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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K/A AMENDMENT NO. 2 ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003
    
    Commission file number 1-496
   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 Stated Value)
8% Convertible Subordinated Debentures due August 15, 2010
9.42% Trust Originated Preferred Securities ($25 liquidation amount), issued by Hercules Trust I
and guaranteed by Hercules Incorporated Indicate by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best of
Registrants knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K . Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes X No . The aggregate market value of registrants common stock, $25/48 stated value (Common
Stock) held by non-affiliates based on the closing price on the last day of the
Companys most recently completed second fiscal quarter, or June 30, 2003, was
approximately $1.1 billion. As of February 27, 2004, registrant had 111,469,048 shares of Common Stock outstanding,
which is registrants only class of common stock. DOCUMENTS INCORPORATED BY REFERENCE
(Specific pages incorporated are identified under the applicable item herein.) Portions of the registrants definitive Proxy Statement for its 2004 Annual Meeting of
Shareholders (the Proxy Statement), when filed, will be incorporated by reference in
Part III of this report. Other documents incorporated by reference in this report are
listed in the Exhibit Index (see pages 82-85).




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EXPLANATORY NOTE This
Amendment No. 2 to the Annual Report on Form 10-K of Hercules Incorporated (the
Company) for the year ended December 31, 2003 is being filed to
restate its Balance Sheets, Statements of Stockholders Equity and related
notes to the Consolidated Financial Statements for income tax adjustments
resulting from a review of the Companys GAAP accounting for income taxes
for the tax years 1987 through 1995. The adjustments reflected in
this Form 10-K/A relate to the computation and application of foreign tax
credits and reduce the tax deposit asset by $65 million, increase deferred
income tax assets by $17 million, and, as a result of the cumulative additional
income tax expense to be recorded for the restated periods, reduce retained
earnings and stockholders equity by $48 million as of
January 1, 1996 and
for previously reported periods affected through December 31, 2003. The
restatement does not affect the previously reported results of operations for
any period subsequent to December 31, 1995. The restatement, which was
previously disclosed in a Form 8-K issued on November 9, 2004, is more fully
described in Note 26 to the Consolidated Financial Statements. In
addition, the Company has changed the classification of the incentive stock plan
activity in the Consolidated Statement of Stockholders Equity from a net
to a gross basis. This change in classification resulted in a net decrease of
$7 million
from Other assets and Unearned compensation included in Stockholders
equity. This
Form 10-K/A includes amendments to the following items and exhibits as a result
of the restatement: ITEM 6.
    
    SELECTED FINANCIAL DATAITEM 7.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9A.
    
    CONTROLS AND PROCEDURESEXHIBIT 23.1
    
    CONSENT OF INDEPENDENT ACCOUNTANTSEXHIBIT
31.1
    
    CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002EXHIBIT
31.2
    
    CERTIFICATION PURSUANT TO 18 U.S.C.
SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002EXHIBIT
32.1
    
    CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002EXHIBIT
32.2
    
    CERTIFICATION 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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TABLE OF CONTENTS  PART IITEM 6. SELECTED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSConsolidated Statements of OperationsConsolidated Balance SheetsConsolidated Statements of Cash FlowsConsolidated Statements of Stockholders Equity (Deficit)Consolidated Statements of Comprehensive Income (Loss)Summary of Significant Accounting PoliciesNotes to Consolidated Financial StatementsITEM 9A. CONTROLS AND PROCEDURESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-KSIGNATURESCONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMCERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICERCERTIFICATION OF VICE PRESIDENT & CHIEF FINANCIAL OFFICERCERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICERCERTIFICATION OF VICE PRESIDENT AND CHIEF FINANCIAL OFFICER    Table of Contents  
 PART I Forward-Looking Statement This
Annual Report on Form 10-K/A includes forward-looking statements, as
defined in the Private Securities Litigation Reform Act of 1995, reflecting
managements current analysis and expectations, based on what management
believes to be reasonable assumptions. Forward-looking statements may involve
known and unknown risks, uncertainties and other factors, which may cause the
actual results to differ materially from those projected, stated or implied,
depending on such factors as: ability to generate cash, ability to raise
capital, ability to refinance, ability to execute productivity
improvements and
reduce costs, business climate, business performance, changes in tax
laws or regulations and related liabilities, economic and competitive
uncertainties, higher manufacturing costs, reduced level of customer orders,
changes in strategies, risks in developing new products and technologies,
environmental and safety regulations and clean-up costs, foreign exchange
rates, the impact of changes in the value of pension fund assets and
liabilities, changes in generally accepted accounting principles, legislative
changes, adverse legal and regulatory developments, including increases in the
number or financial exposures of claims, lawsuits, settlements or judgments, or
the inability to eliminate or reduce such financial exposures by collecting
indemnity payments from insurers, the impact of increased accruals and reserves
for such exposures, and adverse changes in economic and political climates
around the world, including terrorist activities and international hostilities.
Accordingly, there can be no assurance that the Company will meet future
results, performance or achievements expressed or implied by such
forward-looking statements. As appropriate, additional factors are contained
in other reports filed by the Company with the Securities and Exchange
Commission. The words or phrases will likely result, are expected to,
will continue, is anticipated, estimate, project or similar expressions
identify forward-looking statements. This paragraph is included to provide
safe harbor for forward-looking statements, which are not generally required to
be publicly revised as circumstances change, and which the Company does not
intend to update except as may be required by law. 2




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ITEM 6. SELECTED FINANCIAL DATA A summary of the selected financial data for Hercules for the years ended
and as of the end of the years specified is set forth in the table below.
During the quarter ended December 31, 2003, the Company changed its method of
accounting for its Employee Stock Ownership Plan (ESOP) to the method
prescribed by Statement of Position 93-6 Employers Accounting for Employee
Stock Ownership Plan (SOP 93-6). Prior year information has been restated
for the Companys change in method of accounting for its ESOP (see Note 1).
Pursuant to Statement of Financial Accounting Standards No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets (SFAS 144), the
BetzDearborn Water Treatment Business has been treated as a discontinued
operation as of February 12, 2002. See Note 25 in the Notes to the
Consolidated Financial Statements for a summary of significant divestitures
that have occurred in the last three years. (Dollars in millions, except per share data)2003
    
    2002
    
    2001
    
    2000
    
    1999Net sales
    
    $
    1,846
    
    
    $
    1,705
    
    
    $
    1,776
    
    
    $
    2,303
    
    
    $
    2,463Profit from operations
    
    
    255
    
    
    
    220
    
    
    
    184
    
    
    
    366
    
    
    
    380Net income (loss) from continuing operations before discontinued
operations and cumulative effect of changes in accounting
principle
    
    
    74
    
    
    
    (47
    )
    
    
    (109
    )
    
    
    60
    
    
    
    118Net income (loss) on discontinued operations, net of tax
    
    
    4
    
    
    
    (196
    )
    
    
    56
    
    
    
    40
    
    
    
    52Net income (loss) before effect of changes in accounting principle
    
    
    78
    
    
    
    (243
    )
    
    
    (53
    )
    
    
    100
    
    
    
    170Cumulative effect of changes in accounting principle, net of tax
    
    
    (33
    )
    
    
    (368
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    45
    
    
    
    (611
    )
    
    
    (53
    )
    
    
    100
    
    
    
    170Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    66
    
    
    
    111Per share of common stockBasic earnings (loss) per shareContinuing operations
    
    
    0.69
    
    
    
    (0.44
    )
    
    
    (1.04
    )
    
    
    0.58
    
    
    
    1.19Discontinued operations
    
    
    0.04
    
    
    
    (1.85
    )
    
    
    0.53
    
    
    
    0.39
    
    
    
    0.52Cumulative effect of changes in accounting principle
    
    
    (0.31
    )
    
    
    (3.47
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    0.42
    
    
    
    (5.76
    )
    
    
    (0.51
    )
    
    
    0.97
    
    
    
    1.71Diluted earnings (loss) per shareContinuing operations
    
    
    0.69
    
    
    
    (0.44
    )
    
    
    (1.04
    )
    
    
    0.58
    
    
    
    1.18Discontinued operations
    
    
    0.04
    
    
    
    (1.85
    )
    
    
    0.53
    
    
    
    0.38
    
    
    
    0.52Cumulative effect of changes in accounting principle
    
    
    (0.31
    )
    
    
    (3.47
    )
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    0.42
    
    
    
    (5.76
    )
    
    
    (0.51
    )
    
    
    0.96
    
    
    
    1.70Dividends declared
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.64
    
    
    
    1.12Total assets*
    
    
    2,711
    
    
    
    2,759
    
    
    
    4,938
    
    
    
    5,463
    
    
    
    5,831Long-term debt
    
    
    1,326
    
    
    
    738
    
    
    
    1,959
    
    
    
    2,342
    
    
    
    1,777Company-obligated preferred securities of subsidiary trusts
    
    
    
    
    
    
    624
    
    
    
    624
    
    
    
    622
    
    
    
    992
  *
    
    As restated for income tax
adjustments described in Note 26 to the Consolidated Financial
Statements.
 3




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in connection with the information
contained in the Consolidated Financial Statements and Notes thereto. All
references to individual Notes refer to Notes to the Consolidated Financial
Statements. As referenced in Note 26 to the Consolidated
Financial Statements, the Consolidated Balance Sheets, Statements of
Stockholders Equity and related Notes to Consolidated Financial
Statements have been restated in connection with adjustments recorded
as of January 1, 1996. The restatement had no impact on the
results of operations for any period subsequent to December 31,
1995. Overview Hercules is a leading global manufacturer and marketer of specialty
chemicals and related services for a broad range of business, consumer and
industrial applications with net sales of $1,846 million, $1,705 million and
$1,776 million, respectively, in 2003, 2002 and 2001. The Companys principal
products are chemicals used by the paper industry to increase product
performance and enhance the manufacturing process; water-soluble polymers;
polypropylene and polyethylene fibers; and specialty resins. Key markets for
the Companys products, as a percent of 2003 net sales, include: Pulp and Paper
 49%; Paints and Adhesives  10%; Construction Materials  9%; Food,
Pharmaceutical and Personal Care  20%; and Industrial Specialties including
Oilfield, Textiles and General Industrial  12%. Over 50% of the Companys
revenues are generated outside of North America. Net sales by region in 2003
were: North America  48%, Europe  38%, Asia Pacific  9% and Latin America 
5%. The Company operates through two reportable segments and four divisions:
Performance Products (Pulp and Paper and Aqualon) and Engineered Materials and
Additives (FiberVisions and Pinova). Net sales for 2003 as a percent of total
sales, by division, were: Pulp and Paper  47%; Aqualon  33%; FiberVisions -
15%; and Pinova  5%. Pulp and Paper is a large and technically advanced provider of pulp and
paper chemicals and technical paper process solutions. The industry in which
Pulp and Paper competes is projected to experience average growth rates of 2%
to 3% through 2004. Demand for process chemicals, retention aids and strength
resins has increased as the quality of pulp used in paper products has been
reduced. However, the industry has become increasingly competitive as
consolidation continues within the pulp and paper customer base. Aqualon is a
supplier of products that manage the properties of aqueous (water-based)
systems. Aqualons products are mostly derived from renewable natural raw
materials, including cellulose and guar, and are used in paints and coatings,
personal care products such as toothpaste and shampoo, oil and gas well
drilling to provide fluid loss control and as a strengthening agent in mortar
and plaster, among other uses. FiberVisions is a global supplier of synthetic fibers made from
polypropylene and polyethylene used primarily in non-woven fabrics for
disposable diapers and other hygienic products. Pinova offers products that
generally are custom made to fit a particular use in an industry and impart or
improve the properties of a variety of compounded substances. Performance in 2003 was impacted by several significant economic factors:
higher costs, especially for energy and energy-related raw materials, but also
for pension benefits; overall flat price-volume-mix growth; 20% appreciation in
the Euro against the U.S. dollar; and continued productivity improvement
offsetting the negative effects of the higher costs. In addition, Pulp and
Paper, Aqualon and FiberVisions benefited from new product introductions. Higher cost energy and natural gas/crude oil (as feedstock) are impacting
many raw materials, particularly derivatives of chlor-alkalai, ethylene,
benzene, propylene and natural gas. The Company has instituted a number of
initiatives to mitigate these negative effects, including product substitution,
exploring new sourcing opportunities and entering into forward contracts for a
portion of its natural gas requirements. Paper and paperboard production was down 2% in North America. Office
paper production in Europe, a key market for Hercules, was also down 2%.
Factors impacting the North American paper industry include a declining
manufacturing base as more production shifts off-shore to countries such as
China, lower classified advertising (newsprint), lower weight magazines and a
slowdown in print advertising, and plastics substitutes for liquid packaging. Market conditions affecting the Aqualon business were generally stable in
2003. Volume growth was fueled by an increase in the construction, oil field
and personal care businesses. Global price increases were implemented in the
first half of 2003, partially offsetting higher raw material and energy costs.
Further price increases have been announced to offset new raw material
increases. In FiberVisions, margins were under pressure in Europe (including the
Middle East and Africa), the Americas and Asia due to renewed competitive
activity and higher raw material prices. The business mitigated these factors
through continued streamlining of its fixed cost structure. New product
introductions and the consolidation of the ES FiberVisions joint ventures
contributed $33 million and $29 million, respectively, to net sales growth in
2003. Lower volumes in the Pinova business were driven by lost business in its
chewing gum and adhesives markets. Higher raw material costs and pension
expense also negatively impacted profits. The business has been successful in
regaining most of the lost volumes through increased sales to existing
customers and the addition of new customers. In addition to the above economic factors, performance in 2003 was
influenced by a number of discrete items, as discussed below. 4




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Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 143, Accounting for Asset Retirement Obligations
(SFAS 143). SFAS 143 requires that the fair value of an asset retirement
obligation be recorded when incurred. Included within the scope of SFAS 143
are environmental remediation liabilities associated with current and former
operations that were incurred during the course of normal operations. As more
fully discussed in Note 12 to the Consolidated Financial Statements, concurrent
with the adoption of SFAS 143, the Company recorded an after-tax charge of $28
million ($44 million on a pre-tax basis), or $0.26 per share, as a cumulative
effect of a change in accounting principle. Also 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 Accounting Standards No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure (SFAS
148). The Company has elected to apply the fair value recognition provisions
of SFAS 123 on a prospective basis to all employee awards granted, modified or
settled after January 1, 2003. The Company did not grant any stock options
pursuant to SFAS 123, as amended by SFAS 148, to employees in 2003. Restricted
stock awards under the Hercules Long-term Incentive Compensation Plan are
valued at the quoted market price (fair value) of the Companys stock on the
grant date (measurement date). The Company recognized $4.3 million, $0.5
million and $1.7 million of expense in 2003, 2002 and 2001, respectively, in
connection with restricted stock awards (see Summary of Significant Accounting
Policies). In August 2003, the Companys Board of Directors granted a special pension
benefit recognizing past service to Dr. William H. Joyce, the then Chief
Executive Officer of the Company. The special pension benefit, which fully
vested on the grant date for the services rendered through that date, has been
accounted for as deferred compensation in accordance with APB No. 12, Omnibus
Opinion, as amended by SFAS No. 106, Employers Accounting for Postretirement
Benefits Other Than Pensions. The special pension benefit has an estimated net
present value of approximately $4.7 million. Any award of incentive
compensation to Dr. Joyce for 2003 will result in an increase in this amount as
a result of the application of the standard pension formula. Subsequently, on October 6, 2003, Dr. Joyce resigned from the Company and
its Board of Directors to accept another executive position in the industry.
The Board elected outside director John K. Wulff as Non-Executive Chairman of
the Board and also named Craig A. Rogerson acting President and Chief Operating
Officer. On December 11, 2003, the Board elected Mr. Rogerson President and
Chief Executive Officer and a member of the Board of Directors. In addition to
these new duties, Mr. Rogerson has remained President of Hercules FiberVisions
and Pinova divisions and Corporate Vice President of Global Procurement,
positions he assumed in April 2002. John K. Wulff continues as Non-Executive
Chairman of the Board. Effective September 30, 2003, the Company elected to partially adopt FASB
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
46), for its variable interest entities (VIEs) that existed prior to January
31, 2003 (the Company has no VIEs created subsequent to January 31, 2003). The
consolidation of ES FiberVisions Holding A/S and ES FiberVisions L.P. increased
2003 net sales by approximately $29 million and profit from operations by $3
million (see Note 7). The Board of Directors has authorized the Company, from time to time,
subject to market conditions and provisions of the Companys credit agreement,
to repurchase up to $140 million of its outstanding indebtedness. Pursuant to
the Term B Loan Credit Agreement, and subject to related covenants, the Company
has the right to use available cash to repurchase, repay or otherwise redeem up
to $100 million of the 11 1/8% senior notes and $40 million of the
company-obligated trust preferred securities (Preferred Securities) in any
fiscal year. During the fourth quarter ended December 31, 2003, the Company
repurchased $24 million (book value) of its 11 1/8% senior notes for $29
million, recognizing a loss of $5 million, and 46,000 of its CRESTS Units for a
total of $34 million, of which $27 million was attributed to the preferred
security component and $7 million was attributed to the warrants. On December 1, 2003, the Company completed the acquisition of Quantum
Hi-Tech Co. Ltd., (Quantum). Quantum is a leading producer of
carboxymethylcellulose products in China. Quantum has current production
capacity of 6,000 MT (metric tons); its leading key markets include food,
toothpaste, ceramics and paper, with annual sales of approximately $10 million
(see Note 25). On December 17, 2003 the Company amended its senior credit facility to,
among other things, lower the term B loan interest rate to LIBOR + 2.50% from
LIBOR + 3.25% (see Note 6). Fourth quarter 2003 net income includes a $6 million pre-tax charge, net
of insurance, to increase the Companys reserve for future asbestos costs
following the conclusion of a study commissioned in early 2003. Based on the
results of the study, the Company estimates that its reasonably possible gross
financial exposure for asbestos-related matters will range from $220 million to
$675 million. The Company recorded a gross charge of $55 million as of
December 31, 2003, thereby increasing its recorded liability for future
asbestos costs, before anticipated insurance recoveries, to $221 million,
reflecting the low end of the range noted above and $1 million for previously
settled but unpaid asbestos cases. The Company believes that it is probable
that at least $169 million of the recorded liability will be paid or reimbursed
by its 5




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insurance carriers. Accordingly, an increase of $49 million to the
associated receivable for anticipated insurance recoveries was recorded as of
December 31, 2003 (see Note 13). As set forth in Note 1 to the Consolidated Financial Statements, in the
fourth quarter ending December 31, 2003, the Company changed its method of
accounting for its Employee Stock Ownership Plan (ESOP). The effect of the
change was to increase net income by $5 million and earnings per share by $0.05
in both 2002 and 2001, as well as to increase net income by $2 million, $1
million and $1 million and earnings per share by $0.02, $0.01 and $0.01 in the
quarters ended March 31, 2003, June 30, 2003 and September 30, 2003,
respectively. In addition, retained earnings at January 1, 2001 was increased
by $5 million, net of taxes, unearned compensation has been increased by $2
million and additional paid-in-capital decreased by $7 million for the
retroactive effect of this change in accounting. On February 12, 2004, the Company completed the sale of its minority
ownership in CP Kelco ApS for $27 million in cash. On March 1, 2004, the
Company announced that the proposed acquisition of Meraklon S.p.A. will not
occur, as a result of difficulties encountered in obtaining antitrust
regulatory approval. The Company implemented Statement of Financial Accounting Standards No.
142, Goodwill and Other Intangible Assets (SFAS 142) effective January 1,
2002. Under the provisions of this standard, goodwill and intangible assets
with indefinite useful lives are not amortized but instead are reviewed for
impairment at least annually and written down only in periods in which it is
determined that the fair value is less than the recorded value. In connection
with the Companys transitional review, recorded goodwill was determined to be
impaired in the BetzDearborn and FiberVisions reporting units. The Company
recognized after-tax impairment charges of $262 million in the BetzDearborn
reporting unit and $87 million in the FiberVisions reporting unit. In
addition, an after-tax impairment charge of $19 million was recognized for the
Companys equity investment in CP Kelco (see Note 4) in the first quarter of
2002. On April 29, 2002, Hercules completed the sale of the Water Treatment
Business to GE Specialty Materials (GESM), a unit of General Electric Company
for $1.8 billion. The Company used the net proceeds to prepay debt under its
senior credit facility and ESOP credit facility (see Notes 6 and 10). Pursuant
to Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144), the BetzDearborn
Water Treatment Business has been treated as a discontinued operation as of
February 12, 2002, and accordingly, all financial information has been
restated. The loss from discontinued operations for the year ended December
31, 2002 includes an after-tax loss on the disposal of the business of $230
million. The BetzDearborn Water Treatment Business had net assets, including
goodwill and identifiable intangibles from the BetzDearborn acquisition, of
approximately $2.0 billion at December 31, 2001. Approximately 3,900 employees
transferred to GESM or left the Company in connection with the sale. Hercules
has an agreement with GESM to distribute water treatment products to the pulp
and paper industry (see Note 25). In June 2001, the Company announced an aggressive and comprehensive
program to improve return on capital and cash flow, streamline organizational
structure, improve work processes, consolidate manufacturing and
non-manufacturing resources and better serve customers. The initial objective
was to achieve fixed cost reductions of $100 million on an annualized basis (as
compared to 2000 results, excluding the Food Gums business and the Resins
divestitures) by June 2002, which was achieved by December 31, 2001. In the
beginning of 2002, the cost reduction target was increased to $200 million in
annualized fixed cost reductions to be achieved by December 2002 (as compared
to 2000 results, excluding the Food Gums business and the Resins divestitures),
including $75 million for the Water Treatment Business and $125 million for the
other remaining businesses. Subsequent to the sale of the Water Treatment
Business, the Company raised the cost reduction target to be achieved by
December 2002 for the remaining businesses to $150 million in annualized fixed
cost reductions (as compared to 2000 results, excluding the Food Gums business,
the Resins divestitures and the Water Treatment Business). At the end of 2002,
the Company achieved approximately $160 million in annualized cost reductions,
exceeding the Companys twice upwardly revised cost reduction target.
Approximately 1,340 employees have left or will leave the Company under this
plan. The Company incurred restructuring charges totaling $51 million during
the third and fourth quarters of 2001. Pursuant to the cost reduction and work
process redesign program initiated in 2001 (see Notes 18 and 19), the Company
incurred restructuring charges totaling $25 million during 2002. The plan
includes reductions throughout the Company with the majority of them from
support functions. The above-mentioned items are primarily included in corporate in each of
the respective years in the segment footnote disclosure (see Note 23). Critical Accounting Estimates The Companys discussion and analysis of its financial condition and
results of operations is based on its consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
Hercules to make estimates and assumptions that affect the amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. Hercules evaluates its estimates on a regular basis,
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 other
benefit obligations. Hercules bases its estimates on various factors including 6




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historical experience, consultation and advice from third party subject
matter experts and on various assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions and circumstances. Hercules believes that the following accounting estimates are critical due
to the significant subjectivity and judgment necessary to account for the
matters or the susceptibility of such matters to change and the affect of the
estimates and assumptions on its consolidated financial statements. The Company maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
Allowances for doubtful accounts are based on historical experience and known
factors regarding specific customers and industries in which the customers
operate. If the financial condition of the Companys customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances would be required. Aside from goodwill and intangible assets, which are tested for impairment
under the guidance provided in SFAS 142, the Company has adopted SFAS 144 and
tests other long-lived assets for impairment based on the guidance provided in
SFAS 144. The Company records an impairment loss on its long-lived assets
based on the excess of the carrying amount over fair value when expected future
undiscounted cash flows are insufficient to recover the carrying amount of the
asset. The fair value represents expected future cash flows from the use of
the assets, discounted at the rate used to evaluate potential investments. If
the Company determines that an impairment loss has occurred, the loss is
recognized in the income statement. Deterioration in future economic
conditions, poor operating results in a business or the determination that the
long-lived asset is unsuitable for one reason or another, new or stronger
competitors, or changes in technology could result in losses or the inability
to recover the carrying value of the asset, thereby possibly requiring an
impairment in the future. Hercules adopted the provisions of SFAS 142 effective January 1, 2002.
Hercules identified the following reporting units: BetzDearborn, Pulp and
Paper, Aqualon, FiberVisions and Pinova. In connection with Hercules
transitional review, recorded goodwill was determined to be impaired in the
BetzDearborn and FiberVisions reporting units. In the first quarter of 2002,
Hercules completed its transitional impairment review of the identified
reporting units and recognized an after-tax impairment loss of $349 million as
a cumulative effect of a change in accounting principle. In addition, an
after-tax impairment loss of $19 million was recognized in the first quarter of
2002 relating to the Companys equity investment in CP Kelco, which had an
impairment under SFAS 142. As a result of Hercules adoption of SFAS 142, the
Company no longer records approximately $50 million of annual amortization
relating to existing goodwill and intangibles. Pursuant to SFAS 142, the
Company is required to perform an annual assessment of its reporting units for
impairment. To assess impairment, the Company compares the reporting units
book value of net assets, including goodwill, to its fair value. Fair value is
estimated using a combination of valuation approaches including the market
value and income approaches. In the event that the book value exceeds the fair
value, the Company recognizes an impairment to the extent the book value of
goodwill exceeds the implied fair value of goodwill for any reporting unit,
calculated by determining the fair value 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, or changes in
technology could result in an inability to recover the carrying value of the
goodwill and intangible assets, thereby requiring an impairment in the future. Hercules records a valuation allowance to reduce its deferred tax assets
to an amount that is more likely than not to be realized after consideration of
future taxable income and reasonable tax planning strategies. At December 31,
2003, the Company had gross deferred tax assets of approximately $734 million,
including capital and operating loss carryforwards of $373 million. Valuation
allowances of approximately $362 million have been set up on the total deferred
tax assets. In the event that Hercules were to determine that it would not be
able to realize all or part of its deferred tax assets, for which a valuation
allowance had not been established, or is able to utilize capital and/or
operating loss carryforwards for which a valuation allowance has been
established, an adjustment to the deferred tax asset will be reflected in
income in the period such determination is made. Hercules has and will continue to record charges for the estimated costs
of employee severance and other exit costs pursuant to the Companys strategy
to continuously improve return on capital, streamline organizational structure,
improve work processes and consolidate manufacturing and non-manufacturing
resources. Since initiating the strategy in the third quarter 2001, the
Company has recognized $83 million in charges for severance and other exit
costs. In the event that it is determined that additional employees must be
involuntarily terminated, or that additional manufacturing or non-manufacturing
facilities must be closed pursuant to work process redesign or other cost
reduction initiatives, supplemental reserves would be required, which would
result in an incremental charge against earnings. In the event that the number
of employees involuntarily terminated pursuant to restructuring plans is less
than anticipated due to greater than anticipated voluntary resignations, an
adjustment to reduce excess restructuring reserves would increase income in the
period that the determination was made. Hercules establishes reserves for environmental matters, litigation and
other contingencies when it is probable that a liability has been incurred and
the amount of the liability is reasonably estimable. At December 31, 2003, the
Company 7




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had accrued $106 million for contingencies and asset retirement
obligations in accordance with Statement of Financial Accounting Standards No.
5, Accounting for Contingencies (SFAS 5), and Statement of Financial
Accounting Standards No. 143, Accounting for Asset Retirement Obligations
(SFAS 143). The actual costs will depend upon numerous factors, including
the number of parties found responsible at each environmental site and their
ability to pay, the actual methods of remediation required or agreed to,
outcomes of negotiations with regulatory authorities, outcomes of litigation,
changes in environmental laws and regulations, technological developments, the
years of remedial activity required, changes in the number or financial
exposures of claims, lawsuits, settlements or judgments, or in the ability to
reduce such financial exposures by collecting indemnity payments from insurers.
If the contingency is resolved for an amount greater or less than has been
accrued, or Hercules share of the contingency increases or decreases, or other
assumptions relevant to the development of the estimate were to change,
Hercules would recognize an additional expense or benefit in income in the
period such determination was made. Hercules has established reserves for asbestos-related personal injury
lawsuits and claims. Based on the results of a study the Company commissioned
of its asbestos-related liability and considering amounts outstanding under
previous settlements, the Company estimated that its reasonably possible
financial exposure for these matters ranged from $220 million to $675 million,
with no amount within this range representing a better estimate than any other
amount. The Companys estimates are based on a number of assumptions including
the number of future claims, the timing and amount of future payments, disease,
venue, the dynamic nature of asbestos litigation and the present uncertainty
concerning the participation of its excess insurance carriers and other
circumstances. At December 31, 2003, the Company has recorded a gross accrued
liability of $221 million, reflecting the low end of the range and $1 million
for previously settled but unpaid asbestos claims, for present and future
potential asbestos claims before anticipated insurance recoveries. The Company
believes that it is probable that $169 million of the $221 million accrual will
be funded by or recovered from insurance carriers. That belief, which is
subject to the various assumptions set forth herein, is based on many factors
that have been evaluated by the Company, along with outside insurance counsel,
including the indemnity and defense payments that have been made by its now
exhausted insurance carriers, and by some of its other carriers, and the limits
of remaining potentially available insurance coverage, as well as the range of
possible outcomes in the Companys insurance coverage litigation taking into
account, among other considerations, the facts and status of that litigation,
and the relevant case law. The Company provides defined benefit pension and postretirement welfare
benefit plans to employees in the United States who meet eligibility
requirements. Similar plans are provided outside the United States in
accordance with local practice. Pension and other postretirement benefit
obligations and the related expense (income) are determined based upon
actuarial assumptions regarding mortality, medical inflation rates, discount
rates, long-term return on assets, salary increases, Medicare availability and
other factors. The assets of the U.S., United Kingdom (U.K.) and the
Netherlands defined benefit plans constitute 84%, 4% and 11%, respectively, of
the total defined benefits plan assets applicable to plans sponsored by the
Company. In 2003, the actual return earned on U.S. plan assets exceeded the
expected long-term rate of return assumption of 8.75%. The historical return
on U.S. plan assets earned in 2001 and 2002 was less than the 9.25% expected
long-term rate of return assumption. In addition, yields on long-term
corporate bonds continued to decrease throughout 2003 and, pursuant to the
Companys annual review of the actuarial assumptions, the discount rate was
lowered to 6.10% at December 31, 2003. Based on current assumptions, pension
and postretirement benefit plan expenses for the years 2004, 2005 and 2006 are
projected to be approximately $58 million, $73 million and $63 million. The
projected increase in pension expense over 2003 in 2004, 2005 and 2006 is due
to the decline in interest rates and the unfavorable performance of the pension
investment portfolio over the period 2000  2002. The increase in 2005 and
2006 also assumes the adoption of the 1994 mortality table in 2005. The
adoption of the 1994 mortality table increases pension and postretirement
expense by approximately $9 million per year. The Company presently
anticipates a decrease in consolidated pension and postretirement expense in
2006 (from 2005) as a result of favorable investment performance in 2003. As a
result of past unfavorable investment performance and the lower discount rate,
the accumulated benefit obligation (ABO) exceeded the fair value of plan
assets at December 31, 2003. At December 31, 2003, the ABO of the U.S., U.K.
and German defined benefit pension plans of $1,325 million, $67 million and $32
million, respectively, exceeded their funded benefits. The Company is required
to recognize an additional liability equal to the sum of such excess plus the
prepaid pension asset balance, with a corresponding after-tax charge to other
comprehensive income in stockholders equity. At December 31, 2002, the
Company recorded an additional minimum liability (AML) of $579 million
(pre-tax) with an after-tax charge to other comprehensive income of $354
million. At December 31, 2003, the AML decreased $25 million to $554 million
(pre-tax) and, accordingly, the change to accumulated other comprehensive
income was decreased by $15 million to $339 million. At December 31, 2003, the
consolidated projected benefit obligation was $1,702 million. A 100-basis
point (1%) decrease or increase in the discount rate has approximately a plus
or minus $193 million impact on the Companys consolidated ABO. At the present
time, the U.S. defined benefit pension plan is at a sufficient funding level as
to not require ERISA mandated contributions. The Company has initiated a study
to review plan changes that are expected to result in a reduction of future
expenses and liabilities to its U.S. defined benefit final pay pension plan.
The Company has decided, however, that it is in the best interests of the
Company and its pension plan participants to make voluntary contributions to
the plan. If the U.S. qualified pension plan performs in accordance with the
actuarial assumptions, the Company presently anticipates making voluntary cash
contributions of approximately $40 million per year over the next few years,
including $40 million contributed to the U.S. defined benefit plan in January 8




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2004. The Company also contributed $7 million to its non-U.S. pension
plans in the fourth quarter 2003 to bring funding to required levels or to
improve government mandated funding provisions. Results of Operations The table below reflects net sales and profit from operations for
continuing operations for the years ended December 31, 2003, 2002 and 2001.
Results of operations for 2002 and 2001 have been restated for the Companys
change in accounting for its Employee Stock Ownership Plan (see Note 1). (Dollars in millions)2003
    
