

 

The provision for income taxes has been determinedusing the asset and liability approach for accounting for income taxes.  Under this approach, deferred taxes representthe future tax consequences expected to occur when the reported amounts ofassets and liabilities are recovered or paid. The provision for income tax represents income taxes paid or payable forthe current year plus the change in deferred taxes during the year.  Deferred taxes result from differencesbetween the financial and tax basis of the Company’s assets and liabilities andare adjusted for changes in tax rates and tax laws when changes areenacted.  Valuation allowances arerecorded to reduce deferred tax assets when it is more likely than not that atax benefit will not be realized.

 

**Asset Retirement Obligations**

 

The Company records aliability at fair value for legal obligations associated with the retirement oftangible long-lived assets that result from the acquisition, construction,development and/or normal operations of a long-lived asset.  The Company’s asset retirement obligationsprincipally relate to environmental remediation liabilities associated withcurrent and former operations that were incurred during the course of normaloperations.

 

**Foreign Currency Translation**

 

The financial statements of Hercules’ non-U.S. entitiesare translated into U.S. dollars using current rates of exchange, with gains orlosses included in accumulated other comprehensive losses.

 

**Derivative Instruments and Hedging**

 

Derivative instruments are recorded on the balancesheet at their fair values.  The Companyhas not designated any derivative as a hedge instrument and accordingly,changes in fair value of derivatives are recorded each period in earnings.  Under procedures and controls established bythe Company’s risk management policies, the Company strategically enters intocontractual arrangements (derivatives) in the ordinary course of business toreduce the exposure to foreign currency rates and interest rates.

 

The Company’s risk management policies establishseveral approved derivative instruments to be utilized in each risk managementprogram and the level of exposure coverage based on the assessment of riskfactors.  Derivative instruments utilizedinclude forwards, swaps and options.  TheCompany uses forward exchange contracts and options, generally no greater thanthree months in term, to reduce its net currency exposure.  The objective of this program is to maintainan overall balanced position in foreign currencies so that exchange gains andlosses resulting from exchange rate changes are minimized.  The Company has used interest rate swapagreements to manage interest costs and risks associated with changing rates.

 

Counterparties to the forward exchange, currency swap,options and interest swap contracts are major financial institutions.  Credit loss from counterparty nonperformanceis not anticipated.

 

**Stock-based Compensation**

 

Effective January 1,2003, the Company adopted Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation – Transition andDisclosure” (“SFAS 148”).  SFAS 148amends SFAS 123 by providing alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation and requiring enhanced disclosure regarding stock-basedcompensation.  The Company has elected toapply the fair value recognition provisions of SFAS 123 on a prospective basisto all employee awards granted, modified or settled after January 1,2003.  Awards under the Company’sstock-based compensation plans vest over periods ranging from 1 to a maximum of10 years; however, vesting can be extended with the approval of the Board ofDirectors.  Therefore, the cost relatedto stock-based employee compensation included in the determination of netincome in 2004 and 2003 is less than that which would have been recognized ifthe fair value based method had been applied to all awards since the originaleffective date of SFAS 123.  The Companydid not grant any stock options pursuant to SFAS 123, as amended by SFAS 148,to employees in 2004 and 2003.  However,the Company did make grants of restricted stock to employees in 2004 and2003.  Restricted stock awards under the Hercules Long-term IncentiveCompensation Plan are recorded at the quoted market price (fair value) of theCompany’s stock on the grant date (measurement date).  Stock acquired through the Employee StockPurchase Plan and “above target” restricted stock awarded under the HerculesManagement Incentive Compensation Plan is discounted 15% from market price aspermitted by IRS regulations and the provisions of the Company’s incentivecompensation plans.  The award and thediscount, if any, are amortized into expense over the vesting (restriction)period.  Forfeitures are recorded asincurred.  The Employee Stock PurchasePlan was terminated effective March 31, 2004.  The Company recognized $3 million, $4 millionand $1 million of expense in 2004, 2003 and 2002, respectively, in connectionwith restricted stock awards.

 

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Pursuant to the disclosure requirements ofSFAS 123, as amended by SFAS 148, the following table presents the pro formaeffect on net income (loss) and earnings (loss) per share assuming the Companyhad applied the fair value recognition provisions of SFAS 123 to allstock-based employee compensation on a retroactive basis.

 
| ** **                                                                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(Dollars in millions, except per share)**                                                                                        | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income  (loss), as reported                                                                                                    |       | $                                | 27         |   | $ | 45 |   | $ | (611 | ) |
| Add: Total  stock-based employee compensation expense recognized in reported  results                                              |       | 2                                |       | 5 |   | 5 |   |
| Deduct:  Total stock-based employee compensation expense determined under the fair  value based method for all awards, net of tax* |       | 4                                |       | 12 |   | 17  |   |
| Pro forma  net income (loss)                                                                                                       |       | $                                | 25         |   | $ | 38 |   | $ | (623 | ) |
| Earnings  (loss) per share:                                                                                                        |       |                             |       |   |   |   |   |
| Basic - as  reported                                                                                                               |       | $                                | 0.25       |   | $ | 0.42 |   | $ | (5.76 | ) |
| Basic - pro  forma                                                                                                                 |       | $                                | 0.23       |   | $ | 0.36 |   | $ | (5.88 | ) |
| Diluted - as  reported                                                                                                             |       | $                                | 0.25       |   | $ | 0.42 |   | $ | (5.76 | ) |
| Diluted -  pro forma                                                                                                               |       | $                                | 0.23       |   | $ | 0.35 |   | $ | (5.88 | ) |

 

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* For information regarding the weighted-averageassumptions used in estimating fair value for 2004, 2003 and 2002, see Note 10.

 

**Recent Accounting Pronouncements**

 

On October 22, 2004, President Bushsigned The American Jobs Creation Act of 2004 (the “Act”).  The Act included some of the most significantchanges to corporate taxation since 1996 and, among other things eliminates theExtraterritorial Income Regime (“ETI”) over a two-year phase out periodbeginning in 2005.  However, the phaseout will still allow the Company to obtain 80% of the ETI benefit for 2005 and60% for 2006.  The Act provides for aspecial one-time tax deduction of 85% of certain foreign earnings that arerepatriated in either an entity’s last tax year that began before the enactmentdate or the first tax year that begins during the one-year period beginning onthe date of enactment.  Additionally, theAct provides for a deduction for U.S. domestic manufacturers beginning in2005.  This new deduction begins at 3% ofthe U.S. domestic manufacturer’s income for 2005 and 2006, increasing to 6% for2007 through 2009 and achieves its maximum rate of 9% after 2009.

 

As a result of the accounting implicationsassociated with the Act, the FASB issued Staff Positions FAS 109-1,“Application of FASB Statement No. 109, Accounting for Income Taxes, to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004” (“FSP 109-1”) and FAS 109-2, “Accounting and DisclosureGuidance for the Foreign Earnings Repatriation Provision within the AmericanJobs Creation Act of 2004” (“FSP 109-2”) in December 2004.  FSP 109-1 clarifies that the domesticmanufacturing deduction should be accounted for as a special deduction to berecognized as earned, as opposed to a rate reduction, under Statement ofFinancial Accounting Standards No. 109, “Accounting for Income Taxes.”  The Company is currently investigating theimpact of FSP 109-1.  Due to the complexnature of the ETI and foreign earnings repatriation provisions of the Act, itis anticipated that Congress or the Treasury Department will provide clarifyingregulations in the near future.  Accordingly,FSP 109-2 allows entities additional time beyond the financial reporting periodin which the Act was enacted to evaluate the impact upon their financialstatements.  Both FSP 109-1 and FSP 109-2became effective upon their issuance in December 2004.  It is anticipated that FSP 109-2 will nothave a material impact on the consolidated financial position, results ofoperations or cash flows as the Company currently repatriates all availableforeign earnings.  Accordingly, thespecial one-time tax deduction regarding certain foreign earnings, asreferenced above, will not be available.

 

In November 2004, the FASB issuedStatement of Financial Accounting Standards No. 151, “Inventory Costs – anamendment of ARB No. 43” (“SFAS 151”). SFAS 151 was one of a number of projects by the FASB to converge U.S.accounting standards to International Accounting Standards.  SFAS 151 requires abnormal amounts of idlefacility expenses, freight, handling costs and spoilage to be recognized ascurrent period charges.  In addition, theallocation of

 

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fixed manufacturing overhead costs to the costs of conversion isrequired to be based on the normal capacity of the manufacturing facilities.SFAS 151 will be effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005.  TheCompany does not expect SFAS 151 to have a material impact on its consolidatedfinancial position, results of operations or cash flows as its currentinventory and conversion cost methodologies are generally consistent with thatrequired by the new standard.

 

In December 2004, the FASB issuedStatement of Financial Accounting Standards No. 153, “Exchanges of Non-monetaryAssets – an amendment of APB Opinion No. 29” (“SFAS 153”).  SFAS 153 was also a result of the FASB’sproject to converge U.S. accounting standards to International AccountingStandards.  The guidance in APB OpinionNo. 29, “Accounting for Non-monetary Transactions” includes certainexceptions to the principle that exchanges of non-monetary assets should bemeasured based on the fair value of the assets exchanged.  SFAS 153 eliminates the exception for similarproductive assets and replaces it with a general exception for exchanges onnon-monetary assets that do not have commercial substance.  SFAS 153 defines a non-monetary exchange ashaving commercial substance if the future cash flows of the entity are expectedto change significantly as a result of the exchange.  SFAS 153 will be effective for fiscal periodsbeginning after June 15, 2005.  TheCompany does not expect SFAS 153 to have a material impact on its consolidatedfinancial position, results of operations or cash flows.

 

In December 2004, the FASB issuedStatement of Financial Accounting Standards No. 123 (Revised 2004),“Share-Based Payment” (“SFAS 123R”), which is a revision of Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” (“SFAS 123”).  SFAS 123Rsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, andamends Statement of Financial Accounting Standards No. 95, “Statement of CashFlows” (“SFAS 95”).  Generally, theapproach in SFAS 123R is similar to the approach described in SFAS 123.  However, SFAS 123R requires all share-based paymentsto employees, including grants of stock options, to be recognized in the incomestatement based on their fair values. The Company expects to adopt SFAS 123R effective July 1, 2005, asrequired. SFAS 123R permits public companies to adopt its requirements usingone of two methods: (1) A “modified prospective” method in which compensationcost is recognized beginning with the effective date (a) based on therequirements of SFAS 123R for all share-based payments granted after theeffective date and (b) based on the requirements of SFAS 123 for all awardsgranted to employees prior to the effective date of SFAS 123R that remainunvested on the effective date; or (2) A “modified retrospective” method whichincludes the requirements of the modified prospective method described above,but also permits entities to restate based on the amounts previously recognizedunder SFAS 123 for purposes of pro forma disclosures either (a) all priorperiods presented or (b) prior interim periods of the year of adoption. TheCompany plans to adopt SFAS 123R using the modified prospective method.

 

The Company previously adopted thefair-value-based method of accounting for share-based payments effective January 1,2003 using the prospective method described in Statement of FinancialAccounting Standards No. 148, “Accounting for Stock-Based Compensation –Transition and Disclosure.”  Accordingly,the Company currently recognizes compensation cost associated with stock awardsgranted subsequent to January 1, 2003 and discloses the pro formacompensation cost of stock awards granted prior to January 1, 2003.  As SFAS 123R must be applied not only to newawards, but to previously granted awards, primarily stock options, that are notfully vested on the effective date, and because the Company adopted theprospective transition method, compensation cost for those previously grantedawards that were not recognized under SFAS 123 will be recognized under SFAS123R.  This results from the prospectiveadoption of SFAS 123, which applied only to awards, principally restrictedstock awards, granted, modified or settled after the adoption date of January 1,2003.  However, had the Company adoptedSFAS 123R in prior periods, the impact would have approximated the impact ofSFAS 123 as described in the disclosure of pro forma net income and earningsper share above in the Summary of Significant Accounting Policies.  Beyond those restricted stock and stockoption awards previously granted, the Company cannot predict with certainty theimpact of SFAS 123R on the consolidated financial statements as such awards aredetermined on an annual basis and encompass a potentially wide range dependingupon the incentive compensation philosophy advocated by the Human ResourcesCommittee of the Company’s Board of Directors. Compensation cost associated with previously granted stock option awardsto be recognized in accordance with SFAS 123R during 2005 is expected to beless than $1 million.

 

SFAS 123R also requires the benefits of taxdeductions in excess of compensation cost recognized in the financialstatements to be reported as a financing cash flow, rather than as an operatingcash flow as currently required under SFAS 95. This requirement, to the extent such benefits exist, will decrease netoperating cash flows and increase net financing cash flows in periodssubsequent to adoption.  The Companycannot estimate what those amounts will be in the future, because they dependon, among other things, when employees exercise stock options.  The amount of operating cash flows recognizedin prior periods for such excess tax deductions was not material for 2004, 2003and 2002 respectively, due to the minimal amount of options exercised duringthose periods.

 

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Currently, the Company utilizes theBlack-Scholes option pricing model to estimate the value of stock optionsgranted to employees and expects to continue the use of this acceptable optionvaluation model upon the required adoption of SFAS 123R.  

 

**Reclassifications**

 

Certain amounts in the 2003 and 2002 consolidatedfinancial statements and notes have been reclassified to conform to the 2004presentation.

 

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**Hercules Incorporated**

**Notes to Consolidated Financial Statements**

 

**1.****                                                              Accounts receivable**:

 

Changes in the allowance for doubtful accounts for theyears ended December 31, 2004, 2003 and 2002 are as follows:

 
| ** **                     | ** ** | **(Dollars in millions)** | ** ** |
|--------------------------------|------------|---------------------------|------------|
| ** **                     | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Balance at  beginning of year  |       | $                         | 5          |   | $ | 12 |   | $ | 24 |   |
| Charged to  costs and expenses |       | 5                         |       | 4 |   | 4 |   |
| Deductions                     |       | (5                        | )          | (11 | ) | (16 | ) |
| Balance at  end of year        |       | $                         | 5          |   | $ | 5 |   | $ | 12 |   |

 

**2.****                                                              Inventories**

 

The components of inventories are:

 
| ** **                         | ** ** | **(Dollars in millions)** | ** ** |
|------------------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Finished  products                 |       | $                         | 95         |   | $ | 100 |   |
| Raw materials  and work-in-process |       | 71                        |       | 65 |   |
| Supplies                           |       | 23                        |       | 22 |   |
|                               |       | $                         | 189        |   | $ | 187 |   |

 

Inventories valued on the LIFO method were lower thanif valued under the average-cost method, which approximates current cost, by$23 million and $21 million at December 31, 2004 and 2003,respectively.  The average-cost value ofinventories subject to LIFO was $44 million and $52 million at December 31,2004 and 2003, respectively.

 

**3.****                                                              AssetsHeld for Sale**

 

The Company maintains ownership over a numberof properties, including land and buildings, which were formerly associatedwith businesses that have been exited, divested or otherwise curtailed.  In order to maximize their value, the Companyis actively engaged in an ongoing process of identifying alternativeutilization strategies including leasing and outright sales of the underlyingproperties.  On December 31, 2004,the Company determined that the plan of sale criteria included in Statement ofFinancial Accounting Standards No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets” has been met for certain properties located inLanghorne, Pennsylvania and Burlington, New Jersey.

 

The Langhorne property represents amanufacturing facility and warehouse formerly associated with the Company’spreviously divested Water Treatment Business. The carrying value of this property was adjusted to its fair value, lesscosts to sell, amounting to approximately $6 million, which is based upon anoffer from a buyer that has been accepted and the fact that the transaction isexpected to close by the end of the first quarter of 2005.  An impairment loss of approximately $2million has been recorded and is included in Other expense, net for 2004 in theConsolidated Statements of Operations.

 

The Burlington property represents the siteof a former manufacturing facility associated with the Company’s previouslydivested resins business.  The carryingvalue of the property is approximately $0.1 million.  In addition, the Company has reflected anasset retirement obligation liability (“ARO liability”) of approximately $4million with respect to this property. The ARO is primarily attributable to the remediation of soil andgroundwater contamination associated with the former manufacturing operations.  On March 10, 2005, the Company signed apreliminary term sheet, the provisions of which are confidential, for the saleof the Burlington property for an amount in excess of its carrying amount.  Among other things, consummation of the saleis contingent upon execution of a definitive purchase and sale agreement andsatisfactory completion of due diligence. It is anticipated that the eventual sale will be completed during thethird or fourth quarter of 2005.

 

The combined amount of approximately $6 millionrelated to the Langhorne and Burlington properties is reflected as “Assets heldfor sale” representing a component of Other current assets as disclosed in Note17.  In addition, the ARO liability ofapproximately $4 million associated with the Burlington property is reflectedas a component of Deferred credits and other liabilities on the ConsolidatedBalance Sheet.

 

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**4.****                                                              Goodwilland Other Intangible Assets**

 

Effective January 1, 2002, the Companyadopted SFAS 142.  Under SFAS 142,goodwill and intangible assets with indefinite useful lives are not amortizedbut instead are reviewed for impairment at least annually and written down onlyin periods in which it is determined that the fair value is less than therecorded value.  SFAS 142 also requiresthe impairment review to be performed on a reporting unit basis.  The Company identified the followingreporting units: BetzDearborn, Pulp and Paper, Aqualon, FiberVisions andPinova.  In connection with the Company’stransitional review, recorded goodwill was determined to be impaired in theBetzDearborn and the FiberVisions reporting units.  In the first quarter of 2002, the Companycompleted its transitional impairment review of identified reporting units andrecognized after-tax impairment losses of $262 million in the BetzDearbornreporting unit and $87 million in the FiberVisions reporting unit as acumulative effect of a change in accounting principle.

 

The impairment charges recognized in theBetzDearborn and FiberVisions reporting units were primarily the result of newand stronger competitors and newer technology, which created significant priceerosion and competition.  In addition,the BetzDearborn reporting unit was negatively impacted by a failure to achieveintegration synergies.  SFAS 142 requiresthe Company to compare a reporting unit’s book value of net assets, includinggoodwill, to its fair value.  In the caseof the BetzDearborn reporting unit, fair value was determined primarily byreference to the negotiated selling price. With respect to the Company’s other reporting units, fair value wasestimated using a combination of valuation approaches including the marketvalue and income approaches. In the event that the book value exceeds the fairvalue, the Company is required to perform a second step to measure the amountof the impairment loss.  In the secondstep, the Company determined the implied value of goodwill by determining thefair value of the assets and liabilities of the BetzDearborn and FiberVisionsreporting units.  To the extent that thebook value of the goodwill exceeded the implied fair value of goodwill for eachreporting unit, impairment existed and was recognized.

 

In addition, an after-tax impairment loss of $19 million was recognizedin the first quarter of 2002 relating to the Company’s equity investment in CPKelco ApS, which had an impairment under SFAS 142.  After recognition of this impairment, thecarrying value for the Company’s investment in CP Kelco ApS was reduced tozero.

 

Accumulated amortization for goodwill uponadoption of SFAS 142 was $185 million. The following table shows changes in the carrying amount of goodwill forthe years ended December 31, 2003 and 2004, by operating segment:

 
| ** **                         | ** ** | **(Dollars in millions)** | ** ** |
|------------------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | ** **                | ** ** | **Engineered** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Performance**           | ** ** | **Materials &** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Products**              | ** ** | **Additives** | ** ** | **Total** | ** ** |
| Balance at December 31,  2002 |       | $                         | 383        |   | $ | 85 |   | $ | 468 |   |
| Foreign  currency translation      |       | 50                        |       | — |   | 50 |   |
| Balance at December 31,  2003 |       | 433                       |       | 85 |   | 518 |   |
| Additions                          |       | 1                         |       | — |   | 1 |   |
| Foreign  currency translation      |       | 31                        |       | — |   | 31 |   |
| Balance at December 31,  2004 |       | $                         | 465        |   | $ | 85 |   | $ | 550 |   |

 

The following table provides information regarding the Company’s otherintangible assets with finite lives:

 
| ** **                       | ** ** | **Customer**      | ** ** | **Trademarks &** | ** ** | **Other**       | ** ** | ** ** | ** ** |
|----------------------------------|------------|-------------------|------------|----------------------|------------|-----------------|------------|------------|------------|
| ** **                       | ** ** | **Relationships** | ** ** | **Tradenames**       | ** ** | **Intangibles** | ** ** | **Total**  | ** ** |
| Gross  Carrying Amount           |       |              |       |                 |       |            |       |       |       |
| Balance, December 31,  2003 |       | $                 | 89         |                 | $          | 72              |       | $          | 50         |   | $ | 211 |   |
| Balance, December 31,  2004 |       | 90                |       | 74                   |       | 52              |       | 216        |       |
|                             |       |              |       |                 |       |            |       |       |       |
| Accumulated  Amortization        |       |              |       |                 |       |            |       |       |       |
| Balance, December 31,  2003 |       | $                 | 12         |                 | $          | 9               |       | $          | 25         |   | $ | 46 |   |
| Balance, December 31,  2004 |       | 14                |       | 11                   |       | 29              |       | 54         |       |

 

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Total amortization expense for other intangible assetsfor the years ended December 31, 2004, 2003 and 2002 was $8 million, $8million and $9 million, respectively, which was included in income fromcontinuing operations.  It is estimatedthat amortization expense will be $8 million for 2005 through 2007, $7 millionfor 2008 and $6 million for 2009.

 

**5****.****                                                              Debt**

 

A summary of debt follows:

 
| ** **                                                                              | ** ** | **(Dollars in millions)** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                              | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Term B loan  due 2010 (a)                                                               |       | $                         | 397        |   | $ | — |   |
| Term B loan  due 2007 (a)                                                               |       | —                    |       | 198 |   |
| 6.60% notes  due 2027 (b)                                                               |       | 100                       |       | 100 |   |
| Term notes  at various rates from 2.96% to 7.9% due in varying amounts through 2006 (c) |       | 28                        |       | 42 |   |
| 11.125%  senior notes due 2007 (d)                                                      |       | 226                       |       | 376 |   |
| 6.75% senior  subordinated notes due 2029 (e)                                           |       | 250                       |       | — |   |
| 8%  convertible subordinated debentures due 2010 (f)                                    |       | 3                         |       | 3 |   |
| 9.42% junior  subordinated deferrable interest debentures due 2029 (g)                  |       | —                    |       | 363 |   |
| 6.5% junior  subordinated deferrable interest debentures due 2029 (g)                   |       | 229                       |       | 262 |   |
| Other                                                                                   |       | 7                         |       | 4 |   |
|                                                                                    |       | $                         | 1,240      |   | $ | 1,348 |   |
| Less:  Current debt obligations                                                         |       | 30                        |       | 22 |   |
| Long-term  debt                                                                         |       | $                         | 1,210      |   | $ | 1,326 |   |

 

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(a)          During April 2004,the Company completed the refinancing of its old Senior Credit Facility with anew Senior Credit Facility consisting of a $400 million term loan (the “Term BLoan”) and a $150 million committed revolving credit facility (the “RevolvingFacility”).  The Company also has the abilityunder the new Senior Credit Facility, subject to lender approval, to borrow anadditional $250 million in the form of an incremental term note.  The Term B Loan matures October 8, 2010and the Revolving Facility matures April 8, 2009.  During August 2004, the Senior CreditFacility was amended to reduce the Term B Loan interest to LIBOR + 1.75%(weighted-average rate of 4% at December 31, 2004) with the Companyholding the option to reset interest rates for one, two, three or six monthperiods.  The new Senior Credit Facilityis secured by liens on the Company’s assets (including real, personal andintellectual properties) and is guaranteed by substantially all of theCompany’s current and future wholly owned domestic subsidiaries (see Note26).  Proceeds from the refinancing wereused in part to fully repay the outstanding Term B loan and, in combinationwith the proceeds from the issuance of the new 6.75% senior subordinated notes(see Note e), to fully redeem the Trust Originated Preferred Securities(“TOPrS”) (see Note g).

 

As of December 31, 2004, $81 million ofthe $150 million Revolving Facility was available for use.  The Company had $69 million of outstandingletters of credit associated with the Revolving Facility at December 31,2004.

 

The Company’s Senior Credit Facility requiresquarterly compliance with certain financial covenants, including a debt/EBITDAratio (“leverage ratio”) and an interest coverage ratio and establishedlimitations on the permitted amount of annual capital expenditures.

 

(b)         30-yeardebentures with a 10-year put option, exercisable by bondholder at a redemptionprice equal to principal amount.

 

(c)          Debtassumed in conjunction with the acquisition of FiberVisions L.L.C., net ofrepayments through December 31, 2004 and 2003.

 

(d)         The seniornotes accrue interest at 11.125% per annum, payable semi-annually.  The senior notes are guaranteed by each ofHercules’ current and future wholly-owned domestic restrictedsubsidiaries.  The senior notes are notredeemable at Hercules’ option prior to maturity.  The Company is not required to make mandatoryredemption or sinking fund payments with respect to the senior notes.  If a change of control occurs, each holder ofthe notes will have the right to require Hercules to repurchase all or any partof that Holder’s notes pursuant to a change of control offer on the terms setforth in the indenture.  In the change ofcontrol offer, Hercules will offer a change of

 

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control payment incash equal to 101% of the aggregate principal amount of the notes repurchasedplus accrued and unpaid interest and liquidated damages, if any, on the notesrepurchased, to the date of purchase.

 

(e)          The Company completed aprivate placement of $250 million aggregate principal amount of 6.75% seniorsubordinated notes due 2029 during April 2004.  On June 30, 2004, Hercules filed aRegistration Statement on Form S-4 with the Securities and Exchange Commissionpursuant to which the Company offered to exchange all of the $250 millionaggregate principal amount of the 6.75% senior subordinated notes due 2029 (the“old notes”) for $250 million aggregate principal amount of 6.75% seniorsubordinated notes due 2029 (the “new notes”). The form and terms of the new notes are the same as the form and terms ofthe old notes except that, because the new notes are registered under theSecurities Act, the new notes do not bear legends restricting their transferand are not entitled to certain registration rights under the registrationrights agreement.  The new notes evidencethe same debt as the old notes and the new notes and the old notes are governedby the same indenture.  Hercules did notreceive any proceeds from the exchange offer. All of the old notes have been exchanged for the new notes.  Proceeds from the private placement were usedin combination with proceeds from the refinancing of the Senior Credit Facilityto fully redeem the TOPrS (see Note g).

 

(f)            The convertiblesubordinated debentures are convertible into common stock at $14.90 per shareand are redeemable at the option of the Company at varying rates.  The annual sinking fund requirement of $5million, beginning in 1996, has been satisfied through conversions ofdebentures.

 

(g)         The 9.42% juniorsubordinated deferrable interest debentures due 2029 (the “9.42% debentures”)were issued to Hercules Trust I (“Trust I”), a subsidiary trust established in1999. Trust I had issued, in an underwritten public offering, an identicalamount of 9.42% preferred securities (the “TOPrS”).

 

The 6.5% junior subordinated deferrable interestdebentures due 2029 (the “6.5% debentures”) had an initial issue price of$741.46 and have a redemption price of $1,000. The 6.5% debentures were issuedto Hercules Trust II (“Trust II”), a subsidiary trust established in 1999.  Trust II had issued, in an underwrittenpublic offering, 350,000 CRESTS Units, each consisting of a 6.5% preferredsecurity of Trust II and a warrant (exercisable through 2029) to purchase23.4192 shares of the Company’s common stock. The preferred securities and the warrants were separable and wereinitially valued at $741.46 and $258.54, respectively.  The Company and Trust II accreted thedifference between the initial valuation of the 6.5% debentures and the preferredsecurities and the redemption value of $1,000 over the term of the 6.5%debentures and the preferred securities.

 

Prior to 2003, Trust I and Trust II (“Trusts”) wereconsolidated subsidiaries.  The 9.42%debentures and the 6.5% debentures payable by the Company to the Trusts and theTrusts’ investment in the 9.42% debentures and the 6.5% debentures wereeliminated in the consolidated financial statements. Therefore the consolidatedfinancial statements reflected only the TOPrS and the preferred securitycomponent of the CRESTS Units as outstanding in the mezzanine section ofthe balance sheet.

 

In 2003, the Company adopted the provisions ofStatement of Financial Accounting Standards No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity” andaccordingly reclassified the TOPrS and the preferred security components of theCRESTS Units from the mezzanine section of the Consolidated Balance Sheetsto Long-term debt.

 

During December 2003, the Company acquired46,000 CRESTS Units for $34 million in an open market purchase. The marketvalue of the preferred securities and warrant components of the CRESTS Unitsrepurchased were $27 and $7 million, respectively.  The accreted book value of the preferred securitiesand the 6.5% debentures at the time of purchase was $34 million, resulting inthe recognition of a $7 million gain. The $7 million associated with the warrants was recorded as a reductionin Additional paid-in capital.

 

At December 31, 2003, the Company adopted theprovisions of FASB Interpretation No. 46 (revised December 2003),“Consolidation of Variable Interest Entities” (“FIN 46R”).  Since the Company was not considered to bethe primary beneficiary of either Trust I or Trust II, the Trusts weredeconsolidated as of December 31, 2003. Accordingly, the 9.42% debenturesand the 6.5% debentures were no longer eliminated in consolidation and werereflected as outstanding debt in the consolidated financial statements at December 31,2003.  The indenture for the 6.5%debentures does not provide the ability for the Company to repay, redeem, ordefease the 6.5% debentures through the purchase of the CRESTS Units.  Therefore the Company’s purchase of theCRESTS Units on the open market did not reduce the outstanding balance of theCompany’s 6.5% debentures.  As a resultof the adoption of FIN 46R, the Company recorded a $5 million after-tax loss asthe cumulative effect of a change in accounting principle to defer the gainfrom the purchase of the CRESTS Units until Trust II was liquidated in recognitionthat the investment in the CRESTS Units was no longer eliminated inconsolidation.

 

47

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The Company caused Trust I to be to be dissolved andliquidated in 2004 and, in connection therewith, Trust I distributed the 9.42%debentures to the holders of the TOPrS and the TOPrS were cancelled.  The Company used a portion of the proceedsfrom the new Senior Credit Facility and the 6.75% senior subordinated notes to fullyredeem the 9.42% debentures.  As a resultof the redemption of the 9.42% debentures, the Company recognized a non-cashexpense of approximately $14 million for the write-off of unamortized debtissuance costs.

 

The Company caused Trust II to be dissolved andliquidated in December 2004 and, in connection therewith, Trust IIdistributed the 6.5% debentures to the holders of the preferred securities andthe preferred securities were cancelled. The CRESTS Units now consist of the6.5% debentures and the warrants. Accordingly the $27 million investment in the CRESTS was liquidated andoffset against the accreted value of $34 million and the $7 million deferredgain was recognized in December 2004.

 

During2003, the Board of Directors authorized the Company, from time to time, subjectto market conditions and the Company’s credit agreements and indentures, torepurchase up to $200 million of its outstanding indebtedness.  During 2003 the Company purchased $24 million(book value) of its 11.125% senior notes for $29 million and recorded a $5million loss in Other expense, net. Through September 30, 2004 the Company acquired an additional $131million (book value) of 11.125% senior notes for $157 million.  The Board terminated the unused portion ofthe initial debt repurchase program in October 2004 and authorized a new$200 million debt repurchase program. Under this new program the Company repurchased $19 million (book value)for $23 million through December 31, 2004. The Company has recognized a $30 million loss on the 2004 repurchase ofdebt and recorded a non-cash expense of $4 million for the write-off of theunamortized debt issuance costs related to the repurchased debt.  In January and March 2005, theCompany acquired an additional $14 million (book value) of the 11.125% seniornotes for $17 million.

 

AtDecember 31, 2004, Hercules had $21 million of foreign lines of credit ofwhich $20 million was unused.

 

Debtmaturities are $30 million in 2005, $9 million in 2006, $230 million in 2007,$4 million in 2008, $5 million in 2009 and $962 million thereafter.

 

**6****.****                                                              Consolidation of Variable Interest Entities**

 

In January 2003, the Financial Accounting Standards Board (“FASB”)issued FASB Interpretation No. 46, “Consolidation of Variable InterestEntities” (“FIN 46”), which is an interpretation of Accounting ResearchBulletin No. 51, “Consolidated Financial Statements” (“ARB 51”).  FIN 46 addresses the application of ARB 51 tovariable interest entities (“VIEs”), and generally requires that assets,liabilities and results of the activity of a VIE be consolidated into thefinancial statements of the enterprise that is considered the primarybeneficiary.  On December 24, 2003,the FASB issued FASB Interpretation No. 46 (revised December 2003),“Consolidation of Variable Interest Entities” (“FIN 46R”).  The Company elected to partially adopt FIN 46in the quarter ending September 30, 2003 for its VIEs that existed priorto January 31, 2003 (the Company has no VIEs created subsequent to January 31,2003).  The financial statements for theyears ended December 31, 2004 and 2003 reflect the consolidation of twojoint venture VIEs, ES FiberVisions Holdings A/S and ES FiberVisions L.P., thatwere previously accounted for using the equity method of accounting.  These entities serve as strategic globalmarketers of the Company’s bicomponent fibers. As of December 31, 2004, the fair value of the assets in thesejoint ventures was approximately $8 million and the fair values of theassociated liabilities and non-controlling interests were approximately $5million.  There are no assets of theCompany that serve as collateral for the VIEs and the creditors of the VIEshave no recourse to the general credit of the Company.

 

**7.****                                                              IncomeTaxes**

 

The domestic and foreign components of income (loss)before income taxes and equity income (loss) from continuing operations are:

 
| ** **                                                  | ** ** | **(Dollars in millions)** | ** ** |
|-------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                  | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Domestic                                                    |       | $                         | (161       | ) | $ | (69 | ) | $ | (209 | ) |
| Foreign                                                     |       | 190                       |       | 164 |   | 157 |   |
| Income  (loss) before income taxes and equity income (loss) |       | $                         | 29         |   | $ | 95 |   | $ | (52 | ) |

 

48

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The componentsof the tax provision from continuing operations are:

 
| ** **                            | ** ** | **(Dollars in millions)** | ** ** |
|---------------------------------------|------------|---------------------------|------------|
| ** **                            | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Currently  payable                    |       |                      |       |   |   |   |   |
| U.S. federal                          |       | $                         | (30        | ) | $ | (28 | ) | $ | (39 | ) |
| Foreign                               |       | 38                        |       | 40 |   | 17 |   |
| State                                 |       | 13                        |       | 1 |   | 2 |   |
| Deferred                              |       |                      |       |   |   |   |   |
| Domestic                              |       | (22                       | )          | 11 |   | 9 |   |
| Foreign                               |       | 3                         |       | (3 | ) | 8 |   |
| Provision  (benefit) for income taxes |       | $                         | 2          |   | $ | 21 |   | $ | (3 | ) |

 

The components of the net deferred taxliabilities (assets) as of December 31, 2004 and 2003 are as follows:

 
| ** **                                   | ** ** | **(Dollars in millions)** | ** ** |
|----------------------------------------------|------------|---------------------------|------------|
| ** **                                   | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Depreciation                                 |       | $                         | 106        |   | $ | 109 |   |
| Pension                                      |       | 1                         |       | 9 |   |
| Investments                                  |       | 162                       |       | 139 |   |
| Goodwill                                     |       | 53                        |       | 46 |   |
| Accrued  expenses                            |       | 4                         |       | 5 |   |
| Other                                        |       | 29                        |       | 13 |   |
| Gross  deferred tax liabilities              |       | $                         | 355        |   | $ | 321 |   |
|                                         |       |                      |       |   |   |
| Postretirement  benefits other than pensions |       | $                         | (53        | ) | $ | (58 | ) |
| Pension                                      |       | (84                       | )          | (80 | ) |
| Inventory                                    |       | (7                        | )          | (8 | ) |
| Goodwill                                     |       | (8                        | )          | (8 | ) |
| Accrued  expenses                            |       | (192                      | )          | (164 | ) |
| Loss  carryforwards                          |       | (415                      | )          | (455 | ) |
| Credit  carryforwards                        |       | (97                       | )          | (20 | ) |
| Other                                        |       | (22                       | )          | (23 | ) |
| Gross  deferred tax assets                   |       | (878                      | )          | (816 | ) |
| Valuation  allowance                         |       | 441                       |       | 444 |   |
| Net deferred  tax (assets) liabilities       |       | $                         | (82        | ) | $ | (51 | ) |

 

The provision for income taxes attributable todiscontinued operations and cumulative effect of changes in accountingprinciple is:

 
| ** **                                                | ** ** | **(Dollars in millions)** | ** ** |
|-----------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Provision on  income from discontinued operations         |       | $                         | —     |   | $ | 2 |   | $ | 21 |   |
| Provision on  loss on disposal of discontinued operations |       | —                    |       | — |   | 51 |   |
| Cumulative  effect of changes in accounting principle     |       | —                    |       | 18 |   | (4 | ) |
|                                                      |       | $                         | —     |   | $ | 20 |   | $ | 68 |   |

 

49

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The reconciliation of the U.S. statutoryincome tax rate to the effective rate from continuing operations is:

 
| ** **                                                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| U.S.  statutory income tax rate                           |       | 35       | %          | 35       | %          | 35       | %          |
| Gain on sale  of CP Kelco ApS                             |       | (33      | )          | —   |       | —   |       |
| Valuation  allowances                                     |       | (80      | )          | (3       | )          | (2       | )          |
| Tax rate  differences on subsidiary earnings              |       | (47      | )          | (9       | )          | 8        |       |
| U.S. tax on  foreign dividends and undistributed earnings |       | 25       |       | 8        |       | (4       | )          |
| State taxes                                               |       | 37       |       | 1        |       | (4       | )          |
| Reserves                                                  |       | 74       |       | —   |       | (30      | )          |
| Exempt  export income                                     |       | (7       | )          | (2       | )          | 3        |       |
| Intellectual  property                                    |       | —   |       | (9       | )          | —   |       |
| Other                                                     |       | 3        |       | 1        |       | —   |       |
| Effective  tax rate                                       |       | 7        | %          | 22       | %          | 6        | %          |

 

Loss carryforwards include both net operating losscarryforwards and capital loss carryforwards. At December 31, 2004, the tax effect of such carryforwardsapproximated $415 million.  Of thisamount, $258 million are domestic capital loss carryforwards that expire in2007 for which full valuation allowances have been established.  State net operating loss carryforwardsapproximate $140 million, with expiration dates ranging from 2005 to 2024, forwhich full valuation allowances have been established.  Foreign net operating loss carryforwardsapproximate $17 million and are offset by valuation allowances of $8million.  Some of these foreign netoperating loss carryforwards expire as early as 2005 and others have expirationdates that are indefinite in nature.  Thetax effect of credit carryforwards approximated $97 million at December 31,2004, with expiration dates ranging from 2009 to 2023, for which no valuationallowances have been established.

 

The Company provides taxes on undistributed earningsof subsidiaries and affiliates to the extent such earnings are planned to beremitted and not permanently reinvested. The undistributed earnings of subsidiaries and affiliates on which noprovision for foreign withholding or U.S. income taxes has been made amountedto approximately $150 million and $195 million at December 31, 2004 and2003, respectively.  U.S. and foreignincome taxes that would be payable if such earnings were distributed may belower than the amount computed at the U.S. statutory rate because of theavailability of tax credits.

 

**8.****                                                             ****Pensionand Other Postretirement Benefits**

 

The Company provides defined benefit pensionplans and postretirement benefit plans to most U.S. employees and some foreignemployees.  Coverage is subject to theiremployment date and other eligibility requirements.  In June 2004, the Board of Directorsapproved an amendment changing the U.S. defined benefit pension plan (“U.S.Plan”) from a “final pay” plan to a “career average pay plan” effective January 1,2005.  In addition, new hires after December 31,2004 are not eligible to participate in the U.S. defined benefit plan.  The effect of this amendment was recognizedbeginning August 1, 2004.  Theforeign plans provide benefits based on years of service and final averagesalary, except for the United Kingdom (“U.K.”) plan which has been amended tochange it to a career average pay plan effective January 1, 2005.

 

Assetsof the defined benefit plans are invested in U.S. and international equitysecurities; U.S. and international fixed income securities and variousderivative and money market securities. The assets of the U.S., the U.K. and the Netherlands defined benefitplans constitute approximately 83%, 4% and 11%, respectively, of the totaldefined benefit plan assets at December 31, 2004 for plans sponsored bythe Company.  The projected benefitobligations of the U.S., the U.K. and the Netherlands defined benefit plansconstitute approximately 81%, 5% and 10%, respectively, of the total projectedbenefit obligations at December 31, 2004 for plans sponsored by theCompany.  The Company also has anunfunded defined benefit pension plan in Germany, with a projected benefitobligation of $38 million at December 31, 2004.

 

TheCompany uses a measurement date of December 31 for all material definedbenefit pension and other postretirement benefit plans.

 

50

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The followingtable sets forth the changes in benefit obligations, plan assets, the fundedstatus of the plans and the amounts recognized in the consolidated financialstatements for the Company’s defined benefit pension and other postretirementbenefit plans. 

 
| ** **                                     | ** ** | **(Dollars in millions)** | ** ** |
|------------------------------------------------|------------|---------------------------|------------|
| ** **                                     | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement Benefits** | ** ** |
| ** **                                     | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Change  in benefit obligation:**             |       |                      |       |   |   |   |   |   |   |
| Benefit  obligation at January 1          |       | $                         | 1,703      |   | $ | 1,528 |   | $ | 206 |   | $ | 208 |   |
| Service cost                                   |       | 19                        |       | 18 |   | 1 |   | 1 |   |
| Interest  cost                                 |       | 98                        |       | 99 |   | 10 |   | 13 |   |
| Plan  amendments                               |       | (45                       | )          | — |   | — |   | (11 | ) |
| Foreign  currency translation                  |       | 27                        |       | 39 |   | — |   | — |   |
| Actuarial  loss (gain)                         |       | 53                        |       | 133 |   | (13 | ) | 16 |   |
| Special  benefits                              |       | 1                         |       | 5 |   | — |   | — |   |
| Benefits  paid from plan assets                |       | (111                      | )          | (110 | ) | — |   | — |   |
| Benefits  paid from Company assets             |       | (6                        | )          | (9 | ) | (24 | ) | (21 | ) |
| Benefit  obligation at December 31        |       | $                         | 1,739      |   | $ | 1,703 |   | $ | 180 |   | $ | 206 |   |
| **Change  in plan assets:**                    |       |                      |       |   |   |   |   |   |   |
| Fair value  of plan assets at January 1   |       | $                         | 1,333      |   | $ | 1,139 |   | $ | — |   | $ | 1 |   |
| Actual  return on plan assets                  |       | 135                       |       | 218 |   | — |   | — |   |
| Company  contributions                         |       | 43                        |       | 55 |   | — |   | — |   |
| Participant  contributions                     |       | 1                         |       | 1 |   | — |   | — |   |
| Foreign  currency translation                  |       | 21                        |       | 30 |   | — |   | — |   |
| Benefits  paid from plan assets                |       | (111                      | )          | (110 | ) | — |   | (1 | ) |
| Fair value  of plan assets at December 31 |       | $                         | 1,422      |   | $ | 1,333 |   | $ | — |   | $ | — |   |
|                                           |       |                      |       |   |   |   |   |   |   |
| Funded  status of the plan:                    |       | $                         | (317       | ) | $ | (370 | ) | $ | (181 | ) | $ | (206 | ) |
| Unrecognized  actuarial loss                   |       | 674                       |       | 676 |   | 107 |   | 125 |   |
| Unrecognized  prior service (benefit) cost     |       | (21                       | )          | 26 |   | (31 | ) | (39 | ) |
| Unrecognized  net transition obligation        |       | 1                         |       | — |   | 1 |   | 1 |   |
| Net amount  recognized                         |       | $                         | 337        |   | $ | 332 |   | $ | (104 | ) | $ | (119 | ) |

 

51

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**Amounts recognized in the ConsolidatedStatements of Financial Position consist of:**

 
| ** **                                        | ** ** | **(Dollars in millions)** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement Benefits** | ** ** |
| ** **                                        | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Prepaid  benefit cost                             |       | $                         | 413        |   | $ | 402 |   | $ | (2 | ) | $ | — |   |
| Accrued  benefit liability                        |       | (76                       | )          | (70 | ) | (102 | ) | (119 | ) |
| Additional  minimum liability                     |       | (578                      | )          | (555 | ) | — |   | — |   |
| Intangible  asset                                 |       | 3                         |       | 23 |   | — |   | — |   |
| Accumulated  other comprehensive losses (pre-tax) |       | 575                       |       | 532 |   | — |   | — |   |
| Net amount  recognized                            |       | $                         | 337        |   | $ | 332 |   | $ | (104 | ) | $ | (119 | ) |

 

**Weighted-average assumptions used todetermine the benefit obligation at December 31, 2004 and 2003 were:**

 
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average  discount rate |       | 5.62     | %          | 5.98     | %          | 5.75     | %          | 6.10     | %          |
| Rate of  compensation increase  |       | 4.18     | %          | 4.22     | %          | 4.49     | %          | 4.49     | %          |

 
| ** **                      | ** ** | **(Dollars in millions)** | ** ** |
|---------------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement Benefits** | ** ** |
| ** **                      | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Net  periodic benefit cost:** |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Service cost                    |       | $                         | 19         |   | $ | 18 |   | $ | 18 |   | $ | 1 |   | $ | 1 |   | $ | 1 |   |
| Interest  cost                  |       | 98                        |       | 99 |   | 99 |   | 10 |   | 13 |   | 15 |   |
| Expected  return on plan assets |       | (111                      | )          | (113 | ) | (126 | ) | — |   | — |   | (1 | ) |
| Amortization  and deferrals     |       | 2                         |       | 4 |   | 6 |   | (8 | ) | (8 | ) | (5 | ) |
| Participant  contributions      |       | (1                        | )          | (1 | ) | (1 | ) | — |   | — |   | — |   |
| Special  benefits/terminations  |       | 1                         |       | 5 |   | 8 |   | — |   | — |   | — |   |
| Actuarial  losses recognized    |       | 37                        |       | 21 |   | 2 |   | 5 |   | 7 |   | 5 |   |
| Benefit cost                    |       | $                         | 45         |   | $ | 33 |   | $ | 6 |   | $ | 8 |   | $ | 13 |   | $ | 15 |   |

 

**Weighted-average assumptions used todetermine net periodic benefit cost:**

 
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average  discount rate |       | 5.98     | %          | 6.53     | %          | 6.98     | %          | 6.10     | %          | 6.75     | %          | 7.25     | %          |
| Expected  return on plan assets |       | 8.27     | %          | 8.09     | %          | 8.60     | %          | N/A      |       | N/A      |       | N/A      |       |
| Rate of  compensation increase  |       | 4.22     | %          | 4.25     | %          | 4.29     | %          | 4.49     | %          | 4.49     | %          | 4.50     | %          |

 

In 2004, theCompany made contributions to its defined benefit plans totaling $43 million,some of which were required by local funding requirements.  The Company presently anticipates makingvoluntary cash contributions to the U.S. defined benefit plan of approximately$40 million per year over the next few years. Additionally, the Company anticipates making voluntary contributions ofapproximately $5 million to its foreign defined benefit plans in 2005.

 

At December 31, 2004 the accumulatedbenefit obligation (“ABO”) of the defined benefit pension plans on aconsolidated basis was $1,667 million, of which $1,358 million related to theU.S. plan; $78 million related to the U.K. plan; $169 million related to theNetherlands plan and $37 million related to the German plan.  At December 31, 2004 and 2003, the ABOof the U.S., the U.K. the Netherlands and German defined benefit pension plansexceeded their funded benefits.  TheCompany is required to recognize an additional liability equal to the sum ofsuch excess plus the prepaid pension asset balance, with a correspondingafter-tax charge to Accumulated other comprehensive losses in stockholders’equity.  At December 31, 2002, theCompany recorded an additional minimum liability (“AML”) of $579 million(pre-tax) with an after-tax charge to Accumulated other comprehensive losses of$354 million.  At December 31, 2003,the AML decreased $24 million to $555 million (pre-tax) and accordingly, thecharge to Accumulated other comprehensive losses 

 

52

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was decreased by $13 million. For the year ended December 31, 2004, the AML increased by $23million to $578 million (pre-tax) and intangible assets were reduced by $20million, thereby increasing the charge to Accumulated other comprehensivelosses by an additional $30 million.  Asof December 31, 2004, the Consolidated Balance Sheet reflects a non-cash,after-tax charge to Accumulated other comprehensive losses of $377 million (seeNote 16).

 

**Other Postretirement Benefits**

 

Thenon-pension postretirement benefit plans include group life insurance coverageand health care reimbursement for eligible U.S., Canadian and the Netherlandsemployees.  The benefit obligation of theU.S. other postretirement benefit plan constitutes approximately 98% of theCompany’s consolidated benefit obligation at December 31, 2004 fornon-pension postretirement benefits.  Theassumed participation rate in these plans for future eligible retirees was 60%for health care and 100% for life insurance. The health care plans are contributory with participants’ contributionsadjusted annually; the life insurance plans are non-contributory for mostretirees.  The accounting for the healthcare plans anticipates future cost-sharing changes to the written plans thatare consistent with the increase in health care cost.  The postretirement health care plans includea limit on the Company’s share of costs for recent and future retirees.  As participants’ contributions are directlyapplied to claim payments, they are not included as contributions to planassets.  Employees hired after December 31,2002 are not eligible for retiree life insurance or benefits supplemental to Medicarehealth care.  The Company periodicallyobtains reimbursement for union retiree claims from a Voluntary Employees’Beneficiary Association Trust established by the Company, while other claimsare paid from Company assets.

 

The accumulated postretirement benefitobligation exceeds plan assets for all of the Company’s other postretirementbenefit plans.

 

**U. S.  Pension and Postretirement Benefit Plans**

 

The Company provides both funded and unfundednon-contributory defined benefit pension plans to substantially all of its U.S.employees.  As previously noted,employees hired after December 31, 2004 are not eligible to participate inthe U.S. defined benefit plan and effective January 1, 2005, the definedbenefit pension plan provides benefits based on years of service and careeraverage salary.  Employees hired after December 31,2002 are not eligible for retiree life insurance or benefits supplemental toMedicare health care.

 

Thefollowing tables present benefit obligations, plan assets and related informationfor the defined benefit pension and postretirement benefit plans as of December 31,2004 and 2003.

 
| ** **                              | ** ** | **(Dollars in millions)** | ** ** |
|-----------------------------------------|------------|---------------------------|------------|
| ** **                              | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement Benefits** | ** ** |
| ** **                              | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Change  in benefit obligation:**      |       |                      |       |   |   |   |   |   |   |
| Benefit  obligation at January 1   |       | $                         | 1,421      |   | $ | 1,309 |   | $ | 204 |   | $ | 207 |   |
| Service cost                            |       | 13                        |       | 12 |   | 1 |   | 1 |   |
| Interest  cost                          |       | 82                        |       | 86 |   | 10 |   | 13 |   |
| Plan  amendments                        |       | (43                       | )          | — |   | — |   | (12 | ) |
| Actuarial  loss (gain)                  |       | 43                        |       | 115 |   | (13 | ) | 16 |   |
| Special  benefits                       |       | 1                         |       | 5 |   | — |   | — |   |
| Benefits  paid from plan assets         |       | (99                       | )          | (98 | ) | — |   | — |   |
| Benefits  paid from Company assets      |       | (5                        | )          | (8 | ) | (24 | ) | (21 | ) |
| Benefit  obligation at December 31 |       | $                         | 1,413      |   | $ | 1,421 |   | $ | 178 |   | $ | 204 |   |

 

The accumulated benefit obligations for theU.S. defined benefit pension plans were $1,358 million and $1,325 million at December 31,2004 and 2003, respectively.

 

Weighted-averageassumptions used to determine the benefit obligations at December 31, 2004and 2003 were as follows:

 
| ** **                      | ** ** | **Pension Benefits** | ** ** | **Other Postretirement Benefits** | ** ** |
|---------------------------------|------------|----------------------|------------|-----------------------------------|------------|
| ** **                      | ** ** | **2004**             | ** ** | **2003**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
| Weighted-average  discount rate |       | 5.75                 | %          | 6.10                              | %          | 5.75 | % | 6.10 | % |
| Rate of  compensation increase  |       | 4.50                 | %          | 4.50                              | %          | 4.50 | % | 4.50 | % |

 

The assumedhealth care cost trend rate was 8% for the year ended December 31, 2004and 10% for the years ending December 31, 2003 and 2002.  The assumed health care cost trend rate willdecrease to 4.5% by 2009 and for subsequent

 

53

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years. A one-percentage point increase or decrease in the assumed health carecost trend rate would increase or decrease the postretirement benefitobligation by approximately $5 million and would not have a material effect onaggregate service and interest cost components.

 
| ** **                                     | ** ** | **(Dollars in millions)** | ** ** |
|------------------------------------------------|------------|---------------------------|------------|
| ** **                                     | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement  Benefits** | ** ** |
| ** **                                     | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Change in plan assets:**                     |       |                      |       |   |   |   |   |   |   |
| Fair value  of plan assets at January 1   |       | $                         | 1,115      |   | $ | 966 |   | $ | — |   | $ | 1 |   |
| Actual  return on plan assets                  |       | 120                       |       | 207 |   | — |   | — |   |
| Company  contributions                         |       | 40                        |       | 40 |   | — |   | — |   |
| Benefits  paid from plan assets                |       | (99                       | )          | (98 | ) | — |   | (1 | ) |
| Fair value  of plan assets at December 31 |       | $                         | 1,176      |   | $ | 1,115 |   | $ | — |   | $ | — |   |

 

Benefits paid from Company assets under thepostretirement benefit plans were $23 million and $21 million for 2004 and2003, respectively.

 

The assetallocation for the U.S. defined benefit pension plan at December 31, 2004and 2003 and the target allocation for 2005, by asset category, follows:  

 
| ** **           | ** ** | **Target  Allocation** | ** ** | **Percentage of Plan Assets  at December 31,** | ** ** |
|----------------------|------------|------------------------|------------|-----------------------------------------------------|------------|
| ** **           | ** ** | **2005**               | ** ** | **2004**                                            | ** ** | **2003** | ** ** |
| **Asset  category:** |       |                   |       |                                                |       |   |   |
| Equity  securities   |       | 55 - 70%               |       | 66                                                  | %          | 70 | % |
| Fixed income         |       | 20 - 35%               |       | 27                                                  | %          | 23 | % |
| Other                |       | 5 - 10%                |       | 7                                                   | %          | 7 | % |
| Totals               |       |                   |       | 100                                                 | %          | 100 | % |

 

Equitysecurities are invested in both U.S. and non- U.S. (international)companies.  U.S. equity includes thecommon stock of large, medium, and small companies that are predominantly U.S.based.  The plan did not own Herculescommon stock as of December 31, 2004; however, the plan held $7million of Hercules common stock (0.6% of total plan assets) at December 31,2003.  Non-U.S. equity represents equitysecurities issued by companies domiciled outside the U.S.  Fixed income securities include U.S. andnon-U.S. government obligations, mortgage-backed securities, collateralizedmortgage obligations and corporate debt obligations.  In 2004, Hercules increased its exposure tobelow investment grade securities, allocating 2% of the total plan assets to adedicated fixed income manager for investing in such securities.  All other fixed income portfolio managers donot hold more than 10% of the fixed income securities in debt securities thatare below investment grade.  Otherinvestments primarily include market neutral-type hedge funds.  Investment managers may employ limited use ofderivatives, including futures contracts, options on futures, and interest rateswaps in place of direct investment in securities to gain efficient exposure tomarkets.

 

The expectedlong-term rate of return on plan assets was 8.75% for both 2004 and 2003.  The overall expected long-term rate of returnon assets assumption is a function of the target asset allocation for planassets, the long-term equilibrium rate of return for the asset class, plus anincremental return attributable to the active management of plan assets.

 

In developing its investment strategy, the Companyconsidered the following factors for its pension plans: the nature and relativesize of the liabilities, the allocation of such liabilities between active andretired members, net cash flows and funded position.  The Company also considers the applicableinvestment horizon, historical and expected capital market return, and thebenefits of investment diversification.

 

The Companymanages plan assets with the primary objective of maximizing the long-terminvestment return given available market opportunities and moderate levels ofrisk consistent with the nature and purpose of the plan.  Plan assets are invested using a combinationof active and passive investment strategies. Active strategies employ multiple investment management firms.  Managers within each asset class cover arange of investment styles and approaches and are combined in a way thatcontrols market capitalization, style (growth, value, and core) and interest raterisk versus benchmark indices.  Securityselection is the primary means where value is added from activemanagement.  Risk is controlled through

 

54

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diversification among multiple asset classes,managers, styles, and securities.  Riskis further controlled both at the manager and asset class level by monitoringperformance against assigned return and variability targets.

 

The fundedstatus of the U.S. defined benefit pension and postretirement benefit plansreconciled to the amount reported in the Consolidated Statements of FinancialPosition follows:

 
| ** **                                 | ** ** | **(Dollars in millions)** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|
| ** **                                 | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement Benefits** | ** ** |
| ** **                                 | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Fair value  of plan assets                 |       | $                         | 1,176      |   | $ | 1,115 |   | $ | — |   | $ | — |   |
| Benefit  obligation                        |       | 1,413                     |       | 1,421 |   | 178 |   | 204 |   |
| Funded  status of the plan                 |       | (237                      | )          | (306 | ) | (178 | ) | (204 | ) |
| Unrecognized  actuarial loss               |       | 584                       |       | 599 |   | 107 |   | 125 |   |
| Unrecognized  prior service (benefit) cost |       | (23                       | )          | 21 |   | (31 | ) | (39 | ) |
| Net amount  recognized                     |       | $                         | 324        |   | $ | 314 |   | $ | (102 | ) | $ | (118 | ) |

 

**Amounts recognized in the ConsolidatedStatements of Financial Position consist of:**

 
| ** **                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Prepaid  benefit cost                             |       | $        | 362        |     | $          | 352      |       | $        | —     |   | $ | — |   |
| Accrued  benefit liability                        |       | (38      | )          | (38      | )          | (102     | )          | (118     | )          |
| Additional  minimum liability                     |       | (506     | )          | (524     | )          | —   |       | —   |       |
| Intangible  asset                                 |       | —   |       | 22       |       | —   |       | —   |       |
| Accumulated  other comprehensive losses (pre-tax) |       | 506      |       | 502      |       | —   |       | —   |       |
| Net amount  recognized                            |       | $        | 324        |     | $          | 314      |       | $        | (102       | ) | $ | (118 | ) |

 

At December 31, 2004 and 2003, thepension plan in the U.S. had a projected benefit obligation in excess of planassets.  The projected benefitobligation, accumulated benefit obligation and fair value of plan assets forthe pension plan in the U.S. were as follows:

 
| ** **                      | ** ** | **(Dollars in millions)** | ** ** |
|---------------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement Benefits** | ** ** |
| ** **                      | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Projected  benefit obligation   |       | $                         | 1,413      |   | $ | 1,421 |   | $ | 178 |   | $ | 204 |   |
| Accumulated  benefit obligation |       | 1,358                     |       | 1,325 |   | 178 |   | 204 |   |
| Fair value  of plan assets      |       | 1,176                     |       | 1,115 |   | — |   | — |   |
|                                 |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

Expected cash flows for the U.S.defined benefit pension and other postretirement benefit plans are as follows:

 
| ** **                                | ** ** | **(Dollars in millions)** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|
| ** **                                | ** ** | **Pension Benefits**      | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Qualified  Plan**       | ** ** | **Non-qualified  Plan** | ** ** | **Total** | ** ** | **Other Postretirement Benefits** | ** ** |
| Expected  employer contributions for 2005 |       | $                         | 40         |   | $ | — |   | $ | 40 |   | $ | — |   |
| Expected  benefit payments                |       |                      |       |   |   |   |   |   |   |
| 2005                                      |       | 84                        |       | 4 |   | 88 |   | 17 |   |
| 2006                                      |       | 83                        |       | 4 |   | 87 |   | 17 |   |
| 2007                                      |       | 82                        |       | 4 |   | 86 |   | 17 |   |
| 2008                                      |       | 82                        |       | 4 |   | 86 |   | 16 |   |
| 2009                                      |       | 83                        |       | 4 |   | 87 |   | 15 |   |
| 2010-2014                                 |       | 442                       |       | 21 |   | 463 |   | 67 |   |
|                                           |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

55

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The above table reflects the totalanticipated contributions to be made by the Company in 2005 and future benefitpayments expected to be paid from the plan or the Company’s assets, reflectingthe Company’s share of the benefit cost. Benefits expected to be paid in 2005 include $88 million in pensionbenefits and $17 million in postretirement benefits, of which $84 million isexpected to be paid from plan assets.

 
| ** **                               | ** ** | **(Dollars in millions)** | ** ** |
|------------------------------------------|------------|---------------------------|------------|
| ** **                               | ** ** | **Pension Benefits**      | ** ** | **Other Postretirement Benefits** | ** ** |
| ** **                               | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Net  periodic benefit cost (credit):** |       |                      |       |   |   |   |   |   |   |   |   |   |   |
| Service cost                             |       | $                         | 13         |   | $ | 12 |   | $ | 13 |   | $ | 1 |   | $ | 1 |   | $ | 1 |   |
| Interest  cost                           |       | 82                        |       | 86 |   | 88 |   | 10 |   | 13 |   | 14 |   |
| Expected  return on plan assets          |       | (96                       | )          | (102 | ) | (117 | ) | — |   | — |   | — |   |
| Amortization  and deferrals              |       | 1                         |       | 4 |   | 5 |   | (8 | ) | (8 | ) | (5 | ) |
| Special  benefits/terminations           |       | 1                         |       | 5 |   | 9 |   | — |   | — |   | — |   |
| Actuarial  losses recognized             |       | 34                        |       | 20 |   | 1 |   | 5 |   | 7 |   | 5 |   |
| Benefit cost  (credit)                   |       | $                         | 35         |   | $ | 25 |   | $ | (1 | ) | $ | 8 |   | $ | 13 |   | $ | 15 |   |

 

**Weighted-average assumptions used todetermine net periodic benefit cost (credit):**

 
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average  discount rate |       | 6.10     | %          | 6.75     | %          | 7.25     | %          | 6.10     | %          | 6.75     | %          | 7.25     | %          |
| Expected  return on plan assets |       | 8.75     | %          | 8.75     | %          | 9.25     | %          | N/A      |       | N/A      |       | N/A      |       |
| Rate of  compensation increase  |       | 4.50     | %          | 4.50     | %          | 4.50     | %          | 4.50     | %          | 4.50     | %          | 4.50     | %          |

 

**U.K. Defined Benefit PensionPlan**

 

TheCompany provides a defined benefit pension plan to its employees in theU.K.  As previously noted, this plan wasamended during 2004 such that, effective January 1, 2005, it will providebenefits based on years of service and career average pay.