    2002
    
    2001Net sales:Performance Products
    
    $
    1,483
    
    
    $
    1,385
    
    
    $
    1,351Engineered Materials and Additives
    
    
    363
    
    
    
    320
    
    
    
    425Consolidated
    
    $
    1,846
    
    
    $
    1,705
    
    
    $
    1,776Profit from operations:Performance Products
    
    $
    262
    
    
    $
    243
    
    
    $
    154Engineered Materials and Additives
    
    
    9
    
    
    
    18
    
    
    
    11Corporate
    
    
    (16
    )
    
    
    (41
    )
    
    
    19Consolidated
    
    $
    255
    
    
    $
    220
    
    
    $
    184
 2003 vs. 2002 Net sales in 2003 increased 8% from 2002. Growth in sales for 2003
compared to 2002 was driven by a 6%, or $110 million, benefit from rate of
exchange and a 2%, or $29 million, benefit from the consolidation of ES
FiberVisions pursuant to FIN 46. The Euro appreciated approximately 20% in
2003 from 2002 levels. Volume and price in the aggregate were flat compared to
2002. Volumes were flat in Pulp and Paper, with declines in the weak North
American and European markets offset by strong sales growth in the emerging
regions of China, Brazil and Russia. Volume growth in Aqualon was a result of
stronger demand in the oil and gas drilling and recovery markets. FiberVisions
volume growth principally reflects the consolidation of ES FiberVisions. Lower
volumes in the Pinova business were driven by lost business in its chewing gum
and adhesives markets. Profit from operations improved 16% compared to 2002. Higher costs in
2003 for energy, raw materials and pension were more than offset by
productivity improvements and the positive effect of the stronger Euro.
Worldwide pension expense was approximately $28 million in 2003, an increase of
$22 million versus 2002. In the Performance Products segment, net sales increased $98 million, or
7%. Net sales were positively impacted 6%, or $91 million, by rates of
exchange. Profit from operations in the segment improved $19 million, or 8%,
equal to the benefit from favorable rates of exchange. Cost increases in
energy, raw materials and pension expense were offset by productivity
improvements. In Pulp and Paper, net sales increased $37 million, or 4%, reflecting a
$48 million positive impact from rates of exchange, principally the euro, and
strong growth in emerging markets. Net sales were up 29% in China, 40% in
Brazil and 17% in Russia. Net sales were negatively impacted by $11 million as
a result of price erosion and unfavorable mix. Global volumes were essentially
flat reflecting the impact of weak market conditions in North America. For
2003, paper and paperboard production was down 2% in North America. Office
paper production in Europe, a key market for Hercules, was also down 2%.
Factors impacting the North American industry include a declining manufacturing
base as more production shifts off-shore to countries such as China, lower
classified advertising (newsprint), lower weight magazines and a slowdown in
print advertising and plastics substitutes for liquid packaging. Profit from
operations was essentially flat, down $1 million versus 2002. Profit from
operations was negatively impacted by higher energy and energy related raw
materials in addition to pension expense. These higher costs, in part, were
offset by supply chain improvements and lower selling, general and
administrative expense. Aqualons net sales grew $61 million, or 11% compared to 2002. Rate of
exchange, principally the Euro, had a $43 million, or 8%, favorable impact and
volume/mix had an $18 million, or 3%, favorable impact. Volume growth was
fueled by an increase in the construction, oil field and personal care
businesses. Global price increases were implemented in the first half of 2003,
partially offsetting higher raw material and energy costs. Profit from
operations improved $20 million, or 14%, compared to 2002, driven by positive
rate of exchange impact ($11 million or 8%) and volume increases even as the
business experienced higher costs for energy, raw material and pension expense. In the Engineered Materials and Additives segment, net sales increased $43
million, or 13%. The consolidation of the ES FiberVisions joint ventures
contributed $29 million, or 9%, to the improvement. Favorable impacts of rates
of 9




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exchange contributed $19 million, or 6%. Lower volumes in Pinova due to
the lost business in its chewing gum and adhesives markets negatively impacted
the segments net sales. Profit from operations decreased $9 million, or 50%,
from 2002. Improvement in FiberVisions profit from operations was more than
completely offset by negative profit from operations in Pinova. FiberVisions net sales increased $57 million, or 26%, over 2002,
reflecting the positive impacts from the consolidation of the ES FiberVisions
joint ventures of $29 million or 13%, rates of exchange of $19 million or 9%,
and pricing and volume/mix totaling $9 million or 4%. FiberVisions has
contractual arrangements with a majority of its customers that enables it to
pass through higher polypropylene costs on a delayed basis. Lower volumes for
fibers used in diapers were partially offset by higher volumes in the wipes
markets. New wipes products generated approximately $23 million and new
bicomponent products generated approximately $10 million in net sales. Profit
from operations improved $3 million, or 30% over 2002. The consolidation of
the ES FiberVisions joint ventures contributed $3 million to profit from
operations. Pinova net sales decreased $14 million, or 14%, from 2002 reflecting a 13%
decrease in volumes due to the lost business in its chewing gum and adhesives
markets. Loss from operations was $4 million compared to an $8 million profit
from operations in 2002. The business has a significant fixed cost structure
that is not easily reduced. The business has been successful in regaining most
of the lost volumes through increased sales to existing customers and the
addition of new customers. 2002 vs. 2001 Net sales were $1,705 million for 2002, a decrease of $71 million, or 4%.
Net sales in 2002 were favorably impacted by approximately $16 million
reflecting the positive impact of the weaker dollar. Approximately $113
million of the decrease is attributable to the businesses comprising the Resins
divestitures (see Note 25). Volumes declined 6% year over year. Regionally,
net sales declined 6% in North America and 14% in Latin America, remained flat
in Europe and improved 2% in Asia Pacific. Profit from operations increased $36 million, or 20%. Profit from
operations in 2002 was favorably impacted by approximately $3 million,
reflecting the positive impact of the weaker dollar. Improvement in operating
profit occurred in all businesses despite a 6% decline in volumes. This was
principally due to reductions in the Companys fixed cost structure pursuant to
the comprehensive cost reduction and work process redesign program (see Notes
18 and 19) initiated in 2001. On an annualized basis, approximately $160
million in fixed cost savings were achieved as of December 31, 2002 (as
compared to 2000 results, excluding the Food Gums business, the Resins
divestitures and the Water Treatment Business). Impacting 2002 profit from
operations were $23 million in net restructuring charges, $7 million in asset
impairment charges and $5 million, net, of other charges. Impacting profit
from operations in 2001 were $74 million of pre-tax gains from the Resins
divestitures and $6 million, net, of other gains, partially offset by $51
million in restructuring charges associated with the comprehensive cost
reduction and work process redesign program. Performance Products segment revenues were up $34 million, or 3%. Net
sales were favorably impacted by approximately $12 million, reflecting the
positive impact of the weaker dollar. Sales improved due to volume
improvements of 6% versus the prior year and favorable product mix, partially
offset by competitive pricing. Profit from operations increased $89 million,
or 58%. Profit from operations primarily benefited from the cost reduction and
work process redesign program commenced in 2001. Profit from operations in
2002 included asset impairment charges of $7 million associated with the
planned shutdown of plant facilities. In Pulp and Paper, both net sales and profit from operations improved year
over year. Sales improved due to volume improvements of 10% versus the prior
year partially offset by competitive pricing and unfavorable product mix.
Sales to GE Betz pursuant to a two-year supply agreement accounted for 2% of
the net sales growth. Lower overhead costs attributable to the cost reduction
and work process redesign program was the primary driver of higher profit from
operations. Profit from operations was negatively impacted by asset impairment
charges of $7 million associated with the shutdown of two plant facilities. Aqualons net sales and profit from operations improved versus the prior
year, despite a decrease in volumes of approximately 2%. Sales improved due to
favorable product mix partially offset by lower volumes and competitive
pricing. Volume declines were reflective of weak sales to the oilfield
industry. Lower raw material costs and lower overhead costs attributable to
the cost reduction and work process redesign program were the primary drivers
of the improved operating performance. Engineered Materials and Additives segment revenues decreased $105
million, or 25%, and profit from operations increased $7 million, or 64%. Net
sales decreased $113 million as a result of the Resins divestitures. In May
2001, Hercules sold its hydrocarbon resins and select portions of its rosin
resins businesses, its peroxy chemicals business and its interest in a toner
resin joint venture (see Note 25). Segment volumes decreased 24% year over
year, again reflecting the Resins business divestitures. 10




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Net sales in FiberVisions improved marginally, largely driven by a
positive rate of exchange effect and 5% higher volumes partially offset by the
contractual customer pass through of lower polypropylene costs and competitive
pricing issues. Operating performance increased by $3 million due to lower
polymer costs and lower overhead costs attributable to the cost reduction and
work process redesign program. Net sales in Pinova significantly declined in 2002 versus the prior year
as a result of the resins divestitures (see Note 25). Volumes were down
approximately 65%. Despite declines in revenues and volumes, operating
performance increased. The improvement in profit from operations was a direct
result of hiring a full time sales team to support the business, replacing the
distribution channel used in 2001 following the Resins divestitures, as well as
a focused effort on cost reduction and work process redesign. Interest and Debt Expense and Preferred Security Distributions; Equity Income (Loss); Provision for Income Taxes Interest and debt expense including preferred security distributions of
subsidiary trusts decreased $26 million, or 17%, in 2003 versus 2002 reflecting
lower outstanding debt balances. In the fourth quarter of 2003, the Company
repurchased 46,000 of the CRESTS Units for $34 million, of which $27 million
was attributable to the preferred security component and $7 million was
attributable to the warrants. In addition, the Company purchased $24 million
of the 11 1/8% senior notes, recognizing a loss of $5 million. Interest and
debt expense and preferred security distributions decreased $105 million, or
40%, in 2002 versus 2001 primarily due to lower outstanding debt balances,
reflecting the application of proceeds from the sale of the BetzDearborn Water
Treatment Business on April 29, 2002, and 2001 asset sales, as well as lower
interest rates. Equity income (loss) of affiliated companies in 2002 reflected equity
income from the FiberVisions ES joint venture that FiberVisions formed in
January 2000 with Chisso Polypro Fiber Co., Ltd. The equity losses recorded in
2001 were a result of the equity losses relating to CP Kelco. The provision for income taxes on continuing operations reflects effective
tax rates of 22% in 2003, 6% in 2002 and (16%) in 2001. The effective tax rate
for 2003 reflects the tax benefit from the donation of intellectual property to
qualified organizations and the use of prior year capital losses. The
effective tax rate for 2002 reflects the tax benefit of the pre-tax loss
partially offset by the effect of increases to tax reserves related to
anticipated tax assessments and other provisions. The effective tax rate for
2001 reflects the tax benefit of the pre-tax loss partially offset by the
effect of increases to tax reserves and the effect of non-deductible goodwill
amortization. Financial Condition Liquidity and financial resources: Net cash flow provided by (used in)
operations was $23 million in 2003, $(215) million in 2002 and $(98) million in
2001. The improvement in operating cash flow in 2003 compared to 2002 reflects
significantly lower payments for income taxes, defined benefit pension plan
contributions, interest, severance and debt repayment penalties. The decrease
in tax payments primarily related to taxes paid on the BetzDearborn
divestiture. The Company paid approximately $15 million in taxes related to
this transaction in 2003; the remaining taxes are estimated to be between $11
million and $21 million and are expected to be paid in 2005. The Company made
contributions to its defined benefits pensions plans of $55 million and $92
million in 2003 and 2002, respectively. Restructuring and severance payments
were $21 million in 2003 versus $39 million in 2002. The Company presently
anticipates severance payments of approximately $10 million in 2004. Partially
offsetting these cash flow improvements is an increase in asbestos settlement
payments. As noted, the Company has exhausted its primary and first level
excess insurance policies that provided coverage for the asbestos-related
matters. The Company has not yet reached agreement with its other insurance
carriers to fund the cost of defending and resolving its asbestos-related
matters. As a result, until the Companys other insurance carriers begin to
fund the cost of defending and resolving these matters, the Company will have
to fully fund the cost of defending and resolving these matters. Net of
insurance, the Company spent $40 million during 2003, which includes $7 million
for defense costs. The Company presently projects asbestos-related payments of
approximately $40 to $45 million in 2004 before consideration of any insurance
coverage or reimbursement, if any, and any potential legislative resolution to
this matter. The change in cash in 2002 compared to 2001 primarily results
from higher income tax payments, $92 million in pension contributions and
payments related to the restructuring plans. Net cash provided by investing activities was $48 million in 2003, $1,659
million in 2002 and $295 million in 2001. In June 2003, the Company used the
$125 million in escrowed funds from its December 2002 refinancing to redeem the
6.625% notes. On December 1, 2003 the Company completed the acquisition of
Quantum for approximately $10 million. As a result of the de-consolidation of
Hercules Trust I and Hercules Trust II, pursuant to FIN 46(R), the Company has
an investment of $27 million in CRESTS Units preferred securities at December
31, 2003. Hercules significant cash flow from investing activities in 2002
was due to the sale of the BetzDearborn Water Treatment Business. Cash flow
from investing activities in 2001 benefited from the monetization of certain
non-core assets. In May 2001, the Company completed the sale of its
hydrocarbon resins business and select portions of its rosin resins business to
a subsidiary of Eastman Chemical Company, receiving proceeds of approximately
$244 million, and the sale of its peroxy chemicals business to GEO Specialty
Chemicals, Inc., receiving proceeds of approximately $92 million. Capital
expenditures were $48 million, $43 million and $52 million, in 2003, 2002 and
2001, respectively. Significant capital spending controls 11




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instituted in early 2001 lowered capital expenditures in 2003, 2002 and
2001. The decrease in capital expenditures in 2002 from 2001 also reflects
completion of the plant expansion in Doel, Belgium in early 2001. Net cash used in financing activities was $171 million, $1,334 million and
$370 million, respectively, in 2003, 2002 and 2001. The Company has used cash
provided by operations in 2003, the December 2002 refinancing and the business
divestitures in 2002 and 2001 to pay down long-term debt. The Board of Directors has authorized the Company, from time to time,
subject to market conditions and provisions of the Companys credit agreement,
to repurchase up to $140 million of its outstanding indebtedness. Pursuant to
the Term B Loan Credit Agreement and subject to related covenants, the Company
has the right to use available cash to repurchase, repay or otherwise redeem up
to $100 million of the 11 1/8% senior notes and $40 million of the
company-obligated trust preferred securities in any fiscal year. During the
fourth quarter ended December 31, 2003, the Company repurchased $24 million
(book value) of its 11 1/8% senior notes for $29 million, recognizing a loss of
$5 million. Subsequently, in 2004, an additional $33 million (book value) of
the 11 1/8% senior notes have been repurchased by the Company at a cost of $40
million. In addition, during the fourth quarter of 2003, the Company purchased
46,000 of the CRESTS Units for a total of $34 million, of which $27 million was
attributed to the preferred security component and $7 million was attributed to
the warrants. The corresponding book value of a similar number of the CRESTS
Units junior subordinated deferrable interest debentures was $34 million.
Accordingly, the Company recognized a gain of $7 million ($5 million after-tax)
in continuing operations. However, the Company has determined that (i)
Hercules Trust I and Hercules Trust II (the Trusts) are variable interest
entities and (ii) the Company is not the primary beneficiary of the Trusts.
Accordingly, the Company has de-consolidated the Trusts and recognized an
after-tax loss of $5 million as a cumulative effect of a change in accounting
principle to defer the above noted gain, effective December 31, 2003, in
accordance with the provisions of FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entries (FIN 46R). As a result
of the de-consolidation, long-term debt reflects the Companys obligation to
Hercules Trust II for the CRESTS Units junior subordinated deferrable interest
debentures (long-term debt at December 31, 2003 also reflects the Companys
obligations to Hercules Trust I on the TOPrS 9.42% junior subordinated
deferrable interest debentures). The indenture for the CRESTS Units junior
subordinated deferrable interest debentures does not provide the ability for
the Company to repay, redeem or defease the CRESTS Units junior subordinated
deferrable interest debentures through purchasing the CRESTS Units.
Accordingly, at December 31, 2003 the outstanding balance of CRESTS Units
junior subordinated deferrable interest debentures has not changed as a result
of the Companys purchase of the CRESTS Units. The $27 million paid to
purchase the CRESTS Units preferred security component is reflected as an
increase in the Companys investment in Hercules Trust II, with the
corresponding gain on the purchase deferred until Hercules Trust II has been
liquidated. The $7 million paid and attributable to the warrants has been
recorded as a reduction in additional paid-in-capital. On December 17, 2003, the Company amended its senior credit facility to,
among other things, (i) lower the term B loan interest to LIBOR + 2.50% (from
LIBOR +3.25%) and (ii) provide the ability for foreign borrowings. On December
20, 2002, the Company completed a refinancing of its then existing senior
credit facility with a new senior credit facility. The senior credit facility
consists of a four year $125 million revolving credit agreement and a $200
million term B loan due May 2007. In addition, the Company has the option of
borrowing an additional $50 million to $150 million on terms identical to the
term B loan. The availability of the incremental term loan does not expire
until the earlier of December 20, 2005 or the repayment of the $200 million
term B loan. In conjunction with the execution of the credit agreement, $125
million of the proceeds of the term B loan was placed into an escrow account to
pay the principal amount of the 6.625% notes in June 2003. The remaining
proceeds from the refinancing were used for general corporate purposes. The
term B loan bears interest at LIBOR + 2.50% (4.02% at December 31, 2003). The
revolving credit agreement bears interest at LIBOR plus an applicable margin,
currently 2.75%, which is determinable based on the Companys leverage ratio.
The senior credit facility is secured by liens on the Companys U.S. assets
(including real, personal and intellectual properties) and is guaranteed by
substantially all of the Companys current and future wholly-owned domestic
subsidiaries. Issuance costs related to the financing are included in deferred
charges and other assets and are being amortized over the term of the loans,
using the effective interest method. The Company used the net proceeds of approximately $1.7 billion from the
sale of the BetzDearborn Water Treatment Business (see Note 25) to permanently
reduce long-term debt, repaying in full the following borrowings: term loan
tranche A, term loan tranche D, the revolving credit agreement and the ESOP
credit facility. In addition, effective with the consummation of the sale of
the Water Treatment Business and the application of the net proceeds, the
revolving credit agreement was permanently reduced from $900 million to $200
million and the Canadian revolving credit agreement was cancelled. A portion
of the net proceeds ($73 million) from the sale of the Water Treatment Business
was used to collateralize the Companys then outstanding letters of credit. As of December 31, 2003, $49 million of the $125 million revolving credit
agreement and $17 million of short-term lines of credit was available for use.
The Company had outstanding letters of credit associated with the revolving
credit agreement of $76 million at December 31, 2003. 12




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##### Table of Contents



Capital Structure and Commitments Total capitalization (stockholders equity (deficit) and debt including
the junior subordinated deferrable interest debentures) is
$1.4 billion and $1.3 billion at
December 31, 2003 and 2002, respectively. Total debt, including junior
subordinated deferrable interest debentures related to the company-obligated
trust preferred securities, was $1.348 billion at December 31, 2003, a decrease
of $159 million from December 31, 2002, reflecting the repayment of the 6.625%
notes in June 2003 and repurchases of the 11 1/8% senior notes in the fourth
quarter 2003. Total capitalization at December 31, 2002 decreased from $3.5
billion at December 31, 2001 principally as a result of the BetzDearborn
divestiture. The current ratio increased to 1.79 at December 31, 2003,
compared to 1.58 at December 31, 2002. The quick ratio increased to 1.39 at
December 31, 2003 compared to 1.30 at December 31, 2002. Capital expenditures are estimated to be between $65 and $70 million in
2004 and $70 to $75 million in 2005. Capital expenditures are presently
estimated to be approximately $60 million per year in 2006 through 2008. As
previously announced, the Company is expanding its Natrosol HEC production
capacity at facilities in New Jersey, Virginia and the Netherlands. The Companys contractual commitments as of December 31, 2003 are
summarized as follows: (Dollars in millions)Payments Due by PeriodLess than
    
    1 - 3
    
    4 - 5
    
    After 5Total
    
    1 year
    
    years
    
    years
    
    yearsLong-term Debt Obligations
    
    $
    1,348
    
    
    $
    22
    
    
    $
    26
    
    
    $
    568
    
    
    $
    732Operating Lease Obligations
    
    
    133
    
    
    
    20
    
    
    
    31
    
    
    
    26
    
    
    
    56Purchase Obligations
    
    
    9
    
    
    
    6
    
    
    
    3
    
    
    
    
    
    
    
    Other Long-term Liabilities
Reflected on the Registrants
Balance Sheet
under GAAP (1)
    
    
    335
    
    
    
    63
    
    
    
    33
    
    
    
    29
    
    
    
    210Total Contractual Cash Obligations
    
    $
    1,825
    
    
    $
    111
    
    
    $
    93
    
    
    $
    623
    
    
    $
    998
  (1)
    
    Includes amounts related to asbestos-related matters, asset
retirement obligation, and workers compensation claims. Due to the
dynamic nature of asbestos litigation and the present uncertainty
concerning the participation of the Companys excess insurance
carriers, it is impractical to determine the anticipated payments in
any given year. Therefore, the non-current asbestos-related liability
of $176 million has been reflected in the after five years column. The Company had the following commercial commitments at December 31, 2003:
lines of credit of $17 million outstanding and letters of credit of $76
million, both of which may require payments in the future. If required, these
commitments would be funded from general corporate funds. The Company projects cash flow from operations will be sufficient to meet
its investing and financing requirements in the next several years. The
Company presently is in discussions to refinance a portion of its debt. The
proposed refinancing, if implemented, is expected to reduce interest expense
and extend 2007 debt maturities to future years. Risk Factors Indebtedness As of December 31, 2003, the Companys total debt was approximately $1,348
million, of which 83% is fixed rate indebtedness. The Companys indebtedness
has significant consequences. For example, it could: increase the Companys
vulnerability to economic downturns and competitive pressures; require the
Company to dedicate a substantial portion of its cash flow from operations to
payments on its indebtedness, thereby reducing the availability of its cash
flow to fund working capital, capital expenditures, research and development
efforts and other general corporate purposes; limit the Companys flexibility
in planning for, or reacting to, changes in its business and the industries in
which it operates or in pursuing attractive business opportunities requiring
debt financing; place the Company at a disadvantage to its competitors that
have less debt; and limit the Companys ability to borrow additional funds due
to restrictive covenants. The senior credit facility and the indenture governing the 11 1/8% senior
notes due 2007, which together account for a large portion of the Companys
debt, contain numerous restrictive covenants, including, among other things,
covenants that limit the Companys ability to: borrow money and incur
contingent liabilities; make dividend or other restricted payments; use assets
as security in other transactions; enter into transactions with affiliates;
enter into new lines of business; issue and sell stock of restricted
subsidiaries; sell assets or merge with or into other companies and make
capital expenditures. In addition, the senior credit facility requires the
Company to meet financial ratios and tests, including 13




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##### Table of Contents



maximum leverage and interest coverage levels. These restrictions could
limit the Companys ability to plan for or react to market conditions or meet
extraordinary capital needs and could otherwise restrict corporate activities. The Companys ability to comply with the covenants and other terms of the
senior credit facility and the indenture governing the senior notes and to
satisfy these and other debt obligations will depend upon the Companys current
and future performance. The Companys performance is affected by general
economic conditions and by financial, competitive, political, business and
other factors, many of which are beyond the Companys control. The Company
believes that the cash generated from its business will be sufficient to enable
the Company to comply with the covenants and other terms of the senior credit
facility and the indenture governing the senior notes and to make debt payments
as they become due. The Company and its subsidiaries may incur additional indebtedness in the
future. As of December 31, 2003, the Company had a $325 million senior credit
facility with a syndicate of banks. Under the senior credit facility, the
Company has a $125 million revolving credit agreement, which permits certain
additional borrowings. In addition, the Company has the option to borrow an
additional $50 million to $150 million under the senior credit facility. If
new indebtedness is added to the Companys current indebtedness levels, the
risks described above could increase. Market Risk Fluctuations in interest and foreign currency exchange rates affect the
Companys financial position and results of operations. The Company has used
several strategies to actively hedge interest rate and foreign currency
exposure and minimize the effect of such fluctuations on reported earnings and
cash flow (see Foreign Currency Translation and Derivative Financial
Instruments and Hedging in the Summary of Significant Accounting Policies and
Notes 21 and 24). Sensitivity of the Companys financial instruments to
selected changes in market rates and prices, which are reasonably possible over
a one-year period, are described below. The market values for interest rate
risk are calculated by the Company utilizing a third-party software model that
employs standard pricing models to determine the present value of the
instruments based on the market conditions as of the valuation date. The Companys derivative and other financial instruments subject to
interest rate risk consist substantially of debt instruments and trust
preferred securities. At December 31, 2003 and 2002, net market value of these
combined instruments was a liability of $1.386 billion and $1.440 billion,
respectively. The sensitivity analysis assumes an instantaneous 100-basis
point move in interest rates from their levels, with all other variables held
constant. A 100-basis point increase in interest rates at December 31, 2003
and 2002 would result in an $85 and $60 million decrease, respectively, in the
net market value of the liability. A 100-basis point decrease in interest
rates at December 31, 2003 and 2002 would result in a $68 and $72 million
increase, respectively, in the net market value of the liability. Our financial instruments subject to foreign currency exchange risk
consist of foreign currency forwards and options and represent a net asset
position of $1.0 million and $0.2 million at December 31, 2003 and 2002,
respectively. The following sensitivity analysis assumes an instantaneous 10%
change in foreign currency exchange rates from year-end levels, with all other
variables held constant. A 10% strengthening of the U.S. dollar versus other
currencies at December 31, 2003 and 2002 would result in a $0.1 million
decrease and a $0.2 million increase, respectively, in the net asset position
while a 10% weakening of the dollar versus all currencies would result in a
$0.1 million increase and a $0.3 million decrease, respectively, in the net
asset position. Foreign exchange forward and option contracts have been used to hedge the
Companys firm and anticipated foreign currency cash flows. Thus, there is
either an asset or cash flow exposure related to all the financial instruments
in the above sensitivity analysis for which the impact of a movement in
exchange rates would be in the opposite direction and substantially equal to
the impact on the instruments in the analysis. There are presently no
significant restrictions on the remittance of funds generated by the Companys
operations outside the United States. The Company has not designated any derivative as a hedge instrument under
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133) and, accordingly, changes in
the fair value of derivatives are recorded each period in earnings. Environmental In the ordinary course of its business, the Company is subject to numerous
environmental laws and regulations covering compliance matters or imposing
liability for the costs of, and damages resulting from, cleaning up sites, past
spills, disposals and other releases of hazardous substances. Changes in these
laws and regulations may have a material adverse effect on the Companys
financial position and results of operations. Any failure by the Company to
adequately comply with such laws and regulations could subject the Company to
significant future liabilities. Environmental remediation expenses are funded from internal sources of
cash. Such expenses are not expected to have a significant effect on the
Companys ongoing liquidity. Environmental cleanup costs, including capital
expenditures for ongoing operations, are a normal, recurring part of operations
and are not significant in relation to total operating costs or cash flows (see
Item 3, Legal Proceedings and Note 13). 14




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Litigation Hercules is a defendant in numerous lawsuits that arise out of, and are
incidental to, the conduct of its business. These suits concern issues such as
product liability, contract disputes, labor-related matters, patent
infringement, antitrust proceedings, environmental proceedings, property damage
and personal injury matters. While it is not feasible to predict the outcome
of all pending suits and claims, the ultimate resolution of these matters could
have a material effect upon the financial position of Hercules, and the
resolution of any of the matters during a specific period could have a material
effect on the quarterly or annual operating results for that period (see Item
3, Legal Proceedings and Note 13). Pension The assets and liabilities associated with the Companys defined benefit
plans are subject to interest rate and market risk. A 100-basis point decrease
or increase in the discount rate has approximately a plus or minus $193 million
impact on the ABO. A 100-basis point decrease or increase in the assumed rate
of return has approximately a plus or minus $10 million impact on the U.S.
pension and postretirement expense estimated for 2004 (see Note 9). Indemnifications In connection with the sale of certain Company assets or businesses, the
Company has indemnified respective buyers against certain liabilities that may
arise in connection with the sales transactions and business activities prior
to the ultimate closing of the sale. These indemnifications typically pertain
to environmental, tax, employee and/or product-related matters. If the
indemnified party were to incur a liability or have a liability increase as a
result of a successful claim, pursuant to the terms of the indemnification, the
Company would be required to reimburse the buyer. These indemnifications are
generally subject to threshold amounts, specified claim periods and other
restrictions and limitations. The carrying amount recorded for all
indemnifications as of December 31, 2003 is $76 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 reasonable estimate of the
maximum potential loss or range of loss. Recent Accounting Pronouncements In December 2003, the SEC issued SAB 104, Revenue Recognition, which
supersedes SAB 101, Revenue Recognition in Financial Statements, and updates
portions of the interpretive guidance included in Topic 13 of the codification
of staff accounting bulletins in order to make this interpretive guidance
consistent with current authoritative accounting guidance. The Company had
previously adopted the necessary changes incorporated into SAB 104, which did
not have a material effect on the Companys financial position, results of
operations or cash flows. In January 2004, the FASB issued Staff Position FAS 106-1, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (FSP 106-1). FSP 106-1 permits a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare
Act). The Medicare Act, which was signed by the President on December 8,
2003, introduces a prescription drug benefit under Medicare (Medicare Part D)
as well as a federal subsidy to sponsors of retiree health care benefit plans
that provide a benefit that is at least actuarially equivalent to Medicare Part
D. The Company offers a drug benefit plan and has elected to defer current
recognition of the effects of the Act in the accounting for its plan pursuant
to FSP 106-1 until authoritative guidance on the accounting for the federal
subsidy is issued. As such, any measures of the accumulated projected benefit
obligation or net periodic postretirement benefit cost in the financial
statements or accompanying notes do not reflect the effects of the Act on the
plan, and as the specific authoritative guidance on the accounting for the
federal subsidy is still pending, it is possible that when guidance is issued
it could require the Company to change previously reported information. 15




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##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
REQUIRED SUPPLEMENTARY DATA
HERCULES INCORPORATED CONSOLIDATED FINANCIAL STATEMENTS
    
    PageReport of
Independent Registered Public Accounting Firm
    
    
    17Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001
    
    
    18Consolidated Balance Sheets as of December 31, 2003 and 2002
    
    
    19Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001
    
    
    20Consolidated Statements of Stockholders Equity (Deficit) for the Years Ended December
31, 2003, 2002 and 2001
    
    
    21Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31,
2003, 2002 and 2001
    
    
    22Summary of Significant Accounting Policies and Notes to Consolidated Financial Statements
    
    
    23SUPPLEMENTARY DATASummary of Quarterly Results (Unaudited)
    
    
    75Valuation and Qualifying Accounts
    
    
    79
 16




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##### Table of Contents



Report of Independent
Registered Public Accounting Firm To the Shareholders and Board of Directors
of Hercules Incorporated: In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) on page 79 present fairly, in all material
respects, the financial position of Hercules Incorporated and subsidiaries at
December 31, 2003 and 2002, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2003 in
conformity with accounting principles generally accepted in the United States
of America. In addition, in our opinion, the financial statement schedule
listed in the index appearing under Item 15(a)(2) on page 79 presents fairly,
in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These
financial statements and the financial statement schedule are the
responsibility of the Companys management; our responsibility is to express an
opinion on these financial statements and the financial statement schedule
based on our audits. We conducted our audits of these statements in accordance
with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. As discussed in Note 1 to the consolidated financial statements, during the
year ended December 31, 2003, the Company changed its method of accounting for
its employee stock ownership plan from the method prescribed by Statement of
Position 76-3, Accounting Practices for Certain Employee Stock Ownership
Plans, to the method prescribed by Statement of Position 93-6, Employers
Accounting for Employee Stock Ownership Plans. As discussed in Note 6 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 150, Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity on July 1, 2003. As discussed in Notes 7 and 14 to the consolidated financial statements, the
Company adopted FASB Interpretation No. 46 (Revised), Consolidation of
Variable Interest Entities on July 1, 2003, as it related to the two joint
ventures, ES FiberVisions Holdings A/S and ES FiberVisions L.P. and on December
31, 2003 as it related to its trust preferred securities. As discussed in Note 11 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards 148, Accounting for
Stock-Based Compensation  Transition and Disclosure on January 1, 2003. As discussed in Note 12 to the consolidated financial statements, the Company
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, the Company
changed its accounting for goodwill and indefinite-lived intangible assets
effective January 1, 2002, with the adoption of Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets. As discussed in Note 26
to the consolidated financial statements, the Company restated the
Consolidated Financial Statements as of December 31, 2003 and
2002 to revise its accounting for income taxes and change in
classification of the incentive stock plan activity. /s/ PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 11, 2004, except as to Note 26, as to which the date
is November 15, 2004. 17




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##### Table of Contents



Hercules Incorporated
Consolidated Statements of Operations (Dollars in millions, except per share)2003
    
    2002
    
    2001Net sales
    
    $
    1,846
    
    
    $
    1,705
    
    
    $
    1,776Cost of sales
    
    
    1,167
    
    
    
    1,040
    
    
    
    1,133Selling, general and administrative expenses
    
    
    360
    
    
    
    348
    
    
    
    398Research and development
    
    
    39
    
    
    
    42
    
    
    
    53Goodwill and intangible asset amortization (Note 4)
    
    
    8
    
    
    
    9
    
    
    
    24Other operating expense (income), net (Note 19)
    
    
    17
    
    
    
    46
    
    
    
    (16
    )Profit from operations
    
    
    255
    
    
    
    220
    
    
    
    184Interest and debt expense (Note 20)
    
    
    131
    
    
    
    99
    
    
    
    204Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    58
    
    
    
    58Other expense, net (Note 21)
    
    
    29
    
    
    
    115
    
    
    
    8Income (loss) before income taxes and equity income (loss)
    
    
    95
    
    
    
    (52
    )
    
    
    (86
    )Provision (benefit) for income taxes (Note 8)
    
    
    21
    
    
    
    (3
    )
    
    
    14Income (loss) before equity income (loss)
    
    
    74
    
    
    
    (49
    )
    
    
    (100
    )Equity income (loss) of affiliated companies, net of tax
    
    
    
    
    
    
    2
    
    
    
    (9
    )Net income (loss) from continuing operations before discontinued
operations and cumulative effect of changes in accounting principle
    
    
    74
    
    
    
    (47
    )
    
    
    (109
    )Net income (loss) on discontinued operations, net of tax (Note 25)
    
    
    4
    
    
    
    (196
    )
    
    
    56Net income (loss) before cumulative effect of changes
in accounting principle
    
    
    78
    
    
    
    (243
    )
    
    
    (53
    )Cumulative effect of changes in accounting principle, net of tax
(Notes 4, 6 and 12)
    
    
    (33
    )
    
    
    (368
    )
    
    
    Net income (loss)
    
    $
    45
    
    
    $
    (611
    )
    
    $
    (53
    )Earnings (loss) per share (Note 22)Basic earnings (loss) per shareContinuing operations
    
    $
    0.69
    
    
    $
    (0.44
    )
    
    $
    (1.04
    )Discontinued operations
    
    $
    0.04
    
    
    $
    (1.85
    )
    
    $
    0.53Cumulative effect of changes in accounting principle
    
    $
    (0.31
    )
    
    $
    (3.47
    )
    
    $
    Net income (loss)
    
    $
    0.42
    
    
    $
    (5.76
    )
    
    $
    (0.51
    )Weighted average number of shares (millions)
    
    
    107.8
    
    
    
    106.0
    
    
    
    104.8Diluted earnings (loss) per shareContinuing operations
    
    $
    0.69
    
    
    $
    (0.44
    )
    
    $
    (1.04
    )Discontinued operations
    
    $
    0.04
    
    
    $
    (1.85
    )
    
    $
    0.53Cumulative effect of changes in accounting principle
    
    $
    (0.31
    )
    
    $
    (3.47
    )
    
    $
    Net income (loss)
    
    $
    0.42
    
    
    $
    (5.76
    )
    
    $
    (0.51
    )Weighted average number of shares (millions)
    
    
    107.9
    
    
    
    106.0
    
    
    
    104.8
 The accompanying accounting policies and notes are an integral part of the consolidated financial statements. 18




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Hercules Incorporated
Consolidated Balance Sheets (Dollars in millions)December 31,2003
    
    2002As Restated(Note 26)ASSETSCurrent assetsCash and cash equivalents
    
    $
    125
    
    
    $
    209Restricted cash (Note 6)
    
    
    
    
    
    
    125Accounts and notes receivable, net (Note 2)
    
    
    415
    
    
    
    395Inventories (Note 3)
    
    
    187
    
    
    
    167Deferred income taxes (Note 8)
    
    
    93
    
    
    
    46Total current assets
    
    
    820
    
    
    
    942Property, plant and equipment, net (Note 17)
    
    
    677
    
    
    
    663Intangible assets, net (Note 4)
    
    
    187
    
    
    
    198Goodwill, net (Note 4)
    
    
    518
    
    
    
    468Deferred income taxes (Note 8)
    
    
    44
    
    
    
    32Deferred charges and other assets (Note 17)
    
    
    465
    
    
    
    456Total assets
    
    $
    2,711
    
    
    $
    2,759LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilitiesAccounts payable
    
    $
    192
    
    
    $
    176Short-term debt (Note 5)
    
    
    22
    
    
    
    145Accrued expenses (Note 17)
    
    
    243
    
    
    
    277Total current liabilities
    
    
    457
    
    
    
    598Long-term debt (Note 6)
    
    
    1,326
    
    
    
    738Deferred income taxes (Note 8)
    
    
    78
    
    
    
    80Pension liability (Note 9)
    
    
    249
    
    
    
    294Other postretirement benefits (Note 9)
    
    
    96
    
    
    
    103Deferred credits and other liabilities (Note 17)
    
    
    494
    
    
    
    493Total liabilities
    
    
    2,700
    
    
    
    2,306Commitments and contingencies (Note 13)
    
    
    
    
    
    
    Company-obligated preferred securities of subsidiary trusts (Note 6)
    
    
    
    
    
    
    624Stockholders equity (deficit)Series preferred stock (Note 15)
    
    
    
    
    
    
    Common
stock, $25/48 par value (Note 16)(shares issued and outstanding: 2003 - 159,984,444; 2002 - 159,984,444)
    
    
    83
    
    
    
    83Additional paid-in capital
    
    
    603
    
    
    
    665Unearned
compensation (Notes 10 and 11)
    
    
    (87
    )
    
    
    (91
    )Accumulated other comprehensive losses
    
    
    (317
    )
    
    
    (454
    )Retained earnings
    
    
    1,495
    
    
    
    1,4501,777
    
    
    
    1,653Reacquired stock, at cost (shares: 2003 - 48,992,628; 2002 - 50,615,487)
    
    
    1,766
    
    
    
    1,824Total stockholders equity (deficit)
    
    
    11
    
    
    
    (171
    )Total liabilities and stockholders equity (deficit)
    
    $
    2,711
    
    
    $
    2,759
 The accompanying accounting policies and notes are an integral part of the consolidated financial statements. 19




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Hercules Incorporated
Consolidated Statements of Cash Flows (Dollars in millions)2003
    
    2002
    
    2001Cash Flow From Operating Activities:Net income (loss)
    
    $
    45
    
    
    $
    (611
    )
    
    $
    (53
    )Net (income) loss from discontinued operations
    
    
    (4
    )
    
    
    196
    
    
    
    (56
    )Adjustments to reconcile net income (loss) to net cash provided by (used in) operations:Depreciation
    
    
    73
    
    
    
    71
    
    
    
    77Amortization
    
    
    27
    
    
    
    29
    
    
    
    57Provision for deferred income taxes
    
    
    8
    
    
    
    17
    
    
    
    (64
    )Gain on disposals
    
    
    (4
    )
    
    
    
    
    
    
    (77
    )Impairment charges
    
    
    2
    
    
    
    368
    
    
    
    3Non-cash charges
    
    
    10
    
    
    
    62
    
    
    
    72Accruals and deferrals of cash receipts and payments (net of acquisitions and dispositions):Affiliates earnings in excess of dividends received
    
    
    
    
    
    
    (2
    )
    
    
    9Accounts receivable
    
    
    14
    
    
    
    (7
    )
    
    
    65Inventories
    
    
    (7
    )
    
    
    (5
    )
    
    
    6Accounts payable and accrued expenses
    
    
    (57
    )
    
    
    (115
    )
    
    
    (214
    )Income taxes payable
    
    
    (88
    )
    
    
    (148
    )
    
    
    122Non-current assets and liabilities
    
    
    4
    
    
    
    (70
    )
    
    
    (45
    )Net cash provided by (used in) continuing operations
    
    
    23
    
    
    
    (215
    )
    
    
    (98
    )Cash Flow From Investing Activities:Capital expenditures
    
    
    (48
    )
    
    
    (43
    )
    
    
    (52
    )Proceeds of investment and fixed asset disposals
    
    
    10
    
    
    
    1,816
    
    
    
    356Decrease (increase) in restricted cash
    
    
    125
    
    
    
    (125
    )
    
    
    Acquisitions, net of cash acquired
    
    
    (10
    )
    
    
    
    
    
    
    Investment in CRESTS Units preferred securities
    
    
    (27
    )
    
    
    
    
    
    
    Other, net
    
    
    (2
    )
    
    
    11
    
    
    
    (9
    )Net cash provided by investing activities from continuing operations
    
    
    48
    
    
    
    1,659
    
    
    
    295Cash Flow From Financing Activities:Long-term debt proceeds
    
    
    
    
    
    
    450
    
    
    
    349Long-term debt payments
    
    
    (165
    )
    
    
    (1,776
    )
    
    
    (626
    )Change in short-term debt
    
    
    (1
    )
    
    
    (8
    )
    
    
    (107
    )Payment of debt issuance costs and underwriting fees
    
    
    
    
    
    
    (5
    )
    
    
    Repurchase of CRESTS Units warrants
    
    
    (7
    )
    
    
    
    
    
    
    Common stock issued
    
    
    2
    
    
    
    5
    
    
    
    15Common stock reacquired
    
    
    
    
    
    
    
    
    
    
    (1
    )Net cash used in financing activities
    
    
    (171
    )
    
    
    (1,334
    )
    
    
    (370
    )Effect of exchange rate changes on cash
    
    
    16
    
    
    
    (2
    )
    
    
    (3
    )Net cash flow from discontinued operations (Note 25)
    
    
    
    
    
    
    25
    
    
    
    198Net (decrease) increase in cash and cash equivalents
    
    
    (84
    )
    
    
    133
    
    
    
    22Cash and cash equivalents at beginning of year
    
    
    209
    
    
    
    76
    
    
    
    54Cash and cash equivalents at end of year
    
    $
    125
    
    
    $
    209
    
    
    $
    76Supplemental Disclosures of Cash Flow Information:Cash paid during the period for:Interest (net of amount capitalized)
    
    $
    122
    
    
    $
    96
    
    
    $
    157Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    57
    
    
    
    61Income taxes, net of refunds received
    
    
    65
    
    
    
    142
    
    
    
    37Non-cash investing and financing activities:Acquisition of minority interest
    
    
    2
    
    
    
    
    
    
    
    Incentive and other employee benefit stock plan issuances
    
    
    19
    
    
    
    7
    
    
    
    11
 The accompanying accounting policies and notes are an integral part of the consolidated financial statements. 20




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##### Table of Contents



Hercules Incorporated
Consolidated Statements of Stockholders Equity (Deficit) (Dollars in millions)AccumulatedUnearned
    
    OtherCommon
    
    Paid-in
    
    Compen-
    
    Comprehen-
    
    Retained
    
    ReacquiredStock
    
    Capital
    
    sation
    
    sive Loss
    
    Earnings
    
    Stock
    
    TotalBalances at January 1, 2001, as previously reported
    
    $
    83
    
    
    $
    726
    
    
    $
    (115
    )
    
    $
    (143
    )
    
    $
    2,157
    
    
    $
    (1,892
    )
    
    $
    816(Common shares: issued, 159,984,444; reacquired, 52,442,393)Adjustment for the cumulative effect on prior years of
retroactively applying the new method of accounting
for the Employee Stock Ownership Plan (Note 1)
    
    
    
    
    
    
    (7
    )
    
    
    2
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    Adjustment
for restatement of periods prior to January 1, 2001
(Note 26)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (48
    )
    
    
    
    
    
    
    (48
    )Balances at
January 1, 2001, as restated (Note 26)
    
    $
    83
    
    
    $
    719
    
    
    $
    (113
    )
    
    $
    (143
    )
    
    $
    2,114
    
    
    $
    (1,892
    )
    
    $
    768Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (53
    )
    
    
    
    
    
    
    (53
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (69
    )
    
    
    
    
    
    
    
    
    
    
    (69
    )Release of shares held by ESOP trust
    
    
    
    
    
    
    (5
    )
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Additional minimum pension liability, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    (6
    )Purchase of common stock, 66,470 shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )Issuances of common stock:Incentive plans, net, 1,311,891 shares, from reacquired
stock
    
    
    
    
    
    
    (29
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48
    
    
    
    19Balances at
December 31, 2001, as restated (Note 26)
    
    $
    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
    
    
    
    
    
    
    
    
    
    
    
    15Release of shares held by ESOP trust
    
    
    
    
    
    
    (5
    )
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Additional minimum pension liability, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (354
    )
    
    
    
    
    
    
    
    
    
    
    (354
    )Reclassification adjustment relating to disposal of business
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    103
    
    
    
    
    
    
    
    
    
    
    
    103Purchase of common stock, 16,960 shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuances of common stock:Incentive plans, net, 598,445 shares, from reacquired stock
    
    
    
    
    
    
    (15
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21
    
    
    
    6Balances at
December 31, 2002, as restated (Note 26)
    
    $
    83
    
    
    $
    665
    
    
    $
    (91
    )
    
    $
    (454
    )
    
    $
    1,450
    
    
    $
    (1,824
    )
    
    $
    (171
    )(Common shares: issued, 159,984,444; reacquired, 50,615,487)Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45
    
    
    
    
    
    
    
    45Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    122
    
    
    
    
    
    
    
    
    
    
    
    122Release of shares held by ESOP trust
    
    
    
    
    
    
    (5
    )
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Debt 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    15Issuances of common stock:Incentive plans, net, 1,622,859 shares, from reacquired
stock, as restated (Note 26)
    
    
    
    
    
    
    (43
    )
    
    
    (11
    )
    
    
    
    
    
    
    
    
    
    
    58
    
    
    
    4Amortization
of unearned compensation, as restated (Note 26)
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Balances at
December 31, 2003, as restated (Note 26)
    
    $
    83
    
    
    $
    603
    
    
    $
    (87
    )
    
    $
    (317
    )
    
    $
    1,495
    
    
    $
    (1,766
    )
    
    $
    11(Common shares: issued, 159,984,444; reacquired, 48,992,628)
 The accompanying accounting policies and notes are an integral part of the consolidated financial statements. 21




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##### Table of Contents



Hercules Incorporated
Consolidated Statements of Comprehensive Income (Loss) (Dollars in millions)Year Ended December 31,2003
    
    2002
    
    2001Net income (loss)
    
    $
    45
    
    
    $
    (611
    )
    
    $
    (53
    )Foreign currency translation
    
    
    122
    
    
    
    15
    
    
    
    (69
    )Reclassification adjustment relating to disposal of business
    
    
    
    
    
    
    103
    
    
    
    Decrease (increase) in additional minimum pension liability, net of tax
    
    
    15
    
    
    
    (354
    )
    
    
    (6
    )Comprehensive income (loss)
    
    $
    182
    
    
    $
    (847
    )
    
    $
    (128
    )
 The accompanying accounting policies and notes are an integral part of the consolidated financial statements. 22




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##### Table of Contents



Hercules Incorporated
Summary of Significant Accounting Policies Principles of Consolidation The Consolidated Financial Statements include the accounts of Hercules,
all majority-owned subsidiaries where control exists, any other subsidiaries
which it controls and variable interest entities (VIEs) in which Hercules is
the primary beneficiary. Following the acquisition of BetzDearborn and
continuing through December 31, 2002, the Company continued BetzDearborns
practice of using a November 30 fiscal year-end for certain former BetzDearborn
non-U.S. subsidiaries to expedite the year-end closing process. As of December
31, 2003, these subsidiaries have adopted a December 31 fiscal year-end. All
intercompany transactions and profits have been eliminated. Investments in
affiliated companies, where Hercules has a 20% to 50% interest and where the
entity is either not a VIE or Hercules is not the primary beneficiary, are
accounted for using the equity method of accounting and, accordingly,
consolidated income includes Hercules share of their income. Subsidiaries of
the Company (Hercules Trust I and Hercules Trust II) that are VIEs and with
respect to which Hercules is not the primary beneficiary have been
de-consolidated as of December 31, 2003. Use of Estimates Preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported
in the Consolidated Financial Statements and accompanying Notes. Actual
results could differ from these estimates. Revenue Recognition The Company recognizes revenue when the earnings process is complete.
This generally occurs when products are shipped to the customer or services are
performed in accordance with terms of the agreement, title and risk of loss
have been transferred, collectibility is probable and pricing is fixed or
determinable. Revenue arrangements with multiple deliverables are reported
separately for deliverables that have stand-alone value when there is objective
and reliable evidence as to the fair value of the deliverable and the delivery
of any undelivered item is probable and substantially controlled by the
Company. Approximately 12%, 12% and 11% of the Companys revenues for the
years ended December 31, 2003, 2002 and 2001, respectively, are from
consignment inventory. For consignment inventory, title and risk of loss are
transferred when the earnings process is considered complete, which generally
occurs when the Companys products have been consumed or used in the customers
production process. Accruals are made for sales returns and other allowances
based on the Companys experience. The corresponding shipping and handling
costs are included in cost of sales. Research and Development Expenditures Research and development expenditures are expensed as incurred. Environmental Expenditures The Company has ongoing expenditures for environmental related projects at
current and former operating facilities. Accruals for environmental
remediation matters are expensed when it is probable that a liability has been
incurred and the amount of the liability is reasonably estimable. The Company
capitalizes environmental expenditures for projects that extend the life,
increase the capacity or improve the safety or efficiency of Company
facilities. In addition, the Company capitalizes asset retirement obligations
relating to environmental remediation liabilities that result from the normal
operation of Company facilities. The Company capitalized environmental related
expenditures and asset retirement obligations totaling $1.9 million, $0.9
million and $2.7 million for the years ended December 31, 2003, 2002 and 2001,
respectively. Cash and Cash Equivalents Cash in excess of operating requirements is invested in short-term,
income-producing instruments. Cash equivalents include commercial paper and
other securities with original maturities of 90 days or less. Book value
approximates fair value because of the short maturity of those instruments. Inventories Inventories are stated at the lower of cost or market. A portion of
domestic inventories are valued on the last-in, first-out (LIFO) method.
Foreign and certain domestic inventories, which in the aggregate represented
84% of total inventories at December 31, 2003 and 2002, are valued principally
on the average-cost method. Elements of costs in inventories include raw
materials, direct labor and manufacturing overhead. Property and Depreciation Property, plant and equipment are stated at cost. The Company changed to
the straight-line method of depreciation, effective January 1, 1991, for newly
acquired processing facilities and equipment. Assets acquired before 23




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##### Table of Contents



Hercules Incorporated
Summary of Significant Accounting Policies then continue to be depreciated by accelerated methods. The Company
believes straight-line depreciation provides a better matching of costs and
revenues over the lives of the assets. The estimated useful lives of
depreciable assets are as follows: buildings  30 years; plant machinery and
equipment  15 years; other machinery and equipment  3 to 15 years. Maintenance, repairs and minor renewals are expensed as incurred; major
renewals and betterments 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 Accounting Standards No. 142, Goodwill
and Other Intangible Assets (SFAS 142), beginning January 1, 2002, goodwill
is not amortized but is tested for impairment at least annually with any
necessary adjustment charged to expense. The Company has selected November 30
as the date for performing the annual impairment test. Prior to January 1,
2002, goodwill and other intangible assets have been amortized on a
straight-line basis over the estimated future periods to be benefited,
generally 40 years for goodwill, customer relationships, trademarks and
tradenames and 5 to 15 years for other intangible assets. Intangible assets
with finite lives are amortized over their useful lives. Investments Investments in affiliated companies in which the Company has a 20% to 50%
interest and exercises significant influence are accounted for using the equity
method of accounting. Accordingly, these investments are included in deferred
charges and other assets on the Companys consolidated balance sheet and the
income or loss from these investments is included in equity income (loss) of
affiliated companies in the Companys Consolidated Statement of Operations. Investments in affiliated companies in which the Company does not have a
controlling interest, or an ownership and voting interest so large as to exert
significant influence, are accounted for using the cost method of accounting.
Accordingly, these investments are included in deferred charges and other
assets on the Companys Consolidated Balance Sheet. Other investments include non-current marketable securities whose value
approximates market value. Investments in Subsidiary Trusts The Company has two subsidiary trusts, Hercules Trust I and Hercules Trust
II, that are variable interest entities for which the Company is not the
primary beneficiary. The Company utilizes the cost method to account for its
investments in the subsidiary trusts. Long-lived Assets The Company reviews its long-lived assets, including other intangibles,
for impairment on an exception basis whenever events or changes in
circumstances indicate carrying amounts of the assets may not be recoverable
through undiscounted future cash flows. If an impairment loss has occurred
based on expected future cash flows (undiscounted), the loss is recognized in
the income statement. The amount of the impairment loss is the excess of the
carrying amount of the impaired asset over the fair value of the asset. The
fair value represents expected future cash flows from the use of the assets,
discounted at the rate used to evaluate potential investments. The Company
reviews its long-lived assets under Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
(SFAS 144). Computer Software Costs The Company follows the American Institute of Certified Public Accountants
Statement of Position 98-1, Accounting for the Cost of Computer Software
Developed or Obtained for Internal Use (SOP 98-1). The Companys prior
accounting was generally consistent with the requirements of SOP 98-1 and,
accordingly, adoption of SOP 98-1 had no material effect. Computer software
costs are being amortized over a period of 5 to 10 years. Deferred Financing Costs The Company capitalizes costs associated with the issuance of debt
(deferred financing costs), including bank, legal, investment advisor and
accounting fees and other expenses. Deferred financing costs are amortized
over the term of the related financing transaction using the effective interest
rate method. 24




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##### Table of Contents



Hercules Incorporated
Summary of Significant Accounting Policies Income Taxes The provision for income taxes has been determined using the asset and
liability approach for accounting for income taxes. Under this approach,
deferred taxes represent the future tax consequences expected to occur when the
reported amounts of assets and liabilities are recovered or paid. The
provision for income tax represents income taxes paid or payable for the
current year plus the change in deferred taxes during the year. Deferred taxes
result from differences between the financial and tax basis of the Companys
assets and liabilities and are adjusted for changes in tax rates and tax laws
when changes are enacted. Valuation allowances are recorded to reduce deferred
tax assets when it is more likely than not that a tax benefit will not be
realized. Asset Retirement Obligations The Company records a liability at fair value for legal obligations
associated with the retirement of tangible long-lived assets that result from
the acquisition, construction, development and/or normal operations of a
long-lived asset. The Companys asset retirement obligations principally
relate to environmental remediation liabilities associated with current and
former operations that were incurred during the course of normal operations. Foreign Currency Translation The financial statements of Hercules non-U.S. entities are translated
into U.S. dollars using current rates of exchange, with gains or losses
included in accumulated other comprehensive losses. Derivative Instruments and Hedging On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133). SFAS 133, as amended by Statement No. 137,
Accounting for Derivative Instruments and Hedging Activity  Deferral of the
Effective Date of FASB Statement No. 133, Statement No. 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities, and Statement
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, requires that all derivative instruments be recorded on the
balance sheet at their fair values. The Company has not designated any
derivative as a hedge instrument and accordingly, changes in fair value of
derivatives are recorded each period in earnings. The adoption of SFAS 133 did
not result in a pre-tax or post-tax cumulative-effect-type adjustment to income
and did not result in a change to other comprehensive losses. Under procedures
and controls established by the Companys risk management policies, the Company
strategically enters into contractual arrangements (derivatives) in the
ordinary course of business to reduce the exposure to foreign currency rates
and interest rates. The Companys risk management policies establish several approved
derivative instruments to be utilized in each risk management program and the
level of exposure coverage based on the assessment of risk factors. Derivative
instruments utilized include forwards, swaps and options. The Company uses
forward exchange contracts and options, generally no greater than three months
in term, to reduce its net currency exposure. The objective of this program is
to maintain an overall balanced position in foreign currencies so that exchange
gains and losses resulting from exchange rate changes are minimized. The
Company has used interest rate swap agreements to manage interest costs and
risks associated with changing rates. The Company has not designated any
non-derivatives as hedging instruments. Counterparties to the forward exchange, currency swap, options and
interest swap contracts are major financial institutions. Credit loss from
counterparty nonperformance is 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 Accounting Standards No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure (SFAS
148). SFAS 148 amends SFAS 123 by providing alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation and requiring enhanced disclosure regarding
stock-based compensation. The Company has elected to apply the fair value
recognition provisions of SFAS 123 on a prospective basis to all employee
awards granted, modified or settled after January 1, 2003. Awards under the
Companys stock-based compensation plans vest over periods ranging from 1 to a
maximum of 10 years; however, vesting can be extended with the approval of the
Board of Directors. Therefore, the cost related to stock-based employee
compensation included in the determination of net income in 2003 is less than
that which would have been recognized if the fair value based method had been
applied to all awards since the original effective date of SFAS 123. The
Company did not grant any stock options pursuant to SFAS 123, as amended by
SFAS 148, to employees in 2003. However, the Company did make grants of
restricted stock to employees in 2003. Restricted stock awards under the
Hercules Long-term Incentive Compensation Plan are valued at the quoted market
price (fair value) of the Companys stock on the grant date (measurement date).
Stock acquired through the Employee Stock Purchase Plan and above target
restricted stock awarded under the Hercules 25




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##### Table of Contents



Hercules Incorporated
Summary of Significant Accounting Policies Management Incentive Compensation Plan is discounted 15% from market price
as permitted by IRS regulations and the provisions of the Companys incentive
compensation plans. The value of the award and the discount, if any, are
amortized into expense over the vesting (restriction) period. Forfeitures are
recorded as incurred. The Company recognized $4 million, $1 million and
$2 million of expense in 2003, 2002 and 2001, respectively, in connection
with restricted stock awards. Pursuant to the disclosure requirements of SFAS 123, as amended by SFAS
148, the following table presents the pro forma effect on net income (loss) and
earnings (loss) per share assuming the Company had applied the fair value
recognition provisions of SFAS 123 to all stock-based employee compensation on
a retroactive basis. (Dollars in millions, except per share)Year Ended December 31,2003
    
    2002
    
    2001Net income (loss), as reported
    
    $
    45
    
    
    $
    (611
    )
    
    $
    (53
    )Add: Total stock-based employee compensation expense
recognized in reported results
    
    
    5
    
    
    
    5
    
    
    
    4Deduct: Total stock-based employee compensation expense
determined under the fair value based method for all awards,
net of tax*
    
    
    12
    
    
    
    17
    
    
    
    24Pro forma net income (loss)
    
    $
    38
    
    
    $
    (623
    )
    
    $
    (73
    )Earnings (loss) per share:Basic  as reported
    
    $
    0.42
    
    
    $
    (5.76
    )
    
    $
    (0.51
    )Basic  pro forma
    
    $
    0.35
    
    
    $
    (5.88
    )
    
    $
    (0.70
    )Diluted  as reported
    
    $
    0.42
    
    
    $
    (5.76
    )
    
    $
    (0.51
    )Diluted  pro forma
    
    $
    0.35
    
    
    $
    (5.88
    )
    
    $
    (0.70
    )
 *
    
    For information regarding the weighted-average assumptions that would be used in estimating fair value for 2003, 2002 and 2001, see Note
11 of the Notes to Consolidated Financial Statements.
 Recent Accounting Pronouncements In December 2003, the SEC issued SAB 104, Revenue Recognition, which
supersedes SAB 101, Revenue Recognition in Financial Statements, and updates
portions of the interpretive guidance included in Topic 13 of the codification
of staff accounting bulletins in order to make this interpretive guidance
consistent with current authoritative accounting guidance. The Company had
previously adopted the necessary changes incorporated into SAB 104, which did
not have a material effect on the Companys financial position, results of
operations or cash flows. In January 2004, the FASB issued Staff Position FAS 106-1, Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (FSP 106-1). FSP 106-1 permits a sponsor of a
postretirement health care plan that provides a prescription drug benefit to
make a one-time election to defer accounting for the effects of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare
Act). The Medicare Act, which was signed by the President on December 8,
2003, introduces a prescription drug benefit under Medicare (Medicare Part D)
as well as a federal subsidy to sponsors of retiree health care benefit plans
that provide a benefit that is at least actuarially equivalent to Medicare Part
D. The Company offers a prescription drug benefit plan and has elected to
defer current recognition of the effects of the Act in the accounting for its
plan pursuant to FSP 106-1 until authoritative guidance on the accounting for
the federal subsidy is issued. As such, any measures of the accumulated
projected benefit obligation or net periodic postretirement benefit cost in the
financial statements or accompanying notes do not reflect the effects of the
Act on the plan and, as the specific authoritative guidance on the accounting
for the federal subsidy is still pending, it is possible that when guidance is
issued it could require the Company to change previously reported information. Reclassifications Certain amounts in the 2002 and 2001 consolidated financial statements and
notes have been reclassified to conform to the 2003 presentation. 26




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements  1.
    
    Change in Method of Accounting for Employee Stock Ownership Plan During the year ended December 31, 2003, the Company changed its method of
accounting for its Employee Stock Ownership Plan (ESOP) from the method
prescribed by Statement of Position 76-3, Accounting Practices for Certain
Employee Stock Ownership Plans, (SOP 76-3) to the method prescribed by
Statement of Position 93-6 Employers Accounting for Employee Stock Ownership
Plans (SOP 93-6). The Company believes that accounting for its ESOP in
accordance with the provisions of SOP 93-6 is preferable as it addresses ESOP
issues that were not contemplated in SOP 76-3, including changes to ESOP since
its inception, and reflects the fair value of compensation costs in the
statement of operations consistent with the preferred method of accounting for
other stock-based compensation plans. In accordance with Accounting Principles
Board Opinion No. 20, Accounting Changes, this change in accounting method
has been applied retroactively by restating prior financial statements for all
affected periods including the quarters ended March 31, 2003, June 30, 2003 and
September 30, 2003. The effect of the change was to increase net income by $5
million and earnings per share by $0.05 in both 2002 and 2001, as well as
increase net income by $2 million, $1 million and $1 million and earnings per
share by $0.02, $0.01 and $0.01 in the quarters ended March 31, 2003, June 30,
2003 and September 30, 2003, respectively. Retained earnings at January 1,
2001 has been increased by $5 million, net of taxes, unearned compensation
increased by $2 million and additional paid-in capital decreased by $7 million,
for the retroactive effect of this change in accounting. Additionally, the
Company has restated prior period basic and diluted earnings (loss) per share
information pursuant to the method prescribed by SOP 93-6, which requires the
exclusion of unallocated ESOP shares from the determination of the
weighted-average number of shares outstanding. The effect of this change was
the exclusion of the following number of shares from the weighted-average
number of shares outstanding used to calculate earnings per share: 2.7 million
shares for 2003, 3.1 million shares for 2002 and 3.4 million shares for 2001.  2.
    
    Accounts and notes receivable: (Dollars in millions)2003
    
    2002Trade
    
    $
    326
    
    
    $
    312Federal tax receivable
    
    
    35
    
    
    
    35Insurance receivable
    
    
    7
    
    
    
    9Other
    
    
    52
    
    
    
    51Total
    
    
    420
    
    
    
    407Less allowance for doubtful accounts
    
    
    5
    
    
    
    12$
    415
    
    
    $
    395
  3.
    
    Inventories The components of inventories are: (Dollars in millions)2003
    
    2002Finished products
    
    $
    100
    
    
    $
    87Raw materials and work-in-process
    
    
    65
    
    
    
    59Supplies
    
    
    22
    
    
    
    21$
    187
    
    
    $
    167
 Inventories valued on the LIFO method were lower than if valued under the
average-cost method, which approximates current cost, by $21 million and $20
million at December 31, 2003 and 2002, respectively. The average-cost value of
inventories subject to LIFO was $52 and $46 million at December 31, 2003 and
2002, respectively.  4.
    