 

Thefollowing tables present the benefit obligation, plan assets and relatedinformation for the U.K. defined benefit pension plan as of December 31,2004 and 2003.

 
| ** **                             | ** ** | **(Dollars  in millions)** | ** ** |
|----------------------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | **Pension  Benefits**      | ** ** |
| ** **                             | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| **Change in benefit obligation:**      | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Benefit obligation at January 1   |       | $                          | 69         |   | $ | 57 |   |
| Service cost                           |       | 1                          |       | 1 |   |
| Interest cost                          |       | 4                          |       | 3 |   |
| Plan amendments                        |       | (2                         | )          | — |   |
| Foreign currency translation           |       | 7                          |       | 7 |   |
| Actuarial loss                         |       | 3                          |       | 4 |   |
| Benefits paid from plan assets         |       | (3                         | )          | (3 | ) |
| Benefit obligation at December 31 |       | $                          | 79         |   | $ | 69 |   |

 

The accumulated benefit obligation for the U.K. planwas $78 million and $67 million, respectively, at December 31, 2004 and2003.

 

56

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Weighted-average assumptions used to determine thebenefit obligation at December 31, 2004 and 2003 were as follows:

 
| ** **                     | ** ** | **Pension  Benefits** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Weighted-average discount rate |       | 5.30                  | %          | 5.40 | % |
| Rate of compensation increase  |       | 2.80                  | %          | 3.70 | % |

 
| ** **                                    | ** ** | **(Dollars  in millions)** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **Pension  Benefits**      | ** ** |
| ** **                                    | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| **Change in plan assets:**                    |       |                       |       |   |   |
| Fair value of plan assets at January 1   |       | $                          | 55         |   | $ | 45 |   |
| Actual return on plan assets                  |       | 5                          |       | 4 |   |
| Company contributions                         |       | 1                          |       | 3 |   |
| Foreign currency translation                  |       | 5                          |       | 6 |   |
| Benefits paid from plan assets                |       | (3                         | )          | (3 | ) |
| Fair value of plan assets at December 31 |       | $                          | 63         |   | $ | 55 |   |

 

The assetallocation for the U.K. defined benefit pension plan at December 31, 2004and 2003 and the target allocation for 2004 by asset category follows:

 
| ** **           | ** ** | **Target**     | ** ** | **Percentage of Plan  Assets** | ** ** |
|----------------------|------------|----------------|------------|--------------------------------|------------|
| ** **           | ** ** | **Allocation** | ** ** | **at December 31,**       | ** ** |
| ** **           | ** ** | **2005**       | ** ** | **2004**                       | ** ** | **2003** | ** ** |
| **Asset  category:** |       |           |       |                           |       |   |   |
| Equity  securities   |       | 50             | %          | 51                             | %          | 50 | % |
| Fixed income         |       | 50             | %          | 49                             | %          | 50 | % |
| Totals               |       |           |       | 100                            | %          | 100 | % |

 

The target assetallocation for the U.K. pension plan is 30% U.K. equity securities, 20%non-U.K. equity securities, 37.5% U.K. government bonds (gilts) and 12.5%corporate bonds.

 

The estimatedtotal return for equity securities is 7.8% annually and assumes a 3% riskpremium over a 4.8% projected return for fixed income.  The expected long-term rate of return on planassets was 6% and 6.3% for 2004 and 2003, respectively.  The overall expected long-term rate of returnon assets assumption is a function of the target asset allocation for planassets, the long-term equilibrium rate of return for the asset class, plus anincremental return attributable to the active management of plan assets.

 

The Company’sU.K. investment policy considers the following factors in the development ofits defined benefit plan investment strategy: the nature and relative size ofthe liabilities, the allocation of such liabilities between active and retiredmembers, net cash flows and funded positions, the applicable investment horizon,historical and expected capital market returns, and the benefits of investmentdiversification.

 

The Companyinvests the assets of the plan with a Manager of Managers.  The Manager of Managers invests the plan’sassets with a broad selection of investment managers who each specialize in adifferent asset class or market.  The aimof this approach is to provide a diversified portfolio of managers tocapitalize on the perceived strengths of each manager within this structure.  The Company delegates responsibility for theselection and monitoring of the underlying investment managers to the Managerof Managers.

 

57

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The funded status of the U.K. defined benefit pensionplan reconciled to the amount reported in the Consolidated Statements ofFinancial Position follows: 

 
| ** **                      | ** ** | **(Dollars in millions)** | ** ** |
|---------------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **Pension  Benefits**     | ** ** |
| ** **                      | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Fair value of plan assets       |       | $                         | 63         |   | $ | 55 |   |
| Projected benefit obligation    |       | 79                        |       | 69 |   |
| Funded status of the plan       |       | (16                       | )          | (14 | ) |
| Unrecognized actuarial loss     |       | 34                        |       | 30 |   |
| Unrecognized prior service cost |       | (1                        | )          | 1 |   |
| Net amount recognized           |       | $                         | 17         |   | $ | 17 |   |

 

**Amountsrecognized in the Consolidated Statements of Financial Position consist of:**

 
| ** **                                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Prepaid benefit cost                             |       | $        | 17         |     | $          | 17 |   |
| Additional minimum liability                     |       | (32      | )          | (29      | )          |
| Intangible asset                                 |       | —   |       | 1        |       |
| Accumulated other comprehensive losses (pre-tax) |       | 32       |       | 28       |       |
| Net amount recognized                            |       | $        | 17         |     | $          | 17 |   |

 

At December 31,2004 and 2003, the U.K. pension plan had a projected benefit obligation in excessof plan assets.  The projected benefitobligation, accumulated benefit obligation, and fair value of plan assets forthe U.K. pension plan were as follows:

 
| ** **                     | ** ** | **(Dollars  in millions)** | ** ** |
|--------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **December 31,**      | ** ** |
| ** **                     | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| Projected benefit obligation   |       | $                          | 79         |   | $ | 69 |   |
| Accumulated benefit obligation |       | 78                         |       | 67 |   |
| Fair value of plan assets      |       | 63                         |       | 55 |   |
|                                |            |                            |            |  |  |  |  |

 

Expected cash flows for the U.K. defined benefitpension plan are as follows:

 
| ** **                               | ** ** | **(Dollars  in millions)** | ** ** |
|------------------------------------------|------------|----------------------------|------------|
| ** **                               | ** ** | **Pension  Plan Benefits** | ** ** |
| Expected employer contributions for 2005 |       | $                          | 3          |   |
| Expected benefit payments                |       |                       |       |
| 2005                                     |       | 3                          |       |
| 2006                                     |       | 3                          |       |
| 2007                                     |       | 3                          |       |
| 2008                                     |       | 3                          |       |
| 2009                                     |       | 3                          |       |
| 2010-2014                                |       | 16                         |       |
|                                          |            |                            |            |  |

 

Theabove table reflects total contributions that the Company anticipates making in2005 and the benefit payments that it expects to be paid from the plan assetsthrough the year ending 2014.

 

58

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| ** **                     | ** ** | **(Dollars  in millions)** | ** ** |
|--------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **Pension  Benefits**      | ** ** |
| ** **                     | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Net periodic benefit cost:** |       |                       |       |   |   |   |   |
| Service cost                   |       | $                          | 1          |   | $ | 1 |   | $ | 1 |   |
| Interest cost                  |       | 4                          |       | 3 |   | 3 |   |
| Expected return on plan assets |       | (3                         | )          | (3 | ) | (3 | ) |
| Actuarial losses recognized    |       | 1                          |       | 1 |   | 1 |   |
| Benefit cost                   |       | $                          | 3          |   | $ | 2 |   | $ | 2 |   |

 

**Weighted-average assumptionsused to determine net periodic benefit cost:**

 
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average  discount rate |       | 5.40     | %          | 5.50     | %          | 5.50     | %          |
| Expected  return on plan assets |       | 6.00     | %          | 6.30     | %          | 6.30     | %          |
| Rate of  compensation increase  |       | 3.70     | %          | 3.50     | %          | 3.50     | %          |

 

**Netherlands Defined BenefitPension Plan**

 

The Company provides a defined benefitpension plan to its employees in the Netherlands.  The following tables present benefitobligation, plan assets and related information for the Netherlands definedbenefit pension plan as of December 31, 2004 and 2003.

 
| ** **                             | ** ** | **(Dollars in millions)** | ** ** |
|----------------------------------------|------------|---------------------------|------------|
| ** **                             | ** ** | **Pension Benefits**      | ** ** |
| ** **                             | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| **Changes  in benefit obligation:**    |       |                      |       |   |   |
| Benefit obligation at January 1   |       | $                         | 154        |   | $ | 114 |   |
| Service cost                           |       | 3                         |       | 3 |   |
| Interest cost                          |       | 8                         |       | 7 |   |
| Foreign currency translation           |       | 15                        |       | 25 |   |
| Actuarial loss                         |       | 7                         |       | 12 |   |
| Benefits paid from plan assets         |       | (8                        | )          | (7 | ) |
| Benefit obligation at December 31 |       | $                         | 179        |   | $ | 154 |   |

 

The accumulated benefit obligation for the Netherlandsplan was $169 million and $141 million, respectively, at December 31, 2004and 2003.

 

Weighted-average assumptions used to determine thebenefit obligation at December 31, 2004 and 2003 were:

 
| ** **                     | ** ** | **Pension  Benefits** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Weighted-average discount rate |       | 4.85                  | %          | 5.25 | % |
| Rate of compensation increase  |       | 2.25                  | %          | 2.50 | % |

 

59

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| ** **                                    | ** ** | **(Dollars  in millions)** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|
| ** **                                    | ** ** | **Pension  Benefits**      | ** ** |
| ** **                                    | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| **Change in plan assets:**                    |       |                       |       |   |   |
| Fair value of plan assets at January 1   |       | $                          | 141        |   | $ | 110 |   |
| Actual return on plan assets                  |       | 10                         |       | 4 |   |
| Expenses                                      |       | —                     |       | (1 | ) |
| Company contributions                         |       | 2                          |       | 12 |   |
| Participant contributions                     |       | 1                          |       | 1 |   |
| Foreign currency translation                  |       | 13                         |       | 22 |   |
| Benefits paid from plan assets                |       | (8                         | )          | (7 | ) |
| Fair value of plan assets at December 31 |       | $                          | 159        |   | $ | 141 |   |

 

The asset allocation for the Company’s defined benefitpension plan in the Netherlands at December 31, 2004 and 2003 and thetarget allocation for 2004 by asset category follows:

 
| ** **           | ** ** | **Target  Allocation** | ** ** | **Percentage of Plan  Assets  at December 31,** | ** ** |
|----------------------|------------|------------------------|------------|------------------------------------------------------|------------|
| ** **           | ** ** | **2005**               | ** ** | **2004**                                             | ** ** | **2003** | ** ** |
| **Asset  category:** |       |                   |       |                                                 |       |   |   |
| Equity  securities   |       | 58                     | %          | 60                                                   | %          | 59 | % |
| Fixed income         |       | 42                     | %          | 39                                                   | %          | 41 | % |
| Other                |       |                   |       | 1                                                    | %          | — |   |
| Totals               |       |                   |       | 100                                                  | %          | 100 | % |

 

The plan’s long-term target asset allocation is 58%global equity securities which are actively managed and 42% fixed incomeinvestments (debt and debt-like securities, including preferredsecurities).  The fixed income securities are denominatedin Euro and are issued and/or guaranteed by European Monetary Union governments(mainly Belgium, Germany, France, Italy and The Netherlands).  The fixed income manager may invest on atactical basis in investment grade corporate bonds denominated in Euro.  Investment managers may employ limited use ofderivatives, including futures contracts, options on futures, and interest rateswaps in place of direct investment in securities to gain efficient exposure tomarkets.  Derivatives are not used toleverage portfolios.

 

The expected long-term rate of return on plan assetswas 6.8% in 2004 and 6.5% in 2003.  Theoverall expected long-term rate of return on assets assumption is a function ofthe target asset allocation for plan assets, the long-term equilibrium rate ofreturn for the asset class, plus an incremental return attributable to theactive management of plan assets. The annual estimated total return for equities is 8.0%; the annualestimated total return for Euro bonds is 5.0%.

 

In developing an investmentstrategy, the Company has considered the following factors: the nature of theplan’s liabilities, the allocation of such liabilities between active membersand retired members, the funded position of the plan, the net cash flow of theplan, the investment horizon of the plan, the size of the plan, historical andexpected capital market returns and the benefits of investment diversification.

 

The Company manages theassets with the primary objective of maximizing the long-term investment returngiven available market opportunities and moderate levels of risk consistentwith the nature and purpose of the plan. To achieve the stated investment objectives, the Company, from time totime, reviews and confirms the following assertions: that plan assets are fullyinvested in the capital markets; that equity investments provide greaterlong-term returns than fixed income investments, although with greatershort-term volatility; that prudent diversification across major asset classesprovides the potential for enhanced long-term returns and decreased portfoliorisk; that investment managers with active mandates can reduce portfolio riskbelow market risk and potentially add value through security selectionstrategies; that it is appropriate to retain multiple investment managersprovided that such managers offer asset class or style diversification; andthat the investment performance of the portfolio, the various asset classes andthe individual investment managers be reviewed regularly against policyobjectives.

 

60

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The funded status of the plan reconciled to the amountreported in the Consolidated Statements of Financial Position follows:

 
| ** **                      | ** ** | **(Dollars  in millions)** | ** ** |
|---------------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | **Pension  Benefits**      | ** ** |
| ** **                      | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| Fair value of plan assets       |       | $                          | 159        |   | $ | 141 |   |
| Projected benefit obligation    |       | 179                        |       | 154 |   |
| Funded status of the plan       |       | (20                        | )          | (13 | ) |
| Unrecognized actuarial loss     |       | 47                         |       | 38 |   |
| Unrecognized prior service cost |       | 3                          |       | 3 |   |
| Net amount recognized           |       | $                          | 30         |   | $ | 28 |   |

 

**Amountsrecognized in the Consolidated Statements of Financial Position consist of:**

 
| ** **                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Prepaid benefit cost                   |       | $        | 30         |     | $          | 28 |   |
| Additional minimum liability           |       | (39      | )          | —   |       |
| Intangible asset                       |       | 3        |       | —   |       |
| Accumulated other comprehensive losses |       | 36       |       | —   |       |
| Net amount recognized                  |       | $        | 30         |     | $          | 28 |   |
|                                        |            |          |            |          |            |  |  |  |  |

 

At December 31,2004 and 2003, the pension plan in the Netherlands had a projected benefitobligation in excess of plan assets.  Theprojected benefit obligation, accumulated benefit obligation and fair value ofplan assets for the pension plan in the Netherlands were as follows:

 
| ** **                     | ** ** | **(Dollars  in millions)** | ** ** |
|--------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **December 31,**      | ** ** |
| ** **                     | ** ** | **2004**                   | ** ** | **2003** | ** ** |
| Projected benefit obligation   |       | $                          | 179        |   | $ | 154 |   |
| Accumulated benefit obligation |       | 169                        |       | 141 |   |
| Fair value of plan assets      |       | 159                        |       | 141 |   |
|                                |            |                            |            |  |  |  |  |

 

Expected cash flows for the Netherlands definedbenefit pension plan are as follows:

 
| ** **                               | ** ** | **(Dollars  in millions)** | ** ** |
|------------------------------------------|------------|----------------------------|------------|
| ** **                               | ** ** | **Pension  Plan Benefits** | ** ** |
| Expected employer contributions for 2005 |       | $                          | 4          |   |
| Expected benefit payments:               |       |                       |       |
| 2005                                     |       | 8                          |       |
| 2006                                     |       | 9                          |       |
| 2007                                     |       | 10                         |       |
| 2008                                     |       | 10                         |       |
| 2009                                     |       | 10                         |       |
| 2010-2014                                |       | 62                         |       |
|                                          |            |                            |            |  |

 

Theabove table reflects total contributions that the Company anticipates making in2005 and benefits expected to be paid from plan assets through the year ending2014.

 

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| ** **                     | ** ** | **(Dollars  in millions)** | ** ** |
|--------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | **Pension  Plan Benefits** | ** ** |
| ** **                     | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Net periodic benefit cost**  |       |                       |       |   |   |   |   |
| Service cost                   |       | $                          | 3          |   | $ | 3 |   | $ | 3 |   |
| Interest cost                  |       | 8                          |       | 7 |   | 5 |   |
| Plan participant contribution  |       | (1                         | )          | — |   | — |   |
| Actuarial losses recognized    |       | 2                          |       | — |   | — |   |
| Expected return on plan assets |       | (10                        | )          | (8 | ) | (5 | ) |
| Amortization and deferrals     |       | 1                          |       | 1 |   | 1 |   |
| Benefit Cost                   |       | $                          | 3          |   | $ | 3 |   | $ | 4 |   |

 

**Weighted-average assumptions used todetermine net periodic benefit cost:**

 
| ** **                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted-average discount rate |       | 5.25     | %          | 5.50     | %          | 5.75     | %          |
| Expected return on plan assets |       | 6.80     | %          | 6.50     | %          | 6.00     | %          |
| Rate of compensation increase  |       | 2.50     | %          | 3.00     | %          | 3.00     | %          |

 

**9.****                                                             ****Savingsand Investment Plan**

 

Effective March 1,2002, the BetzDearborn Inc. Employee Stock Ownership and 401(k) Plan was mergedinto the Hercules Incorporated Savings and Investment Plan (“SIP Plan”).  On April 29, 2002, the Company used aportion of the proceeds from the sale of the BetzDearborn Water TreatmentBusiness to fully prepay the long-term third party debt (“ESOP creditfacility”) held by the ESOP trust. Concurrent with the prepayment of the ESOP credit facility, the trustborrowed $75 million from the Company under an existing loan agreement.  At December 31, 2004 and 2003, the ESOPtrust had $51 million and $65 million in long-term debt outstanding,respectively, under the loan agreement; the Company has an offsettingreceivable in each year, which are eliminated upon consolidation.  The Company recognized $24 million inprepayment penalties in 2002 as a result of the prepayment of the ESOP creditfacility.

 

Under the provisions of the SIP Plan,employees may invest 1% to 50% of eligible compensation subject to certainlimitations.  The Company’s matchingcontributions, made in the form of Hercules’ common stock contributed through theESOP, are equal to 50% of the first 6% of the employee’s contributedcompensation and vest immediately. Effective December 31, 2003, the Company changed its method ofaccounting for the ESOP to the method prescribed by SOP 93-6.  Under SOP 93-6, shares used to fulfill theCompany’s matching contribution are released at the fair market value of thoseshares in the period in which they are allocated.  The pre-tax difference between cost and fairmarket value of these allocated shares, which was $8 million, $8 million and $7million for the years ended December 31, 2004, 2003 and 2002,respectively, is recorded in additional paid-in capital.  The unallocated shares held by the trust arereflected in Unearned compensation as a reduction inStockholders’ equity on the balance sheet of $66 million and $80 million at December 31,2004 and 2003, respectively.  Theunallocated shares have a cost basis of $31.625 per share.

 
| ** **                       | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|
| Allocated                        |       | 1,464,530 |       | 1,594,739 |       |
| Unallocated                      |       | 2,099,176 |       | 2,520,433 |       |
| Total shares  held by ESOP trust |       | 3,563,706 |       | 4,115,172 |       |

 

The Company’s SIP related expense was approximately $4million for each of the years ended December 31, 2004, 2003 and 2002.

 

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**10.****                                                       Long-termIncentive Compensation Plans**

 

The Company’s long-term incentive compensation plansprovide for the grant of stock options and the award of common stock and othermarket-based units to certain key employees and non-employee directors.  Restricted stock and other market-based unitsare awarded with respect to certain programs. During the restriction period, award holders have the rights ofstockholders, including the right to vote and receive cash dividends, but theycannot transfer ownership and nonvested shares are subject to forfeiture.  TheCompany did not grant any stock options covered by SFAS 123, as amended by SFAS148, to employees in 2004 and 2003. During 2004 and 2003, the Company granted 21,000 options to itsnon-employee directors and expensed $0.1 million in each year as the fair valueof these stock options.  Restricted stock awards under the HerculesLong-term Incentive Compensation Plan are recorded at the quoted market price(fair value) of the Company’s stock on the grant date (measurement date).  The number of awarded sharesoutstanding was 2,119,380 at December 2004, 1,299,214 at December 31,2003 and 351,937 at December 31, 2002.

 

At December 31, 2004, under the Company’sincentive compensation plans, 3,396,668 shares of common stock were availablefor grant as stock awards or stock option awards.  Stock awards are limited to approximately 15%of the total authorizations.  Regularstock options are granted at the market price on the date of grant and areexercisable at various periods from one to five years after date of grant.  Performance-accelerated stock options arealso granted at the market price on the date of grant and are normallyexercisable at nine and one-half years. Exercisability may be accelerated based upon the achievement of predeterminedperformance goals.  Both regular andperformance-accelerated stock options expire 10 years after the date of grant.

 

Restricted shares, stock options andperformance-accelerated stock options are forfeited and revert to the Companyin the event of employment termination, except in the case of death,disability, retirement, or other specified events.

 

The Company recognized $3 million, $4 million and $1million of expense in 2004, 2003, and 2002, respectively, in connection withrestricted stock awards.

 

Below is a summary of outstanding stock option grantsunder the incentive compensation plans during 2002, 2003 and 2004:

 
| ** **              | ** ** | **Regular**           | ** ** | **Performance-Accelerated** | ** ** |
|-------------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **              | ** ** | **Number of  Shares** | ** ** | **Weighted-average  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted-average  Price** | ** ** |
| December 31,  2001 |       | 13,248,798            |       | $                           | 27.51      |   | 5,767,325 |   | $ | 44.42 |   |
| Granted                 |       | 2,031,699             |       | 11.88                       |       | — |   | — |   |
| Exercised               |       | (4,275                | )          | 11.28                       |       | — |   | — |   |
| Forfeited               |       | (2,068,588            | )          | 26.91                       |       | (578,400 | ) | 49.00 |   |
| December 31,  2002 |       | 13,207,634            |       | $                           | 25.21      |   | 5,188,925 |   | $ | 43.91 |   |
| Granted                 |       | 21,000                |       | 10.09                       |       | — |   | — |   |
| Exercised               |       | —                |       | —                      |       | — |   | — |   |
| Forfeited               |       | (922,075              | )          | 32.34                       |       | (409,225 | ) | 46.77 |   |
| December 31,  2003 |       | 12,306,559            |       | $                           | 24.47      |   | 4,779,700 |   | $ | 43.66 |   |
| Granted                 |       | 21,000                |       | 14.25                       |       | — |   | — |   |
| Exercised               |       | (402,855              | )          | 11.48                       |       | — |   | — |   |
| Forfeited               |       | (886,820              | )          | 33.19                       |       | (963,725 | ) | 38.25 |   |
| December 31,  2004 |       | 11,037,884            |       | $                           | 24.22      |   | 3,815,975 |   | $ | 45.03 |   |

 

The fair value of regular stock options granted during2004, 2003 and 2002 using the Black-Scholes option pricing model was $5.38,$4.67 and $5.09, respectively.  Therewere no performance-accelerated stock options granted during 2004, 2003 or2002.

 

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Following is a summary of regular stock optionsexercisable at December 31, 2004, 2003 and 2002, and their respectiveweighted-average share prices:

 
| ** **              | ** ** | **Number of** | ** ** | **Weighted-average** | ** ** |
|-------------------------|------------|---------------|------------|----------------------|------------|
| **Options Exercisable** | ** ** | **Shares**    | ** ** | **Exercise Price**   | ** ** |
| December 31,  2004 |       | 10,793,876    |       | $                    | 24.50      |   |
| December 31,  2003 |       | 10,973,895    |       | $                    | 26.09      |   |
| December 31,  2002 |       | 9,150,134     |       | $                    | 31.05      |   |

 

At December 31, 2004, 2003 and 2002,respectively, there were no performance-accelerated stock optionsexercisable.  Following is a summary ofstock options outstanding at December 31, 2004:

 
| ** **                             | ** ** | **Outstanding Options**                | ** ** | ** **                               | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | ** **                             | ** ** | **Weighted-**                            | ** ** | **Weighted-** | ** ** | **Exercisable Options** | ** ** |
| ** **                             | ** ** | **Number  Outstanding at  12/31/2004** | ** ** | **average  Remaining  Contractual Life** | ** ** | **average  Exercise  Price** | ** ** | **Number  Exercisable  12/31/2004** | ** ** | **Weighted-  average  Exercise Price** | ** ** |
| Regular  Stock Options                 |       |                                   |       |                                     |       |   |   |   |   |   |   |
| $8.50 - $11.75                         |       | 1,167,075                              |       | 6.73                                     |       | $ | 11.20 |   | 1,159,075 |   | $ | 11.21 |   |
| $11.76 - $15.00                        |       | 3,087,624                              |       | 6.95                                     |       | $ | 11.99 |   | 2,851,616 |   | $ | 11.98 |   |
| $15.01 - $22.50                        |       | 1,767,525                              |       | 5.15                                     |       | $ | 17.16 |   | 1,767,525 |   | $ | 17.16 |   |
| $22.51 - $33.75                        |       | 1,466,975                              |       | 3.69                                     |       | $ | 25.89 |   | 1,466,975 |   | $ | 25.89 |   |
| $33.76 - $40.00                        |       | 2,422,560                              |       | 3.53                                     |       | $ | 38.43 |   | 2,422,560 |   | $ | 38.43 |   |
| $40.01 - $60.00                        |       | 1,126,125                              |       | 2.06                                     |       | $ | 49.63 |   | 1,126,125 |   | $ | 49.63 |   |
|                                   |       | 11,037,884                             |       |                                     |       |   |   | 10,793,876 |   |   |   |
| Performance-Accelerated  Stock Options |       |                                   |       |                                     |       |   |   |   |   |   |   |
| $24.00 - $36.00                        |       | 131,400                                |       | 4.70                                     |       | $ | 29.02 |   | — |   | — |   |
| $36.01 - $45.00                        |       | 999,430                                |       | 3.69                                     |       | $ | 38.21 |   | — |   | — |   |
| $45.01 - $50.00                        |       | 2,287,845                              |       | 1.92                                     |       | $ | 47.05 |   | — |   | — |   |
| $50.01 - $61.00                        |       | 397,300                                |       | 1.04                                     |       | $ | 55.88 |   | — |   | — |   |
|                                   |       | 3,815,975                              |       |                                     |       |   |   | — |   |   |   |

 

The Company’s Employee Stock Purchase Plan wasoriginally a qualified non-compensatory plan, which allowed eligible employeesto acquire shares of common stock through systematic payroll deductions.  The plan was converted to a non-qualifiedemployee stock purchase plan in 2001 and the shares were funded from treasurystock.  The plan consisted of three-monthsubscription periods, beginning July 1 of each year.  The purchase price was 85% of the fair marketvalue of the common stock on either the first or last day of that subscriptionperiod, whichever was lower (the “look-back”). Purchases ranged from 2% to 15% of an employee’s base salary each payperiod, subject to certain limitations. Shares issued at December 31, 2001 under the qualified plan were1,758,081.  The shares issued under thenon-qualified plan totaled 875,236 at December 31, 2004.  Pursuant to SFAS 123, the look-backconstituted a stock option.  The Companyestimated and expensed the value of the option for the applicable subscriptionperiod using the Black-Scholes option pricing model.  The expense attributable to the look-backprovision was not significant.  The 15%discount on the purchase price of the common stock was recognized ascompensation expense for the non-qualified Employee Stock Purchase Plan.  The plan was terminated effective April 1,2004.