    Goodwill and Other Intangible Assets Effective January 1, 2002, the Company adopted SFAS 142. Under SFAS 142,
goodwill and intangible assets with indefinite useful lives are not amortized
but instead are reviewed for impairment at least annually and written down only
in periods in which it is determined that the fair value is less than the
recorded value. SFAS 142 also requires the impairment review to be performed
on a reporting unit basis. The Company identified the following reporting
units: BetzDearborn, Pulp and Paper, Aqualon, FiberVisions and Pinova (formerly
Rosin and Terpenes). In connection with the Companys transitional review,
recorded goodwill was determined to be impaired in the BetzDearborn and the
FiberVisions reporting units. In the first quarter of 2002, the Company
completed its transitional impairment review of identified reporting units and
recognized after-tax impairment losses of $262 million in the BetzDearborn
reporting unit and $87 million in the FiberVisions reporting unit as a
cumulative effect of a change in accounting principle. 27




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements The impairment charges recognized in the BetzDearborn and FiberVisions
reporting units were primarily the result of new and stronger competitors and
newer technology, which created significant price erosion and competition. In
addition, the BetzDearborn reporting unit was negatively impacted by a failure
to achieve integration synergies. SFAS 142 requires the Company to compare a
reporting units book value of net assets, including goodwill, to its fair
value. In the case of the BetzDearborn reporting unit, fair value was
determined primarily by reference to the negotiated selling price. With
respect to the Company s other reporting units, fair value was estimated using
a combination of valuation approaches including the market value and income
approaches. In the event that the book value exceeds the fair value, the
Company is required to perform a second step to measure the amount of the
impairment loss. In the second step, the Company determined the implied value
of goodwill by determining the fair value of the assets and liabilities of the
BetzDearborn and FiberVisions reporting units. To the extent that the book
value of the goodwill exceeded the implied fair value of goodwill for each
reporting unit, impairment existed and was recognized. In addition, an after-tax impairment loss of $19 million was recognized in
the first quarter of 2002 relating to the Companys equity investment in CP
Kelco, which had an impairment under SFAS 142. After recognition of this
impairment, the carrying value for the Companys investment in CP Kelco was
zero. The following table reflects the effect of the adoption of SFAS 142 on net
income (loss) and net earnings (loss) per share as if SFAS 142 had been in
effect for the periods presented. (Dollars in millions, except per share)Year Ended December 312003
    
    2002
    
    2001Net income (loss) before cumulative effect of changes in accounting
principle:As reported
    
    $
    78
    
    
    $
    (243
    )
    
    $
    (53
    )Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    50Adjusted net income (loss) before cumulative effect of changes in accounting
principle:
    
    $
    78
    
    
    $
    (243
    )
    
    $
    (3
    )Basic and diluted net earnings (loss) per share before cumulative effect of
changes in accounting principle:As reported
    
    $
    0.73
    
    
    $
    (2.29
    )
    
    $
    (0.51
    )Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    0.48Adjusted basic and diluted earnings (loss) per share before cumulative
effect of changes in accounting principle
    
    $
    0.73
    
    
    $
    (2.29
    )
    
    $
    (0.03
    )Net income (loss):As reported
    
    $
    45
    
    
    $
    (611
    )
    
    $
    (53
    )Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    50Adjusted net income (loss)
    
    $
    45
    
    
    $
    (611
    )
    
    $
    (3
    )Basic and diluted net earnings (loss) per share:As reported
    
    $
    0.42
    
    
    $
    (5.76
    )
    
    $
    (0.51
    )Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    0.48Adjusted basic and diluted earnings (loss) per share
    
    $
    0.42
    
    
    $
    (5.76
    )
    
    $
    (0.03
    )
 28




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Hercules Incorporated
Notes to Consolidated Financial Statements Accumulated amortization for goodwill upon adoption of SFAS 142 was $185
million. The following table shows changes in the carrying amount of goodwill
for the years ended December 31, 2002 and 2003, by operating segment: (Dollars in millions)EngineeredPerformance
    
    MaterialsProducts
    
    & Additives
    
    TotalBalance at January 1, 2002
    
    $
    1,725
    
    
    $
    172
    
    
    $
    1,897Discontinued operationsBetzDearborn
    
    
    (923
    )
    
    
    
    
    
    
    (923
    )Total discontinued operations
    
    
    (923
    )
    
    
    
    
    
    
    (923
    )Impairment lossesBetzDearborn, discontinued operations
    
    
    (179
    )
    
    
    
    
    
    
    (179
    )BetzDearborn, cumulative effect
    
    
    (267
    )
    
    
    
    
    
    
    (267
    )FiberVisions, cumulative effect
    
    
    
    
    
    
    (87
    )
    
    
    (87
    )Total impairment losses
    
    
    (446
    )
    
    
    (87
    )
    
    
    (533
    )Foreign currency translation
    
    
    27
    
    
    
    
    
    
    
    27Balance at December 31, 2002
    
    
    383
    
    
    
    85
    
    
    
    468Foreign currency translation
    
    
    50
    
    
    
    
    
    
    
    50Balance at December 31, 2003
    
    $
    433
    
    
    $
    85
    
    
    $
    18
 The following table provides information regarding the Companys other
intangible assets with finite lives: Customer
    
    Trademarks &
    
    OtherRelationships
    
    Tradenames
    
    Intangibles
    
    TotalGross Carrying AmountBalance, December 31, 2002
    
    $
    89
    
    
    $
    72
    
    
    $
    94
    
    
    $
    255Balance, December 31, 2003
    
    
    89
    
    
    
    72
    
    
    
    91
    
    
    
    252Accumulated AmortizationBalance, December 31, 2002
    
    $
    9
    
    
    $
    8
    
    
    $
    40
    
    
    $
    57Balance, December 31, 2003
    
    
    12
    
    
    
    9
    
    
    
    44
    
    
    
    65
 Total amortization expense for other intangible assets for the years ended
December 31, 2003, 2002 and 2001 was $8 million, $11 million and $26 million,
respectively, of which $8 million in 2003 and $9 million in 2002 and 2001,
respectively, was included in income from continuing operations. Total
goodwill amortization expense for the year ended December 31, 2001 was $50
million, of which $15 million was included in income from continuing
operations. Estimated amortization expense is $8 million for 2004 and $7
million per year for 2005 through 2008. 29




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements 5. Short-term Debt A summary of short-term debt follows: (Dollars in millions)2003
    
    2002Banks
    
    $
    
    
    
    $
    1Current maturities of long-term debt
    
    
    22
    
    
    
    144$
    22
    
    
    $
    145
 Bank borrowings represent primarily foreign overdraft facilities and
short-term lines of credit, which are generally payable on demand with interest
at various rates. Book values of bank borrowings approximate market value
because of their short maturity period. At December 31, 2003, Hercules had $17
million of unused short-term lines of credit that may be drawn as needed, with
interest at a negotiated spread over lenders cost of funds. The
weighted-average interest rate on short-term borrowings at December 31, 2002
was 2.67%. 6. Long-term Debt A summary of long-term debt follows: (Dollars in millions)2003
    
    20026.60% notes due 2027 (a)
    
    $
    100
    
    
    $
    1006.625% notes due 2003 (b)
    
    
    
    
    
    
    12511.125% senior notes due 2007 (c)
    
    
    376
    
    
    
    4008% convertible subordinated debentures due 2010 (d)
    
    
    3
    
    
    
    3Term notes at various rates from 4.07% to 8.56% due in varying
amounts through 2006 (e)
    
    
    42
    
    
    
    50Term B loan due 2007 (f)
    
    
    198
    
    
    
    2009.42% junior subordinated deferrable interest debentures due 2029 (g)
    
    
    363
    
    
    
    6.5% junior subordinated deferrable interest debentures due 2029 (g)
    
    
    262
    
    
    
    Other
    
    
    4
    
    
    
    4$
    1,348
    
    
    $
    882Current maturities of long-term debt
    
    
    (22
    )
    
    
    (144
    )Net long-term debt
    
    $
    1,326
    
    
    $
    738
   (a)
    
    30-year debentures with a 10-year put option, exercisable by
bondholder at a redemption price equal to principal amount.(b)
    
    Par value of $125 million issued June 1993. In conjunction with the
execution of the credit agreement on December 20, 2002 (see (f) below),
$125 million of the proceeds of the term B loan were placed into an
escrow account and used to pay the principal amount upon maturity in
June 2003.(c)
    
    The senior notes accrue interest at 11 1/8% per annum, payable
semi-annually. The senior notes are guaranteed by each of Hercules
current and future wholly-owned domestic restricted subsidiaries. The
senior notes are not redeemable at Hercules option prior to maturity.
The Company is not required to make mandatory redemption or sinking fund
payments with respect to the senior notes. If a change of control
occurs, each holder of the notes will have the right to require Hercules
to repurchase all or any part of that Holders notes pursuant to a
change of control offer on the terms set forth in the indenture. In the
change of control offer, Hercules will offer a change of control payment
in cash equal to 101% of the aggregate principal amount of the notes
repurchased plus accrued and unpaid interest and liquidated damages, if
any, on the notes repurchased, to the date of purchase. The notes were
subject to a registration rights agreement that required Hercules to
file a Registration Statement on Form S-4 with the Securities and
Exchange Commission, pursuant to which the Company offered to exchange
all of its $400 million aggregate principal amount of 11 1/8% senior
notes due 2007 (old notes) for $400 million aggregate principal amount
of 11 1/8% senior notes due 2007 (new notes). The form and terms of
the new notes are the same as the form and terms of the old notes except
that, because the issuance of the new notes was registered under the
Securities Act, the new notes do not bear legends restricting their
transfer and are not entitled to certain registration rights. The new
notes evidence the same debt as the old notes and the new notes and the
old notes are governed by the same indenture. Hercules did not receive
any proceeds from the exchange offer. 30




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements The Company has the right to use available cash to repurchase, repay or
otherwise redeem senior notes in an aggregate amount not to exceed $100
million in any fiscal year, subject to certain restrictions based on the
Companys leverage ratio. During the fourth quarter ended December 31,
2003, the Company repurchased notes with a book value of $24 million for
$29 million, recognizing a loss of $5 million. Subsequently, in 2004, an
additional $33 million (book value) of the notes have been repurchased by
the Company at a cost of $40 million.(d)
    
    The convertible subordinated debentures are convertible into common
stock at $14.90 per share and are redeemable at the option of the
Company at varying rates. The annual sinking fund requirement of $5
million, beginning in 1996, has been satisfied through conversions of
debentures.(e)
    
    Debt assumed in conjunction with the acquisition of FiberVisions
L.L.C., net of repayments through December 31, 2003 and 2002.(f)
    
    On December 20, 2002, the Company completed a refinancing of its then
existing senior credit facility with a new senior credit facility (the
Senior Credit Facility). The Senior Credit Facility consists of a
four-year $125 million revolving credit agreement and a $200 million
term B loan due May 2007. In addition, the Company has the option of
borrowing an additional $50 million to $150 million on terms identical
to the term B loan. The incremental term loan will remain available
until the earlier of December 20, 2005 or the repayment of the $200
million term B loan. In conjunction with the execution of the credit
agreement, $125 million of the proceeds of the term B loan was placed
into an escrow account to pay the principal amount of the 6.625% notes
in June 2003 and was recognized as restricted cash on the Consolidated
Balance Sheet. The 6.625% notes were paid in June 2003 with the
proceeds held in the escrow account. Effective December 17, 2003, the
Senior Credit Facility was amended, reducing the term B loan interest
rate to LIBOR + 2.50% (4.02% at December 31, 2003) from LIBOR + 3.25%
and adding strategic foreign subsidiaries of the Company as approved
borrowers. The revolving credit agreement bears interest at LIBOR plus
an applicable margin, currently 2.75%, which is determinable based on
the Companys leverage ratio. Interest rates are reset for one, two,
three or six month periods at the Companys option. The Senior Credit
Facility is secured by liens on the Companys U.S. assets (including
real, personal and intellectual properties) and is guaranteed by
substantially all of the Companys current and future wholly-owned
domestic subsidiaries.As of December 31, 2003, $49 million of the $125 million revolver was
available for use. The Company had outstanding letters of credit
associated with the credit facility of $76 million at December 31, 2003.The Companys Senior Credit Facility requires quarterly compliance with
certain financial covenants, including a debt/EBITDA ratio (leverage
ratio) and an interest coverage ratio and establishes limitations on the
permitted amount of annual capital expenditures.(g)
    
    In March 1999, Hercules Trust I (Trust I), a subsidiary trust,
completed a $362 million underwritten public offering of 14,500,000
9.42% Trust Originated Preferred Securities (TOPrS). Trust I invested
the proceeds from the sale of the preferred securities and the related
common securities in an equal principal amount of 9.42% Junior
Subordinated Deferrable Interest Debentures of Hercules due March 2029.
The Company used these proceeds to repay long-term debt. Trust I
distributes quarterly cash payments it receives from the Company as
interest on the debentures to preferred security holders at an annual
rate of 9.42% on the liquidation amount of $25 per preferred security.
The Company may defer interest payments on the debentures at any time,
for up to 20 consecutive quarters. If this occurs, Trust I will also
defer distribution payments on the preferred securities. The deferred
distributions, however, will accumulate distributions at a rate of 9.42%
per annum. Trust I will redeem the preferred securities when the
debentures are repaid, or at maturity on March 31, 2029. The Company
may redeem the debentures, in whole or, on or after March 17, 2004, in
part, before their maturity at a price equal to 100% of the principal
amount of the debentures redeemed, plus accrued interest. When the
Company redeems any Debentures before their maturity, Trust I will use
the cash it receives to redeem preferred securities and common
securities as provided in the trust agreement. The Company guarantees
the obligations of Trust I on the preferred securities. In July 1999, the Company and Hercules Trust II (Trust II), a subsidiary
trust, completed a $350 million underwritten public offering of 350,000
CRESTS Units. Each CRESTS Unit consists of one preferred security of
Trust II and one warrant to purchase 23.4192 shares of the Companys
common stock at an initial exercise price of $1,000 (equivalent to $42.70
per share). The preferred security component of the CRESTS Units was
initially valued at $741.46 per unit and the warrant component of the
CRESTS Units was initially valued at $258.54 per warrant. The preferred
security and warrant components of each CRESTS Unit may be separated and
transferred independently. The warrants may be exercised, subject to
certain conditions, at any time before March 31, 2029, unless there is a
reset and remarketing event. No reset and remarketing event will occur
before July 27, 2004, unless all of the Companys common stock is acquired
in a transaction that includes cash for a price above a predetermined
level. Trust II used the proceeds from the sale of its preferred
securities to purchase junior 31




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements subordinated deferrable interest debentures of Hercules. The Company pays
interest on the debentures, and Trust II pays distributions on its
preferred securities quarterly at an annual rate of 61/2% of the
scheduled liquidation amount of $1,000 per debenture and/or preferred
security until the scheduled maturity date and redemption date of June 30,
2029, unless there is a reset and remarketing event. The Company
guarantees the obligations of Trust II on the preferred securities. Trust
II must redeem the preferred securities when the debentures are redeemed
or repaid at maturity. As of December 31, 2003, no warrants had been
exercised. The Company used the proceeds from the CRESTS Units offering
to repay long-term debt. Issuance costs related to the preferred security
component of the CRESTS Units are being amortized over the life of the
security and costs related to the warrants were charged to additional
paid-in capital. In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150
requires certain financial instruments with both debt and equity
characteristics to be classified as debt. The statement requires initial
and subsequent valuation of this debt at a present or fair market value
and was effective July 1, 2003. In accordance with SFAS 150, the TOPrS and CRESTS Units constitute
mandatorily redeemable financial instruments. The Company guarantees the
obligations of Hercules Trust I and Hercules Trust II (the Trusts) on
the preferred securities. Upon adoption of SFAS 150 on July 1, 2003, the
company-obligated preferred securities of subsidiary trusts have been
reclassified prospectively from the mezzanine section to the long-term
liabilities section of the Consolidated Balance Sheet. Items previously
shown separately on the Consolidated Statement of Operations as preferred
security distributions of subsidiary trusts are combined with interest and
debt expense in the current period in accordance with the requirements of
SFAS 150. During the fourth quarter of 2003, the Company purchased 46,000 of the
CRESTS Units for a total of $34 million, of which $27 million was
attributed to the preferred security component and $7 million was
attributed to the warrants. The corresponding book value of a similar
number of the CRESTS Units junior subordinated deferrable interest
debentures was $34 million. Accordingly, the Company recognized a gain of
$7 million ($5 million after-tax) in continuing operations. However, the
Company has determined that (i) the Trusts are variable interest entities
and (ii) the Company is not the primary beneficiary of the Trusts.
Accordingly, the Company has de-consolidated the Trusts and recognized an
after-tax loss of $5 million as a cumulative effect of a change in
accounting principle to defer the above noted gain, effective December 31,
2003, in accordance with the provisions of FASB Interpretation No. 46
(revised December 2003), Consolidation of Variable Interest Entities
(FIN 46R). As a result of the de-consolidation, long-term debt reflects
the Companys obligation to the Trusts for the CRESTS Units junior
subordinated deferrable interest debentures and TOPrS junior subordinated
deferrable interest debentures. The indenture for the CRESTS Units junior
subordinated deferrable interest debentures does not provide the ability
for the Company to repay, redeem or defease the CRESTS Units junior
subordinated deferrable interest debentures through purchasing the CRESTS
Units. Accordingly, at December 31, 2003 the outstanding balance of
CRESTS Units junior subordinated deferrable interest debentures has not
changed as a result of the Companys purchase of the CRESTS Units. The
$27 million paid to purchase the CRESTS Units preferred security component
is reflected as an increase in the Companys investment in Hercules Trust
II, with the corresponding gain on the purchase deferred until Hercules
Trust II has been liquidated. The $7 million paid and attributable to the
warrants has been recorded as a reduction in additional paid-in-capital. Long-term debt maturities are $22 million in 2004, $19 million in 2005, $7
million in 2006, $568 million in 2007, $0 million in 2008 and $732 million
thereafter. 7. Consolidation of Variable Interest Entities In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
46), which is an interpretation of Accounting Research Bulletin No. 51,
Consolidated Financial Statements (ARB 51). FIN 46 addresses the
application of ARB 51 to variable interest entities (VIEs), and generally
requires that assets, liabilities and results of the activity of a VIE be
consolidated into the financial statements of the enterprise that is considered
the primary beneficiary. The provisions of FIN 46 apply on a prospective basis
to VIEs created after January 31, 2003 and were to become effective after June
30, 2003 for VIEs that existed prior to January 31, 2003. On October 8, 2003,
the FASB deferred the effective date for VIEs that existed prior to January 31,
2003. FASB Staff Position FIN 46-6 (FSP FIN 46-6) established the first
interim or annual period ending after December 15, 2003 as the new effective
date for VIEs that existed prior to January 31, 2003. However, FSP FIN 46-6
permitted early and partial adoption of FIN 46. On December 24, 2003, the FASB
issued FASB Interpretation No. 46 (revised December 2003), Consolidation of
Variable Interest Entries (FIN 46R). The Company elected to partially adopt
FIN 46 in the quarter ending September 30, 2003 for its VIEs that existed prior
to January 31, 2003 (the Company has no VIEs created subsequent to January 31,
2003). The financial statements for the year ended December 31, 2003 32




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements reflect the consolidation of two joint venture VIEs, ES FiberVisions
Holdings A/S and ES FiberVisions L.P., that were previously accounted for using
the equity method of accounting. These entities serve as strategic global
marketers of the Companys bicomponent fibers. As of December 31, 2003, the
fair value of the assets in these joint ventures was approximately $7 million
and the fair values of the associated liabilities and non-controlling interests
were approximately $6 million. There are no assets of the Company that serve
as collateral for the VIEs and the creditors of the VIEs have no recourse to
the general credit of the Company. 8. Income Taxes (Restated) The domestic and foreign components of income (loss) before income taxes
and equity income (loss) from continuing operations are: (Dollars in millions)2003
    
    2002
    
    2001Domestic
    
    $
    (69
    )
    
    $
    (209
    )
    
    $
    (149
    )Foreign
    
    
    164
    
    
    
    157
    
    
    
    63Income (loss) before income taxes and equity income (loss)
    
    $
    95
    
    
    $
    (52
    )
    
    $
    (86
    )
 The components of the tax provision from continuing operations are: (Dollars in millions)2003
    
    2002
    
    2001Currently payable
U.S. federal
    
    $
    (28
    )
    
    $
    (39
    )
    
    $
    24Foreign
    
    
    40
    
    
    
    17
    
    
    
    32State
    
    
    1
    
    
    
    2
    
    
    
    22DeferredDomestic
    
    
    11
    
    
    
    9
    
    
    
    (55
    )Foreign
    
    
    (3
    )
    
    
    8
    
    
    
    (9
    )Provision (benefit) for income taxes
    
    $
    21
    
    
    $
    (3
    )
    
    $
    14
 (Dollars in millions)2003
    
    2002As Restated(Note 26)Depreciation
    
    $
    109
    
    
    $
    109Pension
    
    
    9
    
    
    
    6Investments
    
    
    139
    
    
    
    129Goodwill
    
    
    46
    
    
    
    54Accrued expenses
    
    
    5
    
    
    
    6Other
    
    
    13
    
    
    
    15Gross deferred tax liabilities
    
    $
    321
    
    
    $
    319Postretirement benefits other than pensions
    
    $
    (58
    )
    
    $
    (60
    )Pension
    
    
    (80
    )
    
    
    (96
    )Inventory
    
    
    (8
    )
    
    
    (6
    )Goodwill
    
    
    (8
    )
    
    
    (8
    )Accrued expenses
    
    
    (164
    )
    
    
    (152
    )Loss carryforwards
    
    
    (373
    )
    
    
    (289
    )Credit carryforwards
    
    
    (20
    )
    
    
    Other
    
    
    (23
    )
    
    
    (8
    )Gross deferred tax assets
    
    
    (734
    )
    
    
    (619
    )Valuation allowance
    
    
    362
    
    
    
    308Net deferred tax (assets) liabilities
    
    $
    (51
    )
    
    $
    8
 The increase in the loss carryforwards and the related valuation allowance
at December 31, 2003 from December 31, 2002 is attributable to the finalization
of the taxable nature of the BetzDearborn divestiture and the overall
components of the capital loss. In calculating the final tax effect and the
related capital loss and valuation allowance, the Company further analyzed the
character of the transaction and reflected the results in its deferred tax
analysis. In addition, the valuation allowance was increased for net operating
losses generated in Belgium and Sweden and offset by a decrease in the
valuation allowance for France. 33




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements The provision for income taxes attributable to discontinued operations and
cumulative effect of changes in accounting principle is: (Dollars in millions)2003
    
    2002
    
    2001Provision on income from discontinued operations
    
    $
    2
    
    
    $
    21
    
    
    $
    60Provision on loss on disposal of discontinued operations
    
    
    
    
    
    
    51
    
    
    
    Cumulative effect of changes in accounting principle
    
    
    18
    
    
    
    (4
    )
    
    
    
 The reconciliation of the U.S. statutory income tax rate to the effective
rate from continuing operations is: 2003
    
    2002
    
    2001U.S. statutory income tax rate
    
    
    35
    %
    
    
    35
    %
    
    
    35
    %Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    (11
    )Valuation allowances
    
    
    (3
    )
    
    
    (2
    )
    
    
    (11
    )Tax rate differences on subsidiary earnings
    
    
    (9
    )
    
    
    8
    
    
    
    13U.S. tax on foreign dividends and undistributed earnings
    
    
    8
    
    
    
    (4
    )
    
    
    (6
    )State taxes
    
    
    1
    
    
    
    (4
    )
    
    
    (4
    )Reserves
    
    
    
    
    
    
    (20
    )
    
    
    (37
    )Intellectual property
    
    
    (9
    )
    
    
    
    
    
    
    Other
    
    
    (1
    )
    
    
    (7
    )
    
    
    5Effective tax rate
    
    
    22
    %
    
    
    6
    %
    
    
    (16
    %)
 Loss carryforwards include both net operating loss carryforwards and
capital loss carryforwards. At December 31, 2003, the tax effect of such
carryforwards approximated $373 million. Of this amount, $285 million are
domestic capital loss carryforwards that expire in 2007 for which full
valuation allowances have been established. The 2003 federal net operating
loss carryforwards approximate $29 million, for which no valuation allowance
has been established. State net operating loss carryforwards approximate $44
million, with expiration dates ranging from 2004 to 2017, for which full
valuation allowances have been established. Foreign net operating loss
carryforwards approximate $15 million and are offset by valuation allowances of
$6 million. Some of these foreign net operating loss carryforwards expire as
early as 2004 and others have expiration dates that are indefinite in nature.
The tax effect of credit carryforwards approximated $20 million at December 31,
2003, with expiration dates ranging from 2006 to 2008, for which no valuation
allowances have been established. The Company provides taxes on undistributed earnings of subsidiaries and
affiliates to the extent such earnings are planned to be remitted and not
permanently reinvested. The undistributed earnings of subsidiaries and
affiliates on which no provision for foreign withholding or U.S. income taxes
has been made amounted to approximately $195 million and $158 million at
December 31, 2003 and 2002, respectively. U.S. and foreign income taxes that
would be payable if such earnings were distributed may be lower than the amount
computed at the U.S. statutory rate because of the availability of tax credits. 9. Pension and Other Postretirement Benefits The Company provides defined benefit pension plans and postretirement
benefit plans to most U.S. employees and some foreign employees. Generally,
the plans provide benefits based on years of service and final average salary,
typically based on the last three to five years of employment. Assets of the defined benefit plans are invested in domestic and
international corporate equity securities; domestic and international fixed
income securities and various derivative and money market securities. The
assets of the U.S., the United Kingdom (U.K.) and the Netherlands defined
benefit plans constitute approximately 84%, 4% and 11%, respectively, of the
total defined benefit plan assets at December 31, 2003 for plans sponsored by
the Company. The projected benefit obligations of the U.S., the U.K., and the
Netherlands defined benefit plans constitute approximately 83%, 4% and 9%,
respectively, of the total projected benefit obligations at December 31, 2003
for plans sponsored by the Company. The Company also has an unfunded defined
benefit pension plan in Germany, with a projected benefit obligation of $35
million at December 31, 2003. The Company uses a measurement date of December 31 for all material
defined benefit pension and other postretirement benefit plans. 34




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements The following table sets forth the changes in projected benefit
obligations, plan assets, the funded status of the plans and the amounts
recognized in the consolidated financial statements for the defined benefit
pension and other postretirement benefit plans. (Dollars in millions)Pension Benefits
    
    Other Postretirement Benefits2003
    
    2002
    
    2003
    
    2002Change in benefit obligation:Projected benefit obligation at January 1
    
    $
    1,528
    
    
    $
    1,495
    
    
    $
    208
    
    
    $
    230Service cost
    
    
    18
    
    
    
    18
    
    
    
    1
    
    
    
    1Interest cost
    
    
    99
    
    
    
    99
    
    
    
    13
    
    
    
    15Prior service cost/plan amendments
    
    
    
    
    
    
    1
    
    
    
    (11
    )
    
    
    (26
    )Divestitures
    
    
    
    
    
    
    (92
    )
    
    
    
    
    
    
    Transition obligation amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )Foreign currency translation
    
    
    39
    
    
    
    28
    
    
    
    
    
    
    
    Actuarial loss
    
    
    132
    
    
    
    77
    
    
    
    16
    
    
    
    17Special benefits
    
    
    5
    
    
    
    4
    
    
    
    
    
    
    
    Benefits paid from plan assets
    
    
    (110
    )
    
    
    (97
    )
    
    
    
    
    
    
    Benefits paid from Company assets
    
    
    (9
    )
    
    
    (5
    )
    
    
    (21
    )
    
    
    (23
    )Projected benefit obligation at December 31
    
    $
    1,702
    
    
    $
    1,528
    
    
    $
    206
    
    
    $
    209Change in plan assets:Fair value of plan assets at January 1
    
    $
    1,139
    
    
    $
    1,286
    
    
    $
    1
    
    
    $
    1Actual return on plan assets
    
    
    218
    
    
    
    (112
    )
    
    
    
    
    
    
    Divestitures
    
    
    
    
    
    
    (52
    )
    
    
    
    
    
    
    Company contributions
    
    
    55
    
    
    
    92
    
    
    
    
    
    
    
    Participant contributions
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    Foreign currency translation
    
    
    30
    
    
    
    21
    
    
    
    
    
    
    
    Benefits paid from plan assets
    
    
    (110
    )
    
    
    (97
    )
    
    
    (1
    )
    
    
    Fair value of plan assets at December 31
    
    $
    1,333
    
    
    $
    1,139
    
    
    $
    
    
    
    $
    1Funded status of the plan:
    
    $
    (369
    )
    
    $
    (389
    )
    
    $
    (206
    )
    
    $
    (208
    )Unrecognized actuarial loss
    
    
    677
    
    
    
    660
    
    
    
    125
    
    
    
    120Unrecognized prior service cost (benefit)
    
    
    26
    
    
    
    29
    
    
    
    (39
    )
    
    
    (39
    )Unrecognized net transition obligation
    
    
    
    
    
    
    1
    
    
    
    1
    
    
    
    1Net amount recognized
    
    $
    334
    
    
    $
    301
    
    
    $
    (119
    )
    
    $
    (126
    )
 (Dollars in millions)Pension Benefits
    
    Other Postretirement Benefits2003
    
    2002
    
    2003
    
    2002Amounts recognized in the Statement of
Financial Position consist of:Prepaid benefit cost
    
    $
    402
    
    
    $
    362
    
    
    $
    
    
    
    $
    Accrued benefit liability
    
    
    (70
    )
    
    
    (61
    )
    
    
    (119
    )
    
    
    (126
    )Additional minimum liability
    
    
    (554
    )
    
    
    (579
    )
    
    
    
    
    
    
    Intangible asset
    
    
    23
    
    
    
    26
    
    
    
    
    
    
    
    Accumulated other comprehensive income (pre-tax)
    
    
    533
    
    
    
    553
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    334
    
    
    $
    301
    
    
    $
    (119
    )
    
    $
    (126
    )
 Weighted-average assumptions used to determine the benefit obligation at December 31, 2003 and 2002 were:Weighted-average discount rate
    
    
    5.98
    %
    
    
    6.55
    %
    
    
    6.10
    %
    
    
    6.75
    %Rate of compensation increase
    
    
    4.22
    %
    
    
    4.32
    %
    
    
    4.49
    %
    
    
    4.50
    %
 35




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements (Dollars in millions)Pension Benefits
    
    Other Postretirement BenefitsNet periodic benefit cost (credit):
    
    2003
    
    2002
    
    2001
    
    2003
    
    2002
    
    2001Service cost
    
    $
    18
    
    
    $
    18
    
    
    $
    26
    
    
    $
    1
    
    
    $
    1
    
    
    $
    1Interest cost
    
    
    99
    
    
    
    99
    
    
    
    105
    
    
    
    13
    
    
    
    15
    
    
    
    15Expected return on plan assets
    
    
    (113
    )
    
    
    (126
    )
    
    
    (141
    )
    
    
    
    
    
    
    (1
    )
    
    
    Amortization and deferrals
    
    
    4
    
    
    
    6
    
    
    
    5
    
    
    
    (8
    )
    
    
    (5
    )
    
    
    (1
    )Participant contributions
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Special benefits/terminations
    
    
    5
    
    
    
    8
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    Actuarial losses recognized
    
    
    21
    
    
    
    2
    
    
    
    
    
    
    
    7
    
    
    
    5
    
    
    
    Amortization of transition asset
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    Benefit cost (credit)
    
    $
    33
    
    
    $
    6
    
    
    $
    (1
    )
    
    $
    13
    
    
    $
    15
    
    
    $
    15
 2003
    
    2002
    
    2001
    
    2003
    
    2002
    
    2001Weighted-average assumptions used to
determine net periodic benefit cost
(credit):Weighted-average discount rate
    
    
    6.53
    %
    
    
    6.98
    %
    
    
    7.19
    %
    
    
    6.75
    %
    
    
    7.25
    %
    
    
    7.50
    %Expected return on plan assets
    
    
    8.09
    %
    
    
    8.60
    %
    
    
    8.58
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/ARate of compensation increase
    
    
    4.25
    %
    
    
    4.29
    %
    
    
    4.26
    %
    
    
    4.49
    %
    
    
    4.50
    %
    
    
    4.50
    %
 In 2003, the Company made contributions to its defined benefit plans
totaling $55 million, some of which was required by local funding requirements.
The Company presently anticipates making voluntary cash contributions to the
U.S. defined benefit plan of approximately $40 million per year over the next
few years, including $40 million contributed in January 2004. Additionally,
the Company anticipates contributing approximately $5 million to its foreign
defined benefit plans in 2004. At December 31, 2003 the accumulated benefit obligation (ABO) of the
defined benefit pension plans on a consolidated basis was $1,585 million, of
which $1,325 million related to the U.S.; $67 million related to the U.K.; $141
million related to the Netherlands; and $32 million related to Germany. At
December 31, 2003 and 2002, the ABO of the U.S., the U.K. and German defined
benefit pension plans exceeded their funded benefits. The Company is required
to recognize an additional liability equal to the sum of such excess plus the
prepaid pension asset balance, with a corresponding after-tax charge to other
comprehensive income in stockholders equity. At December 31, 2002, the
Company recorded an additional minimum liability (AML) of $579 million
(pre-tax) with an after-tax charge to other comprehensive income of $354
million. At December 31, 2003, the AML decreased $25 million to $554 million
(pre-tax) and accordingly, the charge to accumulated other comprehensive income
was decreased by $15 million. As of December 31, 2003, the Consolidated
Balance Sheet reflects a non-cash, after-tax charge to other comprehensive
income of $339 million. The fair value of plan assets for the Netherlands plan
slightly exceeded the ABO at December 31, 2003. Other Postretirement Benefits The non-pension postretirement benefit plans include group life insurance
coverage and health care reimbursement for U.S. and Canadian employees. The
projected benefit obligation of the U.S. other postretirement benefit plan
constitutes approximately 99% of the Companys consolidated projected benefit
obligation at December 31, 2003. The assumed 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
contributions adjusted annually; the life insurance plans are non-contributory
for most retirees. The accounting for the health care plans anticipates future
cost-sharing changes to the written plans that are consistent with the increase
in health care cost. The postretirement health care plans include a limit on
the Companys share of costs for recent and future retirees. Participants
contributions are immediately used to cover claim payments, and for this reason
do not appear as contributions to plan assets. Employees hired after December
31, 2002 are not eligible for retiree life insurance or benefits supplemental
to Medicare health care. The Company periodically obtains reimbursement for
union retiree claims from a Voluntary Employees Beneficiary Association Trust
established by the Company, while other claims are paid from Company assets. The accumulated postretirement benefit obligation exceeds plan assets for
all of the Companys other postretirement benefit plans. U. S. Pension and Postretirement Benefit Plans The Company provides both funded and unfunded non-contributory defined
benefit pension plans to substantially all of its U.S. employees. Employees
hired after December 31, 2002 are not eligible for retiree life insurance or
benefits supplemental to Medicare health care. The defined benefit pension
plan provides benefits based on years of service and final average salary. 36




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements The following tables present benefit obligations, plan assets and related
information for the defined benefit pension and postretirement benefit plans as
of December 31, 2003 and 2002. (Dollars in millions)Pension Benefits
    
    Other Postretirement Benefits2003
    
    2002
    
    2003
    
    2002Change in benefit obligation:Projected benefit obligation at January 1
    
    $
    1,309
    
    
    $
    1,243
    
    
    $
    207
    
    
    $
    228Service cost
    
    
    12
    
    
    
    13
    
    
    
    1
    
    
    
    1Interest cost
    
    
    86
    
    
    
    88
    
    
    
    13
    
    
    
    14Prior service cost/plan amendments
    
    
    
    
    
    
    1
    
    
    
    (12
    )
    
    
    (26
    )Divestitures
    
    
    
    
    
    
    (30
    )
    
    
    
    
    
    
    Transition obligation amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )Actuarial loss
    
    
    115
    
    
    
    80
    
    
    
    16
    
    
    
    17Special benefits
    
    
    5
    
    
    
    8
    
    
    
    
    
    
    
    Benefits paid from plan assets
    
    
    (98
    )
    
    
    (89
    )
    
    
    
    
    
    
    Benefits paid from Company assets
    
    
    (8
    )
    
    
    (5
    )
    
    
    (21
    )
    
    
    (23
    )Projected benefit obligation at December 31
    
    $
    1,421
    
    
    $
    1,309
    
    
    $
    204
    
    
    $
    207
 The accumulated benefit obligations for the U.S. defined benefit pension
plans were $1,325 million and $1,227 million at December 31, 2003 and 2002,
respectively. Weighted-average assumptions used to determine the benefit obligations at
December 31, 2003 and 2002 were as follows: Other PostretirementPension Benefits
    
    Benefits2003
    
    2002
    
    2003
    
    2002Weighted-average discount rate
    
    
    6.10
    %
    
    
    6.75
    %
    
    
    6.10
    %
    
    
    6.75
    %Rate of compensation increase
    
    
    4.50
    %
    
    
    4.50
    %
    
    
    4.50
    %
    
    
    4.50
    %
 The assumed health care cost trend rate was 10% for the years ending
December 31, 2003 and 2002 and 7% for the year ending December 31, 2001. The
assumed health care cost trend rate will be 8% in 2004, decreasing to 4.5% by
2007 and for subsequent years. A one-percentage point increase or decrease in
the assumed health care cost trend rate would increase or decrease the
postretirement benefit obligation by approximately $2 million and would not
have a material effect on aggregate service and interest cost components. (Dollars in millions)Pension Benefits
    
    Other Postretirement Benefits2003
    
    2002
    
    2003
    
    2002Change in plan assets:Fair value of plan assets at January 1
    
    $
    966
    
    
    $
    1,098
    
    
    $
    1
    
    
    $
    1Actual return on plan assets
    
    
    207
    
    
    
    (108
    )
    
    
    
    
    
    
    Company contributions
    
    
    40
    
    
    
    65
    
    
    
    
    
    
    
    Benefits paid from plan assets
    
    
    (98
    )
    
    
    (89
    )
    
    
    (1
    )
    
    
    Fair value of plan assets at December 31
    
    $
    1,115
    
    
    $
    966
    
    
    $
    
    
    
    $
    1
 Employer contributions totaled $40 million and $65 million for 2003 and
2002, respectively, and benefits paid from pension plan assets were $98 million
and $89 million in 2003 and 2002, respectively. Benefits paid from Company
assets under the postretirement benefit plans were $21 million and $23 million
in 2003 and 2002, respectively. The asset allocation for the U.S. defined benefit pension plan at December
31, 2003 and 2002 and the target allocation for 2003, by asset category,
follows: Percentage of Plan AssetsTargetAllocation
    
    at December 31,2003
    
    2003
    
    2002Asset category:Equity securities
    
    
    55-70
    %
    
    
    70
    %
    
    
    64
    %Fixed income
    
    
    20-35
    %
    
    
    23
    %
    
    
    36
    %Other
    
    
    5-10
    %
    
    
    7
    %
    
    
    0
    %Totals
    
    
    
    
    
    
    100
    %
    
    
    100
    %
 37




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements Equity securities are invested in both U.S. and non- U.S. (international)
companies. U.S. equity includes the common stock of large, medium, and small
companies that are predominantly U.S. based, including Hercules common stock in
the amounts of $7 million (0.6% of total plan assets) and $5 million (0.5% of
total plan assets) at December 31, 2003 and 2002, respectively. Non-U.S.
equity represents equity securities issued by companies domiciled outside the
U.S. Fixed income securities include U.S. and non-U.S. government obligations,
mortgage-backed securities, collateralized mortgage obligations and corporate
debt obligations. Up to 10% of fixed income assets can be in debt securities
that are below investment grade. Other investments primarily include market
neutral-type hedge funds. Investment managers may employ limited use of
derivatives, including futures contracts, options on futures, and interest rate
swaps in place of direct investment in securities to gain efficient exposure to
markets. The expected long-term rate of return on plan assets was 8.75% in 2003 and
9.25% in 2002. The overall expected long-term rate of return on assets
assumption is a function of the target asset allocation for plan assets, the
long-term equilibrium rate of return for the asset class, plus an incremental
return attributable to the active management of plan assets. The estimated
total return for equity securities is 9.0% annually and assumes a 3% risk
premium over a 6% projected return for fixed income. In developing its investment strategy, the Company considered the
following factors for its pension plans: the nature and relative size of the
liabilities, the allocation of such liabilities between active and retired
members, net cash flows and funded position. The Company also considers the
applicable investment horizon, historical and expected capital market return,
and the benefits of investment diversification. The Company manages the assets with the primary objective of maximizing
the long-term investment return given available market opportunities and
moderate levels of risk consistent with the nature and purpose of the plans.
Plan assets are invested using a combination of active and passive investment
strategies. Active strategies employ multiple investment management firms.
Managers within each asset class cover a range of investment styles and
approaches and are combined in a way that controls market capitalization, style
(growth, value, and core) and interest rate risk versus benchmark indices.
Security selection is the primary means where value is added from active
management. Risk is controlled through diversification among multiple asset
classes, managers, styles, and securities. Risk is further controlled both at
the manager and asset class level by monitoring performance against assigned
return and variability targets. The funded status of the U.S. defined benefit pension and postretirement
benefit plans reconciled to the amount reported in the Consolidated Statements
of Financial Position follows: (Dollars in millions)Pension Benefits
    
    Other Postretirement Benefits2003
    
    2002
    
    2003
    
    2002Fair value of plan assets
    
    $
    1,115
    
    
    $
    966
    
    
    $
    
    
    
    $
    1Projected benefit obligation
    
    
    1,421
    
    
    
    1,309
    
    
    
    204
    
    
    
    207Funded status of the plan
    
    
    (306
    )
    
    
    (343
    )
    
    
    (204
    )
    
    
    (206
    )Unrecognized actuarial loss
    
    
    599
    
    
    
    610
    
    
    
    125
    
    
    
    120Unrecognized prior service cost (benefit)
    
    
    21
    
    
    
    25
    
    
    
    (39
    )
    
    
    (39
    )Net amount recognized
    
    $
    314
    
    
    $
    292
    
    
    $
    (118
    )
    
    $
    (125
    )
 2003
    
    2002
    
    2003
    
    2002Amounts recognized in the Statement of
Financial Position consist of:Prepaid benefit cost
    
    $
    352
    
    
    $
    327
    
    
    $
    
    
    
    $
    Accrued benefit liability
    
    
    (38
    )
    
    
    (35
    )
    
    
    (118
    )
    
    
    (125
    )Additional minimum liability
    
    
    (524
    )
    
    
    (552
    )
    
    
    
    
    
    
    Intangible asset
    
    
    22
    
    
    
    25
    
    
    
    
    
    
    
    Accumulated other comprehensive income (pre-tax)
    
    
    502
    
    
    
    527
    
    
    
    
    
    
    
    Net amount recognized
    
    $
    314
    
    
    $
    292
    
    
    $
    (118
    )
    
    $
    (125
    )
 38




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##### Table of Contents



Hercules IncorporatedNotes to Consolidated Financial Statements At December 31, 2003 and 2002, the pension plan in the U.S. had a
projected benefit obligation in excess of plan assets. The projected benefit
obligation, accumulated benefit obligation and fair value of plan assets for
the pension plan in the U.S. were as follows: (Dollars in millions)Other PostretirementPension Benefits
    
    BenefitsDecember 31,
    
    December 31,2003
    
    2002
    
    2003
    
    2002Projected benefit obligation
    
    $
    1,421
    
    
    $
    1,309
    
    
    $
    204
    
    
    $
    207Accumulated benefit obligation
    
    
    1,325
    
    
    
    1,227
    
    
    
    204
    
    
    
    207Fair value of plan assets
    
    
    1,115
    
    
    
    966
    
    
    
    
    
    
    
    1
 Information about the expected cash flows for the U.S. defined benefit
pension and other postretirement benefit plans follows. (Dollars in millions)Pension Benefits
    
    
    
    
    
    Other Postretirement BenefitsQualified Plan
    
    Non-qualified Plan
    
    TotalExpected employer contributions for 2004
    
    $
    40
    
    
    $
    
    
    
    $
    40
    
    
    $
    Expected benefit payments2004
    
    
    86
    
    
    
    5
    
    
    
    91
    
    
    
    222005
    
    
    84
    
    
    
    5
    
    
    
    89
    
    
    
    222006
    
    
    83
    
    
    
    5
    
    
    
    88
    
    
    
    212007
    
    
    83
    
    
    
    5
    
    
    
    88
    
    
    
    202008
    
    
    83
    
    
    
    5
    
    
    
    88
    
    
    
    192009-2013
    
    
    437
    
    
    
    23
    
    
    
    460
    
    
    
    82
 The above table reflects the total anticipated contributions to be made by
the Company in 2004 and future benefit payments expected to be paid from the
plan or from the Companys assets, including both the Companys share of the
benefit cost and the participants share of the cost, which is funded by
participant contributions to the plan. Benefits expected to be paid in 2004
include $91 million in pension benefits and $22 million in postretirement
benefits, of which $86 million is expected to be paid from plan assets. (Dollars in millions)Pension Benefits
    
    Other Postretirement Benefits2003
    
    2002
    
    2001
    
    2003
    
    2002
    
    2001Net periodic benefit cost (credit):Service cost
    
    $
    12
    
    
    $
    13
    
    
    $
    19
    
    
    $
    1
    
    
    $
    1
    
    
    $
    1Interest cost
    
    
    86
    
    
    
    88
    
    
    
    92
    
    
    
    13
    
    
    
    14
    
    
    
    14Expected return on plan assets
    
    
    (102
    )
    
    
    (117
    )
    
    
    (126
    )
    
    
    
    
    
    
    
    
    
    
    Amortization and deferrals
    
    
    4
    
    
    
    5
    
    
    
    4
    
    
    
    (8
    )
    
    
    (5
    )
    
    
    (5
    )Special benefits/terminations
    
    
    5
    
    
    
    9
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    Actuarial losses recognized
    
    
    20
    
    
    
    1
    
    
    
    1
    
    
    
    7
    
    
    
    5
    
    
    
    4Amortization of transition asset
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    Benefit cost (credit)
    
    $
    25
    
    
    $
    (1
    )
    
    $
    (6
    )
    
    $
    13
    
    
    $
    15
    
    
    $
    14
 2003
    
    2002
    
    2001
    
    2003
    
    2002
    
    2001Weighted-average assumptions used to
determine net periodic benefit
cost (credit):Weighted-average discount rate
    
    
    6.75
    %
    
    
    7.25
    %
    
    
    7.50
    %
    
    
    6.75
    %
    
    
    7.25
    %
    
    
    7.50
    %Expected return on plan assets
    
    
    8.75
    %
    
    
    9.25
    %
    
    
    9.25
    %
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/ARate of compensation increase
    
    
    4.50
    %
    
    
    4.50
    %
    
    
    4.50
    %
    
    
    4.50
    %
    
    
    4.50
    %
    
    
    4.50
    %
 39




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements U.K. Defined Benefit Pension Plan The Company provides a defined benefit pension plan to its employees in
the U.K. The following tables present the benefit obligation, plan assets and
related information for the U.K. defined benefit pension plan as of December
31, 2003 and 2002. (Dollars in millions)Pension BenefitsChange in benefit obligation:
    
    2003
    
    2002Projected benefit obligation at January 1
    
    $
    57
    
    
    $
    93Service cost
    
    
    1
    
    
    
    1Interest cost
    
    
    3
    
    
    
    3Divestitures
    
    
    
    
    
    
    (45
    )Foreign currency translation
    
    
    7
    
    
    
    7Actuarial loss
    
    
    4
    
    
    
    Benefits paid from plan assets
    
    
    (3
    )
    
    
    (2
    )Projected benefit obligation at December 31
    
    $
    69
    
    
    $
    57
 The accumulated benefit obligation for the U.K. plan was $67 million and
$55 million, respectively, at December 31, 2003 and 2002. Weighted-average assumptions used to determine the benefit obligation at
December 31, 2003 and 2002 were as follows: Pension Benefits2003
    
    2002Weighted-average discount rate
    
    
    5.40
    %
    
    
    5.50
    %Rate of compensation increase
    
    
    3.70
    %
    
    
    3.50
    %
 (Dollars in millions)Pension Benefits2003
    
    2002Fair value of plan assets at January 1
    
    $
    45
    
    
    $
    76Actual return on plan assets
    
    
    4
    
    
    
    (8
    )Divestitures
    
    
    
    
    
    
    (37
    )Company contributions
    
    
    3
    
    
    
    10Foreign currency translation
    
    
    6
    
    
    
    6Benefits paid from plan assets
    
    
    (3
    )
    
    
    (2
    )Fair value of plan assets at December 31
    
    $
    55
    
    
    $
    45
 Employer contributions totaled $3 million and $10 million for 2003 and
2002, respectively, and benefits paid from plan assets under the U.K. pension
plan were $3 million and $2 million in 2003 and 2002, respectively. The asset allocation for the U.K. defined benefit pension plan at December
31, 2003 and 2002 and the target allocation for 2003 by asset category follows: Percentage of PlanTarget
    
    AssetsAllocation
    
    at December 31,Asset category:
    
    2003
    
    2003
    
    2002Equity securities
    
    
    44-56
    %
    
    
    50
    %
    
    
    81
    %Fixed income
    
    
    44-56
    %
    
    
    50
    %
    
    
    19
    %Totals
    
    
    
    
    
    
    100
    %
    
    
    100
    %
 The target asset allocation 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. When determining the strategy, the Company
recognizes that the value of the plans liabilities move with gilt yields (and
with gilt prices). Investing a proportion of the plans assets in equity
securities introduces incremental market risk. While this risk can lead to
volatility in the funding 40




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements level disclosed at a subsequent actuarial valuation, the Company believes
this risk is acceptable in view of the potential benefits to be realized due to
the higher expected rates of returns on equity securities over the long term. The expected long-term rate of return on plan assets was 6.30% for both
2003 and 2002. The overall expected long-term rate of return on assets
assumption is a function of the target asset allocation for plan assets, the
long-term equilibrium rate of return for the asset class, plus an incremental
return attributable to the active management of plan assets. The plans target
asset allocation is 50% equity and 50% fixed income investments (debt and
debt-like securities, including preferred securities). The estimated total return for equity securities is 7.8% annually and
assumes a 3% risk premium over a 4.8% projected return for fixed income.
Incremental returns from active management combined with the asset allocation
and assumed asset class returns form the basis of the expected long-term rate
of return on assets. The Companys U.K. investment policy considers the following factors in
the development of its defined benefit plan investment strategy: the nature and
relative size of the liabilities, the allocation of such liabilities between
active and retired members, net cash flows and funded positions, the applicable
investment horizon, historical and expected capital market returns, and the
benefits of investment diversification. The Company invests the assets of the plan with a Manager of Managers.
The Manager of Managers invests the plans assets with a broad selection of
investment managers who each specialize in a different asset class or market.
The aim of this approach is to provide a diversified portfolio of managers to
capitalize on the perceived strengths of each manager within this structure.
The Company delegates responsibility for the selection and monitoring of the
underlying investment managers to the Manager of Managers. The funded status of the U.K. defined benefit pension plan reconciled to
the amount reported in the Consolidated Statements of Financial Position
follows: (Dollars in millions)Pension Benefits2003
    
    2002Fair value of plan assets
    
    $
    55
    
    
    $
    45Projected benefit obligation
    
    
    69
    
    
    
    57Funded status of the plan
    
    
    (14
    )
    
    
    (12
    )Unrecognized actuarial loss
    
    
    30
    
    
    
    26Unrecognized prior service cost
    
    
    1
    
    
    
    1Net amount recognized
    
    $
    17
    
    
    $
    15Amounts recognized in the Statement of Financial Position consist of:Prepaid benefit cost
    
    $
    17
    
    
    $
    15Additional minimum liability
    
    
    (29
    )
    
    
    (25
    )Intangible asset
    
    
    1
    
    
    
    1Accumulated other comprehensive income (pre-tax)
    
    
    28
    
    
    
    24Net amount recognized
    
    $
    17
    
    
    $
    15
 As of December 31, 2003 and 2002, the U.K. pension plan had a projected
benefit obligation in excess of plan assets. The projected benefit obligation,
accumulated benefit obligation, and fair value of plan assets for the U.K.
pension plan were as follows: (Dollars in millions)December 31,2003
    
    2002Projected benefit obligation
    
    $
    69
    
    
    $
    57Accumulated benefit obligation
    
    
    67
    
    
    
    55Fair value of plan assets
    
    
    55
    
    
    
    45
 41




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Information about the expected cash flows for the U.K. defined benefit
pension plan follows: (Dollars in millions)Pension Plan BenefitsExpected employer contributions for 2004
    
    $
    1Expected benefit payments
2004
    
    
    32005
    
    
    32006
    
    
    32007
    
    
    32008
    
    
    32009-2013
    
    
    17
 The above table reflects the total contribution that the Company
anticipates making in 2004 and the benefit payments that it expects to be paid
from the plan assets through the year ending 2013. (Dollars in millions)Pension BenefitsNet periodic benefit cost:
    
    2003
    
    2002
    
    2001Service cost
    
    $
    1
    
    
    $
    1
    
    
    $
    2Interest cost
    
    
    3
    
    
    
    3
    
    
    
    5Expected return on plan assets
    
    
    (3
    )
    
    
    (3
    )
    
    
    (7
    )Actuarial loss recognized
    
    
    1
    
    
    
    1
    
    
    
    Benefit cost
    
    $
    2
    
    
    $
    2
    
    
    $
    
 Weighted-average assumptions used todetermine net periodic benefit cost:
    
    2003
    
    2002
    
    2001Weighted-average discount rate
    
    
    5.50
    %
    
    
    5.50
    %
    
    
    6.25
    %Expected return on plan assets
    
    
    6.30
    %
    
    
    6.30
    %
    
    
    6.30
    %Rate of compensation increase
    
    
    3.50
    %
    
    
    3.50
    %
    
    
    2.50
    %
 Netherlands Defined Benefit Pension Plan The Company provides a defined benefit pension plan to its employees in
the Netherlands. The following tables present benefit obligation, plan assets
and related information for the Netherlands defined benefits pension plan as of
December 31, 2003 and 2002. (Dollars in millions)Pension BenefitsChanges in benefit obligation:
    
    2003
    
    2002Projected benefit obligation at January 1
    
    $
    114
    
    
    $
    98Service cost
    
    
    3
    
    
    
    3Interest cost
    
    
    7
    
    
    
    5Divestitures
    
    
    
    
    
    
    (1
    )Foreign currency translation
    
    
    25
    
    
    
    17Actuarial loss
    
    
    12
    
    
    
    (3
    )Benefits paid from plan assets
    
    
    (7
    )
    
    
    (5
    )Projected benefit obligation at December 31
    
    $
    154
    
    
    $
    114
 The accumulated benefit obligation for the Netherlands plan was $141
million and $110 million, respectively, at December 31, 2003 and 2002. Weighted-average assumptions used to determine the benefit obligation at
December 31, 2003 and 2002 were: Pension Benefits2003
    
    2002Weighted-average discount rate
    
    
    5.25
    %
    
    
    5.50
    %Rate of compensation increase
    
    
    2.50
    %
    
    
    3.00
    %
 42




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements (Dollars in millions)Pension BenefitsChange in plan assets:
    
    2003
    
    2002Fair value of plan assets at January 1
    
    $
    110
    
    
    $
    78Actual return on plan assets
    
    
    4
    
    
    
    4Expenses
    
    
    (1
    )
    
    
    (1
    )Company contributions
    
    
    12
    
    
    
    17Participant contributions
    
    
    1
    
    
    
    1Foreign currency translation
    
    
    22
    
    
    
    16Benefits paid from plan assets
    
    
    (7
    )
    
    
    (5
    )Fair value of plan assets at December 31
    
    $
    141
    
    
    $
    110
 Employer contributions totaled $12 million and $17 million for 2003 and
2002, respectively, and benefits paid from plan assets were $7 million and $5
million in 2003 and 2002, respectively. The asset allocation for the Companys defined benefit pension plan in the
Netherlands at December 31, 2003 and 2002 and the target allocation for 2003,
by asset category follows: Percentage of PlanTarget
    
    AssetsAllocation
    
    at December 31,Asset category:
    
    2003
    
    2003
    
    2002Equity securities
    
    
    42-76
    %
    
    
    59
    %
    
    
    53
    %Fixed income
    
    
    37-47
    %
    
    
    41
    %
    
    
    47
    %Totals
    
    
    
    
    
    
    100
    %
    
    
    100
    %
 The target asset allocation is 22% U.S. equity securities, 29% European
equity securities, 7% Asia Pacific equity securities and 42% fixed income
securities valued in euros. U.S. equity securities are invested in a passively
managed Standard & Poors 500 Commingled Trust Fund; European and Asia Pacific
equity securities represent investments in actively managed regional funds;
fixed income securities are denominated in 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 a
tactical basis in investment grade corporate bonds denominated in euro.
Investment managers may employ limited use of derivatives, including futures
contracts, options on futures, and interest rate swaps in place of direct
investment in securities to gain efficient exposure to markets. Derivatives
are not used to leverage portfolios. The expected long-term rate of return on plan assets was 6.5% in 2003 and
6.0% in 2002. The overall expected long-term rate of return on assets
assumption is a function of the target asset allocation for plan assets, the
long-term equilibrium rate of return for the asset class, plus an incremental
return attributable to the active management of plan assets. The plans
long-term (policy) target asset allocation is 58% equity and 42% fixed income
investments (debt and debt-like securities, including preferred securities).
The annual estimated total return for equities is 8.0%; the annual estimated
total return for Euro bonds is 5.0%. In developing an investment strategy, the Company has considered the
following factors: the nature of the plans liabilities, the allocation of such
liabilities between active members and retired members, the funded position of
the plan, the net cash flow of the plan, the investment horizon of the plan,
the size of the plan, historical and expected capital market returns and the
benefits of investment diversification. The Company manages the assets with the primary objective of maximizing
the long-term investment return given available market opportunities and
moderate levels of risk consistent with the nature and purpose of the plan. To
achieve the stated investment objectives, the Company, from time to time,
reviews and confirms the following assertions: that plan assets are fully
invested in the capital markets; that equity investments provide greater
long-term returns than fixed income investments, although with greater
short-term volatility; that prudent diversification across major asset classes
provides the potential for enhanced long-term returns and decreased portfolio
risk; that investment managers with active mandates can reduce portfolio risk
below market risk and potentially add value through security selection
strategies; that it is appropriate to retain multiple investment managers
provided that such managers offer asset class or style diversification; and
that the investment performance of the portfolio, the various asset classes and
the individual investment managers be reviewed regularly against policy
objectives. 43




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements The funded status of the plan reconciled to the amount reported in the
Consolidated Statements of Financial Position follows: (Dollars in millions)Pension Benefits2003
    
    2002Fair value of plan assets
    
    $
    141
    
    
    $
    110Projected benefit obligation
    
    
    154
    
    
    
    114Funded status of the plan
    
    
    (13
    )
    
    
    (4
    )Unrecognized actuarial loss
    
    
    38
    
    
    
    17Unrecognized prior service cost
    
    
    3
    
    
    
    3Net amount recognized
    
    $
    28
    
    
    $
    16Amounts recognized in the
Statement of Financial
Position consist of:Prepaid benefit cost
    
    
    28
    
    
    
    16Net amount recognized
    
    $
    28
    
    
    $
    16
 As of December 31, 2003 and 2002, the pension plan in the Netherlands had
a projected benefit obligation in excess of plan assets. The projected benefit
obligation, accumulated benefit obligation and fair value of plan assets for
the pension plan in the Netherlands were as follows: (Dollars in millions)December 31,2003
    
    2002Projected benefit obligation
    
    $
    154
    
    
    $
    114Accumulated benefit obligation
    
    
    141
    
    
    
    110Fair value of plan assets
    
    
    141
    
    
    
    110
 Information about the expected cash flows for the Netherlands defined
benefit pension plan follows: (Dollars in millions)Pension Plan BenefitsExpected employer contributions for 2004
    
    $
    4Expected benefit payments:2004
    
    
    82005
    
    
    92006
    
    
    102007
    
    
    112008
    
    
    122009-2013
    
    
    62
 The above table reflects the total contribution that the Company
anticipates making in 2004 and the benefits expected to be paid from the plan
assets through the year ending 2013. (Dollars in millions)Pension Plan Benefits2003
    
    2002
    
    2001Service cost
    
    $
    3
    
    
    $
    3
    
    
    $
    3Interest cost
    
    
    7
    
    
    
    5
    
    
    
    5Expected return on plan assets
    
    
    (8
    )
    
    
    (5
    )
    
    
    (7
    )Amortization of prior service cost
    
    
    1
    
    
    
    1
    
    
    
    Benefit Cost
    
    $
    3
    
    
    $
    4
    
    
    $
    1
 Weighted-average assumptionsused to determine net periodicbenefit cost:
    
    2003
    
    2002
    
    2001Weighted-average discount rate
    
    
    5.50
    %
    
    
    5.75
    %
    
    
    5.75
    %Expected return on plan assets
    
    
    6.50
    %
    
    
    6.00
    %
    
    
    6.00
    %Rate of compensation increase
    
    
    3.00
    %
    
    
    3.00
    %
    
    
    3.00
    %
 44




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements 10. Employee Stock Ownership Plan (ESOP) Effective March 1, 2002, the BetzDearborn Inc. Employee Stock Ownership
and 401(k) Plan was merged into the Hercules Incorporated Savings and
Investment Plan (SIP Plan). On April 29, 2002, the Company used a portion of
the proceeds from the sale of the BetzDearborn Water Treatment Business to
fully prepay the long-term third party debt (ESOP credit facility) held by
the ESOP trust. Concurrent with the prepayment of the ESOP credit facility,
the trust borrowed $75 million from the Company under an existing loan
agreement. At December 31, 2003, and 2002, the ESOP trust had $65 million and
$76 million in long-term debt outstanding, respectively, under the loan
agreement; the Company has an offsetting receivable in each year. The Company
recognized $24 million in prepayment penalties in 2002 as a result of the
prepayment of the ESOP credit facility (see Note 21). Under the provisions of the SIP Plan, employees may invest 1% to 50% of
eligible compensation. The Companys matching contributions, made in the form
of Hercules common stock contributed through the ESOP, are equal to 50% of the
first 6% of the employees contributed compensation and vest immediately.
Effective December 31, 2003, the Company changed its method of accounting for
the ESOP to the method prescribed by SOP 93-6 (Note 1). Under SOP 93-6, shares
used to fulfill the Companys matching contribution are released at the fair
market value of those shares in the period in which they are allocated. The
pre-tax difference between cost and fair market value of these allocated
shares, which was $8 million, $7 million, and $7 million for the years ended
December 31, 2003, 2002 and 2001, respectively, is recorded in additional
paid-in capital. The unallocated shares held by the trust are reflected in
unearned compensation as a reduction in stockholders equity on the balance
sheet of $80 million and $91 million at December 31, 2003 and 2002,
respectively. The unallocated shares have a cost basis of $31.625 per share. 2003
    
    2002Allocated
    
    
    1,594,739
    
    
    
    1,530,314Unallocated
    
    
    2,520,433
    
    
    
    2,869,338Total shares held by ESOP
    
    
    4,115,172
    
    
    
    4,399,652
 The ESOP expense was $4 million for each of the years ended December 31,
2003, 2002 and 2001. 11. Long-term Incentive Compensation Plans 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 Accounting Standards No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure (SFAS
148). SFAS 148 amends SFAS 123 by providing alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation and requiring enhanced disclosure regarding
stock-based compensation. The Company has elected to apply the fair value
recognition provisions of SFAS 123 on a prospective basis to all employee
awards granted, modified or settled after January 1, 2003. Awards under the
Companys stock-based compensation plans vest over periods ranging from 1 to a
maximum of 5 years; however, vesting can be extended with the approval of the
Board of Directors. Therefore, the cost related to stock-based employee
compensation included in the determination of net income in 2003 is less than
that which would have been recognized if the fair value based method had been
applied to all awards since the original effective date of SFAS 123. The
Company did not grant any stock options covered by SFAS 123, as amended by SFAS
148, to employees in 2003. However, during 2003 the Company did make grants of restricted
stock representing a charge to unearned compensation in
stockholders equity of $11 million. Of this amount,
$4 million was amortized during 2003 and included in total
compensation expense. Restricted stock awards under the Hercules
Long-term Incentive Compensation Plan are valued at the quoted market price
(fair value) of the Companys stock on the grant date (measurement date).
Stock acquired through the Employee Stock Purchase Plan and above target
restricted stock awarded under the Hercules Management Incentive Compensation
Plan is discounted 15% from market price as permitted by IRS regulations and
the provisions of the Companys incentive compensation plans. The value of the
award and the discount, if any, are amortized into expense over the vesting
(restriction) period. Forfeitures are recorded as incurred. The Company
recognized $4 million, $1 million and $2 million of expense in 2003, 2002
and 2001, respectively, in connection with restricted stock awards. The Companys long-term incentive compensation plans provide for the grant
of stock options and the award of common stock and other market-based units to
certain key employees and non-employee directors. Through 1994, shares of
common stock awarded under these plans normally were either restricted stock or
performance shares. During the restriction period, award holders have the
rights of stockholders, including the right to vote and receive cash dividends,
but they cannot transfer ownership. In 1995, Hercules changed the structure of its long-term incentive
compensation plans to place a greater emphasis on shareholder value creation
through grants of regular stock options, performance-accelerated stock options
and Cash Value Awards (performance-based awards denominated in cash and payable
in shares of common or restricted stock, 45




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Hercules Incorporated
Notes to Consolidated Financial Statements subject to the same restrictions as
restricted stock). Restricted stock and other market-based units are awarded
with respect
to certain programs. The number of awarded shares outstanding was
1,299,214 at December 31, 2003, 351,937 at December 31, 2002 and 189,704 at
December 31, 2001, respectively. At December 31, 2003, under the Companys incentive compensation plans,
2,429,395 shares of common stock were available for grant as stock awards or
stock option awards. Stock awards are limited to approximately 15% of the
total authorizations. Regular stock options are granted at the market price on
the date of grant and are exercisable at various periods from one to five years
after date of grant. Performance-accelerated stock options are also granted at
the market price on the date of grant and are normally exercisable at nine and
one-half years. Exercisability may be accelerated based upon the achievement
of predetermined performance goals. Both regular and performance-accelerated
stock options expire 10 years after the date of grant. Restricted shares, options and performance-accelerated stock options are
forfeited and revert to the Company in the event of employment termination,
except in the case of death, disability, retirement, or other specified events. Below is a summary of outstanding stock option grants under the incentive
compensation plans during 2001, 2002 and 2003: Regular
    