 

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The following weighted-average assumptions are used indetermining the fair value of stock options and shares awarded under theEmployee Stock Purchase Plan for 2004, 2003 and 2002:

 
| ** **               | ** ** | **Regular Plan** | ** ** | **Employee Stock  Purchase Plan** | ** ** |
|--------------------------|------------|------------------|------------|-----------------------------------|------------|
| 2004  Assumptions        |       |             |       |                              |       |
| Dividend  yield          |       | 0.00%            |       | 0.00%                             |       |
| Risk-free  interest rate |       | 3.73%            |       | 1.00%                             |       |
| Expected  life           |       | 6 yrs.           |       | 3 mos.                            |       |
| Expected  volatility     |       | 31.22%           |       | 32.90%                            |       |
|                     |       |             |       |                              |       |
| 2003  Assumptions        |       |             |       |                              |       |
| Dividend  yield          |       | 0.00%            |       | 0.00%                             |       |
| Risk-free  interest rate |       | 3.54%            |       | 1.00%                             |       |
| Expected  life           |       | 6 yrs.           |       | 3 mos.                            |       |
| Expected  volatility     |       | 42.79%           |       | 35.88%                            |       |
|                     |       |             |       |                              |       |
| 2002  Assumptions        |       |             |       |                              |       |
| Dividend  yield          |       | 0.00%            |       | 0.00%                             |       |
| Risk-free  interest rate |       | 4.97%            |       | 1.65%                             |       |
| Expected  life           |       | 6 yrs.           |       | 3 mos.                            |       |
| Expected volatility      |       | 34.60%           |       | 41.97%                            |       |

 

The pro forma effect on net income (loss) and earnings(loss) per share, assuming the Company had applied the fair value recognitionprovisions of SFAS 123 to stock-based employee compensation for all yearsreported, is presented in the Summary of Significant Accounting Policies.

 

**11****.****                                                       Asset Retirement Obligations**

 

Effective January 1, 2003, the Company adopted Statement ofFinancial Accounting Standards No. 143, “Accounting for Asset RetirementObligations” (“SFAS 143”).  SFAS 143establishes accounting and reporting standards for the recognition andmeasurement of legal obligations associated with the retirement of tangiblelong-lived assets.  SFAS 143 requiresthat the fair value of an asset retirement obligation be recorded whenincurred.  Included within the scope ofSFAS 143 are environmental remediation liabilities that resulted from thenormal operation of a long-lived asset. The Company has a number of environmental remediation liabilitiesassociated with current and former operations that were incurred during thecourse of normal operations.  The mostsignificant differences in the measurement of these obligations under SFAS 143are outlined below:

 

**Recording of Full Obligation**

 

SFAS 143 requires that the fair value of an assetretirement obligation be recorded when it is incurred if a reasonable estimateof fair value can be made.  Under SFAS143, uncertainties (probability) in the amount and timing of settlement areincorporated into the fair value measure of the recognized liability, whereasunder Statement of Financial Accounting Standards No. 5, “Accounting forContingencies,” and FASB Interpretation 14, “Reasonable Estimation of theAmount of a Loss,” uncertainties are considered in determining recognition of aliability.

 

**Present Value of Obligation**

 

SFAS 143 requires that the fair value of theasset retirement obligation be discounted using a credit adjusted risk-freerate.

 

**Capitalization of Costs Related toEnvironmental Contamination**

 

SFAS 143 requires capitalization of costs asa component of fixed assets to the extent there is a corresponding operatingasset.  Emerging Issues Task Force IssueNo. 90-8, “Capitalization of Costs to Treat Environmental Contamination,”permitted capitalization of environmental remediation costs incurred inpreparing a property for sale.

 

65

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Effective with the adoption of SFAS 143 on January 1, 2003, theCompany recorded an increase to its environmental remediation liabilities of$28 million with a corresponding increase to property, plant, and equipment of$2 million and a decrease in capitalized environmental remediation costs of $18million, resulting in an after-tax charge of $28 million ($44 million on apre-tax basis), or $0.26 per share, as a cumulative effect of a change inaccounting principle.

 

The following table provides a reconciliation of the changes in theasset retirement obligations during the period.

 
| ** **                          | ** ** | ** **                          | ** ** | **Environmental Remediation  Liabilities** | ** ** |
|-------------------------------------|------------|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **Capitalized  Remediation  Costs** | ** ** | **SFAS 143  ARO  Sites**                   | ** ** | **Non-SFAS  143 sites** | ** ** | **Total  Accrued  Liability** | ** ** |
| Balance January 1,  2003       |       | $                                   | (18        | )                                          | $          | 85 |   | $ | 3 |   | $ | 88 |   |
| Adoption of  SFAS 143:              |       |                                |       |                                       |       |   |   |   |   |
| Cumulative  effect adjustment       |       | 18                                  |       | 26                                         |       | — |   | 26 |   |
| Capitalized  Retirement Obligations |       | —                              |       | 2                                          |       | — |   | 2 |   |
| Liabilities  Settled                |       | —                              |       | (12                                        | )          | — |   | (12 | ) |
| Accretion                           |       | —                              |       | 2                                          |       | — |   | 2 |   |
| Balance December 31,  2003     |       | $                                   | —     |                                       | $          | 103 |   | $ | 3 |   | $ | 106 |   |
| Liabilities  Settled                |       | —                              |       | (9                                         | )          | — |   | (9 | ) |
| Accretion                           |       | —                              |       | 2                                          |       | — |   | 2 |   |
| Balance December 31,  2004     |       | $                                   | —     |                                       | $          | 96 |   | $ | 3 |   | $ | 99 |   |

 

**12.****                                                       Commitmentsand Contingencies**

 

**Guarantees**

 

In accordance with FASB Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others” (“FIN 45”), disclosures abouteach group of similar guarantees are provided below:

 

**Indemnifications**

 

In connection with the sale of the Company assets andbusinesses, the Company has indemnified respective buyers against certainliabilities that may arise in connection with the sales transactions andbusiness activities prior to the ultimate closing of the sale.  These indemnifications typically pertain toenvironmental, tax, employee and/or product related matters.  If the indemnified party were to incur aliability or have a liability increase as a result of a successful claim,pursuant to the terms of the indemnification, the Company would be required toreimburse the buyer.  Theseindemnifications are generally subject to threshold amounts, specified claimperiods and other restrictions and limitations. As of December 31, 2004, the Company has recorded indemnificationstotaling $40 million.  Although it isreasonably possible that future payments may exceed amounts accrued, due to thenature of indemnified items, it is not possible to make a reasonable estimateof the maximum potential loss or range of loss. Generally, there are no specific recourse provisions.  Approximately $1 million in cash is held inescrow or collateral.

 

In addition, the Company provides certainindemnifications in the ordinary course of business such as product, patent andperformance warranties in connection with the manufacture, distribution andsale of its products and services.  Dueto the nature of these indemnities, it is not possible to make a reasonableestimate of the maximum potential loss or range of loss.

 

**Debt Obligations**

 

The Company has directly guaranteed up to $44million of various obligations under agreements with third parties related tosubsidiaries and affiliates of which $28 million is outstanding.  The outstanding balance reflects guaranteesof $18 million related to the debt of FiberVisions A/S that matures at variousdates through 2006, $3 million related to the debt of Shanghai HerculesChemical that expires in 2005, $5 million related to a foreign-based pensionplan with an indefinite term and $2 million related to debt obligations ofpreviously disposed operations that expire in 2007.  In addition

 

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to theaforementioned $5 million guarantee, the Company has provided approximately $3million in collateral through a mortgage security related to the $5 millionpension liability.  Existing guaranteesfor subsidiaries and affiliates arose from liquidity needs in normaloperations.  The Company also has $69million of outstanding letters of credit at December 31, 2004.  The Company will be required to perform onthese guarantees in the event of default by the guaranteed party.

 

**Intercompany Guarantees**

 

The Company and itssubsidiaries have intercompany guarantees between and among themselves whichaggregated approximately $169 million as of December 31, 2004.  These guarantees relate to intercompany loansused to facilitate normal business transactions such as the sale and purchaseof products.  All of the $169 million hasbeen eliminated in the Company’s consolidated financial statements.

 

**Leases**

 

Hercules has operating leases (including office space,transportation and data processing equipment) expiring at various dates.  Lease expense of $22 million, $25 million and$34 million in 2004, 2003 and 2002, respectively, is net of sub-lease income of$5 million, $4 million and $3 million in 2004, 2003 and 2002, respectively.

 

At December 31, 2004, minimum rental paymentsunder non-cancelable leases aggregated $173 million with offsetting subleasesof $42 million.  A significant portion ofthese payments relate to a long-term operating lease for corporate officefacilities.  The minimum payments overthe next five years, net of minimum sublease receipts, are $20 million in 2005,$18 million in 2006, $16 million in 2007, $15 million in 2008, $24 million in2009 and $38 million thereafter.

 

**Environmental**

 

In the ordinary course of its business, theCompany is subject to numerous environmental laws and regulations coveringcompliance matters or imposing liability for the costs of, and damagesresulting from, cleaning up sites, past spills, disposals and other releases ofhazardous substances.  Changes in theselaws and regulations may have a material adverse effect on the Company’sfinancial position and results of operations. Any failure by the Company to adequately comply with such laws andregulations could subject the Company to significant future liabilities.

 

Hercules has been identified as a potentiallyresponsible party (“PRP”) by U.S. federal and state authorities, or by privateparties seeking contribution for the cost of environmental investigation and/orcleanup at numerous sites.  Herculesbecomes aware of sites in which it may be named a PRP in investigatory and/orremedial activities through correspondence from the U.S. EnvironmentalProtection Agency (“EPA”) or other government agencies or from previously namedPRPs, who either request information or notify the Company of its potentialliability.  The Company has establishedprocedures for identifying environmental issues at its plant sites.  In addition to environmental audit programs,the Company has environmental coordinators who are familiar with environmentallaws and regulations and act as a resource for identifying environmentalissues.

 

The range of the reasonably possible share ofcosts for the investigation and cleanup of current and former operating sites,and other locations where the Company may have a known liability, is between$99 million and $207 million.  Inaccordance with generally accepted accounting principles, the Company hasaccrued a liability of $99 million at December 31, 2004, representing thelow end of the range, since no amount within the range is a better estimate thanany other amount.  This accrued liabilityis evaluated quarterly based on currently available information, including theprogress of remedial investigations at each site and the current status ofnegotiations with regulatory authorities regarding the method and extent ofapportionment of costs among other PRPs.

 

The actual costs for these matters willdepend upon numerous factors, including the number of parties found responsibleat each environmental site and their ability to pay; the actual methods of remediationrequired or agreed to; outcomes of negotiations with regulatory authorities;outcomes of litigation; changes in environmental laws and regulations;technological developments; and the years of remedial activity required, whichcould range from 0 to 30 or more years. While it is not feasible to predict the outcome of all pendingenvironmental matters, the ultimate resolution of one or more of theseenvironmental matters could have a material effect upon the Company’s financialposition, results of operations and/or cash flows for any annual, quarterly orother period.

 

While the Company is involved in numerousenvironmental matters, the following matters are described below because theyare currently viewed by management as potentially material to the Company’sconsolidated financial position, results of operations and cash flows.

 

United States,et al. v. Vertac Corporation, et al., USDC No.  LR-C-80-109 and LR-C-80-110 (E.D. Ark.)

 

This case, a cost-recovery action based uponthe Comprehensive Environmental Response, Compensation and Liability Act(“CERCLA”, or the Superfund statute), as well as other statutes, has beenpending since 1980, and involves

 

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liability forcosts in connection with the investigation and remediation of the VertacChemical Company (“Vertac”) site in Jacksonville, Arkansas.  Hercules owned and operated the site from December 1961until 1971.  The site was used for themanufacture of certain herbicides and, at the order of the United States, AgentOrange.  In 1971, the site was leased toVertac’s predecessor.  In 1976, Herculessold the site to Vertac.  The site wasabandoned by Vertac in 1987, and Vertac was subsequently placed intoreceivership.  Both prior to andfollowing the abandonment of the site, the EPA and the Arkansas Department ofPollution Control and Ecology (“ADPC&E”) were involved in the investigationand remediation of contamination at and around the site.  Pursuant to several orders issued underCERCLA, Hercules actively participated in many of these activities.  The cleanup is essentially complete, exceptfor certain on-going maintenance and monitoring activities.  This litigation primarily concerns theresponsibility and allocation of liability for the costs incurred in connectionwith the activities undertaken by the EPA and the ADPC&E.

 

Although the case initially involved manyparties, as a result of various United States District Court rulings anddecisions, as well as a trial, Hercules and Uniroyal were held jointly andseverally liable for the approximately $100 million in costs allegedly incurredby the EPA and ADPC&E, as well as costs to be incurred in the future.  That decision was made final by the DistrictCourt on September 13, 1999.  BothHercules and Uniroyal timely appealed that judgment to the United States Courtof Appeals for the Eighth Circuit.

 

On February 8, 2000, the District Courtissued a final judgment on the allocation between Hercules and Uniroyal findingUniroyal liable for 2.6% and Hercules liable for 97.4% of the costs atissue.  Hercules timely appealed thatjudgment.  Oral argument on both appealswas held before the Eighth Circuit on June 12, 2000.  On April 10, 2001, the United StatesCourt of Appeals for the Eighth Circuit issued an opinion in the consolidatedappeals described above.  In thatopinion, the Appeals Court reversed the District Court’s decision which hadheld Hercules jointly and severally liable for costs incurred and to be incurredat the Jacksonville site, and remanded the case back to the District Court forseveral determinations, including a determination of whether the harms at thesite giving rise to the government’s claims were divisible.  The Appeals Court also vacated the DistrictCourt’s allocation decision holding Hercules liable for 97.4% of the costs atissue, ordering that these issues be revisited following further proceedingswith respect to divisibility.  Finally,the Appeals Court affirmed the judgment of liability against Uniroyal.

 

The trial on remand commenced on October 9,2001, continued through October 19, 2001, resumed on December 11,2001 and concluded on December 14, 2001. At the trial, the Company presented both facts and law to the DistrictCourt in support of its belief that the Company should not be liable underCERCLA for some or all of the costs incurred by the government in connectionwith the site because those harms are divisible.  The District Court has not yet rendered itsdecision.  Should the Company prevail on remand, any liability to the government will be eithereliminated or reduced from the prior judgment.

 

Alleghany Ballistics Laboratory

 

The Alleghany Ballistics Laboratory (“ABL”)is a government-owned facility, which was operated by Hercules from 1945 to1995 under contract with the United States Department of the Navy.  The Navy has notified Hercules that it wouldlike to negotiate with Hercules with respect to certain environmentalliabilities which, the Navy alleges, are attributable to Hercules’ pastoperations at ABL.  During the course ofdiscussions, the Navy has stated that, pursuant to CERCLA, it has spent a totalof approximately $25 million and expects to spend an additional $44 millionover the next 10 years.  The Company hasconducted an initial investigation of the Navy’s allegations, including thebasis of the Navy’s claims, and believes the contracts with the governmentpursuant to which the Company operated ABL may provide the Company with adefense from some or all of the amounts sought. The Company has exchanged information with the Navy and anticipatesentering into negotiations with the Navy in the near future in an attempt toamicably resolve this matter without litigation.  At this time, however, the Company cannotreasonably estimate its liability, if any, with respect to ABL and,accordingly, has not included this site in the range of its environmentalliabilities reported above.

 

Kim Stan Landfill

 

Hercules is one of a limited number ofindustrial companies that have been identified by the EPA as a PRP at the KimStan Landfill, near Covington, Virginia. The EPA seeks to have the PRPs undertake the remediation of the site ata currently estimated cost of $12 million (including EPA oversight charges).  Based on the investigation conducted to date,Hercules believes that parties not named by the EPA as PRPs may be responsiblefor the majority of the costs that have been and will be incurred at the site,and Hercules intends to seek contribution from those parties to the extent itis required to pay any monies in connection with the site.  Hercules is continuing to evaluate the EPA’sallegations and, pending further factual investigation, is not able todetermine its exposure, if any, with respect to this site.

 

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**Litigation**

 

The Company is involved in litigation arisingout of or incidental to the conduct of its business.  Such litigation typically falls within thefollowing broad categories:  environmental(discussed above); antitrust; commercial; intellectual property; labor andemployment; personal injury; property damage; product liability; and toxictort.  These matters typically seekunspecified or large monetary damages or other relief.  While it is not feasible to predict theoutcome of all pending matters, the ultimate resolution of one or more of thesematters could have a material effect upon the Company’s financial position,results of operations and/or cash flows for any annual, quarterly or otherperiod.  While the Company is involved innumerous matters, the following matters are described below because they arecurrently viewed by management as potentially material.  From time to time, management may determine(based on further analysis or additional information that becomes available,through discovery or otherwise) that other matters are or have becomepotentially material to the Company.  Asappropriate, descriptions of such matters will be included in the periodicreport following such determination. Occasionally, management may not determine that a matter is materialuntil it has been settled or otherwise resolved.  In such a situation, that matter may not havebeen described in the Company’s periodic reports prior to such settlement orresolution, but the impact of such settlement or resolution would be reflectedin the financial statements included in the periodic report following suchsettlement or resolution.

 

Asbestos

 

The Company is a defendant in numerousasbestos-related personal injury lawsuits and claims which typically arise fromalleged exposure to asbestos fibers from resin encapsulated pipe and tankproducts which were sold by one of the Company’s former subsidiaries to alimited industrial market (“products claims”). The Company is also a defendant in lawsuits alleging exposure toasbestos at facilities formerly or presently owned or operated by the Company(“premises claims”).  Claims are receivedand settled or otherwise resolved on an on-going basis.

 

As of December 31, 2004, there wereapproximately 33,150 unresolved claims, of which approximately 935 werepremises claims and the rest were products claims.  There were also approximately 2,605 unpaidclaims which have been settled or are subject to the terms of a settlementagreement.  In addition, as of December 31,2004, there were approximately 3,970 claims which have either been dismissedwithout payment or are in the process of being dismissed without payment, butwith plaintiffs retaining the right to re-file should they be able to establishexposure to an asbestos-containing product for which the Company bearsliability.

 

Between January 1, 2004 and December 31,2004, the Company received approximately 8,305 new claims, approximately onethird of which were included in “consolidated” complaints naming one hundred ormore plaintiffs and a large number of defendants, but providing littleinformation connecting any specific plaintiff’s alleged injuries to anyspecific defendant’s products or premises. It is the Company’s belief that a significant majority of these “consolidated”claims will be dismissed for no payment.

 

The Company’s primary and first level excessinsurance policies that provided coverage for these asbestos-related mattersexhausted their products limits at or before the end of July 2003.  Since that time, and not taking into accountthe impact of the settlements described below, the Company has fully funded thecosts associated with the defense and settlement of its asbestos-relatedliabilities.  From January 1, 2004through December 31, 2004, the Company spent approximately $49 million onthese matters, including approximately $41 million in settlement payments andapproximately $8 million for defense costs.

 

Both prior to and following the exhaustion ofthe products limits of the Company’s primary and first level excess insurancepolicies, the Company undertook efforts to negotiate with certain of its otherexcess insurance carriers for reimbursement of defense costs and indemnitypayments relating to these asbestos-related liabilities.  Those efforts, however, did not progress at arate satisfactory to the Company.  As aresult, on November 27, 2002, the Company initiated litigation against thesolvent excess insurance carriers that provided insurance coverage forasbestos-related liabilities in a matter captioned Hercules Incorporated v.OneBeacon, et al., Civil Action No. 02C-11-237 (SCD), Superior Court ofDelaware, New Castle County.  Beginningin August 2004 and continuing through October 2004, the Companyentered into settlements with all of the insurers named in that lawsuit.  As a result, the lawsuit was dismissed inearly November 2004.

 

Specifically, effective August 23, 2004,the Company entered into a comprehensive settlement agreement with respect tothose insurance policies issued by certain underwriters at Lloyd’s, London, andreinsured by Equitas Limited and related entities (“Equitas”) (the “FirstSettlement Agreement”).  As part of thatsettlement, during the third quarter of 2004, Equitas paid $30 million tothe Company and placed $67 million into a trust.  While many of the specific terms of thatFirst Settlement Agreement are confidential, the First Settlement Agreementgenerally provides for the payment of money to the Company in exchange for therelease by the Company of past, present and future claims under those policiesand the cancellation of those policies; the agreement by the Company toindemnify the underwriters from any such claims asserted under those policies;and the impact on the settlement should federal asbestos reform legislation beenacted on or before

 

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January 3, 2007.  The trustfunds have been and are continuing to be used to reimburse the Company for aportion of costs it incurs to resolve certain asbestos claims from and after August 2004.  The Company’s ability to use any of the trustfunds, however, is subject to specified confidential criteria, as well aslimits on the amount that may be drawn from the trust in any one month. Iffederal asbestos reform legislation is enacted into law on or prior to January 3,2007, the Company will be required to return any funds remaining in the trustto Equitas should certain criteria be met.  If such legislation is not enacted by thatdate, any funds remaining in the trust will be available to the Company to payasbestos-related liabilities or to use for other corporate purposes.

 

In addition, effective October 8, 2004,the Company entered into a comprehensive settlement agreement with respect tocertain insurance policies issued by various insurance companies operating inthe London insurance market, and by one insurance company located in the UnitedStates (the “Second Settlement Agreement”). Under the terms of the Second Settlement Agreement, the Company willreceive payments from the participating insurers totaling approximately$102 million over a four-year period beginning in 2005.  The payments will be placed by the insurancecompanies into a trust. The trust funds may be used to reimburse the Companyfor costs it incurs to resolve asbestos claims from and after October 8,2004.  Any funds remaining in trustsubsequent to 2008 may be used by the Company to pay both asbestos-relatedclaims and non-asbestos related claims. As of February 28, 2005, $35 million of the $102 million was placedinto the trust.  While many of thespecific terms of the Second Settlement Agreement are confidential, the SecondSettlement Agreement generally provides for the payment of money to the Companyin exchange for the release by the Company of past, present and future claimsunder those policies and the cancellation of such policies; and the agreementby the Company to indemnify the released insurers from any such claims assertedunder those policies.  In addition, theSecond Settlement Agreement provided the United States insurer until December 28,2004 to elect an alternative payment option that would have modified thatinsurer’s payment obligations but the United States insurer did not elect toexercise that option.

 

The Company also reached settlementagreements with additional insurers whose level of participation in theCompany’s insurance program is substantially lower than the aggregateparticipation of the insurers referred to above (the “Other SettlementAgreements”).  Pursuant to the OtherSettlement Agreements, the Company has released or partially released itsrights to coverage under insurance policies issued by such insurers.  The Other Settlement Agreements originallyprovided for cash payments to be received by the Company at various timescommencing in 2004 and ending in 2011. One insurer, however, elected to pre-pay its obligations at a discountedrate.  As a result of this pre-payment,combined with amounts due in 2004 and February 2005, the Company hasreceived payments totaling approximately $22 million in full satisfaction ofamounts due under the Other Settlement Agreements.

 

In addition, effective October 13, 2004,the Company reached a confidential settlement agreement with the balance of itssolvent excess insurers whereby a significant portion of the costs incurred bythe Company with respect to future asbestos product liability claims will bereimbursed, subject to those claims meeting certain qualifying criteria (the“Future Coverage Agreement”).  Thatagreement is not expected to result in reimbursement to the Company, however,unless and until defense costs and settlement payments for qualifying asbestosproducts claims paid by the Company aggregate to approximately $330 million to$370 million, with the foregoing approximation based on various assumptions,including that there are sufficient qualifying claims to require such payments,that for such qualifying claims the time periods of each claimant’s allegedexposure to asbestos products falls within the time periods covered by theparticipating insurers’ policies, and that the participating insurers remainsolvent and honor their commitments under the terms of the Future CoverageAgreement.  The Company expects that suchamounts, if required to be paid, would be paid by the Company using monies fromthe above settlements and from other sources. If and when such amounts are paid by the Company, the insurers’obligations pursuant to the terms of the Future Coverage Agreement would be triggered,and the participating insurers would thereafter be required to pay theirallocated share of defense costs and settlement payments for asbestos productliability claims that qualify for reimbursement subject to the limits of theirinsurance policies, which limits are believed to be sufficient to cover theinsurers’ allocated shares of an amount that exceeds the high end of thereasonably possible range of financial exposure described below.  The Company will be responsible for paymentof the share of such costs and payments that are not paid by the participatinginsurers pursuant to the terms of the Future Coverage Agreement, as well as forsuch costs and payments for those claims that do not qualify for reimbursementunder the terms of the Future Coverage Agreement.  Should asbestos reform legislation be passed,some or all of the obligations under the Future Coverage Agreement will besuspended for so long as such legislation remains in effect.

 

As a result of the above settlements, theCompany is expected to have available to it a combination of cash and trustfund monies which can be used to pay or reimburse the Company for a significantportion of the defense costs and settlement payments that may be incurred bythe Company with respect to its asbestos-related liabilities.  If such liabilities exceed the total amountof the cash and trust fund monies received by the Company as a result of suchsettlements, then the Company will be required to fund such liabilities itselfuntil such time as the insurers’ obligations under the Future CoverageAgreement are triggered.  If and whenthose obligations are triggered, the Company and the insurers who areparticipants in the Future Coverage Agreement will share such costs andpayments at varying levels over time, with the

 

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Company typically bearing a slightly largershare than such participating insurers.  Of note, as a result of the First SettlementAgreement, Second Settlement Agreement and Other Settlement Agreements,substantially all of the Company’s insurance coverage applicable to asbestosproducts claims has been cancelled (except for obligations under the FutureCoverage Agreement), and such insurance coverage will no longer be available tocover any such claims.  In addition andas described above, as a result of the First Settlement Agreement, SecondSettlement Agreement and Other Settlement Agreements, substantial amounts ofinsurance coverage that would have been available to cover insured claims otherthan asbestos products claims have been cancelled and will no longer beavailable to cover such claims.

 

Based on the current number of claimspending, the amounts the Company anticipates paying to resolve those claimswhich are not dismissed or otherwise resolved without payment, and anticipatedfuture claims, the Company believes that the total monetary recovery under thesettlements noted above will cover the majority of the Company’s monetaryexposure for its current and estimated future asbestos-related liabilities.  The foregoing, however, assumes that all ofthe monies received and to be received from the settlements described abovewill be utilized only for asbestos liabilities. In fact, there are likely to be timing differences between the receiptof cash settlements and the payment of asbestos claims by the Company, and itis likely that the Company will use some of the proceeds received and to bereceived from the settlements described above for other corporatepurposes.  As a result, from a cash flowperspective, in any particular period of time, the Company may be required tofund some or all of its asbestos-related liabilities using cash flows fromoperations or sources other than the settlements described above.  Further, as monies received and to bereceived from the settlements described above are used by the Company, and asthe balance remaining on amounts yet to be received from the settlementsdescribed above decline, it is likely that there will come a time when theCompany will be responsible for payment of all or a majority of suchliabilities until such time as the obligations under the Future CoverageAgreement are triggered, at which point in time the Company is expected toshare such liabilities with the participating insurers, with it beinganticipated that the Company will typically bear a slightly larger share thanthe participating insurers.  In anyperiod of time, including after obligations under the Future Coverage Agreementare triggered, the amounts paid by the Company in connection with the defenseand settlement of asbestos claims versus the amounts funded and to be funded bysettlement monies and amounts anticipated to be reimbursed by the FutureCoverage Agreement are expected to vary significantly.  Moreover, as described in greater detailbelow, the Company’s projection of its current and estimated futureasbestos-related liabilities may change. As a result of these and other factors, although the Company believesthat the majority of its total monetary exposure will ultimately be covered bythe total monetary recovery under the settlements described above,there can be no assurance such will be the case.

 

In the fourth quarter 2003, the Companycommissioned a study of its asbestos-related liabilities by a professor at amajor national university, who is a member of the American Academy of Actuarieswith broad experience in estimating such liabilities.  Based on the results of the study, theCompany estimated that its reasonably possible financial exposure for thesematters (excluding approximately $1 million for previously settled but unpaidclaims) ranged from $220 million to $675 million at December 31,2003.  In October 2004, the sameprofessor updated the above-referenced study to take into account more currentdata concerning, among other factors, the Company’s claims and paymentexperience and, as a result, the Company’s estimated reasonably possibleexposure for these matters was revised to a range of $265 million to $800million.  Such study was updated again bysuch professor in January 2005 to take into account more current data, andthe Company’s estimated reasonably possible exposure for these matters as of December 31,2004 was revised to a range of $260 million to $780 million.  Due to inherent uncertainties in estimatingthe timing and amounts of future payments, the foregoing range does not includethe effects of inflation and has not been discounted for the time value ofmoney.  In addition, the range offinancial exposures set forth above does not include estimates for future legalcosts.  It is the Company’s policy toexpense these legal costs as incurred. As stated above, the Company presently believes that the majority ofthis range of financial exposures will ultimately be funded by the settlementswhich it has made with the Company’s insurers. Cash payments related to this exposure are expected to be made over anextended number of years and actual payments, when made, could be for amountsin excess of the range due to potential future changes in estimates as well asthe effects of inflation.

 

The foregoing is based on the Company’sassumption that the number of future claims filed per year and claim resolutionpayments will vary considerably from year-to-year and by plaintiff, disease,venue and other circumstances, but will, when taken as a whole, remainrelatively consistent with the Company’s experience to date and will decline asthe population of potential future claimants expires due tonon-asbestos-related causes.  It is alsobased on the results of the updated study and the status of the Company’ssettlements with its insurers, as described above.  However, the Company recognizes that thenumber of future claims filed per year and claim resolution payments couldgreatly exceed those reflected by its past experience and contemplated by thestudy referenced above, that the Company’s belief of the range of itsreasonably possible financial exposure could change as the study referencedabove is periodically updated, that its evaluation of the total payments to bereceived from its insurers may change depending upon numerous variablesincluding potential legislation and the risk that one or more insurancecarriers may refuse or be unable to meet their obligations to the Company.

 

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Due to the dynamic nature of asbestoslitigation, the Company’s estimates are inherently uncertain, and these mattersmay present significantly greater financial exposures than presentlyanticipated.  In addition, the Companyintends to periodically update the asbestos study referenced above, and furtheranalysis combined with new data received in the future could result in amaterial modification of the range of reasonably possible financial exposureset forth above.  As a result of all ofthe foregoing, the Company’s liability with respect to asbestos-related matterscould vary significantly from present estimates and may require a materialchange in the accrued liability for these matters within the next 12months.  If the Company’s liability doesexceed amounts recorded in the balance sheet, the Company presently believesthat the majority of the liability it may reasonably anticipate will be paid orreimbursed as a result of the settlements the Company has made with itsinsurers, as described above.  However,there can be no assurance that such liabilities will be reimbursed.

 

The findings of the updated study referencedabove identify a range of the Company’s reasonably possible financial exposurefor these asbestos-related matters.  TheCompany adjusted its accrual for present and future potential asbestos claimsbefore anticipated insurance recoveries at December 31, 2004 to $260million, reflecting the low end of the range noted above in accordance withgenerally accepted accounting principles (since no amount within the range is abetter estimate than any other amount). In addition, pursuant to the First Settlement Agreement described aboveand the results of its September 30, 2004 re-evaluation of insurancerecovery expectations with its other carriers, the Company adjusted itsinsurance receivable during 2004.  As aresult of the foregoing, the Company recognized a net pre-tax charge of $34million in 2004, reflecting $80 million to re-establish asbestos reserves, a$49 million increase in asbestos-related insurance receivables and $3 millionin fees incurred in reaching the settlement. The Company does not offset insurance assets against its estimatedliability.  The following table presentsthe 2004 balance sheet activity and ending balances for the Company’sasbestos-related accounts.

 
| ** **                                 | ** ** | ** **          | ** ** | **Insurance**    | ** ** | **Insurance**   | ** ** | ** **             | ** ** | ** **            | ** ** |
|--------------------------------------------|------------|---------------------|------------|------------------|------------|-----------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **Balance**         | ** ** | **Settlements/** | ** ** | **Recovered/**  | ** ** | ** **             | ** ** | **Balance**           | ** ** |
| ** **                                 | ** ** | **January 1,** | ** ** | **Additional**   | ** ** | **Liabilities** | ** ** | **Reclassifications/** | ** ** | **December 31,** | ** ** |
| **(Dollars in millions)**                  | ** ** | **2004**            | ** ** | **Accruals**     | ** ** | **Settled**     | ** ** | **Accretion**          | ** ** | **2004**              | ** ** |
| Asbestos-related  assets:                  |       |                |       |             |       |            |       |                   |       |                  |       |
| Insurance  receivable                      |       | $                   | 7          |             | $          | —          |       | $                      | (10        | )                     | $          | 9 |   | $ | 6 |   |
| Asbestos-related  assets, current          |       | 7                   |       | —           |       | (10             | )          | 9                      |       | 6                     |       |
|                                       |       |                |       |             |       |            |       |                   |       |                  |       |
| Insurance  receivable                      |       | 162                 |       | 49               |       | (36             | )          | (76                    | )          | 99                    |       |
| Restricted  cash in trust (1)              |       | —              |       | —           |       | (4              | )          | 68                     |       | 64                    |       |
| Asbestos-related  assets, non-current      |       | 162                 |       | 49               |       | (40             | )          | (8                     | )          | 163                   |       |
| Total  asbestos-related assets             |       | $                   | 169        |             | $          | 49              |       | $                      | (50        | )                     | $          | 1 |   | $ | 169 |   |
| Asbestos-related  liabilities:             |       |                |       |             |       |            |       |                   |       |                  |       |
| Asbestos-related  liabilities, current     |       | 45                  |       | —           |       | (41             | )          | 43                     |       | 47                    |       |
| Asbestos-related  liabilities, non-current |       | 176                 |       | 80               |       | —          |       | (43                    | )          | 213                   |       |
|                                       |       |                |       |             |       |            |       |                   |       |                  |       |
| Total  asbestos-related liabilities        |       | $                   | 221        |             | $          | 80              |       | $                      | (41        | )                     | $          | — |   | $ | 260 |   |

 

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(1)                                  Amountis reflected as a non-current asset as its availability for reimbursement tothe Company is restricted to asbestos claims and related defense costsreimbursable to the Company as discussed above in connection with the FirstSettlement Agreement.

 

The Company, in conjunction with outsideadvisors, will continue to study its asbestos-related matters, insurancerecovery expectations and reserves on an on-going basis, and make adjustmentsas appropriate.

 

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Composite Products Antitrust and Qui TamMatters

 

In August 1999, the Company was sued inan action styled as Cape Composites, Inc. v. Mitsubishi Rayon Co., Ltd.,Case No. 99-08260 (U.S. District Court, Central District of California), one ofa series of similar purported class action lawsuits brought on behalf ofpurchasers (excluding government purchasers) of carbon fiber and carbon prepregin the United States from the named defendants from January 1, 1993through January 31, 1999.  Thelawsuits were brought following published reports of a Los Angeles federalgrand jury investigation of the carbon fiber and carbon prepregindustries.  In these lawsuits,plaintiffs allege violations of Section 1 of the Sherman Antitrust Act foralleged price fixing.  In September 1999,these lawsuits were consolidated by the Court into a case captioned Thomas& Thomas Rodmakers v. Newport Adhesives and Composites, Case No. CV-99-07796-GHK (CTx) (U.S. District Court, Central District ofCalifornia), with all related cases ordered dismissed.  This lawsuit is proceeding through discoveryand motion practice.  On May 2, 2002, theCourt granted plaintiffs’ Motion to Certify Class.  The Company is named in connection with itsformer Composites Products Division, which was sold to Hexcel Corporation in1996.  During the third quarter of 2004,the Company learned that four of its co-defendants had reached settlements withthe plaintiffs.  Those settlements wereapproved by the court on January 31, 2005. On February 25, 2005, the Company reached a settlement in principlewith the plaintiffs for $11.25 million and has accrued this amount in itscurrent liabilities as of December 31, 2004.  The settlement is subject to courtapproval.  The Company has denied andcontinues to deny liability to plaintiffs but entered into the settlement toavoid the risks, uncertainties and costs inherent in litigation.  The settlement was agreed to by Herculeswithout any admission of liability.  Thesettlement will not affect the pendency of the various other related lawsuitsdescribed below.

 

Since September 2001, the Company, alongwith the other defendants in the Thomas & Thomas Rodmakers actionreferred to above, has been sued in nine California state court purported classactions brought on behalf of indirect purchasers of carbon fiber.  In January 2002, these were consolidatedinto a case captioned Carbon Fiber Cases I, II, and III, JudicialCouncil Coordination Proceeding Nos. 4212, 4216 and 4222, Superior Court ofCalifornia, County of San Francisco. These actions all allege violations of the California Business andProfessions Code relating to alleged price fixing of carbon fiber and unfaircompetition.  The Company has deniedliability and is vigorously defending each of these actions.

 

In June 2002, a purported class actionwas filed in Massachusetts under the caption Saul M. Ostroff, et al. v.Newport Adhesives, et al., Civil Action No. 02-2385, Superior Court ofMiddlesex County.  This matter is apurported class action brought on behalf of consumers who purchased merchandisemanufactured with carbon fiber, and alleges the same types of price fixingactivities alleged in the actions described in the above two paragraphs.  In October 2002, the Company wasnotified that Horizon Sports Technologies had “opted out” of the federalantitrust class action described above (Thomas & Thomas Rodmakers) andfiled its own suit against Hercules and the other defendants in that action (HorizonSports Technologies, Inc. v. Newport Adhesives and Composites, Inc., etal., Case No. CV02-8126 FMC (RNEX), U.S. District Court, Central District ofCalifornia, Western Division).

 

Further, in April 2002, a related “QuiTam” action was unsealed by the U.S. District Court for the Southern Districtof California.  That action is captioned RandallM. Beck, et al. v. Boeing Defense and Space Group, Inc., et al., (CivilAction No. 99 CV 1557 JM JAH), was filed under seal in 1999, and is a “FalseClaims” action brought pursuant to the False Claims Act (31 U.S.C. Section 729et seq.).  In that action, the relators,in the name of the U.S. Government, allege the same price fixing activitieswhich are the subject of the above-described actions.  The relators then allege that those allegedprice fixing activities resulted in inflated prices being charged by the defendantcarbon fiber manufacturers to defense contractors, who, in turn, submittedclaims for payment to the U.S. Government under various governmentcontracts.  It is alleged that thoseclaims for payment were “false claims” because the prices charged for thecarbon fiber and carbon prepreg were “fixed” contrary to the laws of the UnitedStates.  The Company has denied liabilityand is vigorously defending each of these actions.

 

In December 2004, the Company filed alawsuit against Hexcel Corporation (Hercules Incorporated v. HexcelCorporation, Supreme Court of the State of New York, County of New York, Index No. 04/604098) seeking indemnification for thecomposite products and qui tam lawsuits described above.  The lawsuit is based on the terms of thepurchase and sale agreement by which the Company sold to Hexcel its CompositeProducts Division in 1996.  In response,Hexcel has denied liability and has filed a counter-claim also seekingindemnification.  That lawsuit isentering the early stages of discovery.

 

In connection with the grand juryinvestigation noted above in the paragraph describing the Cape Compositeslitigation, in January 2000, the United States Department of Justice(“DOJ”), Antitrust Division, served a grand jury subpoena duces tecum uponHercules.  The Company was advised thatit was one of several manufacturers of carbon fiber and carbon prepreg thatwere served with such a subpoena.  In December 2003,the Company was advised that the grand jury investigation had been closed.

 

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Agent Orange Litigation

 

Agent Orange is a defoliant that wasmanufactured by several companies, including Hercules, at the direction of theU.S. Government, and used by the U.S. Government in military operations in bothKorea and Vietnam from 1965 to 1970.  In1984, as part of a class action settlement, the Company and other defendantssettled the claims of persons who were in the U.S., New Zealand and AustralianArmed Forces who alleged injury due to exposure to Agent Orange.  In Re “Agent Orange” Prod. Liab.  Litig., 597 F. Supp. 740 (E.D.N.Y.1984).  Following that settlement, allclaims for alleged injuries due to exposure to Agent Orange by persons who hadserved in the Armed Forces of those countries were treated as covered by thatclass action settlement.

 

On June 9, 2003, the United StatesSupreme Court affirmed the decision of the United States Court of Appeals forthe Second Circuit in a case captioned Dow Chemical Company, et al. v.Daniel Raymond Stephenson, et al., 123 S. Ct. 2161 (2003), where plaintiffsStephenson and Isaacson (in a separate but consolidated case) alleged that theywere injured from exposure to Agent Orange and that such injury did notmanifest until after exhaustion of the settlement fund created through the 1984class action settlement.  As a result ofthat decision, the claims of persons who allege injuries due to exposure toAgent Orange and whose injuries first manifest themselves after exhaustion ofthe settlement fund created through the 1984 class action settlement may nolonger be barred by the 1984 class action settlement, and such persons may nowbe able to pursue claims against the Company and the other former manufacturersof Agent Orange.

 

Since 1998, the Company has been sued in atotal of twenty-three lawsuits (including two purported class actions) whereplaintiffs allege that exposure to Agent Orange caused them to sustain variouspersonal injuries.  On February 9,2004, the U.S. District Court for the Eastern District of New York issued aseries of rulings granting several motions filed by defendants in the two casesthat had been remanded to the U.S. District Court by the U.S. Court of Appealsfor the Second Circuit on remand from the U.S. Supreme Court (In re: “AgentOrange” Product Liability Litigation: Joe Isaacson, et al v. Dow ChemicalCompany, et al. and Daniel Ray Stephenson, et al. v. Dow Chemical Company, etal.  (MDL 381, CV 98-6383 (JBW), CV 99-3056 (JBW))).  In relevantpart, those rulings held that plaintiffs’ claims against the defendant manufacturersof Agent Orange are properly removable to federal court under the “federalofficer removal statute” and that such claims are subject to dismissal byapplication of the “government contractor defense.”  The Court thendismissed plaintiffs’ claims, but stayed its decision to allow plaintiffs toobtain additional discovery and to move for reconsideration of the Court’sdecision.  A hearing on the motion forreconsideration was held on February 28, 2005.  By Orders dated March 2, 2005, the Courtdenied reconsideration, lifted the stay of the earlier decision, and dismissedplaintiffs’ claims in all twenty-three pending lawsuits.  The Company anticipates that plaintiffs willappeal the dismissals of their claims.

 

In addition, in January 2004, theCompany was sued in a class action filed in the United States District Courtfor the Eastern District of New York by The Vietnam Association for Victims ofAgent Orange/Dioxin and several individuals who claim to represent between twoand four million Vietnamese who allege that Agent Orange used by the UnitedStates during the Vietnam War caused them or their families to sustain personalinjuries.  (TheVietnam Association for Victims of Agent Orange/Dioxin, et al. v. The Dow Chemical Company, et al., Civil Action No. 04 CV 0400 (JBW).)  That complaint alleges violations ofinternational law and war crimes, as well as violations of the common law forproducts liability, negligence and international torts.  The defendants moved to dismiss this case onseveral grounds, including failure to state a claim under the Alien Tort ClaimsStatute, lack of jurisdiction and justiciability, the bar of the statute oflimitations, failure to state claims for violations of international law, andthe “government contractor defense.”  Ahearing on these motions was held on February 28, 2005.  By order dated March 10, 2005, the Courtdismissed this lawsuit.  The Companyanticipates that plaintiffs will appeal the Court’s decision.

 

The Company believes that it has substantialmeritorious defenses to all of the Agent Orange-related claims described aboveand those that may yet be brought.  To that end, the Company denies anyliability to plaintiffs, and will vigorously defend all actions now pending orthat may be brought in the future.

 

Other Litigation

 

In November 2002, an action fordeclaratory judgment was filed in the U.S. District Court for the District ofDelaware under the caption of Atofina Chemicals, Inc. and Atofina v.Hercules Incorporated (Civil Action No. 02-1613).  In this action, Atofina seeks a declaratoryjudgment that Hercules cannot recover antitrust damages for purchases ofmonochloroacetic acid (“MCAA”) that Hercules made outside of the United Statesor for purchases from producers of MCAA not alleged to have participated in anyconspiracy to fix prices and allocate the market for MCAA.  In response, Hercules has filed acounter-claim, seeking damages from and injunctive relief against Akzo NobelChemicals, Atofina Chemicals, Hoechst AG, Hoechst Celanese, Clariant and othersrelated to the fixing of prices of MCAA and sodium monochloracetate fromapproximately 1995 through 2000.  Thelawsuit is in the discovery phase. Hercules has settled with some of the parties.  The terms of those settlements areconfidential.

 

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By Order dated May 6, 2003, the U.S. DistrictCourt for the Middle District of Louisiana remanded to the 18thJudicial District Court for the Parish of Iberville, Louisiana, a total of nineconsolidated lawsuits, including two lawsuits in which the Company is adefendant.  These twolawsuits, Jerry Oldham, et al. v. The State of Louisiana, etal., Civil Action No. 55,160, 18th Judicial District Court,Parish of Iberville, Louisiana, and John Capone, et al. v. The State ofLouisiana, et al., Civil Action No. 56,048C, 18th JudicialDistrict Court, Parish of Iberville, Louisiana, were served on the Company in September 2002and October 2002, respectively.  TheOldham case is a purported class action comprised of approximately 2,000plaintiffs who are or were direct employees of Georgia Gulf, and the Caponecase is a consolidated action by approximately 44 plaintiffs who are or werecontract employees at Georgia Gulf.  Bothactions assert claims against the State of Louisiana, the Company, AmericanPetroFina, Inc., Hercofina, Ashland Oil, International Minerals and Chemicals,Allemania Chemical, Ashland Chemical and the Parish of Iberville.  The purported class members and plaintiffs,who claim to have worked or lived at or around the Georgia Gulf plant inIberville Parish, allege injury and fear of future illness from the consumptionof contaminated water and, specifically, elevated levels of arsenic in thatwater.  As to the Company, plaintiffsallege that the Company itself and as part of a joint venture operated a nearbyplant and, as part of those operations, used a groundwater injection well todispose of various wastes, and that those wastes contaminated the potable watersupply at Georgia Gulf.  On October 17,2002, the Company removed these matters to federal court.  In January 2003, the U.S. District Courtfor the Middle District of Louisiana consolidated the Oldham andCapone matters with other lawsuits (including the Batton matter,discussed below) in which the Company is not or was not a party.  Plaintiffs sought remand which, as notedabove, was granted by Order dated May 6, 2003. In March 2004, Atofina, successor to American PetroFina, Inc. wasdismissed without prejudice.  In January 2005,plaintiffs filed a motion to add Hercules and other defendants to a casecaptioned Georgenner Batton, et al. v. The State ofLouisiana, et al., CivilAction No. 55,285, 18th Judicial District Court, Parish ofIberville, Louisiana; that motion was granted by the Court in February 2005.  The Batton lawsuit is a purportedclass action comprised of plaintiffs who are or were contract employees ofGeorgia Gulf since 1995 and who are asserting nearly identical allegations asthe plaintiffs in the Oldham lawsuit. Discovery is continuing. Plaintiffs have filed a motion to certify the purported classes ofplaintiffs in the Oldham and Batton matters, and a hearing is setfor December 5-7, 2005.  The Companydenies any liability and intends to vigorously defend these matters.

 

On October 6, 2003, the Company receiveda Notice of Deficiency with respect to the Company’s 1996 through 1997 federalincome tax returns wherein, among other issues, the IRS disallowed a capitalloss that the Company carried back to 1996 and 1997.  The IRS had indicated that it would notsettle that issue prior to a final decision after trial on the merits.  On December 23, 2003, the Company fileda Petition asking the U.S. Tax Court for a re-determination of the deficiencyset forth in the October 6, 2003 Notice of Deficiency.  On December 16, 2004, the Company andthe IRS entered into an agreement to settle the capital loss issue, whereby theCompany agreed to pay approximately $30 million in taxes and $6 million inpenalties.  The Company had previouslyestablished sufficient reserves and has amounts on deposit with the IRS forthese items.  The IRS has indicated thatit is willing to address the other issues included in the Notice of Deficiencythrough standard IRS administrative appeals procedures without litigation.  The Company believes that it is remote thatthe ultimate disposition of these other issues will have a material adverseimpact on the Company’s financial position in light of existing tax reservesand amounts already on deposit with the IRS.

 

On May 7, 2004, Ciba Specialty ChemicalsCorporation (“Ciba”) filed a Complaint against Hercules Incorporated and CytecIndustries, Inc. (“Cytec”) in the United States District Court for the Districtof Delaware alleging infringement of two patents owned by Ciba.  The two patents in question are U.S. Patent5,167,766 (issued on December 1, 1992) entitled “Charged Organic PolymerMicrobeads in Paper Making Process” and U.S. Patent 5,171,808 (issued on December 15,1992) entitled “Cross-linked Anionic and Amphoteric PolymericMicroparticles.”  The alleged conductrelates to the manufacture, use, sale and offer to sell of certain products ofthe Company’s Pulp and Paper business. Ciba seeks to enjoin alleged continued infringement, obtain a judgmentthat the defendants have infringed the patents, and obtain an award of damagesand reasonable attorneys fees.  The Company believes that there aresubstantial meritorious defenses to this action, and has denied liability toCiba and will vigorously defend against this action.  The Company has agreed to indemnify Cytec inthis action.  The lawsuit is in the earlystages of discovery and the trial has been scheduled to begin on August 14, 2006.

 

On or about June 1, 2004, a Complaintcaptioned Charles Stepnowski v. Hercules Inc.; The Pension Plan of HerculesInc.; The Hercules Inc. Finance Committee; and Edward V. Carrington, Hercules’Vice President Human Resources, Civil Action No. 04-cv-2296, was filedin the United States District Court, Eastern District of Pennsylvania.  An Amended Complaint was filed on June 16,2004.  Styled as a class action, theAmended Complaint seeks benefits under the Pension Plan of HerculesIncorporated (the “Plan”), and alleges violations of the Employee RetirementIncome Security Act, 29 U.S.C. §1001 et seq. (“ERISA”).  Under the Plan, eligible retirees of theCompany may opt to receive a single cash payment of 51% of the present value oftheir accrued benefit (with the remaining 49% payable as a monthlyannuity).  The Amended Complaint allegesthat the Company’s adoption of a new interest rate assumption used to determinethe 51% cash payment constitutes a breach of fiduciary duty and a violation ofthe anti-cutback requirements of ERISA and the Internal Revenue Code.  The Amended Complaint seeks the payment ofadditional benefits under ERISA (as well as costs and

 

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attorneys fees)and seeks to compel the Company to use an interest rate assumption that is morefavorable to eligible retirees.  TheAmended Complaint seeks to establish a class comprised of all Plan participantswho retired (or who will retire) on or after December 1, 2001.  On August 23, 2004, the Company filed aMotion to Dismiss and Motion to Strike Plaintiff’s Class Allegations.  On that same date, plaintiff filed a Motionto Certify This Action As a Class Action.  Responsive pleadings have and continue to befiled.  The Company denies all liability,and intends to vigorously defend this action.

 

In February 2005, the Company was amongthe Defendants/Relators who filed a Petition for Writ of Mandamus in the TexasSupreme Court seeking to set aside an order of the trial court consolidatingfive plaintiffs for a single trial now set for June 6, 2005.  The underlying case, Acevedo,et al. v. Union Pacific Railroad Company, et al., Cause No.  C-4885-99-F. 332nd Judicial District Court,Hildago County, Texas, was originally filed in 2001, has been consolidated withanother related action, and is a toxic tort lawsuit alleging pesticide exposurerelating to operations at a former pesticide formulation facility in Mission,Texas.  There are currently approximately1,900 plaintiffs and approximately 30 defendants, including the Company.  Plaintiffs include former workers at thepesticide formulation facility, and persons who currently reside, or in thepast resided, near the facility.  Allplaintiffs allege personal injuries and some plaintiffs also allege propertydamage.  The vast majority of theplaintiffs allege residential exposure to a variety of pesticide and chemicalproducts as a result of leaks, spills, flooding, and airborne emissions fromthe pesticide formulation facility.  Itis alleged that certain of the Company’s products were sold to or used by thepesticide formulation facility prior to its ceasing operations in 1967.  On August 9, 2004, the trial courtjoined five plaintiffs for a consolidated trial, which is now set for June 6,2005.  On November 4, 2004, theCorpus Christi Court of Appeals denied Defendants’/Relators’ Petition for aWrit of Mandamus.  In February 2005,Defendants/Relators filed a Petition for a Writ of Mandamus in the TexasSupreme Court.  No decision has yet beenrendered with respect to that petition. The Company denies any liability to plaintiffs and intends to vigorouslydefend these matters.

 

Amounts Accrued for Non-Asbestos Litigation

 

At December 31, 2004, the ConsolidatedBalance Sheet reflects a current liability for non-asbestos related litigationof approximately $18 million, representing management’s best estimate of theprobable and reasonably estimable losses related to these matters.  While it is not feasible to predict theoutcome of all pending legal proceedings, it is reasonably possible that an exposureto loss exists in excess of the amounts accrued for these and other matters,and the ultimate resolution of one or more of these matters could have amaterial effect upon the Company’s financial position, results of operationsand/or cash flows for any annual, quarterly or other period.

 

**13.****                                                       Company-obligatedPreferred Securities of Subsidiary Trusts**

 

The Company determined that Hercules Trust I and II(the “Trusts”) were variable interest entities and that the Company was not theprimary beneficiary of the Trusts pursuant to the provisions of FIN 46R.  Accordingly, the Company de-consolidated theTrusts at December 31, 2003.  During2004, the Trusts were liquidated and dissolved. Summarized below is the condensed financial information of the Trusts asof December 31, 2003.

 
| ** **               | ** ** | **(Dollars in millions)** | ** ** |
|--------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **Hercules Trust I**      | ** ** | **Hercules Trust II** | ** ** |
| Non-current  assets      |       | $                         | 363        |   | $ | 262 |   |
| Non-current  liabilities |       | 363                       |       | 262 |   |
|                          |            |                           |            |  |  |  |  |

 

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**14.****                                                       SeriesPreferred Stock**

 

There are 2,000,000 shares of series preferred stockwithout par value authorized for issuance, none of which have been issued.

 

**15.****                                                       CommonStock**

 

Hercules common stock has a stated value of $25/48,and 300,000,000 shares are authorized for issuance.  At December 31, 2004, a total of25,550,678 shares were reserved for issuance for the following purposes:14,853,859 shares for the exercise of awards under the Stock Option Plan;3,396,668 shares for awards under incentive compensation plans; 172,550 sharesfor conversion of debentures; 7,119,437 shares for exercise of the warrantcomponent of the CRESTS Units and 8,164 shares for sale to the Savings PlanTrustee.

 

In 1991, the Board of Directors authorized the Companyto repurchase up to 74,650,000 shares under its stock repurchase program.  Total shares reacquired pursuant to thisprogram were 66,614,242, at an average price of $37.31 per share.  The program was suspended in 1999.

 

**16****.****                                                       Accumulated Other Comprehensive Losses**

 

The components ofaccumulated other comprehensive losses are as follows:

 
| ** **                                        | ** ** | **(Dollars in millions)** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | **December 31,**     | ** ** |
| ** **                                        | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Additional  minimum pension liability, net of tax |       | $                         | (377       | ) | $ | (347 | ) | $ | (360 | ) |
| Foreign  currency translation adjustment          |       | 101                       |       | 30 |   | (94 | ) |
|                                              |       | $                         | (276       | ) | $ | (317 | ) | $ | (454 | ) |

 

**17.****                                                       AdditionalBalance Sheet Detail**

 
| ** **                                 | ** ** | **(Dollars in millions)** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|
| ** **                                 | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Property,  plant and equipment:            |       |                      |       |   |   |
| Land                                       |       | $                         | 20         |   | $ | 20 |   |
| Buildings  and equipment                   |       | 1,998                     |       | 1,979 |   |
| Construction  in progress                  |       | 71                        |       | 40 |   |
| Total                                      |       | 2,089                     |       | 2,039 |   |
| Accumulated  depreciation and amortization |       | (1,394                    | )          | (1,362 | ) |
| Property,  plant and equipment, net        |       | $                         | 695        |   | $ | 677 |   |

 

Depreciation expense for the years ended December 31,2004, 2003 and 2002 was $75 million, $73 million and $71 million, respectively.

 

The Company recognized asset impairments of $3 millionand $4 million, respectively, in relation to its manufacturing facility inKalamazoo, Michigan, and a production line at its Hopewell, Virginia, facility(see Note 19).  Both facilities are partof the Performance Products segment. Impairment charges of $2 million were recognized against a facilityassociated with a discontinued operation (see Note 21).

 

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| ** **                   | ** ** | **(Dollars in millions)** | ** ** |
|------------------------------|------------|---------------------------|------------|
| ** **                   | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Other  current assets:       |       |                      |       |   |   |
| Federal tax  receivable      |       | $                         | 12         |   | $ | 35 |   |
| Supplier  rebates receivable |       | 15                        |       | 13 |   |
| Value-added  tax receivable  |       | 10                        |       | 9 |   |
| Assets held  for sale        |       | 6                         |       | — |   |
| Other                        |       | 15                        |       | 38 |   |
|                         |       | $                         | 58         |   | $ | 95 |   |

 
| ** **                                       | ** ** | **(Dollars in millions)** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Deferred  charges and other assets:              |       |                      |       |   |   |
| Tax deposits                                     |       | $                         | 89         |   | $ | 52 |   |
| Capitalized  software, net                       |       | 73                        |       | 84 |   |
| Cash  surrender value of life insurance policies |       | 19                        |       | 18 |   |
| Unamortized  debt issuance costs                 |       | 14                        |       | 16 |   |
| Prepaid  pension assets                          |       | 7                         |       | 35 |   |
| Investments                                      |       | 6                         |       | 53 |   |
| Other                                            |       | 38                        |       | 58 |   |
|                                             |       | $                         | 246        |   | $ | 316 |   |

 
| ** **                                  | ** ** | **(Dollars in millions)** | ** ** |
|---------------------------------------------|------------|---------------------------|------------|
| ** **                                  | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Accrued  expenses:                          |       |                      |       |   |   |
| Compensation  and benefits                  |       | $                         | 42         |   | $ | 59 |   |
| Current  portion of postretirement benefits |       | 23                        |       | 23 |   |
| Current  portion of environmental accrual   |       | 20                        |       | 19 |   |
| Litigation  accrual                         |       | 18                        |       | 4 |   |
| Interest  payable                           |       | 13                        |       | 8 |   |
| Current  deferred income taxes              |       | 8                         |       | 8 |   |
| Rebates                                     |       | 6                         |       | 8 |   |
| Income taxes  payable                       |       | 5                         |       | 14 |   |
| Current  pension liability                  |       | 7                         |       | 8 |   |
| Severance  and other exit costs             |       | 5                         |       | 6 |   |
| Other taxes  payable                        |       | 2                         |       | 5 |   |
| Other                                       |       | 53                        |       | 45 |   |
|                                        |       | $                         | 202        |   | $ | 207 |   |

 

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| ** **                               | ** ** | **(Dollars in millions)** | ** ** |
|------------------------------------------|------------|---------------------------|------------|
| ** **                               | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Deferred  credits and other liabilities: |       |                      |       |   |   |
| Non-current  income tax liabilities      |       | $                         | 108        |   | $ | 99 |   |
| Environmental  accrual - non-current     |       | 79                        |       | 87 |   |
| Indemnifications                         |       | 40                        |       | 40 |   |
| Deferred  rent                           |       | 39                        |       | 45 |   |
| Workers  compensation                    |       | 22                        |       | 21 |   |
| Other                                    |       | 26                        |       | 26 |   |
|                                     |       | $                         | 314        |   | $ | 318 |   |

 

**18.****                                                       Severanceand Other Exit Costs**

 

The consolidated balance sheets reflectliabilities for employee severance benefits and other costs of $5 million and$6 million at December 31, 2004 and 2003, respectively.  Commencing in 2001 and continuing through March 31,2003, management authorized and committed to various plans to reduce theworkforce as part of a comprehensive cost reduction and work process redesign program(the “2001 Plan”).  During that period,the Company incurred $78 million in employee severance benefits, exit costs andcontract terminations.  Subsequent to March 31,2003, the Company recognized an additional $5 million in 2003 for employeetermination benefits in accordance with Statement of Financial AccountingStandards No. 112, “Employer’s Accounting forPost-Employment Benefits” (“SFAS 112”), under its Severance Pay Plan andDismissal Wage Plans (“Dismissal Plans”).

 

During 2004, the Company recognizedadditional charges of $9 million for employee termination benefits under theDismissal Plans in accordance with SFAS 112, increasing the number ofemployees identified for dismissal under both plans to approximately 1,550, ofwhich approximately 1,545 have left the Company.  The Company terminated approximately 160employees during the year ended December 31, 2004 and anticipates theremaining identified actions, which are nominal, will be finalized by September 30,2005.