    Performance-AcceleratedNumber of
    
    Weighted-average
    
    Number of
    
    Weighted-averageShares
    
    Price
    
    Shares
    
    PriceDecember 31, 2000
    
    
    11,149,928
    
    
    $
    31.57
    
    
    
    6,084,425
    
    
    $
    43.47Granted
    
    
    2,806,525
    
    
    $
    11.58
    
    
    
    
    
    
    $
    Exercised
    
    
    (44,400
    )
    
    $
    15.01
    
    
    
    (187,500
    )
    
    $
    14.06Forfeited
    
    
    (663,255
    )
    
    $
    25.89
    
    
    
    (129,600
    )
    
    $
    43.61December 31, 2001
    
    
    13,248,798
    
    
    $
    27.51
    
    
    
    5,767,325
    
    
    $
    44.42Granted
    
    
    2,031,699
    
    
    $
    11.88
    
    
    
    
    
    
    $
    Exercised
    
    
    (4,275
    )
    
    $
    11.28
    
    
    
    
    
    
    $
    Forfeited
    
    
    (2,068,588
    )
    
    $
    26.91
    
    
    
    (578,400
    )
    
    $
    49.00December 31, 2002
    
    
    13,207,634
    
    
    $
    25.21
    
    
    
    5,188,925
    
    
    $
    43.91Granted
    
    
    21,000
    
    
    $
    10.09
    
    
    
    
    
    
    $
    Exercised
    
    
    
    
    
    $
    0.00
    
    
    
    
    
    
    $
    Forfeited
    
    
    (922,075
    )
    
    $
    32.34
    
    
    
    (409,225
    )
    
    $
    46.77December 31, 2003
    
    
    12,306,559
    
    
    $
    24.47
    
    
    
    4,779,700
    
    
    $
    43.66
 The weighted-average fair value of regular stock options granted during
2001, 2002 and 2003 using the Black-Scholes option pricing model was $5.90,
$5.09 and $4.67, respectively. During the fourth quarter of 2003, the
Companys Compensation Committee granted each of the non-employee directors
3,000 stock options (21,000 in total) under the Omnibus Equity Compensation
Plan for Non-Employee Directors. There were no performance-accelerated stock
options granted during 2001, 2002 or 2003. Following is a summary of regular stock options exercisable at December
31, 2001, 2002 and 2003, and their respective weighted-average share prices: Number of
    
    Weighted-averageOptions Exercisable
    
    Shares
    
    Exercise PriceDecember 31, 2001
    
    
    9,471,983
    
    
    $
    33.04December 31, 2002
    
    
    9,150,134
    
    
    $
    31.05December 31, 2003
    
    
    10,973,895
    
    
    $
    26.09
 46




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Hercules Incorporated
Notes to Consolidated Financial Statements At December 31, 2001, 2002 and 2003, respectively, there were no
performance-accelerated stock options exercisable. Following is a summary of
stock options outstanding at December 31, 2003: Outstanding Options
    
    Exercisable OptionsNumber
    
    Weighted-average
    
    Weighted-
    
    Number
    
    Weighted-Outstanding
    
    Remaining
    
    average
    
    Exercisable
    
    averageat 12/31/2003
    
    Contractual Life
    
    Exercise Price
    
    12/31/2003
    
    Exercise PriceRegular Stock Options$8.50 - $11.75
    
    
    1,484,825
    
    
    
    7.72
    
    
    $
    11.21
    
    
    
    1,231,355
    
    
    $
    11.24$11.76 - $15.00
    
    
    3,227,699
    
    
    
    7.95
    
    
    $
    11.98
    
    
    
    2,120,505
    
    
    $
    12.01$15.01 - $22.50
    
    
    1,862,875
    
    
    
    6.16
    
    
    $
    17.16
    
    
    
    1,862,875
    
    
    $
    17.16$22.51 - $33.75
    
    
    1,675,775
    
    
    
    4.69
    
    
    $
    25.86
    
    
    
    1,687,775
    
    
    $
    25.92$33.76 - $40.00
    
    
    2,708,060
    
    
    
    4.25
    
    
    $
    38.31
    
    
    
    2,714,060
    
    
    $
    38.31$40.01 - $60.00
    
    
    1,347,325
    
    
    
    3.10
    
    
    $
    49.57
    
    
    
    1,357,325
    
    
    $
    49.5712,306,559
    
    
    
    
    
    
    
    
    
    
    
    10,973,895Performance-Accelerated Stock Options$24.00 - $36.00
    
    
    638,400
    
    
    
    4.99
    
    
    $
    31.74
    
    
    
    
    
    
    
    $36.01 - $45.00
    
    
    1,207,355
    
    
    
    4.63
    
    
    $
    38.29
    
    
    
    
    
    
    
    $45.01 - $50.00
    
    
    2,468,720
    
    
    
    2.95
    
    
    $
    47.09
    
    
    
    
    
    
    
    $50.01 - $61.00
    
    
    465,225
    
    
    
    2.06
    
    
    $
    55.81
    
    
    
    
    
    
    
    4,779,700
    
    
    
    
    
    
    
    
    
    
    
    
 The Companys Employee Stock Purchase Plan was originally a qualified
non-compensatory plan, which allowed eligible employees to acquire shares of
common stock through systematic payroll deductions. The plan was converted to
a non-qualified employee stock purchase plan in 2001 and the shares are funded
from treasury stock. The plan consists of three-month subscription periods,
beginning July 1 of each year. The purchase price is 85% of the fair market
value of the common stock on either the first or last day of that subscription
period, whichever is lower (the look-back). Purchases may range from 2% to
15% of an employees base salary each pay period, subject to certain
limitations. Shares issued at December 31, 2001 under the qualified plan were
1,758,081. Currently, there are no shares of Hercules common stock registered
for offer and sale under the qualified plan. The shares issued under the
non-qualified plan totaled 833,195 at December 31, 2003. Pursuant to SFAS 123,
the look-back constitutes a stock option. The Company estimates and expenses
the value of the option for the applicable subscription period using
Black-Scholes. The expense attributable to the look-back provision is not
significant. The 15% discount on the purchase price of the common stock has
been recognized as compensation expense for the non-qualified Employee Stock
Purchase Plan. 47




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Hercules Incorporated
Notes to Consolidated Financial Statements The following weighted-average assumptions are used in determining the
fair value for 2003, 2002 and 2001: Employee Stock2003 Assumptions
    
    Regular Plan
    
    Purchase PlanDividend 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 AssumptionsDividend 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
    %2001 AssumptionsDividend yield
    
    
    0.00
    %
    
    
    0.00
    %Risk-free interest rate
    
    
    5.15
    %
    
    
    3.80
    %Expected life
    
    8 yrs.
    
    3 mos.Expected volatility
    
    
    35.54
    %
    
    
    54.09
    %
 The pro forma effect on net income (loss) and earnings (loss) per share,
assuming the Company had applied the fair value recognition provisions of SFAS
123 to stock-based employee compensation for all years reported, is presented
in the Summary of Significant Accounting Policies. 12. Asset Retirement Obligations Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 143, Accounting for Asset Retirement Obligations
(SFAS 143). SFAS 143 establishes accounting and reporting standards for the
recognition and measurement of legal obligations associated with the retirement
of tangible long-lived assets. SFAS 143 requires that the fair value of an
asset retirement obligation be recorded when incurred. Included within the
scope of SFAS 143 are environmental remediation liabilities that resulted from
the normal operation of a long-lived asset. The Company has a number of
environmental remediation liabilities associated with current and former
operations that were incurred during the course of normal operations. The most
significant differences in the measurement of these obligations under SFAS 143
are outlined below: Recording of Full Obligation SFAS 143 requires that the fair value of an asset retirement obligation be
recorded when it is incurred if a reasonable estimate of fair value can be
made. Under SFAS 143, uncertainties (probability) in the amount and timing of
settlement are incorporated into the fair value measure of the recognized
liability, whereas under Statement of Financial Accounting Standards No. 5,
Accounting for Contingencies, and FASB Interpretation 14, Reasonable
Estimation of the Amount of a Loss, uncertainties are considered in
determining recognition of a liability. Present Value of Obligation SFAS 143 requires that the fair value of the asset retirement obligation
be discounted using a credit adjusted risk-free rate. Capitalization of Costs Related to Environmental Contamination SFAS 143 requires capitalization of costs as a component of fixed assets
to the extent there is a corresponding operating asset. Emerging Issues Task
Force Issue No. 90-8, Capitalization of Costs to Treat Environmental
Contamination, permitted capitalization of environmental remediation costs
incurred in preparing a property for sale. With the adoption of SFAS 143, the Company 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 $18 million, resulting in an
after-tax charge of $28 million ($44 million on a pre-tax basis), or $0.26 per
share, as a cumulative effect of a change in accounting principle. 48




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Hercules Incorporated
Notes to Consolidated Financial Statements The following table provides a reconciliation of the changes in the asset
retirement obligations during the period. (Dollars in millions)SFAS 143 AdoptionBalance
    
    Cumulative
    
    Capitalized
    
    
    
    
    
    
    
    
    
    BalanceJanuary 1,
    
    Effect
    
    Retirement
    
    Liabilities
    
    
    
    
    
    December 31,2003
    
    Adjustment
    
    Obligations
    
    Settled
    
    Accretion
    
    2003Capitalized
remediation costs
    
    $
    18
    
    
    $
    (18
    )
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Environmental
Remediation
Liabilities:SFAS 143 ARO sites
    
    
    (85
    )
    
    
    (26
    )
    
    
    (2
    )
    
    
    12
    
    
    
    (2
    )
    
    
    (103
    )Non-SFAS 143 sites
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3
    )$
    (70
    )
    
    $
    (44
    )
    
    $
    (2
    )
    
    $
    12
    
    
    $
    (2
    )
    
    $
    (106
    )
 Had the Company adopted SFAS 143 effective January 1, 2002, the liability
for asset retirement obligations as of that date would have been $122 million. 13. Commitments and Contingencies Guarantees In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). The Company has adopted the
disclosure requirements of FIN 45 as of December 31, 2002. Disclosures about
each group of similar guarantees are provided below: Indemnifications In connection with the sale of the Company assets and businesses, the
Company has indemnified respective buyers against certain liabilities that may
arise in connection with the sales transactions and business activities prior
to the ultimate closing of the sale. These indemnifications typically pertain
to environmental, tax, employee and/or product related matters. If the
indemnified party were to incur a liability or have a liability increase as a
result of a successful claim, pursuant to the terms of the indemnification, the
Company would be required to reimburse the buyer. These indemnifications are
generally subject to threshold amounts, specified claim periods and other
restrictions and limitations. The carrying amount recorded for all
indemnifications as of December 31, 2003 is $76 million. Although it is
reasonably possible that future payments may exceed amounts accrued, due to the
nature of indemnified items, it is not possible to make a reasonable estimate
of the maximum potential loss or range of loss. Generally, there are no
specific recourse provisions. Approximately $1 million in cash is held in
escrow or collateral. In addition, the Company provides certain indemnifications in the ordinary
course of business such as product, patent and performance warranties in
connection with the manufacture, distribution and sale of its products and
services. Due to the nature of these indemnities, it is not possible to make a
reasonable estimate of the maximum potential loss or range of loss. Debt Obligations The Company has directly guaranteed various debt obligations under
agreements with third parties related to subsidiaries and affiliates, and/or
other unaffiliated companies. At December 31, 2003, the Company had directly
guaranteed $19 million of such obligations. This represents the maximum
principal amount of potential future payments that the Company could be
required to make under the guarantees. Any applicable interest and expenses
would generally be added to the amount of obligations. The Companys Consolidated Financial Statements include $7 million of
outstanding directly guaranteed obligations, including $2 million recorded as
debt and $5 million recorded as pension liability. The Company has provided
approximately $3 million in collateral through a mortgage security related to
the pension liability. Existing guarantees for subsidiaries and affiliates
arose from liquidity needs in normal operations. The Company will be required
to perform on these guarantees in the event of default by the guaranteed party. The Company guarantees the obligations of Hercules Trust I and Hercules
Trust II on the preferred securities (see Note 6). 49




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Hercules Incorporated
Notes to Consolidated Financial Statements Intercompany Guarantees The Company and its subsidiaries have intercompany guarantees between and
among themselves, which aggregate approximately $156 million as of December 31,
2003. These guarantees relate to intercompany loans used to facilitate normal
business transactions such as the sale and purchase of products. All of the
$156 million has been eliminated from the Companys consolidated financial
statements. Leases Hercules has operating leases (including office space, transportation and
data processing equipment) expiring at various dates. Rental expense was $25
million in 2003, $34 million in 2002 and $56 million in 2001. At December 31, 2003, minimum rental payments under non-cancelable leases
aggregated $181 million with offsetting subleases of $48 million. A
significant portion of these payments relate to a long-term operating lease for
corporate office facilities. The minimum payments over the next five years,
net of minimum sublease receipts, are $20 million in 2004, $17 million in 2005,
$14 million in 2006, $13 million in 2007, $13 million in 2008 and $56 million
thereafter. Environmental In the ordinary course of its business, the Company is subject to numerous
environmental laws and regulations covering compliance matters or imposing
liability for the costs of, and damages resulting from, cleaning up sites, past
spills, disposals and other releases of hazardous substances. Changes in these
laws and regulations may have a material adverse effect on the Companys
financial position and results of operations. Any failure by the Company to
adequately comply with such laws and regulations could subject the Company to
significant future liabilities. Hercules has been identified as a potentially responsible party (PRP) by
U.S. federal and state authorities, or by private parties seeking contribution,
for the cost of environmental investigation and/or cleanup at numerous sites.
The range of the reasonably possible share of costs for the investigation and
cleanup of current and former operating sites, and other locations where the
Company may have a known liability is between $106 million and $218 million.
The actual costs will depend upon numerous factors, including the number of
parties found responsible at each environmental site and their ability to pay;
the actual methods of remediation required 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, which could range from 0 to 30 years. Hercules becomes aware of sites in which it may be named a PRP in
investigatory and/or remedial activities through correspondence from the U.S.
Environmental Protection Agency (EPA) or other government agencies or from
previously named PRPs, who either request information or notify the Company of
its potential liability. The Company has established procedures for
identifying environmental issues at its plant sites. In addition to
environmental audit programs, the Company has environmental coordinators who
are familiar with environmental laws and regulations and act as a resource for
identifying environmental issues. 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 upon the Comprehensive
Environmental Response, Compensation and Liability Act (CERCLA, or the
Superfund statute), as well as other statutes, has been pending since 1980, and
involves liability for costs in connection with the investigation and
remediation of the Vertac Chemical Company (Vertac) site in Jacksonville,
Arkansas. Hercules owned and operated the site from December 1961 until 1971.
The site was used for the manufacture of certain herbicides and, at the order
of the United States, Agent Orange. In 1971, the site was leased to Vertacs
predecessor. In 1976, Hercules sold the site to Vertac. The site was
abandoned by Vertac in 1987, and Vertac was subsequently placed into
receivership. Both prior to and following the abandonment of the site, the EPA
and the Arkansas Department of Pollution Control and Ecology (ADPC&E) were
involved in the investigation and remediation of contamination at and around
the site. Pursuant to several orders issued under CERCLA, Hercules actively
participated in many of these activities. The cleanup is essentially complete,
except for certain on-going maintenance and monitoring activities. This
litigation primarily concerns the responsibility and allocation of liability
for the costs incurred in connection with the activities undertaken by EPA and
the ADPC&E. Although the case initially involved many parties, as a result of various
United States District Court rulings and decisions, as well as a trial,
Hercules and Uniroyal were held jointly and severally liable for the
approximately $100 million in costs allegedly incurred by the EPA and ADPC&E,
as well as costs to be incurred in the future. That decision was made final by
the District Court on September 13, 1999. Both Hercules and Uniroyal timely
appealed that judgment to the United States Court of Appeals for the Eighth
Circuit. On February 8, 2000, the District Court issued a final judgment on the
allocation between Hercules and Uniroyal finding Uniroyal liable for 2.6
percent and Hercules liable for 97.4 percent of the costs at issue. Hercules
timely appealed 50




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Hercules Incorporated
Notes to Consolidated Financial Statements that judgment. Oral argument on both appeals was held before
the Eighth Circuit on June 12, 2000. On April 10, 2001, the United States
Court of Appeals for the Eighth Circuit issued an opinion in the consolidated
appeals described above. In that opinion, the Appeals Court reversed the
District Courts decision which had held Hercules jointly and severally liable
for costs incurred and to be incurred at the Jacksonville site, and remanded
the case back to the District Court for several determinations, including a
determination of whether the harms at the site giving rise to the governments
claims were divisible. The Appeals Court also vacated the District Courts
allocation decision holding Hercules liable for 97.4 percent of the costs at
issue, ordering that these issues be revisited following further proceedings
with respect to divisibility. Finally, the Appeals Court affirmed the judgment
of liability against Uniroyal. The trial on remand commenced on October 8, 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 District
Court in support of its belief that the Company should not be liable under
CERCLA for some or all of the costs incurred by the government in connection
with the site because those harms are divisible. The District Court has not
yet rendered its decision. Should the Company prevail on remand, any liability
to the government will be either eliminated 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 to 1995 under contract with
the United States Department of the Navy. The Navy has notified Hercules that
it would like to negotiate with Hercules with respect to certain environmental
liabilities which, the Navy alleges, are attributable to Hercules past
operations at ABL. In recent discussions, the Navy has stated that, pursuant
to CERCLA, it has spent a total of $24.8 million and expects to spend an
additional $44 million over the next 10 years. The Company is currently
investigating the Navys allegations, including the basis of the Navys claims,
and whether the contracts with the government pursuant to which the Company
operated ABL may provide to the Company a defense from some or all of the
amounts sought. At this time, however, the Company cannot reasonably estimate
its liability, if any, with respect to ABL and, accordingly, has not included
this site in the range of its environmental liabilities reported above. At December 31, 2003, the Companys accrued liability for environmental
remediation was $106 million. The extent of liability is evaluated quarterly
based on currently available information, including the progress of remedial
investigations at each site and the current status of negotiations with
regulatory authorities regarding the method and extent of apportionment of
costs among other PRPs. While it is not feasible to predict the outcome of all
pending suits and claims, the ultimate resolution of these environmental
matters could have a material effect upon the results of operations and the
financial position of Hercules, and the resolution of any of these matters
during a specific period could have a material effect on the quarterly or
annual results of that period. Litigation The Company is a defendant in numerous asbestos-related personal injury
lawsuits and claims which typically arise from alleged exposure to asbestos
fibers from resin encapsulated pipe and tank products which were sold by one of
the Companys former subsidiaries to a limited industrial market (products
claims). The Company is also a defendant in lawsuits alleging exposure to
asbestos at facilities formerly or presently owned or operated by the Company
(premises claims). Claims are received and settled or otherwise resolved on
an on-going basis. In late December 1999, the Company entered into a
settlement agreement to resolve the majority of the claims then pending. In
connection with that settlement, the Company also entered into an agreement
with several of the insurance carriers, which sold primary and first level
excess insurance policies insuring that former subsidiary. Under the terms of
that agreement, the majority of the amounts paid to resolve those products
claims were insured, subject to the limits of the insurance coverage provided
by those policies. The terms of both settlement agreements are confidential. Since entering into the agreements referenced in the above paragraph, the
Company has continued to receive and settle or otherwise resolve claims on an
on-going basis. Between January 1, 2003 and December 31, 2003, the Company
received approximately 16,885 new claims, over half of which were included in
consolidated complaints naming anywhere from one hundred to thousands of
plaintiffs and a large number of defendants, but providing little information
connecting any specific plaintiffs alleged injuries to any specific
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. During that same time period, the Company also received approximately
3,175 other new claims, all of which were included in consolidated complaints
and which have either been dismissed without payment or are in the process of
being dismissed without payment, but with plaintiffs retaining the right to
re-file should they be able to establish exposure to an asbestos-containing
product for which the Company bears liability. With respect to total claims
pending, as of January 31, 2004, there were approximately 33,220 unresolved
claims, of which approximately 1,080 were premises claims and the rest were
products claims. There were also approximately 1,615 unpaid claims which have
been settled or are subject to the terms of a settlement agreement. In
addition, as of January 31, 2004, there were approximately 11,920 claims (an
amount that includes the 3,175 claims noted above) which have either been
dismissed without payment or are in the process of being 51




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Hercules Incorporated
Notes to Consolidated Financial Statements dismissed without payment, but with plaintiffs retaining the right to
re-file should they be able to establish exposure to an asbestos-containing
product for which the Company bears liability. In June and July 2003, the Company entered into several settlement
agreements which will permanently resolve approximately 12,500 claims. Of
those claims, approximately 3,600 are categorized as unresolved in the above
paragraph, and approximately 8,900 are among those claims that have been
dismissed without payment or are in the process of being dismissed without
payment. The terms of these settlement agreements are confidential. The
Company believes that the vast majority of these claims will be permanently
dismissed without payment. The Companys primary and first level excess insurance policies that
provided coverage for these asbestos-related matters have exhausted their
limits. The Company has not yet reached agreement with its other insurance
carriers to fund the cost of defending and resolving its asbestos-related
matters. As a result, until the Companys other insurance carriers begin to
fund the cost of defending and resolving these matters, the Company will have
to fully fund the cost of defending and resolving these matters. Net of
insurance payments received or made on its behalf, the Company spent $40
million on these matters during the year ended December 31, 2003, including $7
million of legal expenses. Nonetheless, based on the current number of claims
pending, the amounts the Company anticipates paying to resolve those claims
which are not dismissed or otherwise resolved without payment and anticipated
future claims, the Company believes that it and its former subsidiary together
have sufficient additional insurance to cover the majority of its current and
estimated future asbestos-related liabilities. However, there can be no
assurance that such liabilities will be sufficiently covered. The foregoing is based on the Companys assumption that the number of
future claims filed per year and claim resolution payments will vary
considerably from year-to-year and by plaintiff, disease, venue and other
circumstances, but will, when taken as a whole, remain relatively consistent
with the Companys experience to date and will decline as the population of
potential future claimants expires due to non-asbestos-related causes. It is
also based on the results of the study discussed below, the Companys
evaluation of potentially available insurance coverage and its review of the
relevant case law. However, the Company recognizes that the number of future
claims filed per year and claim resolution payments could greatly exceed those
reflected by its past experience and contemplated by the study referenced
below, that the Companys belief of the range of its reasonably possible
financial exposure could change as the study referenced below is periodically
updated, that its evaluation of potentially available insurance coverage may
change depending upon numerous variables including risks inherent in
litigation, potential legislation, and the risk that one or more insurance
carriers may refuse or be unable to meet its obligations to the Company, and
that conclusions resulting from its review of relevant case law may be impacted
by future court decisions or legislative or other changes in the law. The Company is seeking defense and indemnity payments or an agreement to
pay from those carriers responsible for excess coverage whose levels of
coverage have been or will soon be reached. Although those excess carriers
have not yet agreed to defend or indemnify the Company, the Company believes
that it is likely that they will ultimately agree to do so, and that the
majority of its estimated future asbestos-related costs will ultimately be paid
or reimbursed by those carriers. However, since the Company has not yet
reached satisfactory agreements with those excess carriers, the Company will be
required to completely fund these matters while it seeks reimbursement from
those carriers. In order to maximize the likelihood of obtaining insurance
payments for these asbestos-related costs, on November 27, 2002, the Company
initiated litigation against its excess insurance carriers in a matter
captioned Hercules Incorporated v. OneBeacon, et al., Civil Action No.
02C-11-237 (SCD), Superior Court of Delaware, New Castle County. That
litigation is proceeding through discovery and motion practice, and trial is
currently scheduled in October 2004. Notwithstanding the filing of this
litigation, the Company is continuing settlement discussions with several of
its key insurers. The Company commissioned a study of its asbestos-related liabilities by
Professor Eric Stallard, who is a Research Professor of Demographic Studies at
a major national university and a Member of the American Academy of Actuaries.
Professor Stallard is a consultant with broad experience in estimating such
liabilities. Based on the results of the study undertaken by Professor
Stallard, the Company estimated that its reasonably possible financial exposure
for these matters (excluding approximately $1 million for previously settled
but unpaid claims) ranged from $220 million to $675 million. Due to inherent
uncertainties in estimating the timing and amounts of future payments, this
range does not include the effects of inflation and has not been discounted for
the time value of money. In addition, the range of financial exposures set
forth above does not include estimates for future legal costs. It is the
Companys policy to expense these costs as incurred. As stated above, the
Company presently believes that the majority of this range of financial
exposures will ultimately be funded by insurance proceeds. Cash payments
related to this exposure are expected to be made over an extended number of
years and actual payments, when made, could be for amounts in excess of the
range due to potential future changes in estimates as well as the effects of
inflation. Due to the dynamic nature of asbestos litigation and the present
uncertainty concerning the participation of its excess insurance carriers, the
Companys estimates are inherently uncertain, and these matters may present
significantly greater financial exposures than presently anticipated. In
addition, the Company intends to periodically update the asbestos study
referenced in the above paragraph, and further analysis combined with new data
received in the future could result in 52




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Hercules Incorporated
Notes to Consolidated Financial Statements a material modification of the range of
reasonably possible financial exposure set forth above. As a result of all of
the foregoing, the Companys liability with respect to asbestos-related matters
could exceed present estimates and may require
a material change in the accrued liability for these matters within the
next 12 months. If the Companys liability does exceed amounts recorded in the
balance sheet, the Company presently believes that the majority of any
additional liability it may reasonably anticipate will be paid or reimbursed by
its insurance carriers. However, there can be no assurance that such
liabilities will be reimbursed. The findings of the study referenced above identify a range of the
Companys reasonably possible financial exposure for these asbestos-related
matters. The Company increased its accrual for present and future potential
asbestos claims before anticipated insurance recoveries at December 31, 2003 to
$221 million, reflecting the low end of the range noted above and $1 million
for previously settled but unpaid asbestos cases, resulting in a charge of $55
million in the period related to these matters. At December 31, 2003, the
Company believes that it is probable that $169 million of the $221 million
accrual will be funded by or recovered from insurance carriers. That belief,
which is subject to the various assumptions set forth herein, is based on many
factors that have been evaluated by the Company, along with its outside
insurance coverage counsel, including the indemnity and defense payments that
have been made by its now exhausted insurers and by some of its other insurers,
the limits of remaining potentially available insurance coverage, and the range
of possible outcomes in the Companys insurance coverage litigation taking into
account, among other considerations, the facts and status of that litigation
and the relevant case law. At December 31, 2003, the Consolidated Balance
Sheet reflects a current insurance receivable of $7 million and a long-term
insurance receivable of $162 million. The Company does not offset estimated
insurance receivables against its estimated liability. In 2002, the Company recorded a gross accrual of $225 million for present
and future potential asbestos claims before anticipated insurance recoveries
resulting in a net charge of $65 million related to these matters in the period
ended September 30, 2002. At December 31, 2002, the Company had an accrual of
$216 million for the gross liability. The Company believes that it is probable
that $137 million of the $216 million accrual will be funded by or recovered
from insurance carriers. At December 31, 2002, the consolidated balance sheet
reflected a current insurance receivable of $9 million and a long-term
insurance receivable of $128 million. The Company, in conjunction with outside advisors, will continue to study
its asbestos-related matters, insurance recovery expectations and reserves on
an on-going basis, and make adjustments as appropriate. In August 1999, the Company was sued in an action styled as Cape
Composites, Inc. v. Mitsubishi Rayon Co., Ltd., Case No. 99-08260 (U.S.
District Court, Central District of California), one of a series of similar
purported class action lawsuits brought on behalf of purchasers (excluding
government purchasers) of carbon fiber and carbon prepreg in the United States
from the named defendants from January 1, 1993 through January 31, 1999. The
lawsuits were brought following published reports of a Los Angeles federal
grand jury investigation of the carbon fiber and carbon prepreg industries. In
these lawsuits, plaintiffs allege violations of Section 1 of the Sherman
Antitrust Act for alleged 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 of California), with all related cases ordered
dismissed. This lawsuit is proceeding through discovery and motion practice.
On May 2, 2002, the Court granted plaintiffs Motion to Certify Class. The
Company is named in connection with its former Composites Products Division,
which was sold to Hexcel Corporation in 1996, denies liability and will
vigorously defend this action. Since September 2001, the Company, along with the other defendants in the
Thomas & Thomas Rodmakers action referred to above, has been sued in nine
California state court purported class actions brought on behalf of indirect
purchasers of carbon fiber. In January 2002, these were consolidated into a
case captioned Carbon Fiber Cases I, II, and III, Judicial Council Coordination
Proceeding Nos. 4212, 4216 and 4222, Superior Court of California, County of
San Francisco. These actions all allege violations of the California Business
and Professions Code relating to alleged price fixing of carbon fiber and
unfair competition. The Company denies liability and will vigorously defend
each of these actions. In June 2002, a purported class action was filed in Massachusetts under
the caption Saul M. Ostroff, et al. v. Newport Adhesives, et al., Civil Action
No. 02-2385, Superior Court of Middlesex County. This matter is a purported
class action brought on behalf of consumers who purchased merchandise
manufactured with carbon fiber, and alleges the same types of price fixing
activities alleged in the actions described in the above two paragraphs. In
October 2002, the Company was notified that Horizon Sports Technologies had
opted out of the federal antitrust class action described above (Thomas &
Thomas Rodmakers) and filed its own suit against Hercules and the other
defendants in that action (Horizon Sports Technologies, Inc. v. Newport
Adhesives and Composites, Inc., et al., Case No. CV02-8126 FMC (RNEX), U.S.
District Court, Central District of California, Western Division). Further, in April 2002, a related Qui Tam action was unsealed by the
U.S. District Court for the Southern District of California. That action is
captioned Randall M. Beck, et al. v. Boeing Defense and Space Group, Inc., et
al., 53




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Hercules Incorporated
Notes to Consolidated Financial Statements (Civil Action No. 99 CV 1557 JM JAH), was filed under seal in 1999, and is
a False Claims action brought pursuant to the False Claims Act (31 U.S.C.
Section 729 et seq.). In that action, the relators, in the name of the U.S.
Government, allege the same price fixing activities which are the subject of
the above-described actions. The relators then allege that those alleged price
fixing activities resulted in inflated prices being charged by the defendant
carbon fiber manufacturers to
defense contractors, who, in turn, submitted claims for payment to the
U.S. Government under various government contracts. It is alleged that those
claims for payment were false claims because the prices charged for the
carbon fiber and carbon prepreg were fixed contrary to the laws of the United
States. By Order dated November 14, 2002, the Court dismissed the relators
complaint without prejudice because the complaint did not meet certain pleading
requirements under the Federal Rules of Civil Procedure. The relators filed a
First Amended Complaint on January 3, 2003. By Order dated July 29, 2003, the
Court dismissed the First Amended Complaint without prejudice for similar
reasons and provided the relators thirty days to re-file their complaint; that
time period was subsequently extended by sixty days. The relators filed a
Second Amended Complaint on or about October 30, 2003. The defendants have
filed a motion to have that complaint dismissed, but no decision has yet been
issued by the Court. The Company denies liability and will vigorously defend
each of these actions. In connection with the grand jury investigation noted above in the
paragraph describing the Cape Composites litigation, in January 2000, the
United States Department of Justice (DOJ), Antitrust Division, served a grand
jury subpoena duces tecum upon Hercules. The Company has been advised that it
is one of several manufacturers of carbon fiber and carbon prepreg that have
been served with such a subpoena. In December 2003, the Company was advised
that the grand jury investigation had been closed. In November 2002, an action for declaratory judgment was filed in the U.S.
District Court for the District of Delaware under the caption of Atofina
Chemicals, Inc. and Atofina v. Hercules Incorporated (Civil Action No.
02-1613). In this action, Atofina sought a declaratory judgment that Hercules
cannot recover antitrust damages for purchases of monochloracetic acid (MCAA)
that Hercules made outside of the United States or for purchases from producers
of MCAA not alleged to have participated in any conspiracy to fix prices and
allocate the market for MCAA. In response, Hercules counter-claimed, seeking
damages from and injunctive relief against Akzo Nobel Chemicals, Atofina
Chemicals, Hoechst AG, Hoechst Celanese, Clariant and others related to the
fixing of prices of MCAA and sodium monochloracetate from approximately 1995
through 2000. The lawsuit is in pre-trial proceedings. Hercules has settled
with some of the parties. The terms of the settlements are confidential. By Order dated May 6, 2003, the U.S. District Court for the Middle
District of Louisiana remanded to the 18th Judicial District Court for the
Parish of Iberville, Louisiana, a total of nine (9) consolidated lawsuits,
including two (2) lawsuits in which the Company is a defendant. These two
lawsuits, Jerry Oldham, et al. v. The State of Louisiana, et al., Civil Action
No. 55,160, 18th Judicial District Court, Parish of Iberville, Louisiana, and
John Capone, et al. v. The State of Louisiana, et al., Civil Action No.
56,048C, 18th Judicial District Court, Parish of Iberville, Louisiana, were
served on the Company in September 2002 and October 2002, respectively. The
Oldham case is a purported class action comprised of as many as 4,000
plaintiffs, and the Capone case is a consolidated action by approximately 50
plaintiffs. Both actions assert claims against the State of Louisiana, the
Company, American PetroFina, 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 in Iberville Parish, allege injury and fear
of future illness from the consumption of contaminated water and, specifically,
elevated levels of arsenic in that water. As to the Company, plaintiffs allege
that the Company itself and as part of a joint venture, operated a nearby plant
and, as part of those operations, used a groundwater injection well to dispose
of various wastes, and that those wastes contaminated the potable water supply
at Georgia Gulf. On October 17, 2002, the Company removed these matters to
federal court. In January 2003, the U.S. District Court for the Middle
District of Louisiana consolidated the Capone and Oldham matters with other
lawsuits in which the Company is not a party. Plaintiffs sought remand which,
as noted above, was granted by Order dated May 6, 2003. Discovery is
continuing. The Company denies any liability and intends to vigorously defend
these matters. On January 31, 2003, the Court granted a Motion for Class Certification in
a lawsuit captioned Douglas C. Smith, Individually and on Behalf of All Others
Similarly Situated v. Hercules Incorporated and Thomas Gossage, CA No.
01C-08-291 WCC, Superior Court of Delaware, New Castle County. This lawsuit,
which was filed on August 31, 2001, on behalf of Mr. Smith and a class of
approximately 130 present and former Hercules employees, seeks payments under
the Integration Synergies Incentive Compensation Plan (the Plan), a program
put into place by the Company following its acquisition of BetzDearborn Inc. in
October 1998. The goal of the Plan was to provide certain financial incentives
to specific employees who were deemed to have significant impact on the
integration of BetzDearborn Inc. into Hercules Incorporated. The amount to be
paid under the Plan was tied to the successful achievement of synergies,
which were defined as the annualized reduction of expenses or improvement of
profits realized as a result of the integration of BetzDearborn Inc. into
Hercules. The lawsuit essentially alleges that the payments made under the
Plan were not adequate and that the Company breached the terms of the Plan.
The lawsuit seeks payments of between $25 million and $30 million, although the
Company does not believe that any payments are owed to the class members. In
February 2003, plaintiffs 54