 

Total cash payments for the year ended December 31,2004, related to the above actions, were approximately $10 million,representing $1 million of cash payments under the 2001 plan and $9 million ofpayments under the Dismissal Plans.

 

The balance at December 31, 2004 representsseverance benefits and other exit costs of which $2 million pertains to thecontinuing benefit payment streams under the 2001 restructuring plan and $3million pertains to other severance benefits accounted for under the Company’sDismissal Plans.

 

A reconciliation of activity with respect to theliabilities established for these plans is as follows:

 
| ** **                                            | ** ** | **(Dollars in millions)** | ** ** |
|-------------------------------------------------------|------------|---------------------------|------------|
| ** **                                            | ** ** | **2004**                  | ** ** | **2003** | ** ** |
| Balance at  beginning of year                         |       | $                         | 6          |   | $ | 22 |   |
| Additional  termination benefits and other exit costs |       | 9                         |       | 7 |   |
| Cash payments                                         |       | (10                       | )          | (21 | ) |
| Reversals  against earnings                           |       | —                    |       | (2 | ) |
| Balance at  end of year                               |       | $                         | 5          |   | $ | 6 |   |

 

In 2004, the Company announced its intent to close itsEuropean research facility located in Barneveld, The Netherlands, which hasapproximately 60 employees.  Theseverance and termination agreements, which constitute one-time terminationbenefits, are subject to consultations with and approvals of the local workscouncil, which have not been finalized. The Company intends to terminate approximately two-thirds of theemployees and offer relocation to the remainder.  The termination and exit costs are subject tothe accounting requirements of Statement of Financial Accounting Standards No.146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS146”), which was adopted by the Company on January 1, 2003.  Accordingly, estimated costs of approximately$3 million associated with the exit and closure of the research facility arebeing charged to expense over the nine-month period from the announcementthrough its

 

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anticipated closure in August 2005.  Expense of approximately $0.3 million wasrecognized in 2004 and is included in Other operatingexpense, net.

 

**19.****                                                       OtherOperating Expense, Net**

 

Other operating expense, net, consists of thefollowing:

 
| ** **                              | ** ** | **(Dollars in millions)**        | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
| ** **                              | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Severance  and restructuring costs, net |       | $                                | 9          |   | $ | 5 |   | $ | 23 |   |
| Nitrocellulose  facility shutdown costs |       | 7                                |       | 1 |   | — |   |
| Asset  impairment charges               |       | 7                                |       | — |   | 7 |   |
| Special  executive pension adjustment   |       | 1                                |       | 7 |   | — |   |
| Proxy costs                             |       | —                           |       | 4 |   | — |   |
| Net  environmental expense              |       | —                           |       | — |   | 11 |   |
| Loss on  previously disposed business   |       | —                           |       | — |   | 2 |   |
| Other  miscellaneous charges            |       | 3                                |       | — |   | 3 |   |
|                                    |       | $                                | 27         |   | $ | 17 |   | $ | 46 |   |

 

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**20.****                                                       Interestand Debt Expense**

 

Interest and debt costs are summarized as follows:

 
| ** **   | ** ** | **(Dollars in millions)**        | ** ** |
|--------------|------------|----------------------------------|------------|
| ** **   | ** ** | **Year Ended December 31,** | ** ** |
| ** **   | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Incurred     |       | $                                | 110        |   | $ | 131 |   | $ | 100 |   |
| Capitalized  |       | 1                                |       | — |   | 1 |   |
| Net expensed |       | $                                | 109        |   | $ | 131 |   | $ | 99 |   |

 

Interest and debt costs incurred in 2002 exclude $58million in interest costs on the Company’s preferred securities.  These costs were recognized as preferredsecurity distributions of subsidiary trusts prior to 2003.  Pursuant to the Company’s adoption of SFAS150 on July 1, 2003, interest and debt costs on the preferred securitieshave been recognized as interest and debt expense for 2004 and 2003 (see Note5).

 

**21****.****                                                       Other Expense, Net**

 

Other expense, net, consists of the following:

 
| ** **                                        | ** ** | **(Dollars in millions)**        | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **Year Ended December 31,** | ** ** |
| ** **                                        | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Asbestos-related  accruals                        |       | $                                | 80         |   | $ | 6 |   | $ | 65 |   |
| Asbestos-related  insurance settlements           |       | (49                              | )          | — |   | — |   |
| Asbestos-related  costs, net(1)                   |       | 18                               |       | 7 |   | 3 |   |
| Loss on  repurchase of 11.125% senior notes (2)   |       | 34                               |       | 5 |   | — |   |
| Litigation  settlements and accruals, net         |       | 19                               |       | 8 |   | 3 |   |
| Write off of  unamortized debt issuance costs     |       | 14                               |       | — |   | — |   |
| Environmental                                     |       | 8                                |       | 5 |   | 1 |   |
| Gain on  repurchase of CREST preferred securities |       | (7                               | )          | (7 | ) | — |   |
| Asset  impairment charges                         |       | 2                                |       | 2 |   | — |   |
| Debt  extinguishment                              |       | —                           |       | — |   | 44 |   |
| Net gains on  dispositions                        |       | —                           |       | — |   | (3 | ) |
| Other, net                                        |       | (3                               | )          | 3 |   | 2 |   |
|                                              |       | $                                | 116        |   | $ | 29 |   | $ | 115 |   |

 

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(1) Legal costs and other costs related to the settlements with insurancecarriers.

(2) Includes $4 million write-off of unamortized debt issuance costs in2004.

 

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**22****.****                                                       Earnings (loss) per Share**

 

The following table shows the amounts used incomputing earnings (loss) per share and the effect on income (loss) and theweighted-average number of shares of dilutive common stock:

 
| ** **                                            | ** ** | **(Dollars in millions, except  per share)** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                            | ** ** | **2004**                                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                            | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Earnings** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                            | ** ** | ** **                                   | ** ** | **Earnings** | ** ** | **Income** | ** ** | **(loss)** | ** ** | ** ** | ** ** | **Loss per** | ** ** |
| ** **                                            | ** ** | **Income**                                   | ** ** | **per share** | ** ** | **(loss)** | ** ** | **per share** | ** ** | **Loss** | ** ** | **share** | ** ** |
| **Basic:**                                            |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| ** **                                            |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Continuing  operations                                |       | $                                            | 27         |   | $ | 0.25 |   | $ | 74 |   | $ | 0.69 |   | $ | (47 | ) | $ | (0.44 | ) |
| Discontinued  operations                              |       | —                                       |       | — |   | 4 |   | 0.04 |   | (196 | ) | (1.85 | ) |
| Cumulative  effect of changes in accounting principle |       | —                                       |       | — |   | (33 | ) | (0.31 | ) | (368 | ) | (3.47 | ) |
| Net income  (loss)                                    |       | $                                            | 27         |   | $ | 0.25 |   | $ | 45 |   | $ | 0.42 |   | $ | (611 | ) | $ | (5.76 | ) |
|                                                  |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Weighted  average number of basic shares (millions)   |       | 107.3                                        |       |   |   | 106.2 |   |   |   | 106.0 |   |   |   |
|                                                  |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| **Diluted:**                                          |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Continuing  operations                                |       | $                                            | 27         |   | $ | 0.25 |   | $ | 74 |   | $ | 0.69 |   | $ | (47 | ) | $ | (0.44 | ) |
| Discontinued  operations                              |       | —                                       |       | — |   | 4 |   | 0.04 |   | (196 | ) | (1.85 | ) |
| Cumulative  effect of changes in accounting principle |       | —                                       |       | — |   | (33 | ) | (0.31 | ) | (368 | ) | (3.47 | ) |
| Net income  (loss)                                    |       | $                                            | 27         |   | $ | 0.25 |   | $ | 45 |   | $ | 0.42 |   | $ | (611 | ) | $ | (5.76 | ) |
|                                                  |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| Weighted  average number of diluted shares (millions) |       | 109.0                                        |       |   |   | 107.2 |   |   |   | 106.0 |   |   |   |

 

For the years ended December 31, 2004 and 2003,the Company had convertible subordinated debentures, stock options andrestricted stock that were convertible into approximately 1.7 million and 1.0million shares of common stock.  Stockoptions, restricted stock and convertible debentures in 2001 were anti-dilutiveand are not included in the calculation of diluted earnings per share.  Related interest on the convertibledebentures has an immaterial impact on earnings per share calculations.

 

The following table shows the number of options andwarrants that have been excluded from the computation of diluted earnings pershare as their exercise price exceeded their current market value:

 
| ** **                                    | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|
| ** **                                    | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Options to  purchase common stock (millions)  |       | 10.6                              |       | 12.4 |   | 18.4 |   |
| Warrants to  purchase common stock (millions) |       | 7.1                               |       | 7.1 |   | 8.2 |   |

 

82

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**23.****                                                       Operationsby Industry Segment and Geographic Area**

 

The financial informationthat follows regarding the Company’s segments, which includes net sales, profitfrom operations and capital employed, is presented in accordance with Statementof Financial Accounting Standards No. 131, “Disclosures about Segments of anEnterprise and Related Information” (“SFAS 131”).  The Company has identified two reportablesegments, Performance Products and Engineered Materials and Additives.

 

*Performance Products (Pulp andPaper and Aqualon):*Products and services in Pulp and Paperare designed to enhance customers’ profitability by improving production yieldsand overall product quality, and to better enable customers to meet theirenvironmental objectives and regulatory requirements.

 

The Company believes Pulp and Paper is one of thelargest suppliers of functional, process and water management chemicals for thepulp and paper industry.  Pulp and Paperoffers a wide and highly-sophisticated range of technology and applicationsexpertise with in-mill capabilities which run from influent treatment throughthe paper machine to paper finishing. The Company is a broad-based global supplier able to offer a completeportfolio of products to its paper customers.

 

The products in Aqualon are principally derived fromnatural resources and are sold as key raw materials to othermanufacturers.  Principal products andmarkets include water-soluble polymers used as thickeners, emulsifiers andstabilizers for water-based paints, oil and gas exploration, building materialsand personal care products.

 

*Engineered Materials andAdditives*(*FiberVisions and Pinova):*Products in this segment provide low-cost, technology driven solutions to meetcustomer needs and market demands. Principal products and markets include polyolefin staple fibers used indisposable diapers, wipes and other hygienic products; industrial fiber products;rosin and hydrocarbon resins for adhesives; food and beverage; flavor andfragrance; and construction specialties.

 

The Company evaluates performance and makes decisionsbased primarily on cash flow, profit from operations and return on investedcapital.  Consolidated capital employedrepresents the total resources employed in the Company and is the sum of totaldebt, Company-obligated preferred securities of subsidiary trusts andstockholders’ equity.  Capital employedin each reportable segment represents the net operating assets employed toconduct business in that segment and generally includes working capital(excluding cash) and property, plant and equipment.  Other assets and liabilities, primarilygoodwill and other intangibles, not specifically allocated to businesssegments, are reflected in corporate in the table below.

 

Hercules has no single customer representing greaterthan 4% of its revenues.

 

**Geographic Reporting**

 

For geographic reporting, no single country, outsidethe United States, is material for separate disclosure.  However, because the Company has significantforeign operations, revenues and net property, plant and equipment aredisclosed by geographic region.

 

Revenues are reported on a “customer basis,” meaningthat net sales are included in the geographic area where the customer islocated.  Net property, plant andequipment is included in the geographic areas in whichthe producing entities are located.

 

Intersegment sales are eliminated in consolidation. 

 

83

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| **(Dollars in millions)****Industry Segments**         | ** ** | **Performance  Products** | ** ** | **Engineered  Materials and  Additives** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------|------------|---------------------------|------------|------------------------------------------|------------|---------------|------------|------------------|------------|
| ** **                                             | ** ** | ** **                | ** ** | ** **                               | ** ** | ** **    | ** ** | ** **       | ** ** |
| **2004**                                               |       |                      |       |                                     |       |          |       |             |       |
| Net sales                                              |       | $                         | 1,617      |                                     | $          | 380           |       | $                | —     |   | $ | 1,997 |   |
| Profit (loss) from operations                          |       | 248                       |       | (15                                      | )          | (6            | )(c)       | 227              |       |
| Interest and debt expense                              |       |                      |       |                                     |       |          |       | 109              |       |
| Gain on sale of CP Kelco ApS                           |       |                      |       |                                     |       |          |       | (27              | )          |
| Other expense, net                                     |       |                      |       |                                     |       |          |       | 116              |       |
| Income before income taxes and equity income           |       |                      |       |                                     |       |          |       | 29               |       |
|                                                   |       |                      |       |                                     |       |          |       |             |       |
| Capital employed (a)                                   |       | 1,252                     |       | 278                                      |       | (193          | )(b)       | 1,337            |       |
| Capital expenditures                                   |       | 64                        |       | 8                                        |       | 5             |       | 77               |       |
| Depreciation and amortization                          |       | 73                        |       | 18                                       |       | 10            |       | 101              |       |
|                                                   |       |                      |       |                                     |       |          |       |             |       |
| **2003**                                               |       |                      |       |                                     |       |          |       |             |       |
| Net sales                                              |       | $                         | 1,483      |                                     | $          | 363           |       | $                | —     |   | $ | 1,846 |   |
| Profit (loss) from operations                          |       | 262                       |       | 9                                        |       | (16           | )(c)       | 255              |       |
| Interest and debt expense                              |       |                      |       |                                     |       |          |       | 131              |       |
| Other expense, net                                     |       |                      |       |                                     |       |          |       | 29               |       |
| Income before income taxes and equity income           |       |                      |       |                                     |       |          |       | 95               |       |
|                                                   |       |                      |       |                                     |       |          |       |             |       |
| Capital employed (a)                                   |       | 1,180                     |       | 248                                      |       | (69           | )(b)       | 1,359            |       |
| Capital expenditures                                   |       | 39                        |       | 5                                        |       | 4             |       | 48               |       |
| Depreciation and amortization                          |       | 74                        |       | 21                                       |       | 5             |       | 100              |       |
|                                                   |       |                      |       |                                     |       |          |       |             |       |
| **2002**                                               |       |                      |       |                                     |       |          |       |             |       |
| Net sales                                              |       | $                         | 1,385      |                                     | $          | 320           |       | $                | —     |   | $ | 1,705 |   |
| Profit (loss) from operations                          |       | 243                       |       | 18                                       |       | (41           | )(c)       | 220              |       |
| Interest and debt expense                              |       |                      |       |                                     |       |          |       | 99               |       |
| Preferred security distributions of subsidiary  trusts |       |                      |       |                                     |       |          |       | 58               |       |
| Other expense, net                                     |       |                      |       |                                     |       |          |       | 115              |       |
| Loss before income taxes and equity income             |       |                      |       |                                     |       |          |       | (52              | )          |
|                                                   |       |                      |       |                                     |       |          |       |             |       |
| Capital employed (a)                                   |       | 1,085                     |       | 235                                      |       | 16            | (b)        | 1,336            |       |
| Capital expenditures                                   |       | 31                        |       | 9                                        |       | 3             |       | 43               |       |
| Depreciation and amortization                          |       | 72                        |       | 18                                       |       | 10            |       | 100              |       |

 

84

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| **(Dollars in millions)****Geographic Areas** | ** ** | **United  States** | ** ** | **Europe** | ** ** | **Americas (d)** | ** ** | **Asia Pacific** | ** ** | **Total**  | ** ** |
|-----------------------------------------------|------------|--------------------|------------|------------|------------|------------------|------------|------------------|------------|------------|------------|
| ** **                                    | ** ** | ** **         | ** ** | ** ** | ** ** | ** **       | ** ** | ** **       | ** ** | ** ** | ** ** |
| **2004**                                      |       |               |       |       |       |             |       |             |       |       |       |
| Net Sales                                     |       | $                  | 921        |       | $          | 762              |       | $                | 99         |       | $          | 215 |   | $ | 1,997 |   |
| Property, plant and equipment, net            |       | 325                |       | 331        |       | 16               |       | 23               |       | 695        |       |
|                                          |       |               |       |       |       |             |       |             |       |       |       |
| **2003**                                      |       |               |       |       |       |             |       |             |       |       |       |
| Net Sales                                     |       | $                  | 885        |       | $          | 693              |       | $                | 94         |       | $          | 174 |   | $ | 1,846 |   |
| Property, plant and equipment, net            |       | 344                |       | 303        |       | 12               |       | 18               |       | 677        |       |
|                                          |       |               |       |       |       |             |       |             |       |       |       |
| **2002**                                      |       |               |       |       |       |             |       |             |       |       |       |
| Net Sales (e)                                 |       | $                  | 870        |       | $          | 586              |       | $                | 89         |       | $          | 160 |   | $ | 1,705 |   |
| Property, plant and equipment, net            |       | 350                |       | 280        |       | 12               |       | 21               |       | 663        |       |

 

----

(a)          Representstotal segment assets net of operating liabilities.

 

(b)         Includesassets and liabilities not specifically allocated to business segments,primarily intangibles and other long-term assets, net of liabilities.

 

(c)          Includes$7 million in facility shutdown costs in 2004, $5 million, $7 million and $4million of severance, special pension adjustment and proxy costs, respectively,in 2003 and $22 million and $12 million of severance and environmental costs,respectively, in 2002.

 

(d)         Excludingoperations in the United States of America.

 

(e)          Excludessales of the divested BetzDearborn Water Treatment Business.

 

**24.****                                                       DerivativeFinancial Instruments and Risk Management**

 

The Company enters into forward-exchange contracts andcurrency options to reduce currency exposure.

 

Notional Amounts and Credit Exposure of Derivatives

 

The notional amounts of the derivative contractssummarized below do not represent the amounts exchanged by the parties involvedand thus, are not a measure of the Company’s exposure to various risks throughits use of derivatives.  The amountsexchanged by the parties are calculated on the basis of the notional amounts,underlyings such as interest rates and foreign currency rates of exchange andother terms of the derivative contracts.

 

Interest Rate Risk Management

 

From time to time, the Company uses interest rate swapagreements to manage interest costs and risks associated with changingrates.  The Company had no interest rateswap agreements at the end of 2004 and 2003.

 

Foreign Exchange Risk Management

 

TheCompany has selectively used foreign currency forward contracts and currencyswaps to offset the effects of foreign currency exchange rate changes onreported earnings, cash flow and net asset positions.  The primary exposures are denominated in theEuro, Swedish kroner, Danish kroner and British pound sterling.  Some of the contracts involved the exchangeof two foreign currencies, according to local needs in foreignsubsidiaries.  The term of the currencyderivatives is rarely more than three months. At December 31, 2004 and 2003, the Company had outstandingforward-exchange contracts to purchase foreign currencies aggregating $0.4million and $0.1 million and to sell foreign currencies aggregating $12.3million and $6.5 million, respectively. Cross-currency trades entered into by non-U.S. dollar denominatedentities aggregated $410 million and $376 million at December 31, 2004 and2003 respectively.  The foreign exchangecontracts outstanding at December 31, 2004 mature on or before March 1,2005.

 

85

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Fair Values

 

The following table presents the carrying amounts andfair values of the Company’s financial instruments at December 31, 2004and 2003:

 
| *** ***                               | *** *** | **(Dollars in millions)** |
|--------------------------------------------|--------------|---------------------------|
| ** **                                 | ** **   | **2004**                  | ** ** | **2003** | ** ** |
| ** **                                 | ** **   | **Carrying**              | ** ** | **Fair** | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                 | ** **   | **Amount**                | ** ** | **Value** | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Investment securities (available for sale) |         | $                         | 2 |   | $ | 2 |   | $ | 1 |   | $ | 1 |   |
| Total debt                                 |         | (1,240                    | ) | (1,265 | ) | (1,348 | ) | (1,386 | ) |
| Foreign exchange contracts                 |         | —                    |   | 1 |   | — |   | 1 |   |
|                                            |              |                           |  |  |  |  |  |  |  |  |  |  |  |

 

Fair values of the above financial instruments areindicative of cash that would have been required had settlement been made at December 31,2004 and 2003.

 

Basis of Valuation

 

•                  Investment securities: Quoted marketprices in 2003 and present value of expected future cash flows for 2004.

•                  Long-term debt: Present value ofexpected cash flows related to existing borrowings discounted at ratescurrently available to the Company for long-term borrowings with similar termsand remaining maturities.

•                  Foreign exchange contracts: Year-endexchange rates.

 

**25.****                                                       Divestitures**

 

On February 12, 2004, a subsidiary of the Companycompleted the sale of its minority ownership in CP Kelco ApS to a subsidiary ofJ. M. Huber Corporation for $27 million. The book value of the Company’s investment in CP Kelco ApS had beenwritten down to zero in 2002 as the result of an after-tax impairment charge of$19 million.

 

Summarized below are the results of operations andcash flows for the month of January 2004 and the years ended December 31,2003 and 2002:

 
| *** ***                    | *** *** | **(Dollars in millions)** | *** *** |
|---------------------------------|--------------|---------------------------|--------------|
| ** **                      | ** **   | **January**               | ** **   | **Year ended December 31,** | ** ** |
| ** **                      | ** **   | **2004**                  | ** **   | **2003** | ** ** | **2002** | ** ** |
| Net sales                       |         | $                         | 37           |   | $ | 427 |   | $ | 395 |   |
| Gross profit                    |         | 11                        |         | 129 |   | 123 |   |
| Profit from operations          |         | 5                         |         | 56 |   | 31 |   |
| Net (loss) income               |         | (2                        | )            | 59 |   | (255 | ) |
|                            |         |                      |         |   |   |   |   |
| Net cash provided by operations |         | $                         | 4            |   | $ | 128 |   | $ | 97 |   |
| Capital expenditures            |         | 1                         |         | 20 |   | 18 |   |

 

Themajor classes of assets and liabilities of CP Kelco ApS at the time of disposalwere as follows:

 
| *** ***              | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
| **(Dollars in millions)** | ** ** |
| **Assets**                | ** ** | ** ** | ** ** | **Liabilities** | ** ** | ** ** | ** ** |
| Cash                      |       | $          | 12         |   | Accounts payable  and accrued expenses |   | $ | 73 |   |
| Accounts receivable, net  |       | 66         |       | Other  liabilities |   | 83 |   |
| Inventory                 |       | 115        |       | Long-term debt |   | 660 |   |
| Fixed assets, net         |       | 412        |       | Equity |   | 116 |   |
| Goodwill                  |       | 218        |       |   |   |   |   |
| Intangible assets         |       | 73         |       |   |   |   |   |
| Other                     |       | 36         |       |   |   |   |   |
|                      |       | $          | 932        |   |   |   | $ | 932 |   |

 

86

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On April 29,2002, Hercules completed the sale of the Water Treatment Business to GESM, aunit of General Electric Company.  Thesale price was $1.8 billion in cash, resulting in net after-tax proceeds ofapproximately $1.7 billion.  The Companyused the net proceeds to prepay debt under its senior credit facility and ESOP creditfacility (see Notes 5 and 9).  Pursuantto SFAS 144, the Water Treatment Business was treated as a discontinuedoperation as of February 12, 2002, and accordingly, all financialinformation was restated.  The loss fromdiscontinued operations for the year ended December 31, 2002 included anafter-tax loss on the disposal of the business of $230 million.  The Paper Process Chemicals Business,representing approximately one-third of the business of BetzDearborn Inc. whenit was originally acquired in 1998, was fully integrated into and continues tobe reported within Pulp and Paper.

 

Summarizedbelow are the results of operations and cash flows of the Water TreatmentBusiness for the period through April 28, 2002.

 
| **(Dollars in millions)**                                                                       | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|------------|------------|
| Net Sales                                                                                       |       | $          | 269        |   |
| Profit from operations                                                                          |       | 53         |       |
| Income before income taxes                                                                      |       | 55         |       |
| Tax provision                                                                                   |       | 21         |       |
| Income from operations                                                                          |       | 34         |       |
| Loss from disposal of business, including a  provision for income taxes of $51 million for 2002 |       | (230       | )          |
| Loss from discontinued operations                                                               |       | $          | (196       | ) |
| Net cash provided by operations                                                                 |       | $          | 28         |   |
| Capital expenditures                                                                            |       | (3         | )          |
| Net cash flow from discontinued operations                                                      |       | $          | 25         |   |

 

87

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The major classes of assets and liabilities includedin the consolidated balance sheet at the time of disposal were as follows:

 
| *** ***                         | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
| **(Dollars in millions)**            | ** ** |
| **Assets**                           | ** ** | ** ** | ** ** | **Liabilities** | ** ** | ** ** | ** ** |
| Accounts receivables, net            |       | $          | 161        |   | Accounts payable |   | $ | 55 |   |
| Inventory                            |       | 76         |       | Accrued expenses |   | 35 |   |
| Fixed assets                         |       | 217        |       | Other liabilities |   | 178 |   |
| Goodwill and other intangible assets |       | 1,419      |       |   |   |   |   |
| Other assets                         |       | 19         |       |   |   |   |   |
|                                 |       | $          | 1,892      |   |   |   | $ | 268 |   |

 

**26.****                                                       CondensedConsolidating Financial Information of Guarantor Subsidiaries**

 

The 11.125% senior notes due 2007 issued on November 14,2000 are guaranteed by substantially all of the Company’s current and futurewholly-owned domestic restricted subsidiaries (the “guarantor subsidiaries”).  The Senior Credit Facility entered into in April 2004also provides for a guarantee by each guarantor subsidiary.  The guarantees by each guarantor subsidiaryare full and unconditional and joint and several.  The indenture under which the Company’s 6.60%notes due 2027 and 6.625% notes, redeemed in 2003, were issued requires suchnotes to be guaranteed or secured on the same basis as any other subsequentlyissued debt that is guaranteed or secured. As a result, at December 31, 2004, the following wholly-owneddomestic restricted subsidiaries fully and unconditionally and jointly andseverally guarantee the Senior Credit Facility, the 6.60% notes due 2027, the11.125% notes due 2007 and the 6.75% notes due 2029.

 

Aqualon Company

Athens Holding Inc.

Covington Holdings, Inc.

East Bay Realty Services, Inc.

FiberVisions Incorporated

FiberVisions, L.L.C.

FiberVisions L.P.

FiberVisions Products, Inc.

Hercules EuroHoldings, L.L.C.

Hercules FinanceCompany

Hercules Flavor, Inc.

HerculesHydrocarbon Holdings, Inc.

Hercules PaperHoldings, Inc.

Hercules SharedServices Corporation

WSP, Inc.

 

The non-guarantor subsidiaries include all of theCompany’s foreign subsidiaries and certain domestic subsidiaries.  The Company conducts much of its businessthrough and derives much of its income from its subsidiaries.  Therefore, the Company’s ability to makerequired payments with respect to its indebtedness and other obligationsdepends on the financial results and condition of its subsidiaries and itsability to receive funds from its subsidiaries. There are no restrictions on the ability of any of the guarantorsubsidiaries to transfer funds to the Company; however, there may be suchrestrictions for certain foreign non-guarantor subsidiaries.

 

The following condensed consolidating financialinformation for the Company presents the financial information of Hercules, theguarantor subsidiaries and the non-guarantor subsidiaries based on the Company’sunderstanding of the Securities and Exchange Commission’s interpretation andapplication of Rule 3-10 under the Securities and ExchangeCommission’s Regulation S-X.  Thefinancial information may not necessarily be indicative of results ofoperations or financial position had the guarantor subsidiaries ornon-guarantor subsidiaries operated as independent entities.

 

Inthis presentation, Hercules consists of parent company operations.  Guarantor subsidiaries and non-guarantorsubsidiaries of Hercules are reported on an equity basis.  Additionally, prior year information has beenreclassified to conform to the 2004 Consolidated Balance Sheet presentation.

 

88

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Condensed ConsolidatingStatement of Operations

Year Ended December 31,2004

 
| ** **                                                                    | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                        | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                                                     | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations and  Adjustments** | ** ** | **Consolidated** | ** ** |
| Net sales                                                                     |       | $                  | 541        |                        | $          | 475                               |       | $ | 1,132 |   | $ | (151 | ) | $ | 1,997 |   |
| Cost of sales                                                                 |       | 377                |       | 353                         |       | 731                               |       | (151 | ) | 1,310 |   |
| Selling, general, and administrative expenses                                 |       | 101                |       | 126                         |       | 155                               |       | — |   | 382 |   |
| Research and development                                                      |       | 20                 |       | 17                          |       | 6                                 |       | — |   | 43 |   |
| Goodwill and intangible asset amortization                                    |       | 6                  |       | 2                           |       | —                            |       | — |   | 8 |   |
| Other operating expenses, net                                                 |       | 5                  |       | 13                          |       | 9                                 |       | — |   | 27 |   |
|                                                                          |       |               |       |                        |       |                              |       |   |   |   |   |
| Profit (loss) from operations                                                 |       | 32                 |       | (36                         | )          | 231                               |       | — |   | 227 |   |
|                                                                          |       |               |       |                        |       |                              |       |   |   |   |   |
| Interest and debt expense (income), net                                       |       | 178                |       | (60                         | )          | (9                                | )          | — |   | 109 |   |
| Preferred security distributions of subsidiary  trusts                        |       | —             |       | —                      |       | —                            |       | — |   | — |   |
| Gain on sale of CP Kelco ApS                                                  |       | —             |       | —                      |       | (27                               | )          | — |   | (27 | ) |
| Other expense (income), net                                                   |       | 256                |       | 4                           |       | (144                              | )          | — |   | 116 |   |
|                                                                          |       |               |       |                        |       |                              |       |   |   |   |   |
| Income (loss) before income taxes and equity income  (loss)                   |       | (402               | )          | 20                          |       | 411                               |       | — |   | 29 |   |
| Provision (benefit) for income taxes                                          |       | (89                | )          | 38                          |       | 53                                |       | — |   | 2 |   |
|                                                                          |       |               |       |                        |       |                              |       |   |   |   |   |
| Equity income (loss) of affiliated companies                                  |       | —             |       | (1                          | )          | 1                                 |       | — |   | — |   |
| Equity income (loss) from consolidated subsidiaires                           |       | 340                |       | 6                           |       | (2                                | )          | (344 | ) | — |   |
| Net income (loss) from continuing operations                                  |       | 27                 |       | (13                         | )          | 357                               |       | (344 | ) | 27 |   |
|                                                                          |       |               |       |                        |       |                              |       |   |   |   |   |
| Net income on discontinued operations, net of tax                             |       | —             |       | —                      |       | —                            |       | — |   | — |   |
| Net income (loss) before cumulative effect of change  in accounting principle |       | 27                 |       | (13                         | )          | 357                               |       | (344 | ) | 27 |   |
| Cumulative effect of changes in accounting  principle, net of tax             |       | —             |       | —                      |       | —                            |       | — |   | — |   |
| Net income (loss)                                                             |       | $                  | 27         |                        | $          | (13                               | )          | $ | 357 |   | $ | (344 | ) | $ | 27 |   |

 

89

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Condensed ConsolidatingStatement of Operations

Year Ended December 31,2003

 
| ** **                                                              | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                        | ** ** |
|-------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                                               | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations and  Adjustments** | ** ** | **Consolidated** | ** ** |
| Net sales                                                               |       | $                  | 509        |                        | $          | 445                               |       | $ | 1,024 |   | $ | (132 | ) | $ | 1,846 |   |
| Cost of sales                                                           |       | 332                |       | 320                         |       | 643                               |       | (128 | ) | 1,167 |   |
| Selling, general, and administrative expenses                           |       | 84                 |       | 84                          |       | 192                               |       | — |   | 360 |   |
| Research and development                                                |       | 17                 |       | 17                          |       | 5                                 |       | — |   | 39 |   |
| Goodwill and intangible asset amortization                              |       | 6                  |       | 2                           |       | —                            |       | — |   | 8 |   |
| Other operating expenses, net                                           |       | 9                  |       | 4                           |       | 4                                 |       | — |   | 17 |   |
|                                                                    |       |               |       |                        |       |                              |       |   |   |   |   |
| Profit from operations                                                  |       | 61                 |       | 18                          |       | 180                               |       | (4 | ) | 255 |   |
|                                                                    |       |               |       |                        |       |                              |       |   |   |   |   |
| Interest and debt expense (income), net                                 |       | 174                |       | (59                         | )          | 16                                |       | — |   | 131 |   |
| Preferred security distributions of subsidiary  trusts                  |       | —             |       | —                      |       | —                            |       | — |   | — |   |
| Other expense, net                                                      |       | 23                 |       | 5                           |       | 1                                 |       | — |   | 29 |   |
|                                                                    |       |               |       |                        |       |                              |       |   |   |   |   |
| Income (loss) before income taxes and equity income  (loss)             |       | (136               | )          | 72                          |       | 163                               |       | (4 | ) | 95 |   |
|                                                                    |       |               |       |                        |       |                              |       |   |   |   |   |
| Provision (benefit) for income taxes                                    |       | (52                | )          | 29                          |       | 46                                |       | (2 | ) | 21 |   |
|                                                                    |       |               |       |                        |       |                              |       |   |   |   |   |
| Equity income of affiliated companies                                   |       | —             |       | (1                          | )          | 1                                 |       | — |   | — |   |
| Equity income from consolidated subsidiaries                            |       | 158                |       | 15                          |       | 2                                 |       | (175 | ) | — |   |
| Net income from continuing operations                                   |       | 74                 |       | 57                          |       | 120                               |       | (177 | ) | 74 |   |
|                                                                    |       |               |       |                        |       |                              |       |   |   |   |   |
| Net income on discontinued operations, net of tax                       |       | 4                  |       | —                      |       | —                            |       | — |   | 4 |   |
| Net income before cumulative effect of changes in  accounting principle |       | 78                 |       | 57                          |       | 120                               |       | (177 | ) | 78 |   |
| Cumulative effect of changes in accounting  principle, net of tax       |       | (33                | )          | —                      |       | —                            |       | — |   | (33 | ) |
|                                                                    |       |               |       |                        |       |                              |       |   |   |   |   |
| Net income                                                              |       | $                  | 45         |                        | $          | 57                                |       | $ | 120 |   | $ | (177 | ) | $ | 45 |   |

 

90

----

 

Condensed ConsolidatingStatement of Operations

Year Ended December 31,2002

 
| ** **                                                                     | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                        | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                                                      | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations  and  Adjustments** | ** ** | **Consolidated** | ** ** |
| Net sales                                                                      |       | $                  | 536        |                        | $          | 423                               |       | $ | 890 |   | $ | (144 | ) | $ | 1,705 |   |
| Cost of sales                                                                  |       | 333                |       | 294                         |       | 557                               |       | (144 | ) | 1,040 |   |
| Selling, general, and administrative expenses                                  |       | 94                 |       | 73                          |       | 181                               |       | — |   | 348 |   |
| Research and development                                                       |       | 19                 |       | 17                          |       | 6                                 |       | — |   | 42 |   |
| Goodwill and intangible asset amortization                                     |       | 5                  |       | 3                           |       | 1                                 |       | — |   | 9 |   |
| Other operating expense (income), net                                          |       | (11                | )          | 31                          |       | 26                                |       | — |   | 46 |   |
|                                                                           |       |               |       |                        |       |                              |       |   |   |   |   |
| Profit from operations                                                         |       | 96                 |       | 5                           |       | 119                               |       | — |   | 220 |   |
|                                                                           |       |               |       |                        |       |                              |       |   |   |   |   |
| Interest and debt expense (income), net                                        |       | 215                |       | (75                         | )          | (41                               | )          | — |   | 99 |   |
| Preferred security distributions of subsidiary  trusts                         |       | —             |       | —                      |       | 58                                |       | — |   | 58 |   |
| Other expense (income), net                                                    |       | 120                |       | —                      |       | (4                                | )          | (1 | ) | 115 |   |
|                                                                           |       |               |       |                        |       |                              |       |   |   |   |   |
| (Loss) income before income taxes and equity income  (loss)                    |       | (239               | )          | 80                          |       | 106                               |       | 1 |   | (52 | ) |
|                                                                           |       |               |       |                        |       |                              |       |   |   |   |   |
| (Benefit) provision for income taxes                                           |       | (59                | )          | 35                          |       | 21                                |       | — |   | (3 | ) |
|                                                                           |       |               |       |                        |       |                              |       |   |   |   |   |
| Equity income of affiliated companies                                          |       | —             |       | 2                           |       | —                            |       | — |   | 2 |   |
| Equity income (loss) from consolidated subsidiaries                            |       | 133                |       | (115                        | )          | 5                                 |       | (23 | ) | — |   |
| Net (loss) income from continuing operations                                   |       | (47                | )          | (68                         | )          | 90                                |       | (22 | ) | (47 | ) |
|                                                                           |       |               |       |                        |       |                              |       |   |   |   |   |
| Net (loss) income on discontinued operations, net of  tax                      |       | (196               | )          | 18                          |       | 12                                |       | (30 | ) | (196 | ) |
| Net (loss) income before cumulative effect of  changes in accounting principle |       | (243               | )          | (50                         | )          | 102                               |       | (52 | ) | (243 | ) |
| Cumulative effect of changes in accounting  principle, net of tax              |       | (368               | )          | (233                        | )          | (135                              | )          | 368 |   | (368 | ) |
|                                                                           |       |               |       |                        |       |                              |       |   |   |   |   |
| Net loss                                                                       |       | $                  | (611       | )                           | $          | (283                              | )          | $ | (33 | ) | $ | 316 |   | $ | (611 | ) |

 

91

----

 

CondensedConsolidating Balance Sheet

December 31, 2004

 
| ** **                                      | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                        | ** ** |
|-------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                       | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations  and  Adjustments** | ** ** | **Consolidated** | ** ** |
| **Assets**                                      |       |               |       |                        |       |                              |       |   |   |   |   |
| Current assets                                  |       |               |       |                        |       |                              |       |   |   |   |   |
| Cash and cash equivalents                       |       | $                  | 43         |                        | $          | 1                                 |       | $ | 83 |   | $ | — |   | $ | 127 |   |
| Accounts receivable, net                        |       | 65                 |       | 55                          |       | 226                               |       | 1 |   | 347 |   |
| Intercompany receivable                         |       | 74                 |       | 26                          |       | 30                                |       | (130 | ) | — |   |
| Inventories                                     |       | 36                 |       | 63                          |       | 104                               |       | (14 | ) | 189 |   |
| Deferred income taxes                           |       | 26                 |       | 17                          |       | 2                                 |       | — |   | 45 |   |
| Asbestos-related assets                         |       | 6                  |       | —                      |       | —                            |       | — |   | 6 |   |
| Other current assets                            |       | 23                 |       | 10                          |       | 25                                |       | — |   | 58 |   |
| Total current assets                            |       | 273                |       | 172                         |       | 470                               |       | (143 | ) | 772 |   |
| Property, plant and equipment, net              |       | 162                |       | 153                         |       | 380                               |       | — |   | 695 |   |
| Investments in subsidiaries and advances, net   |       | 2,279              |       | 88                          |       | 49                                |       | (2,416 | ) | — |   |
| Goodwill and other intangible assets, net       |       | 196                |       | 88                          |       | 428                               |       | — |   | 712 |   |
| Deferred income taxes                           |       | 266                |       | (159                        | )          | 15                                |       | — |   | 122 |   |
| Asbestos-related assets                         |       | 163                |       | —                      |       | —                            |       | — |   | 163 |   |
| Deferred charges and other assets               |       | 206                |       | 6                           |       | 34                                |       | — |   | 246 |   |
| Total assets                                    |       | $                  | 3,545      |                        | $          | 348                               |       | $ | 1,376 |   | $ | (2,559 | ) | $ | 2,710 |   |
| **Liabilities and Stockholders’  Equity**  |       |               |       |                        |       |                              |       |   |   |   |   |
| Current liabilities                             |       |               |       |                        |       |                              |       |   |   |   |   |
| Accounts payable                                |       | $                  | 42         |                        | $          | 26                                |       | $ | 130 |   | $ | — |   | $ | 198 |   |
| Accrued expenses                                |       | 78                 |       | 73                          |       | 51                                |       | — |   | 202 |   |
| Asbestos-related liabilities                    |       | 47                 |       | —                      |       | —                            |       | — |   | 47 |   |
| Intercompany payable                            |       | 7                  |       | 77                          |       | 45                                |       | (129 | ) | — |   |
| Current debt obligations                        |       | 4                  |       | —                      |       | 26                                |       | — |   | 30 |   |
| Total current liabilities                       |       | 178                |       | 176                         |       | 252                               |       | (129 | ) | 477 |   |
| Long-term debt                                  |       | 1,201              |       | —                      |       | 9                                 |       | — |   | 1,210 |   |
| Deferred income taxes                           |       | —             |       | —                      |       | 77                                |       | — |   | 77 |   |
| Pension liability                               |       | 177                |       | —                      |       | 64                                |       | — |   | 241 |   |
| Other postretirement benefits                   |       | 79                 |       | 2                           |       | —                            |       | — |   | 81 |   |
| Deferred credits and other liabilities          |       | 250                |       | 41                          |       | 23                                |       | — |   | 314 |   |
| Asbestos-related liabilities                    |       | 213                |       | —                      |       | —                            |       | — |   | 213 |   |
| Intercompany notes payable (receivable)         |       | 1,350              |       | (1,182                      | )          | (168                              | )          | — |   | — |   |
| Total stockholders’ equity                 |       | 97                 |       | 1,311                       |       | 1,119                             |       | (2,430 | ) | 97 |   |
| Total liabilities and stockholders’ equity |       | $                  | 3,545      |                        | $          | 348                               |       | $ | 1,376 |   | $ | (2,559 | ) | $ | 2,710 |   |

 

92

----

 

CondensedConsolidating Balance Sheet

December 31, 2003

 
| ** **                                      | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                        | ** ** |
|-------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                       | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations  and  Adjustments** | ** ** | **Consolidated** | ** ** |
| **Assets**                                      |       |               |       |                        |       |                              |       |   |   |   |   |
| Current assets                                  |       |               |       |                        |       |                              |       |   |   |   |   |
| Cash and cash equivalents                       |       | $                  | 9          |                        | $          | 2                                 |       | $ | 115 |   | $ | — |   | $ | 126 |   |
| Accounts receivable, net                        |       | 61                 |       | 50                          |       | 210                               |       | — |   | 321 |   |
| Intercompany receivable                         |       | 70                 |       | 21                          |       | 32                                |       | (123 | ) | — |   |
| Inventories                                     |       | 46                 |       | 58                          |       | 97                                |       | (14 | ) | 187 |   |
| Deferred income taxes                           |       | 94                 |       | —                      |       | 9                                 |       | (10 | ) | 93 |   |
| Asbestos-related assets                         |       | 7                  |       | —                      |       | —                            |       | — |   | 7 |   |
| Other current assets                            |       | 57                 |       | 5                           |       | 33                                |       | — |   | 95 |   |
| Total current assets                            |       | 344                |       | 136                         |       | 496                               |       | (147 | ) | 829 |   |
| Property, plant and equipment, net              |       | 168                |       | 167                         |       | 342                               |       | — |   | 677 |   |
| Investments in subsidiaries and advances, net   |       | 2,248              |       | 92                          |       | 51                                |       | (2,391 | ) | — |   |
| Goodwill and other intangible assets, net       |       | 201                |       | 90                          |       | 392                               |       | — |   | 683 |   |
| Deferred income taxes                           |       | 150                |       | —                      |       | 13                                |       | (119 | ) | 44 |   |
| Asbestos-related assets                         |       | 162                |       | —                      |       | —                            |       | — |   | 162 |   |
| Deferred  charges and other assets              |       | 244                |       | 10                          |       | 62                                |       | — |   | 316 |   |
| Total assets                                    |       | $                  | 3,517      |                        | $          | 495                               |       | $ | 1,356 |   | $ | (2,657 | ) | $ | 2,711 |   |
| **Liabilities and Stockholders’  Equity**  |       |               |       |                        |       |                              |       |   |   |   |   |
| Current liabilities                             |       |               |       |                        |       |                              |       |   |   |   |   |
| Accounts payable                                |       | $                  | 46         |                        | $          | 18                                |       | $ | 118 |   | $ | — |   | $ | 182 |   |
| Accrued expenses                                |       | 107                |       | 52                          |       | 58                                |       | (10 | ) | 207 |   |
| Asbestos-related liabilities                    |       | 45                 |       | —                      |       | —                            |       | — |   | 45 |   |
| Intercompany payable                            |       | 8                  |       | 73                          |       | 42                                |       | (123 | ) | — |   |
| Current debt oligations                         |       | 2                  |       | —                      |       | 20                                |       | — |   | 22 |   |
| Total current liabilities                       |       | 208                |       | 143                         |       | 238                               |       | (133 | ) | 456 |   |
| Long-term debt                                  |       | 1,300              |       | —                      |       | 26                                |       | — |   | 1,326 |   |
| Deferred income taxes                           |       | —             |       | 119                         |       | 78                                |       | (119 | ) | 78 |   |
| Pension liability                               |       | 203                |       | —                      |       | 47                                |       | — |   | 250 |   |
| Other postretirement benefits                   |       | 52                 |       | 44                          |       | —                            |       | — |   | 96 |   |
| Deferred credits and other liabilities          |       | 265                |       | 29                          |       | 24                                |       | — |   | 318 |   |
| Asbestos-related liabilities                    |       | 176                |       | —                      |       | —                            |       | — |   | 176 |   |
| Intercompany notes payable (receivable)         |       | 1,302              |       | (1,090                      | )          | (213                              | )          | 1 |   | — |   |
| Total stockholders’ equity                 |       | 11                 |       | 1,250                       |       | 1,156                             |       | (2,406 | ) | 11 |   |
| Total liabilities and stockholders’ equity |       | $                  | 3,517      |                        | $          | 495                               |       | $ | 1,356 |   | $ | (2,657 | ) | $ | 2,711 |   |

 

93

----

 

CondensedConsolidating Statement of Cash Flows

Year Ended December 31, 2004

 
| ** **                                                | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                        | ** ** |
|-----------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                                 | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations  and  Adjustments** | ** ** | **Consolidated** | ** ** |
| **Net Cash Provided By Operations**                       |       | $                  | 155        |                        | $          | 42                                |       | $ | 490 |   | $ | (566 | ) | $ | 121 |   |
|                                                      |       |               |       |                        |       |                              |       |   |   |   |   |
| **Cash Flow From Investing  Activities:**                 |       |               |       |                        |       |                              |       |   |   |   |   |
| Capital expenditures                                      |       | (23                | )          | (15                         | )          | (39                               | )          | — |   | (77 | ) |
| Proceeds of investment and fixed asset disposals          |       | 1                  |       | —                      |       | —                            |       | — |   | 1 |   |
| Proceeds from sale of minority interests in CP Kelco  ApS |       | 27                 |       | —                      |       | —                            |       | — |   | 27 |   |
| Acquisitions, net of cash acquired                        |       | —             |       | —                      |       | —                            |       | — |   | — |   |
| Decrease in restricted cash                               |       | —             |       | —                      |       | —                            |       | — |   | — |   |
| Investment in CRESTS Units preferred securities           |       | —             |       | —                      |       | —                            |       | — |   | — |   |
| Other, net                                                |       | 1                  |       | (2                          | )          | 1                                 |       | — |   | — |   |
| Net cash (used in) provided by investing activities       |       | 6                  |       | (17                         | )          | (38                               | )          | — |   | (49 | ) |
| **Cash Flow From Financing  Activities:**                 |       |               |       |                        |       |                              |       |   |   |   |   |
| Long-term debt proceeds                                   |       | 650                |       | —                      |       | —                            |       | — |   | 650 |   |
| Long-term debt payments                                   |       | (713               | )          | —                      |       | (17                               | )          | — |   | (730 | ) |
| Change in short-term debt                                 |       | —             |       | —                      |       | 2                                 |       | — |   | 2 |   |
| Payment of debt issuance costs and underwriting fees      |       | (8                 | )          | —                      |       | —                            |       | — |   | (8 | ) |
| Change in intercompany, non-current                       |       | (68                | )          | (26                         | )          | (262                              | )          | 356 |   | — |   |
| Treasury stock issued                                     |       | 6                  |       | —                      |       | —                            |       | — |   | 6 |   |
| Dividends paid                                            |       | —             |       | —                      |       | (210                              | )          | 210 |   | — |   |
| Other                                                     |       | 6                  |       | —                      |       | —                            |       | — |   | 6 |   |
| Net cash used in financing activities                     |       | (127               | )          | (26                         | )          | (487                              | )          | 566 |   | (74 | ) |
|                                                      |       |               |       |                        |       |                              |       |   |   |   |   |
| Effect of exchange rate changes on cash                   |       | —             |       | —                      |       | 3                                 |       | — |   | 3 |   |
| Net increase (decrease) in cash and cash equivalents      |       | 34                 |       | (1                          | )          | (32                               | )          | — |   | 1 |   |
| Cash and cash equivalents at beginning of year            |       | 9                  |       | 2                           |       | 115                               |       | — |   | 126 |   |
| Cash and cash equivalents at end of year                  |       | $                  | 43         |                        | $          | 1                                 |       | $ | 83 |   | $ | — |   | $ | 127 |   |

 

94

----

 

Condensed ConsolidatingStatement of Cash Flows

Year Ended December 31, 2003

 
| ** **                                           | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                      | ** ** |
|------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **(Dollars in millions)**                            | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non- Guarantor Subsidiaries** | ** ** | **Eliminations  and  Adjustments** | ** ** | **Consolidated** | ** ** |
| **Net Cash Provided By Operations**                  |       | $                  | 13         |                        | $          | 53                              |       | $ | 129 |   | $ | (172 | ) | $ | 23 |   |
|                                                 |       |               |       |                        |       |                            |       |   |   |   |   |
| **Cash Flow From Investing  Activities:**            |       |               |       |                        |       |                            |       |   |   |   |   |
| Capital expenditures                                 |       | (13                | )          | (13                         | )          | (22                             | )          | — |   | (48 | ) |
| Proceeds of investment and fixed asset disposals     |       | 4                  |       | 1                           |       | 5                               |       | — |   | 10 |   |
| Acquisitions, net of cash acquired                   |       | —             |       | —                      |       | (9                              | )          | — |   | (9 | ) |
| Decrease in restricted cash                          |       | 125                |       | —                      |       | —                          |       | — |   | 125 |   |
| Investment in CRESTS Units preferred securities      |       | (27                | )          | —                      |       | —                          |       | — |   | (27 | ) |
| Other, net                                           |       | (2                 | )          | 1                           |       | (1                              | )          | — |   | (2 | ) |
| Net cash (used in) provided by investing activities  |       | 87                 |       | (11                         | )          | (27                             | )          | — |   | 49 |   |
|                                                 |       |               |       |                        |       |                            |       |   |   |   |   |
| **Cash Flow From Financing  Activities:**            |       |               |       |                        |       |                            |       |   |   |   |   |
| Long-term debt repayments                            |       | (151               | )          | —                      |       | (14                             | )          | — |   | (165 | ) |
| Change in short-term debt                            |       | —             |       | —                      |       | (1                              | )          | — |   | (1 | ) |
| Change in intercompany, non-current                  |       | (66                | )          | (47                         | )          | (104                            | )          | 217 |   | — |   |
| Repurchase of CRESTS Units warrants                  |       | (7                 | )          | —                      |       | —                          |       | — |   | (7 | ) |
| Treasury stock issued                                |       | 2                  |       | —                      |       | —                          |       | — |   | 2 |   |
| Dividends paid                                       |       | —             |       | —                      |       | 45                              |       | (45 | ) | — |   |
| Net cash used in financing activities                |       | (222               | )          | (47                         | )          | (74                             | )          | 172 |   | (171 | ) |
|                                                 |       |               |       |                        |       |                            |       |   |   |   |   |
| Effect of exchange rate changes on cash              |       | —             |       | —                      |       | 16                              |       | — |   | 16 |   |
| Net (decrease) increase in cash and cash equivalents |       | (122               | )          | (5                          | )          | 44                              |       | — |   | (83 | ) |
| Cash and cash equivalents at beginning of year       |       | 131                |       | 7                           |       | 71                              |       | — |   | 209 |   |
| Cash and cash equivalents at end of year             |       | $                  | 9          |                        | $          | 2                               |       | $ | 115 |   | $ | — |   | $ | 126 |   |

 

95

----

 

CondensedConsolidating Statement of Cash Flows

YearEnded December 31, 2002

 
| ** **                                           | ** ** | **Unconsolidated** | ** ** | ** **                  | ** ** | ** **                        | ** ** |
|------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **(Dollars in millions)**                            | ** ** | **Parent**         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations  and  Adjustments** | ** ** | **Consolidated** | ** ** |
| **Net Cash (Used In) Provided By Operations**        |       | $                  | (340       | )                           | $          | (142                              | )          | $ | 353 |   | $ | (86 | ) | $ | (215 | ) |
|                                                 |       |               |       |                        |       |                              |       |   |   |   |   |
| **Cash Flow From Investing  Activities:**            |       |               |       |                        |       |                              |       |   |   |   |   |
| Capital expenditures                                 |       | (17                | )          | (8                          | )          | (18                               | )          | — |   | (43 | ) |
| Proceeds of investment and fixed asset disposals     |       | 1,813              |       | 2                           |       | 1                                 |       | — |   | 1,816 |   |
| Increase in restricted cash                          |       | (125               | )          | —                      |       | —                            |       | — |   | (125 | ) |
| Other, net                                           |       | 11                 |       | —                      |       | —                            |       | — |   | 11 |   |
| Net cash provided by (used in) investing activities  |       | 1,682              |       | (6                          | )          | (17                               | )          | — |   | 1,659 |   |
|                                                 |       |               |       |                        |       |                              |       |   |   |   |   |
| **Cash Flow From Financing  Activities:**            |       |               |       |                        |       |                              |       |   |   |   |   |
| Long-term debt proceeds                              |       | 450                |       | —                      |       | —                            |       | — |   | 450 |   |
| Long-term debt repayments                            |       | (1,680             | )          | (83                         | )          | (13                               | )          | — |   | (1,776 | ) |
| Change in short-term debt                            |       | (4                 | )          | —                      |       | (4                                | )          | — |   | (8 | ) |
| Payment of debt issuance costs and underwriting fees |       | (5                 | )          | —                      |       | —                            |       | — |   | (5 | ) |
| Change in intercompany, non-current                  |       | 15                 |       | 221                         |       | (285                              | )          | 49 |   | — |   |
| Treasury stock issued                                |       | 5                  |       | —                      |       | —                            |       | — |   | 5 |   |
| Dividends paid                                       |       | —             |       | —                      |       | (37                               | )          | 37 |   | — |   |
| Net cash (used in) provided by financing activities  |       | (1,219             | )          | 138                         |       | (339                              | )          | 86 |   | (1,334 | ) |
|                                                 |       |               |       |                        |       |                              |       |   |   |   |   |
| Net cash flow provided by discontinued operations    |       | —             |       | 5                           |       | 20                                |       | — |   | 25 |   |
| Effect of exchange rate changes on cash              |       | —             |       | —                      |       | (2                                | )          | — |   | (2 | ) |
| Net increase (decrease) in cash and cash equivalents |       | 123                |       | (5                          | )          | 15                                |       | — |   | 133 |   |
| Cash and cash equivalents at beginning of year       |       | 8                  |       | 12                          |       | 56                                |       | — |   | 76 |   |
| Cash and cash equivalents at end of year             |       | $                  | 131        |                        | $          | 7                                 |       | $ | 71 |   | $ | — |   | $ | 209 |   |

 

96

----

 

**HerculesIncorporated**

**Summary of Quarterly Results (Unaudited)**

 
| ** **                                                                                                                             | ** ** | **(Dollars in millions except per share amounts)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **1st Quarter**                                    | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** | **Year** | ** ** |
| ** **                                                                                                                             | ** ** | **2004**                                           | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                                                                                                                              |       | $                                                  | 475        |   | $ | 447 |   | $ | 510 |   | $ | 478 |   | $ | 501 |   | $ | 463 |   | $ | 511 |   | $ | 458 |   | $ | 1,997 |   | $ | 1,846 |   |
| Cost of sales                                                                                                                          |       |                                               | 305        |   |   | 284 |   |   | 325 |   |   | 298 |   |   | 328 |   |   | 289 |   |   | 352 |   |   | 296 |   |   | 1,310 |   |   | 1,167 |   |
| Selling, general and administrative expenses                                                                                           |       |                                               | 98         |   |   | 91 |   |   | 98 |   |   | 90 |   |   | 94 |   |   | 89 |   |   | 92 |   |   | 90 |   |   | 382 |   |   | 360 |   |
| Research and development                                                                                                               |       |                                               | 11         |   |   | 10 |   |   | 11 |   |   | 10 |   |   | 11 |   |   | 9 |   |   | 10 |   |   | 10 |   |   | 43 |   |   | 39 |   |
| Goodwill and intangible asset amortization                                                                                             |       |                                               | 2          |   |   | 2 |   |   | 2 |   |   | 2 |   |   | 2 |   |   | 2 |   |   | 2 |   |   | 2 |   |   | 8 |   |   | 8 |   |
| Other operating expense (income), net                                                                                                  |       |                                               | 13         |   |   | (1 | ) |   | 9 |   |   | 2 |   |   | 1 |   |   | 9 |   |   | 4 |   |   | 7 |   |   | 27 |   |   | 17 |   |
| Profit from operations                                                                                                                 |       |                                               | 46         |   |   | 61 |   |   | 65 |   |   | 76 |   |   | 65 |   |   | 65 |   |   | 51 |   |   | 53 |   |   | 227 |   |   | 255 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest and debt expense                                                                                                              |       |                                               | 30         |   |   | 34 |   |   | 30 |   |   | 33 |   |   | 25 |   |   | 32 |   |   | 24 |   |   | 32 |   |   | 109 |   |   | 131 |   |
| Gain on sale of CP Kelco SpA                                                                                                           |       |                                               | (26        | ) |   | — |   |   | — |   |   | — |   |   | — |   |   | — |   |   | (1 | ) |   | — |   |   | (27 | ) |   | — |   |
| Other expense, net                                                                                                                     |       |                                               | 17         |   |   | 4 |   |   | 27 |   |   | 6 |   |   | 50 |   |   | 7 |   |   | 22 |   |   | 12 |   |   | 116 |   |   | 29 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss) before income taxes                                                                                                      |       |                                               | 25         |   |   | 23 |   |   | 8 |   |   | 37 |   |   | (10 | ) |   | 26 |   |   | 6 |   |   | 9 |   |   | 29 |   |   | 95 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Provision (benefit) for income taxes                                                                                                   |       |                                               | (1         | ) |   | 9 |   |   | 4 |   |   | 5 |   |   | 41 |   |   | 9 |   |   | (42 | ) |   | (2 | ) |   | 2 |   |   | 21 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss) from continuing operations before  discontinued operations and cumulative effect of changes in accounting  principle |       |                                               | 26         |   |   | 14 |   |   | 4 |   |   | 32 |   |   | (51 | ) |   | 17 |   |   | 48 |   |   | 11 |   |   | 27 |   |   | 74 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income on discontinued operations, net of tax                                                                                      |       |                                               | —     |   |   | — |   |   | — |   |   | 2 |   |   | — |   |   | — |   |   | — |   |   | 2 |   |   | — |   |   | 4 |   |
| Net income (loss) before cumulative effect of  changes in accounting principle                                                         |       |                                               | 26         |   |   | 14 |   |   | 4 |   |   | 34 |   |   | (51 | ) |   | 17 |   |   | 48 |   |   | 13 |   |   | 27 |   |   | 78 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cumulative effect of changes in accounting principle                                                                                   |       |                                               | —     |   |   | (28 | ) |   | — |   |   | — |   |   | — |   |   | — |   |   | — |   |   | (5 | ) |   | — |   |   | (33 | ) |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                                                                      |       | $                                                  | 26         |   | $ | (14 | ) | $ | 4 |   | $ | 34 |   | $ | (51 | ) | $ | 17 |   | $ | 48 |   | $ | 8 |   | $ | 27 |   | $ | 45 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Earnings (loss) per share                                                                                                              |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic earnings (loss) per share:                                                                                                       |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                                                  |       | $                                                  | 0.24       |   | $ | 0.13 |   | $ | 0.04 |   | $ | 0.30 |   | $ | (0.47 | ) | $ | 0.16 |   | $ | 0.44 |   | $ | 0.10 |   | $ | 0.25 |   | $ | 0.69 |   |
| Discontinued operations                                                                                                                |       |                                               | —     |   |   | — |   |   | — |   |   | 0.02 |   |   | — |   |   | — |   |   | — |   |   | 0.02 |   |   | — |   |   | 0.04 |   |
| Cumulative effect of changes in accounting principle                                                                                   |       |                                               | —     |   |   | (0.26 | ) |   | — |   |   | — |   |   | — |   |   | — |   |   | — |   |   | (0.05 | ) |   | — |   |   | (0.31 | ) |
| Net income (loss)                                                                                                                      |       | $                                                  | 0.24       |   | $ | (0.13 | ) | $ | 0.04 |   | $ | 0.32 |   | $ | (0.47 | ) | $ | 0.16 |   | $ | 0.44 |   | $ | 0.07 |   | $ | 0.25 |   | $ | 0.42 |   |
|                                                                                                                                   |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted earnings (loss) per share:                                                                                                     |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                                                  |       | $                                                  | 0.24       |   | $ | 0.13 |   | $ | 0.04 |   | $ | 0.30 |   | $ | (0.47 | ) | $ | 0.16 |   | $ | 0.44 |   | $ | 0.10 |   | $ | 0.25 |   | $ | 0.69 |   |
| Discontinued operations                                                                                                                |       |                                               | —     |   |   | — |   |   | — |   |   | 0.02 |   |   | — |   |   | — |   |   | — |   |   | 0.02 |   |   | — |   |   | 0.04 |   |
| Cumulative effect of changes in accounting principle                                                                                   |       |                                               | —     |   |   | (0.26 | ) |   | — |   |   | — |   |   | — |   |   | — |   |   | — |   |   | (0.05 | ) |   | — |   |   | (0.31 | ) |
| Net income (loss)                                                                                                                      |       | $                                                  | 0.24       |   | $ | (0.13 | ) | $ | 0.04 |   | $ | 0.32 |   | $ | (0.47 | ) | $ | 0.16 |   | $ | 0.44 |   | $ | 0.07 |   | $ | 0.25 |   | $ | 0.42 |   |
|                                                                                                                                        |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