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Hercules Incorporated
Notes to Consolidated Financial Statements agreed to dismiss Thomas Gossage from the lawsuit.
In June 2003, potential members who had previously signed releases in favor of
the Company were provided an opportunity to opt in to the class, and the
remaining class members were provided an opportunity to opt out of the class.
As a result of this process, the size of the class has been reduced to
approximately 87 members and, as a result, the maximum potential damages
payable to the class, even should plaintiffs
prevail, should be significantly lower than the amounts noted above.
Trial is scheduled for April 2004. The Company denies any liability to the
plaintiffs and is vigorously defending this action. Agent Orange is a defoliant that was manufactured by several companies,
including Hercules, at the direction of the U.S. Government, and used by the
U.S. Government in military operations in both Korea and Vietnam from 1965 to
1970. In 1984, as part of a class action settlement, the Company and other
defendants settled the claims of persons who were in the U.S., New Zealand and
Australian Armed 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, all claims for alleged injuries due to exposure to
Agent Orange by persons who had served in the Armed Forces of those countries
were treated as covered by that class action settlement. On June 9, 2003, the United States Supreme Court affirmed the decision of
the United States Court of Appeals for the Second Circuit in a case captioned
Dow Chemical Company, et al. v. Daniel Raymond Stephenson, et al., 123 S. Ct.
2161 (2003), where plaintiffs Stephenson and Isaacson (in a separate but
consolidated case) alleged that they were injured from exposure to Agent Orange
and that such injury did not manifest until after exhaustion of the settlement
fund created through the 1984 class action settlement. As a result of that
decision, the claims of persons who allege injuries due to exposure to Agent
Orange and whose injuries first manifest themselves after exhaustion of the
settlement fund created through the 1984 class action settlement may no longer
be barred by the 1984 class action settlement, and such persons may now be able
to pursue claims against the Company and the other former manufacturers of
Agent Orange. At this time, the Company is a defendant in twenty lawsuits (including two
purported class actions) where plaintiffs allege that exposure to Agent Orange
caused them to sustain various personal injuries. In addition, in January
2004, the Company was sued in a class action filed in the United States
District Court for the Eastern District of New York by The Vietnam Association
for Victims of Agent Orange/Dioxin and several individuals who claim to
represent between two and four million Vietnamese who allege that Agent Orange
used by the United States during the Vietnam War caused them or their families
to sustain personal injuries. That complaint alleges violations of
international law and war crimes, as well as violations of the common law for
products liability, negligence and international torts. On February 9, 2004, the U.S. District Court for the Eastern District of
New York issued a series of rulings granting several motions filed by
defendants in the two cases that had been remanded to the U.S. District Court
by the U.S. Court of Appeals for the Second Circuit on remand from the U.S.
Supreme Court (In re: Agent Orange Product Liability Litigation: Joe
Isaacson, et al v. Dow Chemical Company, et al. and Daniel Ray Stephenson, et
al. v. Dow Chemical Company, et al. (MDL 381, CV 98-6383 (JBW), CV 99-3056
(JBW))). In relevant part, those rulings held that plaintiffs claims against
the defendant manufacturers of Agent Orange are properly removable to federal
court under the federal officer removal statute and that such claims are
subject to dismissal by application of the government contractor defense.
The Court then dismissed plaintiffs claims, but stayed its decision until
October 12, 2004, to permit plaintiffs time to pursue additional discovery to
support their position that the government contractor defense should not apply
to their claims, and to seek reconsideration of the Courts dismissal order. The Company believes that it has substantial meritorious defenses to all
of the Agent Orange-related claims described above, and that may yet be
brought. To that end, the Company denies any liability to plaintiffs, and will
vigorously defend all actions now pending or that may be brought in the future. On October 6, 2003, the Company received a Notice of Deficiency with
respect to the Companys 1996 through 1997 federal income tax returns wherein,
among other issues, the IRS is disallowing a capital loss that the Company
carried back to 1996 and 1997. The IRS has indicated that it will not settle
that issue prior to a final decision after trial on the merits. The IRS has
indicated that it is willing to address the other issues included in the Notice
of Deficiency through standard IRS administrative appeals procedures without
litigation. On December 23, 2003, the Company filed a Petition asking the U.S.
Tax Court for a re-determination of the deficiency set forth in the October 6,
2003 Notice of Deficiency. The Company believes that it is remote that the
ultimate disposition of these issues will have a material adverse impact on the
Companys financial position in light of existing tax reserves and amounts
already on deposit with the IRS. At December 31, 2003, the consolidated balance sheet reflects a current
liability of approximately $49 million and a long-term liability of
approximately $176 million for litigation and claims. These amounts represent
managements best estimate of the probable and reasonably estimable losses
related to litigation or claims. The extent of the liability and recovery is
evaluated quarterly. While it is not feasible to predict the outcome of all
pending suits and claims, the ultimate resolution of these matters could have a
material effect upon the financial position of Hercules, and the resolution of
any of the matters during a specific period could have a material effect on the
quarterly or annual operating results for that period. 55




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Hercules Incorporated
Notes to Consolidated Financial Statements 14. Company-obligated Preferred Securities of Subsidiary Trusts The Company has determined that (i) Hercules Trust I and Hercules Trust II
(the Trusts) are variable interest entities and (ii) the Company is not the
primary beneficiary of the Trusts pursuant to the provisions of FASB
Interpretation No. 46 (revised December 2003), Consolidation of Variable
Interest Entities (FIN 46R). Accordingly, the Company has de-consolidated
the Trusts at December 31, 2003. Summarized below is the condensed financial
information of the Trusts as of December 31, 2003.


(Dollars in millions)Hercules
    
    HerculesTrust I
    
    Trust IINon-current assets
    
    
    363
    
    
    
    262Non-current liabilities
    
    
    363
    
    
    
    262


The non-current assets for Hercules Trust I relates to its investment in
the 9.42% junior subordinated deferrable interest debentures of Hercules due
March 31, 2029. The non-current assets for Hercules Trust II represent its
investment in the 6.50% junior subordinated deferrable interest debentures of
Hercules due June 30, 2029.

15. Series Preferred Stock

There are 2,000,000 shares of series preferred stock without par value
authorized for issuance, none of which have been issued.

16. Common Stock

Hercules common stock has a stated value of $25/48, and 300,000,000 shares
are authorized for issuance. At December 31, 2003, a total of 26,819,747
shares were reserved for issuance for the following purposes: 8,164 shares for
sales to the Savings Plan Trustee; 17,086,259 shares for the exercise of awards
under the Stock Option Plan; 2,429,395 shares for awards under incentive
compensation plans; 176,492 shares for conversion of debentures and notes; and
7,119,437 shares for exercise of the warrant component of the CRESTS Units.

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

17. Additional Balance
Sheet Detail (Restated)

(Dollars in millions)2003
    
    2002Property, plant and equipment:Land
    
    $
    20
    
    
    $
    21Buildings and equipment
    
    
    1,979
    
    
    
    1,873Construction in progress
    
    
    40
    
    
    
    31Total
    
    
    2,039
    
    
    
    1,925Accumulated depreciation and amortization
    
    
    (1,362
    )
    
    
    (1,262
    )Property, plant and equipment, net
    
    $
    677
    
    
    $
    663
 (Dollars in millions)2003
    
    2002As Restated(Note 26)Deferred charges and other assets:Insurance receivables  non-current
    
    $
    162
    
    
    $
    128Tax deposits
    
    
    52
    
    
    
    87Capitalized software
    
    
    84
    
    
    
    86Prepaid pension assets
    
    
    35
    
    
    
    21Investments
    
    
    51
    
    
    
    7Other
    
    
    81
    
    
    
    127$
    465
    
    
    $
    456
 56




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Hercules Incorporated
Notes to Consolidated Financial Statements (Dollars in millions)2003
    
    2002Accrued expenses:Compensation and benefits
    
    $
    57
    
    
    $
    48Income taxes payable
    
    
    14
    
    
    
    7Current deferred income taxes
    
    
    8
    
    
    
    6Current pension liability
    
    
    8
    
    
    
    5Severance and other exit costs
    
    
    6
    
    
    
    22Interest payable
    
    
    8
    
    
    
    10Current portion of postretirement benefits
    
    
    23
    
    
    
    23Current portion of litigation accrual
    
    
    4
    
    
    
    4Current portion of asbestos accrual
    
    
    45
    
    
    
    24Current portion of environmental accrual
    
    
    19
    
    
    
    27Other
    
    
    51
    
    
    
    101$
    243
    
    
    $
    277
 (Dollars in millions)2003
    
    2002Deferred credits and other liabilities:Asbestos accrual  non-current
    
    $
    176
    
    
    $
    193Environmental accrual  non-current
    
    
    87
    
    
    
    61Non-current income tax liabilities
    
    
    99
    
    
    
    110Deferred rent
    
    
    45
    
    
    
    51Other
    
    
    87
    
    
    
    78$
    494
    
    
    $
    493
 18. Severance and Other Exit Costs The consolidated balance sheet reflects liabilities for employee severance
benefits and other exit costs of $6 million and $22 million at December 31,
2003 and 2002, respectively. During 2001, management authorized and committed
to a plan to reduce the workforce as part of the comprehensive cost reduction
and work process redesign program, incurring $51 million of restructuring
charges for employee termination benefits and exit costs related to facility
closures. During 2002, the estimate for severance benefits and other exit
costs related to facility closures and contract terminations increased $22
million and $3 million, respectively. During 2003, the Company incurred $2
million of additional charges, constituting the final employee termination
benefits under this plan. The Company incurred an additional $5 million for
employee termination benefits, recognized in accordance with Statement of
Financial Accounting Standards No. 112, Employers Accounting for
Post-employment Benefits, under its Dismissal Salary and Dismissal Wage Plans
(Dismissal Plans). Under these combined plans, approximately 1,412 employees
have left or will leave the Company by June 30, 2004, of which 1,387 employees
were terminated pursuant to these plans through December 31, 2003.
Approximately 173 employees were terminated during the year ended December 31,
2003. The Company anticipates the remaining 25 employees will leave the
Company prior to June 30, 2004. The plans include reductions throughout the
Company with the majority of them from support functions. The restructuring liabilities, as of December 31, 2002, also included
amounts relating to the 1998 plan initiated upon the acquisition of
BetzDearborn for the restructuring of the BetzDearborn and Pulp and Paper
Divisions and corporate realignment due to the divestiture of non-core
businesses. Cash payments during 2003 and 2002 included $21 million and $39 million,
respectively, for severance benefits and other exit costs. Severance benefits
paid during the current year represent the continuing benefit streams of
previously terminated employees as well as those terminated in the current
year. During 2002, the Company completed assessments of the remaining
expenditures for the 1998 BetzDearborn plan. As a result of these assessments,
the estimates for severance benefits and other exit costs were lowered by $5
million in 2002, with corresponding reductions to goodwill of $3 million and to
expense of $2 million. During 2003, the remaining balance related to the 1998
plan was reversed against earnings. The lower than planned severance benefits
are the result of higher than anticipated attrition, with voluntary
resignations not requiring the payment of termination benefits. Actions under
the 1998 plan are complete. 57




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Hercules Incorporated
Notes to Consolidated Financial Statements A reconciliation of activity with respect to the liabilities established
for these plans is as follows: (Dollars in millions)2003
    
    2002Balance at beginning of year
    
    $
    22
    
    
    $
    43Additional termination benefits and other exit costs
    
    
    7
    
    
    
    25Cash payments
    
    
    (21
    )
    
    
    (39
    )Reversals against goodwill
    
    
    
    
    
    
    (3
    )Reversals against earnings
    
    
    (2
    )
    
    
    (2
    )Transferred with discontinued operations
    
    
    
    
    
    
    (2
    )Balance at end of year
    
    $
    6
    
    
    $
    22
 The balance at the end of 2003 represents severance benefits and other
exit costs of which $3 million pertains to the continuing benefit payment
streams under the 2001 restructuring plan and $3 million pertains to other
severance benefits accounted for under the Companys Dismissal Plans. Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 146, Accounting for Costs Associated with Exit or
Disposal Activities (SFAS 146). SFAS 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs in a Restructuring). SFAS 146 defines the timing of the
recognition of costs associated with exit or disposal activities, the types of
costs that may be recognized and the methodology for calculating the fair value
of such costs. The Company did not recognize any costs associated with exit or
disposal activities pursuant to SFAS 146 during the year ended December 31,
2003. 19. Other Operating Expense (Income), Net Other operating expense, net, in 2003 includes $5 million of net charges
for severance and other exit costs (see Note 18) and proxy and executive
benefit costs of $4 million and $7 million, respectively. The executive
benefit costs include approximately $5 million of special pension benefits
granted to Dr. William H. Joyce prior to his retirement as the Companys Chief
Executive Officer and approximately $2 million for the vesting of Dr. Joyces
previously granted restricted stock units. The Company also recognized net
expense of $1 million in 2003 as a result of resolving issues related to prior
year transactions. Other operating expense (income), net, in 2002 includes $11 million of net
environmental expense and additional restructuring charges of $25 million
associated with the comprehensive cost reduction and work process redesign
program announced in September 2001 (see Note 18). Partially offsetting these
restructuring charges was $2 million of reversals pertaining to prior year
plans. Additionally, the Company recognized $7 million in asset impairment
charges in the Performance Products segment. As a result of resolving issues
relating to prior year business divestitures, an additional loss of $2 million
was recognized. Miscellaneous expenses of $3 million were also incurred during
the year. Other operating expense (income), net, in 2001 includes $74 million in net
gains from the sale of the Companys hydrocarbon resins business, select
portions of its rosin resins business, its peroxy chemicals business and its
50% interest in Hercules-Sanyo, Inc. In addition, a pension curtailment gain
of $5 million was recognized related to the divestiture of the Companys
hydrocarbon resins business and select portions of its rosins resins business.
As a result of resolving issues relating to a prior year business divestiture,
an additional gain of $5 million was recognized. The Company incurred $51
million in restructuring charges associated with the comprehensive cost
reduction and work process redesign program (see Note 18). Partially
offsetting these restructuring charges was $5 million of reversals pertaining
to prior year plans. In addition, the Company recognized $10 million in net
environmental expense, $5 million of executive severance charges, $5 million in
pre-payment penalties relating to the ESOP credit facility, $3 million in fees
related to the 2001 proxy contest and other matters and $1 million of income
for other miscellaneous items. 58




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements 20. Interest and Debt Expense Interest and debt costs are summarized as follows: (Dollars in millions)2003
    
    2002
    
    2001Costs incurred
    
    $
    131
    
    
    $
    100
    
    
    $
    207Amount capitalized
    
    
    
    
    
    
    1
    
    
    
    3Amount expensed
    
    $
    131
    
    
    $
    99
    
    
    $
    204
 Interest and debt costs incurred in 2002 and 2001 exclude interest costs
on the Companys preferred securities. These costs were recognized as
preferred security distributions of subsidiary trusts prior to 2003. Pursuant
to the Companys adoption of SFAS 150 on July 1, 2003, interest and debt costs
on the preferred securities has been recognized as interest and debt expense
for 2003 (see Note 6). 21. Other Expense, Net Other expense, net, consists of the following: (Dollars in millions)2003
    
    2002
    
    2001Litigation settlements and accruals, net
    
    $
    24
    
    
    $
    6
    
    
    $
    13Net gains on dispositions
    
    
    
    
    
    
    (3
    )
    
    
    (3
    )Debt extinguishment
    
    
    
    
    
    
    44
    
    
    
    Repurchase of CREST preferred securities
    
    
    (7
    )
    
    
    
    
    
    
    Repurchase of 11.125% senior notes
    
    
    5
    
    
    
    
    
    
    
    Asbestos accruals, net
    
    
    6
    
    
    
    65
    
    
    
    3Asset impairment
    
    
    2
    
    
    
    
    
    
    
    Foreign currency exchange
    
    
    1
    
    
    
    (2
    )
    
    
    (6
    )Other, net
    
    
    (2
    )
    
    
    5
    
    
    
    1$
    29
    
    
    $
    115
    
    
    $
    8
 Litigation settlements and accruals, net, in all years primarily represent
certain other legal expenses and settlements associated with former operations
of the Company. Litigation settlements and accruals in 2003 include, among
other items, $7 million for expenses related to asbestos litigation, $6 million
for workers compensation related to divested businesses and $5 million for
legal costs primarily associated with former operations of the Company. The
Company recognized $6 million, $65 million and $3 million in net charges for
additional estimated asbestos litigation exposures for years ended December 31,
2003, 2002 and 2001, respectively, (see Note 13). Additionally, in 2002, the
Company recognized $44 million for debt prepayment penalties and the write-off
of debt issuance costs associated with the repayment of debt with the proceeds
from the sale of the BetzDearborn Water Treatment Business (see Notes 6 and
25). Net gains on dispositions include a $3 million gain from the sale of the
corporate jet, hangar and artwork in 2002 and a $3 million gain from the sale
of the country club in 2001. The Company recognized a net gain of $7 million ($5 million after tax) on
the purchase of 46,000 CRESTS Units preferred securities and a $5 million loss
from the repurchase of 11 1/8% senior notes which had a book value of $24
million. With respect to the gain on the CRESTS Units preferred securities,
pursuant to the adoption of FIN 46(R) the Company de-consolidated Hercules
Trust II and recognized an after-tax loss of $5 million as a cumulative effect
of a change in accounting principle to defer the gain from the purchase of the
CRESTS Units preferred securities until Hercules Trust II is liquidated. 59




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Hercules Incorporated
Notes to Consolidated Financial Statements 22. Earnings (Loss) per Share The following table shows the amounts used in computing earnings (loss)
per share and the effect on income (loss) and the weighted-average number of
shares of dilutive common stock: (Dollars in millions, except per share)2003
    
    2002
    
    2001Earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    (Loss)Income
    
    (loss)
    
    
    
    
    
    Loss per
    
    (Loss)
    
    earnings(loss)
    
    per share
    
    Loss
    
    share
    
    income
    
    per shareBasic:Continuing operations
    
    $
    74
    
    
    $
    0.69
    
    
    $
    (47
    )
    
    $
    (0.44
    )
    
    $
    (109
    )
    
    $
    (1.04
    )Discontinued operations
    
    
    4
    
    
    
    0.04
    
    
    
    (196
    )
    
    
    (1.85
    )
    
    
    56
    
    
    
    0.53Cumulative effect of changes
in accounting principle
    
    
    (33
    )
    
    
    (0.31
    )
    
    
    (368
    )
    
    
    (3.47
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    45
    
    
    $
    0.42
    
    
    $
    (611
    )
    
    $
    (5.76
    )
    
    $
    (53
    )
    
    $
    (0.51
    )Weighted average number
of basic shares (millions)
    
    
    107.8(b)
    
    
    
    
    
    
    
    106.0(b)
    
    
    
    
    
    
    
    104.8(b)Diluted:Continuing operations
    
    $
    74
    
    
    $
    0.69
    
    
    $
    (47
    )
    
    $
    (0.44
    )
    
    $
    (109
    )
    
    $
    (1.04
    )Discontinued operations
    
    
    4
    
    
    
    0.04
    
    
    
    (196
    )
    
    
    (1.85
    )
    
    
    56
    
    
    
    0.53Cumulative effect of changes
in accounting principle
    
    
    (33
    )
    
    
    (0.31
    )
    
    
    (368
    )
    
    
    (3.47
    )
    
    
    
    
    
    
    Net income (loss)
    
    $
    45
    
    
    $
    0.42
    
    
    $
    (611
    )
    
    $
    (5.76
    )
    
    $
    (53
    )
    
    $
    (0.51
    )Weighted average number
of diluted shares (millions)
    
    
    107.9
    (a,b)
    
    
    
    
    
    
    106.0
    (a,b)
    
    
    
    
    
    
    104.8
    (a,b)
  (a)
    
    For the years ended December 31, 2003, 2002 and 2001, the Company had
approximately 0.2 million convertible subordinated debentures. However,
the common stock shares into which these debentures are convertible have
not been included in the dilutive share calculations for the years 2002
and 2001 because the impact of their inclusion would be anti-dilutive.(b)
    
    The Company has restated its basic and diluted weighted-average
number of shares pursuant to the method prescribed by SOP 93-6 which
requires the exclusion of unallocated employee stock ownership plan shares from the calculation of shares outstanding (see Note 1). 23. Operations by Industry Segment and Geographic Area The financial information below regarding the Companys segments, which
includes net sales, profit from operations and capital employed, is presented
in accordance with Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information (SFAS
131). Subsequent to the sale of the BetzDearborn Water Treatment Business on
April 29, 2002, the Company realigned its segments. The Company has identified
two reportable segments, Performance Products and Engineered Materials and
Additives. Historical information has been restated to conform to the current
presentation. Performance Products (Pulp and Paper and Aqualon):Products and services
in Pulp and Paper are designed to enhance customers profitability by improving
production yields and overall product quality, and to better enable customers
to meet their environmental objectives and regulatory requirements. The Company believes Pulp and Paper is one of the largest suppliers of
functional process and water management chemicals for the pulp and paper
industry. Pulp and Paper offers a wide and highly-sophisticated range of
technology and applications expertise with in-mill capabilities which run from
influent treatment through the paper machine to paper finishing. The Company
is a broad-based global supplier able to offer a complete portfolio of products
to its paper customers. The products in Aqualon are principally derived from natural resources and
are sold as key raw materials to other manufacturers. Principal products and
markets include water-soluble polymers used as thickeners, emulsifiers and
stabilizers for water-based paints, oil and gas exploration, building materials
and personal care products. 60




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Engineered Materials and Additives(FiberVisions and Pinova):Products in
this segment provide low-cost, technology driven solutions to meet customer
needs and market demands. Principal products and markets include polyolefin
staple fibers used in disposable diapers, wipes and other hygienic products;
industrial fiber products; rosin and hydrocarbon resins for adhesives; food and
beverage; flavor and fragrance; and construction specialties. The Company evaluates performance and makes decisions based primarily on
cash flow, profit from operations and return on capital employed. Consolidated
capital employed represents the total resources employed in the Company and is
the sum of total debt, Company-obligated preferred securities of subsidiary
trusts and stockholders equity. Capital employed in each reportable segment
represents the net operating assets employed to conduct business in that
segment and generally includes working capital (excluding cash) and property,
plant and equipment. Other assets and liabilities, primarily goodwill and
other intangibles, not specifically allocated to business segments, are
reflected in corporate in the table below. Hercules has no single customer representing greater than 10% of its
revenues. Geographic Reporting For geographic reporting, no single country, outside the United States, is
material for separate disclosure. However, because the Company has significant
foreign operations, revenues and net property, plant and equipment are
disclosed by geographic region. Revenues are reported on a customer basis, meaning that net sales are
included in the geographic area where the customer is located. Net property,
plant and equipment is included in the geographic areas in which the producing
entities are located. Intersegment sales are eliminated in consolidation. 61




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Hercules Incorporated
Notes to Consolidated Financial Statements (Dollars in millions)EngineeredPerformance
    
    Materials andIndustry Segments
    
    Products
    
    Additives
    
    Corporate
    
    
    
    
    
    Consolidated2003Net sales
    
    $
    1,483
    
    
    $
    363
    
    
    $
    
    
    
    
    
    
    
    $
    1,846Profit (loss) from operations
    
    
    262
    
    
    
    9
    
    
    
    (16
    )(c)
    
    
    
    
    
    
    255Interest and debt expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    131Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other expense, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29Income before income taxes and equity income (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    95Capital employed (a)
    
    
    1,189
    
    
    
    287
    
    
    
    (48
    )(b)
    
    
    
    
    
    
    1,428Capital expenditures
    
    
    39
    
    
    
    5
    
    
    
    4
    
    
    
    
    
    
    
    48Depreciation and amortization
    
    
    74
    
    
    
    21
    
    
    
    5
    
    
    
    
    
    
    
    1002002*Net sales
    
    $
    1,385
    
    
    $
    320
    
    
    $
    
    
    
    
    
    
    
    $
    1,705Profit (loss) from operations
    
    
    243
    
    
    
    18
    
    
    
    (41
    )(c)
    
    
    
    
    
    
    220Interest and debt expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    99Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58Other expense, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115Loss before income taxes and equity income (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (52
    )Capital employed (a)
    
    
    1,085
    
    
    
    235
    
    
    
    64
    (b)
    
    
    
    
    
    
    1,384Capital expenditures
    
    
    31
    
    
    
    9
    
    
    
    3
    
    
    
    
    
    
    
    43Depreciation and amortization
    
    
    72
    
    
    
    18
    
    
    
    10
    
    
    
    
    
    
    
    1002001*Net sales
    
    $
    1,351
    
    
    $
    425
    
    
    $
    
    
    
    
    
    
    
    $
    1,776Profit (loss) from operations
    
    
    154
    
    
    
    11
    
    
    
    19
    (d)
    
    
    
    
    
    
    184Interest and debt expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    204Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    58Other expense, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8Loss before income taxes and equity income (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (86
    )Capital employed (a)
    
    
    479
    
    
    
    116
    
    
    
    2,697
    (b)
    
    
    
    
    
    
    3,292Capital expenditures
    
    
    35
    
    
    
    10
    
    
    
    7
    
    
    
    
    
    
    
    52Depreciation and amortization
    
    
    80
    
    
    
    32
    
    
    
    22
    
    
    
    
    
    
    
    134
 *Prior year information has been restated for the Companys change in method of
accounting for its Employee Stock Ownership Plan (see Note 1). 62




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Hercules Incorporated
Notes to Consolidated Financial Statements UnitedGeographic Areas
    
    States
    
    Europe
    
    Americas (e)
    
    Asia Pacific
    
    Total2003Net Sales
    
    $
    885
    
    
    $
    693
    
    
    $
    94
    
    
    $
    174
    
    
    $
    1,846Property, plant and equipment, net
    
    
    344
    
    
    
    303
    
    
    
    12
    
    
    
    18
    
    
    
    6772002Net Sales (f)
    
    $
    870
    
    
    $
    586
    
    
    $
    89
    
    
    $
    160
    
    
    $
    1,705Property, plant and equipment, net
    
    
    350
    
    
    
    280
    
    
    
    12
    
    
    
    21
    
    
    
    6632001Net Sales (f)
    
    $
    928
    
    
    $
    587
    
    
    $
    104
    
    
    $
    157
    
    
    $
    1,776Property, plant and equipment, net
    
    
    523
    
    
    
    302
    
    
    
    41
    
    
    
    37
    
    
    
    903
  (a)
    
    Represents total segment assets net of operating liabilities. The
2001 figures do not include the capital employed by the divested Water
Treatment Business.  (b)
    
    Includes assets and liabilities not specifically allocated to
business segments, primarily intangibles and other long-term assets, net
of liabilities, except the 2001 balance which also includes goodwill.  (c)
    
    Includes net environmental charges, restructuring charges relating to
the 2001 cost reduction program (see Note 18), and years 2002 and 2001
include additional loss recognition relating to prior year business
divestitures. Partially offsetting these charges were restructuring
reversals pertaining to prior year plans (see Note 18).  (d)
    
    Includes environmental charges, legal and insurance expenses,
pre-payment penalties relating to the ESOP credit facility (see Note 10)
and restructuring charges relating to the 2001 cost reduction program
(see Note 18). Partially offsetting these charges were net gains from
the sale of the hydrocarbon resins business, select portions of the
rosins resins business and the peroxy chemicals business, restructuring
reversals pertaining to prior year plans, a pension curtailment gain and
an additional gain recognition relating to a prior year business
divestiture.  (e)
    
    Excluding operations in the United States of America.  (f)
    
    Excludes sales of the divested BetzDearborn Water Treatment Business. 24. Derivative Financial Instruments and Risk Management The Company enters into forward-exchange contracts and currency options to
reduce currency exposure. Notional Amounts and Credit Exposure of Derivatives The notional amounts of the derivative contracts summarized below do not
represent the amounts exchanged by the parties involved and thus, are not a
measure of the Companys exposure to various risks through its use of
derivatives. The amounts exchanged by the parties are calculated on the basis
of the notional amounts, underlyings such as interest rates and foreign
currency rates of exchange and other terms of the derivative contracts. Interest Rate Risk Management From time to time, the Company uses interest rate swap agreements to
manage interest costs and risks associated with changing rates. The Company
had no interest rate swap agreements at the end of 2003 and 2002. Foreign Exchange Risk Management The Company has selectively used foreign currency forward contracts and
currency swaps to offset the effects of foreign currency exchange rate changes
on reported earnings, cash flow and net asset positions. The primary exposures
are denominated in the Euro, Swedish kroner and British pound sterling. Some
of the contracts involved the exchange of two foreign currencies, according to
local needs in foreign subsidiaries. The term of the currency derivatives is
rarely more than three months. At December 31, 2003 and 2002, the Company had
outstanding forward-exchange contracts to purchase foreign currencies
aggregating $0.1 million and $17.8 million and to sell foreign currencies
aggregating $6.5 million and $18.8 million, respectively. Cross-currency
trades entered into by non-U.S. dollar denominated entities aggregated $376
million and $238 million at December 31, 2003 and 2002 respectively. The
foreign exchange contracts outstanding at December 31, 2003 matured on or
before March 1, 2004. 63




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Hercules Incorporated
Notes to Consolidated Financial Statements Fair Values The following table presents the carrying amounts and fair values of the
Companys financial instruments at December 31, 2003 and 2002: (Dollars in millions)2003
    
    2002Carrying
    
    Fair
    
    Carrying
    
    FairAmount
    
    Value
    
    Amount
    
    ValueInvestment securities (available for sale)
    
    $
    1
    
    
    $
    1
    
    
    $
    2
    
    
    $
    2Long-term debt
    
    
    (1,326
    )
    
    
    (1,364
    )
    
    
    (738
    )
    
    
    (777
    )Company-obligated preferred securities of subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    (624
    )
    
    
    (517
    )Foreign exchange contracts
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
 Fair values of derivative contracts are indicative of cash that would have
been required had settlement been made at December 31, 2003 and 2002. Basis of Valuation  
    
    Investment securities: Quoted market prices.  
    
    Long-term debt: Present value of expected cash flows related to existing borrowings discounted at rates currently
available to the Company for long-term borrowings with similar terms and remaining maturities.  
    
    Company-obligated preferred securities of subsidiary trusts: Year-end interest rates and Company common stock price.  
    
    Foreign exchange contracts: Year-end exchange rates.  
    