97

----

 

**HerculesIncorporated**

**PrincipalConsolidated Subsidiaries as of December 31, 2004**

 
| **Argentina**                                    |
|--------------------------------------------------|
| Hercules Argentina S.A.                          |
|                                             |
| **Australia**                                    |
| Hercules Chemicals Solutions Pte Ltd             |
| Little H Pty Ltd.                                |
|                                             |
| **Austria**                                      |
| Hercules Austria GmbH                            |
|                                             |
| **Bahamas**                                      |
| Hercules International Trade Corporation Limited |
|                                             |
| **Belgium**                                      |
| Hercules Beringen B.V.B.A.                       |
| Hercules Doel B.V.B.A.                           |
| Hercules Europe B.V.B.A.                         |
| Hercules Holding B.V./B.V.B.A.                   |
|                                             |
| **Bermuda**                                      |
| Curtis Bay Insurance Co. Ltd.                    |
|                                             |
| **Brazil**                                       |
| Hercules do Brasil Produtos  Quimicos Ltda.      |
|                                             |
| **British Virgin Islands**                       |
| Ever Success Overseas Limited                    |
|                                             |
| **Canada**                                       |
| Hercules Canada (2002) Inc.                      |
|                                             |
| **Chile**                                        |
| Hercules Chile Limitada                          |
|                                             |
| **China**                                        |
| FiberVisions (China) A/S                         |
| FiberVisions (China) Textile Products Ltd.       |
| Hercules Chemicals (Jiangmen) Company Limited    |
| Hercules Trading (Shanghai) Company Ltd.         |
| Shanghai Hercules Chemicals Co., Ltd. (1)        |
|                                             |
| **Czech (Republic)**                             |
| Hercules CZ s.r.o.                               |
|                                             |
| **Denmark**                                      |
| ES FiberVisions ApS                              |
| ES FiberVisions Holding ApS                      |
| FiberVisions, A/S                                |
| Hercules Investments ApS                         |
|                                             |
| **Finland**                                      |
| Hercules Finland OY                              |
|                                             |
| **France**                                       |
| Aqualon France B.V.                              |
| Hercules SA                                      |
|                                             |
| **Germany**                                      |
| Abieta Chemie GmbH (1)                           |
| FiberVisions GmbH                                |
| Hercules Deutschland GmbH                        |
| Hercules GmbH                                    |
|                                             |
| **Hong Kong**                                    |
| Hercules China Limited                           |
| ES FiberVisions Hong Kong Ltd.                   |
|                                             |
| **India**                                        |
| Hercules Industrial Chemicals Private Limited    |
|                                             |
| **Indonesia**                                    |
| P.T. Hercules Chemicals Indonesia                |
|                                             |
| **Italy**                                        |
| Hercules Italia S.p.A.                           |
|                                             |
| **Japan**                                        |
| Hercules Japan Ltd.                              |
|                                             |
| **Korea**                                        |
| Hercules Korea Chemical Co. Ltd.                 |
|                                             |
| **Liechtenstein**                                |
| Organa Trust, Registered                         |
|                                             |
| **Luxembourg**                                   |
| Hercules Investments S.a.r.l.                    |
|                                             |
| **Mexico**                                       |
| Hercules Services Mexico S.A.  de C.V.           |
| Hercules Mexico, S.A. de C.V.                    |
|                                             |
| **Netherlands**                                  |
| Aqualon France B.V.                              |
| Hercules B.V.                                    |
| Hercules Chemical B.V.                           |
| Hercules Holding Specialty Materials B.V.        |

 

98

----

 
| **Norway**                                             |
|--------------------------------------------------------|
| Hercules Norway AS                                     |
|                                                   |
| **Peru**                                               |
| Hercules Peru S.R.L.                                   |
|                                                   |
| **Poland**                                             |
| Hercules Polska Sp. z.o.o.                             |
|                                                   |
| **Portugal**                                           |
| Misan Portuguesa Lda.                                  |
|                                                   |
| **Russia**                                             |
| Hercules Russia L.L.C.                                 |
|                                                   |
| **Singapore**                                          |
| Hercules Chemical Solutions Pte Ltd.                   |
|                                                   |
| **South Africa**                                       |
| Hercules Chemicals South Africa (Proprietary)  Limited |
|                                                   |
| **Spain**                                              |
| Hercules Quimica S.A.                                  |
|                                                   |
| **Sweden**                                             |
| Hercules Holdings AB                                   |
|                                                   |
| **Switzerland**                                        |
| FiberVisions A.G./FiberVisions Ltd.                    |
| Franchem AG                                            |
|                                                   |
| **Taiwan**                                             |
| Hercules Chemicals (Taiwan) Co., Ltd.                  |
|                                                   |
| **Thailand**                                           |
| Hercules Chemical Solutions (Thailand) Ltd.            |
|                                                   |
| **United Kingdom**                                     |
| Hercules Holding II Limited                            |
| Hercules Limited                                       |
|                                                   |
| **United States**                                      |
| Aqualon Company, Delaware                              |
| Athens Holdings Inc., Delaware                         |
| Covington Holdings Inc., Delaware                      |
| East Bay Realty Services, Inc., Delaware          |
| FiberVisions Incorporated, Delaware                    |
| FiberVisions, L.L.C., Delaware                         |
| FiberVisions L.P., Delaware                            |
| FiberVisions Products, Inc., Georgia              |
| Hercules Country Club, Inc.                       |
| Hercules Euro Holdings, L.L.C., Delaware               |
| Hercules Finance Company, Delaware                     |
| Hercules Flavor, Inc., Delaware                   |
| Hercules Hydrocarbon Holdings, Inc.               |
| Hercules Paper Holdings, Inc.                     |
| Hercules Shared Services Corporation, Delaware         |
| WSP, Inc., Delaware                               |
|                                                   |
| **Virgin Islands**                                     |
| Hercules Islands Corporation (1)                       |

 

----

*(1)*                               *This entity is owned inpart by Hercules with the remaining interest held by a third party*

 

99

----

 
| **ITEM 9.** | **CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

 

None.

 
| **ITEM 9A.** | **CONTROLS AND PROCEDURES** |
|--------------|-----------------------------|

 

TheCompany carried out an evaluation, under the supervision and with theparticipation of the Company’s management, including the Company’s Presidentand Chief Executive Officer and the Company’s Vice President and ChiefFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15as of December 31, 2004.  Based uponthat evaluation, the Company’s President and Chief Executive Officer and theCompany’s Vice President and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective.  However, as more fully described in Item 4,Controls and Procedures, of the Company’s Form 10-Q/A for thequarterly period ended September 30, 2004, the Company had determined thatit had cumulative additional tax liabilities for the years 1987 through 1995that had not been reconciled to the various general ledger tax balances.  Accordingly, the Company amended its Form 10-Kfor 2003 and each of its Form 10-Q’s for 2004, includingdescriptions of the control weaknesses identified and the disclosure controlsand procedures subsequently instituted and implemented over the tax process inorder to mitigate future occurrences. Disclosure controls and procedures are controls and procedures that aredesigned to ensure that information required to be disclosed in Company reportsfiled or submitted under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

There have been no significant changes in the Company’s internalcontrols over financial reporting that occurred during the Company’s fourthfiscal quarter, subsequent to the implementation of the aforementioned taxcontrols, that have materially affected, or are reasonably likely to materiallyaffect the registrant’s internal control over financial reporting.

 

Management’s Report on Internal Control Over Financial Reporting is on page 30of this Form 10-K.

 
| **ITEM 9B.** | **OTHER INFORMATION** |
|--------------|-----------------------|

 

None.

 

**PART III**

 
| **ITEM 10.** | **DIRECTORS AND EXECUTIVE OFFICERS OF THE  REGISTRANT** |
|--------------|---------------------------------------------------------|

 

**Board ofDirectors**

 

Informationregarding directors and nominees for directors of Hercules will be included inthe Company’s Proxy Statement and is incorporated herein by reference.

 

**Executive Officers of The Registrant**

 

Information regarding each executive officer ofHercules is included in Part I, Executive Officers of the Registrants, ofthis Form 10-K and is incorporated herein by reference.

 
| **ITEM 11.** | **EXECUTIVE COMPENSATION** |
|--------------|----------------------------|

 

Information regardingcompensation of Hercules’ directors and executive officers will be included inthe Company’s Proxy Statement and is incorporated herein by reference.

 
| **ITEM 12.** | **SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS  AND MANAGEMENT** |
|--------------|---------------------------------------------------------------------|

 

Information regarding beneficial ownership of Herculescommon stock by certain beneficial owners and by directors and executiveofficers of Hercules will be included in the Company’s Proxy Statement and isincorporated herein by reference.

 

Equity Compensation Plan Information

 

The following table provides information as of December 31,2004 concerning the number of shares of common stock to be issued upon theexercise of outstanding options, warrants and rights issued under all of theCompany’s existing equity compensation plans, including the HerculesIncorporated Long-Term Incentive Compensation Plan and the HerculesIncorporated Non-Employee Director Stock Accumulation Plan; theweighted-average exercise price of such options, warrants and rights and thenumber of securities remaining available for future issuance under suchplans.  All of the Company’s equitycompensation plans have been approved by the Company’s shareholders.

 

100

----

 
| **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         |       | 14,853,859                                                                                          | (1)(2)     | $                                                                                  | 29.57      |                                                                                                                                                   | 3,396,668  |   |
|                                                            |       |                                                                                                |       |                                                                               |       |                                                                                                                                                   |       |
| Equity compensation plans not approved by security  holders (3) |       | —                                                                                              |       | —                                                                             |       | —                                                                                                                                                 |       |
| Total                                                           |       | 14,853,859                                                                                          |       | $                                                                                  | 29.57      |                                                                                                                                                   | 3,396,668  |   |

 

----

(1) Includes7,266,410 options with exercise prices in excess of the weighted average priceof $29.57.

(2) Includesoptions to purchase 4,059,983 shares that were not vested at December 31,2004.

(3) There areno equity compensation plans that have not been approved by the Company’sshareholders.

 
| **ITEM 13.** | **CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS** |
|--------------|----------------------------------------------------|

 

Information regarding relationships or transactionsbetween directors and officers and the Company will be included in the Company’sProxy Statement and is incorporated herein by reference.

 
| **ITEM 14.** | **PRINCIPAL ACCOUNTANT FEES AND SERVICES** |
|--------------|--------------------------------------------|

 

Information regarding principal accountant fees and services will beincluded in the Company’s Proxy Statement and is incorporated herein byreference.

 

101

----

 

**PART IV**

 
| **ITEM 15.** | **EXHIBITS AND FINANCIAL STATEMENT SCHEDULES** |
|--------------|------------------------------------------------|

 

(a)                                  Documentsfiled as part of this Report:

 

1.               ConsolidatedFinancial Statements

 
| Management’s  Report on Internal Control over Financial Reporting                                                     |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|
| Report  of Independent Registered Public Accounting Firm                                                                   |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2004, 2003 and  2002                          |   |
| Consolidated Balance Sheets  as of December 31, 2004 and 2003                                                         |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and  2002                          |   |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the Years Ended  December 31, 2004, 2003 and 2002 |   |
| Consolidated  Statements of Comprehensive Income (Loss) for the Years Ended  December 31, 2004, 2003 and 2002         |   |
| Summary of  Significant Accounting Policies and Notes to Consolidated Financial  Statements                                |   |

 

2.               Financial StatementSchedules:

 

**Schedule II – Valuation andQualifying Accounts**

 
| ** **              | ** ** | **Balance at** | ** ** | **Charged to** | ** ** | **Charged to** | ** ** | ** **     | ** ** | **Balance at** | ** ** |
|-------------------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **              | ** ** | **beginning**  | ** ** | **costs and**  | ** ** | **other**      | ** ** | ** **     | ** ** | **end**        | ** ** |
| **Description**         | ** ** | **of period**  | ** ** | **expenses**   | ** ** | **accounts**   | ** ** | **Deductions** | ** ** | **of period**  | ** ** |
| **Year 2004**           |       |           |       |           |       |           |       |           |       |           |       |
| Tax valuation allowance |       | $              | 444        |           | $          | (23            | )          | $              | 20         |           | $          | — |   | $ | 441 |   |
| **Year 2003**           |       |           |       |           |       |           |       |           |       |           |       |
| Tax valuation allowance |       | $              | 373        |           | $          | (3             | )          | $              | 74         |           | $          | — |   | $ | 444 |   |
| **Year 2002**           |       |           |       |           |       |           |       |           |       |           |       |
| Tax valuation allowance |       | $              | 124        |           | $          | 1              |       | $              | 248        |           | $          | — |   | $ | 373 |   |

 

All other schedules areomitted because they are not applicable, not required or the informationrequired is either presented in the Notes to Financial Statements or has notchanged materially from that previously reported.

 

3.               Exhibits:

 

A complete listingof exhibits is included in the Exhibit Index that precedes the exhibitsfiled with this Report.

 

102

----

 

**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized on March 16, 2005.

 
|   | HERCULES  INCORPORATED                 |
|--------|----------------------------------------|
|   |                                   |
|   |                                   |
|   | By:                                    | /s/ Craig A.  Rogerson |   |
|   | President and  Chief Executive Officer |
|        |                                        |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant in thecapacities indicated on March 16, 2005.

 
| **Principal  Executive Officer and Director:** |                                  |   |
|------------------------------------------------|---------------------------------------|--------|
| President and Chief Executive Officer          | /s/ Craig A.  Rogerson                |   |
|                                           | Craig A.  Rogerson                    |   |
| **Principal  Financial Officer:**              |                                  |   |
| Vice President and Chief Financial Officer     | /s/ Allen A.  Spizzo                  |   |
|                                           | Allen A. Spizzo                       |   |
| **Principal  Accounting Officer:**             |                                  |   |
| Vice President and Controller                  | /s/ Fred G.  Aanonsen                 |   |
|                                           | Fred G. Aanonsen                      |   |
|                                           |                                  |   |
| **Directors:**                                 |                                  |   |
|                                           | /s/ John K.  Wulff                    |   | /s/ Robert D.  Kennedy |   |
|                                           | John K. Wulff,  Chairman of the Board |   | Robert D.  Kennedy |   |
|                                           |                                  |   |
|                                           | /s/ Patrick Duff                      |   | /s/ Jeffrey M.  Lipton |   |
|                                           | Patrick Duff                          |   | Jeffrey M.  Lipton |   |
|                                           |                                  |   |
|                                           | /s/ Thomas P.  Gerrity                |   | /s/ Joe B. Wyatt |   |
|                                           | Thomas P.  Gerrity                    |   | Joe B. Wyatt |   |
|                                           |                                  |   |
|                                           | /s/ John C.  Hunter, III         |   |   |   |
|                                           | John C. Hunter, III              |   |   |   |
|                                                |                                       |        |  |  |  |

 

103

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**EXHIBITINDEX**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                 | ** ** | **Incorporated by Reference To**                                                                                         |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------|
| 2.1        |       | Agreement and  Plan of Merger among Hercules, Water Acquisition Company and BetzDearborn  Inc., dated July 30, 1998                                                                                                                                                        |       | Exhibit 2.1,  BetzDearborn Inc. Current Report on Form 8-K, filed July 30,  1998                          |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 3.1        |       | Restated  Certificate of Incorporation of Hercules, as revised and amended July 6,  1988                                                                                                                                                                                   |       | Exhibit 3-A,  Annual Report on Form 10-K filed March 26, 1993                                             |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 3.2        |       | Certificate of  Amendment dated October 24, 1995, to Hercules’ Restated Certificate of  Incorporation as revised and amended July 5, 1998                                                                                                                        |       | Exhibit 4.1a,  Registration Statement on Form S-3, filed September 15, 1998                               |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 3.3        |       | By-Laws of  Hercules, as revised and amended as of July 15, 2003                                                                                                                                                                                                           |       | Exhibit 3.1,  Quarterly Report on Form 10-Q filed August 7, 2003                                          |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.1        |       | Officers’  Certificate, dated as of July 27, 1999, pursuant to the Junior  Subordinated Debentures Indenture between Hercules and Chase, dated as of November 12,  1998                                                                                          |       | Exhibit 4.1,  Current Report on Form 8-K, dated July 27, 1999                                             |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.2        |       | Unit Agreement,  dated July 27, 1999, among Hercules, Hercules Trust II and The Chase  Manhattan Bank, as unit agent                                                                                                                                                       |       | Exhibit 4.3,  Current Report on Form 8-K, dated July 27, 1999                                             |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.3        |       | Warrant  Agreement, dated July 27, 1999, between Hercules and The Chase Manhattan  Bank, as warrant agent                                                                                                                                                                  |       | Exhibit 4.4,  Current Report on Form 8-K, dated July 27, 1999                                             |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.4        |       | Form of Series A  Junior Subordinated Deferrable Interest Debentures                                                                                                                                                                                                  |       | Exhibit 4.5,  Current Report on Form 8-K, dated July 27, 1999                                             |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.5        |       | Form of  CRESTS Unit                                                                                                                                                                                                                                                       |       | Exhibit 4.7,  Current Report on Form 8-K, dated July 27, 1999                                             |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.6        |       | Form of  Warrant                                                                                                                                                                                                                                                           |       | Exhibit 4.8,  Current Report on Form 8-K, dated July 27, 1999                                             |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.7        |       | Rights  Agreement, dated as of August 24, 2000, between Hercules Incorporated  and Chase Mellon Shareholder Services, L.L.C.                                                                                                                                               |       | Exhibit 4.1  to Hercules Registration of Certain Classes of Securities on Form 8-A  filed August 10, 2000 |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.8        |       | Indenture, dated  as of November 14, 2000, between Hercules Incorporated, as issuer and  Wells Fargo Bank Minnesota, N.A., as trustee (including the form of 11.125%  senior notes due 2007 included as Exhibit A thereto).                                           |       | Exhibit 4-A,  Quarterly Report on Form 10-Q, filed November 14, 2000                                      |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.9        |       | Registration  Rights Agreement, dated as of November 14, 2000, among Hercules  Incorporated and all of its domestic subsidiaries and Donaldson, Lufkin &  Jenrette Securities Corporation and Credit Suisse First Boston Corporation,  as the initial purchasers. |       | Exhibit 4-B  Quarterly Report on Form 10-Q, filed November 14, 2000                                       |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.10       |       | Amendment No. 1  to the Hercules Incorporated Rights Agreement, dated as of June 5, 2003                                                                                                                                                                              |       | Exhibit 4.2,  Registration Statement on Form 8-A, filed June 5, 2003                                      |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.11       |       | Amendment No. 2  to the Hercules Incorporated Rights Agreement, dated as of August 21,  2003                                                                                                                                                                          |       | Exhibit 4.1,  Current Report on Form 8-K, filed September 22, 2003                                        |
|       |       |                                                                                                                                                                                                                                                                            |       |                                                                                                                     |
| 4.12       |       | Indenture, dated  as of April 8, 2004, between Hercules Incorporated and each of the  Guarantors party thereto and Wells Fargo Bank, National Association                                                                                                                  |       | Exhibit 4.1,  Quarterly Report on Form 10-Q filed May 10, 2004                                            |

 

104

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| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                     | ** ** | ** **                                                                              |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|
| 4.13       |       | Registration  Rights Agreement, dated April 8, 2004, between Hercules Incorporated and  the Guarantors listed on Schedule A thereto and Credit Suisse First  Boston LLC, Wachovia Capital Markets, LLC, Scotia Capital (USA) Inc. and  Deutsche Bank Securities Inc. |       | Exhibit 4.2,  Quarterly Report on Form 10-Q, filed May 10, 2004          |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.1       |       | Hercules  Executive Survivor Benefit Plan                                                                                                                                                                                                                                      |       | Exhibit 10-D,  Annual Report on Form 10-K, filed March 27, 1981          |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.2       |       | Hercules 1993  Non-Employee Director Stock Accumulation and Deferred Compensation Plan                                                                                                                                                                                         |       | Exhibit 4.1,  Registration Statement on Form S-8, filed July 16, 1993    |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.3       |       | Hercules  Employee Pension Restoration Plan                                                                                                                                                                                                                                    |       | Exhibit 10-L,  Annual Report on Form 10-K, filed March 26, 1993          |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.4       |       | Hercules Amended  and Restated Long Term Incentive Compensation Plan                                                                                                                                                                                                           |       | Exhibit 10-K,  Annual Report on Form 10-K, filed March 29, 2000          |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.5       |       | CRESTS Units  Underwriting Agreement, dated July 21, 1999, among Hercules, Hercules  Trust II and the Underwriters named therein                                                                                                                                          |       | Exhibit 1.1,  Current Report on Form 8-K, dated July 27, 1999            |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.6       |       | Common Stock  Underwriting Agreement, dated July 21, 1999, among Hercules and the  Underwriters named therein                                                                                                                                                             |       | Exhibit 1.2,  Current Report on Form 8-K, dated July 27, 1999            |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.7       |       | Form of  Change-of-Control Employment Agreements entered into as of August 24,  2000 by Hercules Incorporated and each of Robert C. Flexon and Craig A.  Rogerson                                                                                                    |       | Exhibit 10-19,  Registration Statement S-4, filed August 9, 2001              |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.8       |       | Resignation  Agreement, dated as of October 17, 2000, between Hercules Incorporated  and Vincent J. Corbo                                                                                                                                                                 |       | Exhibit 10-20,  Registration Statement on Form S-4, filed August 9, 2001 |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.9       |       | Letter  Agreement, dated November 1, 2000, between Hercules Incorporated and  Harry J. Tucci                                                                                                                                                                              |       | Exhibit 10-21,  Registration Statement on Form S-4, filed August 9, 2001 |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.10      |       | Form of  Change-of-Control Employment Agreements entered into as of June 15, 2001  by Hercules Incorporated and Richard G. Dahlen                                                                                                                                    |       | Exhibit 10-25,  Registration Statement S-4, filed August 9, 2001              |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.11      |       | Separation  Agreement and General Release of Claims, dated June 21, 2001, between  Hercules Incorporated and George MacKenzie                                                                                                                                             |       | Exhibit 10-27,  Registration Statement on Form S-4, filed August 9, 2001 |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.12      |       | Change-of-Control  Employment Agreement, dated as of July 2, 2001, by and between Hercules  Incorporated and Fred G. Aanonsen                                                                                                                                             |       | Exhibit 10-28,  Registration Statement on Form S-4, filed August 9, 2001 |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.13      |       | Stock and Asset  Purchase Agreement, dated as of February 12, 2002, by and among Hercules  Incorporated, General Electric Company and Falcon Acquisition Corp.                                                                                                            |       | Exhibit 10.1,  Current Report on Form 8-K, dated February 12, 2002       |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.14      |       | Amendment 2002-1  to Amended and Restated Long Term Incentive Compensation Plan                                                                                                                                                                                                |       | Exhibit I,  Proxy Statement, dated May 15, 2002                               |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.15      |       | Amendment 2002-1  to Non-Employee Director Stock Accumulation Plan                                                                                                                                                                                                             |       | Exhibit II,  Proxy Statement, dated May 15, 2002                              |
|       |       |                                                                                                                                                                                                                                                                           |       |                                                                                    |
| 10.16      |       | Hercules  Incorporated Compensation Benefits Grantor Trust Agreement for Management  Employees                                                                                                                                                                                 |       | Exhibit 10-Ee,  Annual Report on Form 10-K/A, filed May 1, 2003          |

 

105

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| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                   | ** ** | ** **                                                                           |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|
| 10.17      |       | Hercules  Incorporated Compensation Benefits Grantor Trust Agreement for Non-Employee  Directors                                                                                                                                                                                             |       | Exhibit 10-Ff,  Annual Report on Form 10-K/A, filed May 1, 2003       |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.18      |       | Amended and  Restated Hercules Incorporated Management Incentive Compensation Plan, dated February 21,  2003                                                                                                                                                                            |       | Exhibit 10-Gg  Annual Report on Form 10-K/A, filed May 1, 2003        |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.19      |       | Hercules Deferred Compensation Plan, restated  December 1995                                                                                                                                                                                                        |       | Exhibit 10-B,  Quarterly Report on Form 10-Q, filed May 15, 2003      |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.20      |       | Employment Offer  Letter - Fred G. Aanonsen, dated June 27, 2001                                                                                                                                                                                                                        |       | Exhibit 10-C,  Quarterly Report on Form 10-Q, filed May 15, 2003      |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.21      |       | Hercules  Executive Survivor Benefit Plan II dated January 1, 1987 - benefit  structure is only applicable to one executive officer                                                                                                                                                     |       | Exhibit 10-E,  Quarterly Report on Form 10-Q, filed May 15, 2003      |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.22      |       | First Amendment  to Credit Agreement, dated December 17, 2003, among Hercules  Incorporated, certain subsidiaries of Hercules several banks and other  financial institutions identified in the agreement and Credit Suisse First  Boston, as administrative agent                      |       | Exhibit 10-Mm,  Annual Report on Form 10-K, filed March 15, 2004      |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.23      |       | Change of  Control Employment Agreement, dated April 15, 2002, by and between  Hercules Incorporated and John Y. Televantos                                                                                                                                                             |       | Exhibit 10-Nn,  Annual Report on Form 10-K, filed March 15, 2004      |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.24      |       | Omnibus Equity  Compensation Plan for Non-Employee Directors                                                                                                                                                                                                                                 |       | Appendix II,  Proxy Statement dated June 20, 2003                          |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.25      |       | Amended and  Restated Credit Agreement, dated as of April 8, 2004, between Hercules  Incorporated and the Guarantors listed on Schedule A thereto and Credit  Suisse First Boston LLC, Wachovia Capital Markets, LLC, Scotia Capital (USA)  Inc. and Deutsche Bank Securities Inc. |       | Exhibit 10.1,  Quarterly Report on Form 10-Q, filed May 10, 2004      |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.26      |       | First Amendment  to Amended and Restated Credit Agreement dated as of August 12, 2004,  among Hercules Incorporated and the Guarantors listed on Schedule A  thereto and Credit Suisse First Boston LLC and Wachovia Bank, National  Association                                   |       | Exhibit 10.1,  Quarterly Report on Form 10-Q, filed November 15, 2004 |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.27*     |       | Employment  Agreement between Hercules Incorporated and Israel J. Floyd, dated August 24,  2000                                                                                                                                                                                         |       |                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.28*     |       | First Amendment  to the Employment Agreement between Hercules Incorporated and Israel J.  Floyd, dated August 24, 2000                                                                                                                                                                  |       |                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.29*     |       | Employment  Agreement between Hercules Incorporated and Allen A. Spizzo, dated August 24,  2000                                                                                                                                                                                         |       |                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.30*     |       | First Amendment  to the Employment Agreement between Hercules Incorporated and Allen A.  Spizzo, dated August 24, 2000                                                                                                                                                                  |       |                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.31*     |       | First Amendment  to the Employment Agreement between Hercules Incorporated and Craig A.  Rogerson, dated August 24, 2000                                                                                                                                                                |       |                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                         |       |                                                                                 |
| 10.32*     |       | Employment Offer  Letter – John Televantos, dated April 15, 2002                                                                                                                                                                                                                   |       |                                                                                 |

 

106

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| ** ** | ** ** | ** **                                                                                                                                                                       | ** ** | ** **                                                                   |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|
| 10.33*     |       | Pension Service  Credit Agreement between Hercules Incorporated Compensation Committee of the  Hercules Board of Directors and John Televantos, dated September 1, 2004     |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 10.34*     |       | Employment Offer  Letter – Paul C. Raymond III, dated December 28, 2004                                                                                                |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 10.35*     |       | Special Pension  Agreement between Hercules Incorporated and William H. Joyce, approved August 21,  2003                                                                    |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 10.36*     |       | General Terms of  Employment between Hercules Incorporated and Certain Executive Officers                                                                                        |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 14         |       | Directors Code  of Business Conduct and Ethics                                                                                                                                   |       | Appendix VII,  Proxy Statement dated June 20, 2003                      |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 18         |       | Letter Regarding  Change in Accounting Principles                                                                                                                                |       | Exhibit 18,  Annual Report on Form 10-K, filed March 15, 2004 |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 21.1       |       | Subsidiaries of  Registrant                                                                                                                                                      |       | See Part II,  Item 8 on page 84 of this Form 10-K             |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 23.1*      |       | Consent of  Independent Registered Public Accounting Firm                                                                                                                        |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 31.1*      |       | Certification of  President and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002      |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 31.2*      |       | Certification of  Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 32.1*      |       | Certification of  President and Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002      |       |                                                                         |
|       |       |                                                                                                                                                                             |       |                                                                         |
| 32.2*      |       | Certification of  Vice President and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |       |                                                                         |

 

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*Filed herewith

 

107

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