    Currency swaps: Year-end interest and exchange rates.  
    
    Interest rate swap contracts: Bank or market quotes or discounted cash flows using year-end interest rates. 25. Acquisitions, Divestitures and Other Subsequent Events On December 1, 2003, Hercules completed the acquisition of Jiangmen
Quantum Hi-Tech Biotechnical Engineering Co. Ltd. (Quantum). Quantum is the
leading producer of carboxymethylcellulose (CMC) products in China. Located in
Jiangmen City, Guangdong Province, the plant has current production capacity of
6,000 MT (metric tons) with room to expand. Quantums leading key markets
include food, toothpaste, ceramics and paper, with annual sales of
approximately $10 million. The Company has concluded the acquisition is a
business combination as defined in Statement of Financial Accounting Standards
No. 141, Business Combinations. The Company is in the process of identifying
and valuing all the acquired assets and liabilities, including all intangible
assets meeting the criteria for separate recognition. On April 29, 2002, Hercules completed the sale of the Water Treatment
Business to GESM, a unit of General Electric Company. The sale price was $1.8
billion in cash, resulting in net after-tax proceeds of approximately $1.7
billion. The Company used the net proceeds to prepay debt under its senior
credit facility and ESOP credit facility (see Notes 6 and 10). Pursuant to
SFAS 144 (as adopted on January 1, 2002), the Water Treatment Business has been
treated as a discontinued operation as of February 12, 2002, and accordingly,
all financial information has been restated. The loss from discontinued
operations for the year ended December 31, 2002 includes an after-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. when it was originally acquired in 1998, was fully integrated into and
continues to be reported within Pulp and Paper. 64




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Hercules Incorporated
Notes to Consolidated Financial Statements Summarized below are the results of operations and cash flows of the Water
Treatment Business for the years ended December 31, 2002 and 2001. (Dollars in millions)Year EndedDecember 31,2002 1
    
    2001Net Sales
    
    $
    269
    
    
    $
    844Profit from operations
    
    
    53
    
    
    
    118Income before income taxes
    
    
    55
    
    
    
    116Tax provision
    
    
    21
    
    
    
    60Income from operations
    
    
    34
    
    
    
    56Loss from disposal of business, including a provision
for income taxes of $51 million for 2002
    
    
    (230
    )
    
    
    (Loss) income from discontinued operations
    
    $
    (196
    )
    
    $
    56
 1 Results of operations for the period are through April 28, 2002. Cash Flow from Discontinued Operations (Dollars in millions)2002
    
    2001Net cash provided by operations
    
    $
    28
    
    
    $
    209Capital expenditures
    
    
    (3
    )
    
    
    (11
    )Net cash flow from discontinued operations
    
    $
    25
    
    
    $
    198
 The major classes of assets and liabilities included in the consolidated
balance sheet at the time of disposal were as follows: (Dollars in millions)Assets
    
    
    
    
    
    LiabilitiesAccounts receivables, net
    
    $
    161
    
    
    Accounts payable
    
    $
    55Inventory
    
    
    76
    
    
    Accrued expenses
    
    
    35Fixed assets
    
    
    217
    
    
    Other liabilities
    
    
    178Goodwill and other intangible assets
    
    
    1,419
    
    
    
    
    $
    268Other assets
    
    
    19$
    1,892
 On May 1, 2001, the Company completed the sale of its hydrocarbon resins
business and select portions of its rosin resins business to a subsidiary of
Eastman Chemical Company, receiving proceeds of approximately $244 million. On
May 31, 2001, the Company completed the sale of its peroxy chemicals business
to GEO Specialty Chemicals, Inc., receiving proceeds of approximately $92
million. Additionally, on May 25, 2001, the Company completed the sale of its
interest in Hercules-Sanyo, Inc., a toner resin joint venture, to Sanam
Corporation, a wholly-owned subsidiary of Sanyo Chemicals Industries, Ltd., the
Companys joint venture partner, receiving proceeds of approximately $8
million. On February 12, 2004, a subsidiary of the Company completed the sale of
its minority ownership in CP Kelco ApS to a subsidiary of J. M. Huber
Corporation for $27 million. 26. Restatement As
a result of its June 24, 2004 settlement with the Internal Revenue Service
(IRS) for the tax years 1990 through 1992 that indicated additional
tax liabilities for such audit cycle, the Company initiated a review of the GAAP
accounting for income taxes for the tax years 1987 through 1995. In conjunction
with this review, the Company undertook an effort to analyze and reconcile the
various general ledger tax account balances relative to the tax years 1990
through 1992, which expanded to encompass the handling of adjustments that
should have occurred relative to the previously settled tax years 1987 through
1989 and the open tax years 1993 through 1995. In addition, the Company also
reviewed the tax years 1996 and forward to confirm that there were no further
implications in years subsequent to 1995 with respect to issues identified as a
result of the 1987 through 1995 analysis. The review indicated cumulative
additional tax liabilities for the years 1987 through 1995 that had not been
reconciled to the various general ledger tax account balances. Based
on this review, on November 9, 2004, the Companys Chief Financial Officer
determined that previously issued financial statements cannot be relied upon and
that restatement of such previously issued financial statements is required. The
Audit Committee of the Board of Directors (Audit Committee)
concurred with this determination. The adjustments reflected in this Form 10-K/A
primarily relate to the computation and application of foreign tax credits and
reduce the tax deposit asset by $65 million, increase deferred
tax assets by $17 million, and, as a result of the cumulative additional income tax expense to be
recorded for the restated periods, reduce retained earnings and
stockholders equity by $48 million as of January 1, 1996 and for
previously reported periods affected through December 31, 2003. The restatement
does not affect the previously reported results of operations for any periods
subsequent to December 31, 1995. The following table reflects the impact of the
restatement adjustments on the Consolidated Balances Sheets as of
December 31,
2003 and 2002, respectively: (Dollars in millions) Previously
    
    As
    
    Net IncreaseReported
    
    Restated
    
    (Decrease)As of December 31, 2003:Deferred income taxes (non-current asset)
    
    $
    27
    
    
    $
    44
    
    
    $
    17Deferred
charges and other assets (tax deposits)*
    
    
    537
    
    
    
    465
    
    
    
    (72
    )Total assets
    
    
    2,766
    
    
    
    2,711
    
    
    
    (55
    )Unearned
compensation*
    
    
    (80
    )
    
    
    (87
    )
    
    
    (7
    )Retained earnings
    
    
    1,543
    
    
    
    1,495
    
    
    
    (48
    )Total
stockholders equity*
    
    
    66
    
    
    
    11
    
    
    
    (55
    )Total liabilities and stockholders equity
    
    
    2,766
    
    
    
    2,711
    
    
    
    (55
    )As of December 31, 2002:Deferred income taxes (non-current asset)
    
    $
    15
    
    
    $
    32
    
    
    $
    17Deferred
charges and other assets (tax deposits)
    
    
    521
    
    
    
    456
    
    
    
    (65
    )Total assets
    
    
    2,807
    
    
    
    2,759
    
    
    
    (48
    )Retained earnings
    
    
    1,498
    
    
    
    1,450
    
    
    
    (48
    )Total stockholders equity
    
    
    (123
    )
    
    
    (171
    )
    
    
    (48
    )Total liabilities and stockholders equity
    
    
    2,807
    
    
    
    2,759
    
    
    
    (48
    )
 *
    
    Also reflects a net decrease of $7
million related to the change in classification of the incentive stock plan activity from a net to a gross basis that is unrelated to
the income tax adjustments noted above.
 27. Condensed Consolidating Financial Information of Guarantor Subsidiaries The 11 1/8% senior notes due 2007 issued on November 14, 2000 are
guaranteed by substantially all of the Companys current and future
wholly-owned domestic restricted subsidiaries (the guarantor subsidiaries).
The senior credit facility entered into in December 2002 also provides for a
guarantee by each guarantor subsidiary. The guarantees by each guarantor
subsidiary are 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 such notes to be guaranteed or secured on 65




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements the same
basis as any other subsequently issued debt that is guaranteed or secured. As
a result, at December 31, 2003, the
following wholly-owned domestic restricted subsidiaries fully and
unconditionally and jointly and severally guarantee the senior credit facility,
the 6.60% notes due 2027 and the 11 1/8% notes due 2007. Aqualon Company
    
    Hercules Credit, Inc.Athens Holding Inc.
    
    Hercules Euro Holdings, L.L.C.Covington Holdings, Inc.
    
    Hercules Finance CompanyEast Bay Realty Services, Inc.
    
    Hercules Flavor, Inc.FiberVisions Incorporated
    
    Hercules Hydrocarbon Holdings, Inc.FiberVisions, L.L.C.
    
    Hercules International Limited, L.L.C.FiberVisions L.P.
    
    Hercules Paper Holdings, Inc.FiberVisions Products, Inc.
    
    Hercules Shared Services CorporationHercules Country Club, Inc.
    
    WSP, Inc.
 The non-guarantor subsidiaries include all of the Companys foreign
subsidiaries and certain domestic subsidiaries. The Company conducts much of
its business through and derives much of its income from its subsidiaries.
Therefore, the Companys ability to make required payments with respect to its
indebtedness and other obligations depends on the financial results and
condition of its subsidiaries and its ability to receive funds from its
subsidiaries. There are no restrictions on the ability of any of the guarantor
subsidiaries to transfer funds to the Company, however, there may be such
restrictions for certain foreign non-guarantor subsidiaries. The following condensed consolidating financial information for the
Company presents the financial information of Hercules, the guarantor
subsidiaries and the non-guarantor subsidiaries based on the Companys
understanding of the Securities and Exchange Commissions interpretation and
application of Rule 3-10 under the Securities and Exchange Commissions
Regulation S-X. The financial information may not necessarily be indicative of
results of operations or financial position had the guarantor subsidiaries or
non-guarantor subsidiaries operated as independent entities.
In this presentation, Hercules consists of parent company operations.
Guarantor subsidiaries and non-guarantor subsidiaries of Hercules are reported
on an equity basis. For companies acquired during 1998, the goodwill and fair
values of the assets and liabilities acquired have been presented on a
push-down accounting basis. Additionally, prior year information has been
restated for the Companys change in accounting for its Employee Stock
Ownership Plan (see Note 1), for the correction of an error
related to deferred income tax and tax
deposit assets for periods prior to January 1, 1996 and the
change in classification of the incentive stock plan activity (see
Note 26). 66




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Statement of Operations
Twelve Months Ended December 31, 2003 (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedNet sales
    
    $
    509
    
    
    $
    445
    
    
    $
    1,024
    
    
    $
    (132
    )
    
    $
    1,846Cost of sales
    
    
    332
    
    
    
    320
    
    
    
    643
    
    
    
    (128
    )
    
    
    1,167Selling, general, and administrative expenses
    
    
    84
    
    
    
    84
    
    
    
    192
    
    
    
    
    
    
    
    360Research and development
    
    
    17
    
    
    
    17
    
    
    
    5
    
    
    
    
    
    
    
    39Goodwill and intangible asset amortization
    
    
    6
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    8Other operating expenses (income), net
    
    
    9
    
    
    
    4
    
    
    
    4
    
    
    
    
    
    
    
    17Profit (loss) from operations
    
    
    61
    
    
    
    18
    
    
    
    180
    
    
    
    (4
    )
    
    
    255Interest and debt expense (income), net
    
    
    174
    
    
    
    (59
    )
    
    
    16
    
    
    
    
    
    
    
    131Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other (expense) income, net
    
    
    (23
    )
    
    
    (5
    )
    
    
    (1
    )
    
    
    
    
    
    
    (29
    )(Loss) income before income taxes and equity income (loss)
    
    
    (136
    )
    
    
    72
    
    
    
    163
    
    
    
    (4
    )
    
    
    95(Benefit) provision for income taxes
    
    
    (52
    )
    
    
    29
    
    
    
    46
    
    
    
    (2
    )
    
    
    21Equity income (loss) of affiliated companies
    
    
    
    
    
    
    (1
    )
    
    
    1
    
    
    
    
    
    
    
    Equity income (loss) from consolidated subsidiaries
    
    
    158
    
    
    
    15
    
    
    
    2
    
    
    
    (175
    )
    
    
    Net income (loss) from continuing operations
    
    
    74
    
    
    
    57
    
    
    
    120
    
    
    
    (177
    )
    
    
    74Net income on discontinued operations, net of tax
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Net income (loss) before cumulative effect of change in
accounting principle
    
    
    78
    
    
    
    57
    
    
    
    120
    
    
    
    (177
    )
    
    
    78Cumulative effect of change in accounting principle, net of tax
    
    
    (33
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33
    )Net income (loss)
    
    $
    45
    
    
    $
    57
    
    
    $
    120
    
    
    $
    (177
    )
    
    $
    45
 67




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Statement of Operations
Twelve Months Ended December 31, 2002 (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedNet sales
    
    $
    536
    
    
    $
    423
    
    
    $
    890
    
    
    $
    (144
    )
    
    $
    1,705Cost of sales
    
    
    333
    
    
    
    294
    
    
    
    557
    
    
    
    (144
    )
    
    
    1,040Selling, general, and administrative expenses
    
    
    94
    
    
    
    73
    
    
    
    181
    
    
    
    
    
    
    
    348Research and development
    
    
    19
    
    
    
    17
    
    
    
    6
    
    
    
    
    
    
    
    42Goodwill and intangible asset amortization
    
    
    5
    
    
    
    3
    
    
    
    1
    
    
    
    
    
    
    
    9Other operating (income) expense, net
    
    
    (11
    )
    
    
    31
    
    
    
    26
    
    
    
    
    
    
    
    46Profit (loss) from operations
    
    
    96
    
    
    
    5
    
    
    
    119
    
    
    
    
    
    
    
    220Interest and debt expense (income), net
    
    
    215
    
    
    
    (75
    )
    
    
    (41
    )
    
    
    
    
    
    
    99Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    58
    
    
    
    
    
    
    
    58Other (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 (loss) of affiliated companies
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    2Equity 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 change in
accounting principle
    
    
    (243
    )
    
    
    (50
    )
    
    
    102
    
    
    
    (52
    )
    
    
    (243
    )Cumulative effect of change in accounting principle, net of tax
    
    
    (368
    )
    
    
    (233
    )
    
    
    (135
    )
    
    
    368
    
    
    
    (368
    )Net (loss) income
    
    $
    (611
    )
    
    $
    (283
    )
    
    $
    (33
    )
    
    $
    316
    
    
    $
    (611
    )
 68




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Statement of Operations
Twelve Months Ended December 31, 2001 (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedNet sales
    
    $
    587
    
    
    $
    565
    
    
    $
    888
    
    
    $
    (264
    )
    
    $
    1,776Cost of sales
    
    
    381
    
    
    
    442
    
    
    
    574
    
    
    
    (264
    )
    
    
    1,133Selling, general, and administrative expenses
    
    
    77
    
    
    
    118
    
    
    
    203
    
    
    
    
    
    
    
    398Research and development
    
    
    29
    
    
    
    16
    
    
    
    8
    
    
    
    
    
    
    
    53Goodwill and intangible asset amortization
    
    
    3
    
    
    
    11
    
    
    
    10
    
    
    
    
    
    
    
    24Other operating (income) expense, net
    
    
    (60
    )
    
    
    34
    
    
    
    10
    
    
    
    
    
    
    
    (16
    )Profit (loss) from operations
    
    
    157
    
    
    
    (56
    )
    
    
    83
    
    
    
    
    
    
    
    184Interest and debt expense (income), net
    
    
    342
    
    
    
    (108
    )
    
    
    (30
    )
    
    
    
    
    
    
    204Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    58
    
    
    
    
    
    
    
    58Other (expense) income, net
    
    
    (13
    )
    
    
    11
    
    
    
    (6
    )
    
    
    
    
    
    
    (8
    )(Loss) income before income taxes and equity income (loss)
    
    
    (198
    )
    
    
    63
    
    
    
    49
    
    
    
    
    
    
    
    (86
    )(Benefit) provision for income taxes
    
    
    (28
    )
    
    
    28
    
    
    
    14
    
    
    
    
    
    
    
    14Equity income (loss) of affiliated companies
    
    
    
    
    
    
    1
    
    
    
    (10
    )
    
    
    
    
    
    
    (9
    )Equity income (loss) from consolidated subsidiaries
    
    
    61
    
    
    
    (10
    )
    
    
    1
    
    
    
    (52
    )
    
    
    Net (loss) income before continuing operations
    
    
    (109
    )
    
    
    26
    
    
    
    26
    
    
    
    (52
    )
    
    
    (109
    )Net income (loss) from discontinued operations, net of tax
    
    
    56
    
    
    
    16
    
    
    
    32
    
    
    
    (48
    )
    
    
    56Net (loss) income before cumulative effect of change
accounting principle
    
    
    (53
    )
    
    
    42
    
    
    
    58
    
    
    
    (100
    )
    
    
    (53
    )Cumulative effect of change in accounting principle, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net (loss) income
    
    $
    (53
    )
    
    $
    42
    
    
    $
    58
    
    
    $
    (100
    )
    
    $
    (53
    )
 69




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Balance Sheet
December 31, 2003
As Restated (Note 26) (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedAssetsCurrent assetsCash and cash equivalents
    
    $
    9
    
    
    $
    2
    
    
    $
    114
    
    
    $
    
    
    
    $
    125Restricted cash
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accounts and notes receivable, net
    
    
    121
    
    
    
    55
    
    
    
    239
    
    
    
    
    
    
    
    415Intercompany receivable
    
    
    70
    
    
    
    21
    
    
    
    32
    
    
    
    (123
    )
    
    
    Inventories
    
    
    46
    
    
    
    58
    
    
    
    97
    
    
    
    (14
    )
    
    
    187Deferred income taxes
    
    
    94
    
    
    
    
    
    
    
    9
    
    
    
    (10
    )
    
    
    93Total current assets
    
    
    340
    
    
    
    136
    
    
    
    491
    
    
    
    (147
    )
    
    
    820Property, plant and equipment, net
    
    
    168
    
    
    
    167
    
    
    
    342
    
    
    
    
    
    
    
    677Investments in subsidiaries and advances, net
    
    
    2,248
    
    
    
    92
    
    
    
    51
    
    
    
    (2,391
    )
    
    
    Goodwill and other intangible assets, net
    
    
    223
    
    
    
    90
    
    
    
    392
    
    
    
    
    
    
    
    705Long-term deferred income taxes
    
    
    150
    
    
    
    
    
    
    
    13
    
    
    
    (119
    )
    
    
    44Deferred charges and other assets
    
    
    388
    
    
    
    10
    
    
    
    67
    
    
    
    
    
    
    
    465Total assets
    
    $
    3,517
    
    
    $
    495
    
    
    $
    1,356
    
    
    $
    (2,657
    )
    
    $
    2,711Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    56
    
    
    $
    18
    
    
    $
    118
    
    
    $
    
    
    
    $
    192Accrued expenses
    
    
    142
    
    
    
    52
    
    
    
    59
    
    
    
    (10
    )
    
    
    243Intercompany payable
    
    
    8
    
    
    
    73
    
    
    
    42
    
    
    
    (123
    )
    
    
    Short-term debt
    
    
    2
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    22Total current liabilities
    
    
    208
    
    
    
    143
    
    
    
    239
    
    
    
    (133
    )
    
    
    457Long-term debt
    
    
    1,300
    
    
    
    
    
    
    
    26
    
    
    
    
    
    
    
    1,326Deferred income taxes
    
    
    
    
    
    
    119
    
    
    
    78
    
    
    
    (119
    )
    
    
    78Other postretirement benefits and other liabilities
    
    
    696
    
    
    
    73
    
    
    
    70
    
    
    
    
    
    
    
    839Company-obligated preferred securities of
subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Intercompany notes payable (receivable)
    
    
    1,302
    
    
    
    (1,090
    )
    
    
    (213
    )
    
    
    1
    
    
    
    Stockholders equity
    
    
    11
    
    
    
    1,250
    
    
    
    1,156
    
    
    
    (2,406
    )
    
    
    11Total liabilities and stockholders equity
    
    $
    3,517
    
    
    $
    495
    
    
    $
    1,356
    
    
    $
    (2,657
    )
    
    $
    2,711
 70




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Balance Sheet
December 31, 2002As Restated (Note 26) (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedAssetsCurrent assetsCash and cash equivalents
    
    $
    131
    
    
    $
    7
    
    
    $
    71
    
    
    $
    
    
    
    $
    209Restricted cash
    
    
    125
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    125Accounts and notes receivable, net
    
    
    122
    
    
    
    55
    
    
    
    218
    
    
    
    
    
    
    
    395Intercompany receivable
    
    
    80
    
    
    
    23
    
    
    
    27
    
    
    
    (130
    )
    
    
    Inventories
    
    
    46
    
    
    
    53
    
    
    
    79
    
    
    
    (11
    )
    
    
    167Deferred income taxes
    
    
    28
    
    
    
    22
    
    
    
    (4
    )
    
    
    
    
    
    
    46Total current assets
    
    
    532
    
    
    
    160
    
    
    
    391
    
    
    
    (141
    )
    
    
    942Property, plant and equipment, net
    
    
    177
    
    
    
    162
    
    
    
    324
    
    
    
    
    
    
    
    663Investments in subsidiaries and advances, net
    
    
    2,351
    
    
    
    67
    
    
    
    51
    
    
    
    (2,469
    )
    
    
    Goodwill and other intangible assets, net
    
    
    234
    
    
    
    91
    
    
    
    341
    
    
    
    
    
    
    
    666Long-term deferred income taxes
    
    
    17
    
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    32Deferred charges and other assets
    
    
    366
    
    
    
    13
    
    
    
    77
    
    
    
    
    
    
    
    456Total assets
    
    $
    3,677
    
    
    $
    493
    
    
    $
    1,199
    
    
    $
    (2,610
    )
    
    $
    2,759Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    $
    55
    
    
    $
    18
    
    
    $
    103
    
    
    $
    
    
    
    $
    176Accrued expenses
    
    
    95
    
    
    
    113
    
    
    
    69
    
    
    
    
    
    
    
    277Intercompany payable
    
    
    11
    
    
    
    76
    
    
    
    43
    
    
    
    (130
    )
    
    
    Short-term debt
    
    
    126
    
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    145Total current liabilities
    
    
    287
    
    
    
    207
    
    
    
    234
    
    
    
    (130
    )
    
    
    598Long-term debt
    
    
    701
    
    
    
    
    
    
    
    37
    
    
    
    
    
    
    
    738Deferred income taxes
    
    
    (105
    )
    
    
    116
    
    
    
    69
    
    
    
    
    
    
    
    80Other postretirement benefits and other liabilities
    
    
    742
    
    
    
    74
    
    
    
    74
    
    
    
    
    
    
    
    890Company-obligated preferred securities of
subsidiary trusts
    
    
    
    
    
    
    
    
    
    
    624
    
    
    
    
    
    
    
    624Intercompany notes payable (receivable)
    
    
    2,223
    
    
    
    (1,039
    )
    
    
    (1,184
    )
    
    
    
    
    
    
    Stockholders equity
    
    
    (171
    )
    
    
    1,135
    
    
    
    1,345
    
    
    
    (2,480
    )
    
    
    (171
    )Total liabilities and stockholders equity
    
    $
    3,677
    
    
    $
    493
    
    
    $
    1,199
    
    
    $
    (2,610
    )
    
    $
    2,759
 71




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Statement of Cash Flows
Twelve Months Ended December 31, 2003 (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedNet Cash Provided By (Used In) Operations
    
    $
    13
    
    
    $
    53
    
    
    $
    129
    
    
    $
    (172
    )
    
    $
    23Cash Flow From Investing Activities:Capital expenditures
    
    
    (13
    )
    
    
    (13
    )
    
    
    (22
    )
    
    
    
    
    
    
    (48
    )Proceeds of investment and fixed asset disposals
    
    
    4
    
    
    
    1
    
    
    
    5
    
    
    
    
    
    
    
    10Acquisitions, net of cash acquired
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    (10
    )Decrease in restricted cash
    
    
    125
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    125Investment in trust preferred securities
    
    
    (27
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (27
    )Other, net
    
    
    (2
    )
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    (2
    )Net cash provided by (used in) investing activities
    
    
    87
    
    
    
    (11
    )
    
    
    (28
    )
    
    
    
    
    
    
    48Cash 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 warrants
    
    
    (7
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7
    )Common stock issued
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Dividends paid
    
    
    
    
    
    
    
    
    
    
    45
    
    
    
    (45
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (222
    )
    
    
    (47
    )
    
    
    (74
    )
    
    
    172
    
    
    
    (171
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    16Net (decrease) increase in cash and cash equivalents
    
    
    (122
    )
    
    
    (5
    )
    
    
    43
    
    
    
    
    
    
    
    (84
    )Cash and cash equivalents at beginning of year
    
    
    131
    
    
    
    7
    
    
    
    71
    
    
    
    
    
    
    
    209Cash and cash equivalents at end of year
    
    $
    9
    
    
    $
    2
    
    
    $
    114
    
    
    $
    
    
    
    $
    125
 72




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Statement of Cash Flows
Twelve Months Ended December 31, 2002 (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedNet 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
    
    
    
    
    
    
    
    1,816Increase in restricted cash
    
    
    (125
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (125
    )Other, net
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11Net cash provided by (used in) investing activities
    
    
    1,682
    
    
    
    (6
    )
    
    
    (17
    )
    
    
    
    
    
    
    1,659Cash Flow From Financing Activities:Long-term debt proceeds
    
    
    450
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    450Long-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
    
    
    
    Common stock issued
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5Dividends 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
    
    
    
    
    
    
    
    25Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    
    
    
    (2
    )Net increase (decrease) in cash and cash equivalents
    
    
    123
    
    
    
    (5
    )
    
    
    15
    
    
    
    
    
    
    
    133Cash and cash equivalents at beginning of year
    
    
    8
    
    
    
    12
    
    
    
    56
    
    
    
    
    
    
    
    76Cash and cash equivalents at end of year
    
    $
    131
    
    
    $
    7
    
    
    $
    71
    
    
    $
    
    
    
    $
    209
 73




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##### Table of Contents



Hercules Incorporated
Notes to Consolidated Financial Statements Condensed Consolidating Statement of Cash Flows
Twelve Months Ended December 31, 2001 (Dollars in millions)UnconsolidatedGuarantor
    
    Non-Guarantor
    
    Eliminations &Parent
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    ConsolidatedNet Cash (Used In) Provided By Operations
    
    $
    (442
    )
    
    $
    278
    
    
    $
    84
    
    
    $
    (18
    )
    
    $
    (98
    )Cash Flow From Investing Activities:Capital expenditures
    
    
    (11
    )
    
    
    (15
    )
    
    
    (26
    )
    
    
    
    
    
    
    (52
    )Proceeds of investment and fixed asset disposals
    
    
    229
    
    
    
    5
    
    
    
    122
    
    
    
    
    
    
    
    356Other, net
    
    
    
    
    
    
    
    
    
    
    (9
    )
    
    
    
    
    
    
    (9
    )Net cash provided by (used in) investing activities
    
    
    218
    
    
    
    (10
    )
    
    
    87
    
    
    
    
    
    
    
    295Cash Flow From Financing Activities:Long-term debt proceeds
    
    
    347
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    349Long-term debt repayments
    
    
    (585
    )
    
    
    (16
    )
    
    
    (25
    )
    
    
    
    
    
    
    (626
    )Change in short-term debt
    
    
    
    
    
    
    
    
    
    
    (107
    )
    
    
    
    
    
    
    (107
    )Change in intercompany, non-current
    
    
    455
    
    
    
    (379
    )
    
    
    (76
    )
    
    
    
    
    
    
    Common stock issued
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15Common stock reacquired
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Dividends paid
    
    
    
    
    
    
    
    
    
    
    (18
    )
    
    
    18
    
    
    
    Net cash provided by (used in) financing activities
    
    
    231
    
    
    
    (395
    )
    
    
    (224
    )
    
    
    18
    
    
    
    (370
    )Net cash flow provided by discontinued operations
    
    
    
    
    
    
    132
    
    
    
    66
    
    
    
    
    
    
    
    198Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (3
    )Net increase in cash and cash equivalents
    
    
    7
    
    
    
    5
    
    
    
    10
    
    
    
    
    
    
    
    22Cash and cash equivalents at beginning of year
    
    
    1
    
    
    
    7
    
    
    
    46
    
    
    
    
    
    
    
    54Cash and cash equivalents at end of year
    
    $
    8
    
    
    $
    12
    
    
    $
    56
    
    
    $
    
    
    
    $
    76
 74




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##### Table of Contents



Hercules Incorporated
Summary of Quarterly Results (Unaudited)* (Dollars in millions, except per share)1st Quarter
    
    2nd Quarter
    
    3rd Quarter
    
    4th Quarter
    
    Year2003
    
    2002
    
    2003
    
    2002
    
    2003
    
    2002
    
    2003
    
    2002
    
    2003
    
    2002Net sales
    
    $
    447
    
    
    $
    402
    
    
    $
    478
    
    
    $
    437
    
    
    $
    463
    
    
    $
    443
    
    
    $
    458
    
    
    $
    423
    
    
    $
    1,846
    
    
    $
    1,705Cost of sales
    
    
    284
    
    
    
    243
    
    
    
    298
    
    
    
    267
    
    
    
    289
    
    
    
    272
    
    
    
    296
    
    
    
    258
    
    
    
    1,167
    
    
    
    1,040Selling, general and administrative expenses
    
    
    91
    
    
    
    86
    
    
    
    90
    
    
    
    83
    
    
    
    89
    
    
    
    86
    
    
    
    90
    
    
    
    93
    
    
    
    360
    
    
    
    348Research and development
    
    
    10
    
    
    
    10
    
    
    
    10
    
    
    
    11
    
    
    
    9
    
    
    
    11
    
    
    
    10
    
    
    
    10
    
    
    
    39
    
    
    
    42Goodwill and intangible asset amortization
    
    
    2
    
    
    
    2
    
    
    
    2
    
    
    
    3
    
    
    
    2
    
    
    
    2
    
    
    
    2
    
    
    
    2
    
    
    
    8
    
    
    
    9Other operating expense (income), net
    
    
    (1
    )
    
    
    5
    
    
    
    2
    
    
    
    19
    
    
    
    9
    
    
    
    11
    
    
    
    7
    
    
    
    11
    
    
    
    17
    
    
    
    46Profit from operations
    
    
    61
    
    
    
    56
    
    
    
    76
    
    
    
    54
    
    
    
    65
    
    
    
    61
    
    
    
    53
    
    
    
    49
    
    
    
    255
    
    
    
    220Interest and debt expense
    
    
    34
    
    
    
    38
    
    
    
    33
    
    
    
    26
    
    
    
    32
    
    
    
    17
    
    
    
    32
    
    
    
    18
    
    
    
    131
    
    
    
    99Preferred security distributions of subsidiary trusts
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    58Other expense (income), net
    
    
    4
    
    
    
    4
    
    
    
    6
    
    
    
    45
    
    
    
    7
    
    
    
    67
    
    
    
    12
    
    
    
    (1
    )
    
    
    29
    
    
    
    115(Loss) income before income taxes and equity (loss) income
    
    
    23
    
    
    
    (1
    )
    
    
    37
    
    
    
    (31
    )
    
    
    26
    
    
    
    (38
    )
    
    
    9
    
    
    
    18
    
    
    
    95
    
    
    
    (52
    )Provision (benefit) for income taxes
    
    
    9
    
    
    
    2
    
    
    
    5
    
    
    
    (9
    )
    
    
    9
    
    
    
    (4
    )
    
    
    (2
    )
    
    
    8
    
    
    
    21
    
    
    
    (3
    )Loss before equity (loss) income
    
    
    14
    
    
    
    (3
    )
    
    
    32
    
    
    
    (22
    )
    
    
    17
    
    
    
    (34
    )
    
    
    11
    
    
    
    10
    
    
    
    74
    
    
    
    (49
    )Equity (loss) income of affiliated companies, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    2Net (loss) income from continuing operations before
discontinued
operations and cumulative effect of change in accounting
principle
    
    
    14
    
    
    
    (3
    )
    
    
    32
    
    
    
    (21
    )
    
    
    17
    
    
    
    (34
    )
    
    
    11
    
    
    
    11
    
    
    
    74
    
    
    
    (47
    )Net (loss) income on discontinued operations, net of tax
    
    
    
    
    
    
    (207
    )
    
    
    2
    
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    4
    
    
    
    (196
    )Net (loss) income before cumulative effect of change
in accounting principle
    
    
    14
    
    
    
    (210
    )
    
    
    34
    
    
    
    (10
    )
    
    
    17
    
    
    
    (34
    )
    
    
    13
    
    
    
    11
    
    
    
    78
    
    
    
    (243
    )Cumulative effect of change in accounting principle, net of tax
    
    
    (28
    )
    
    
    (368
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (33
    )
    
    
    (368
    )Net (loss) income
    
    $
    (14
    )
    
    $
    (578
    )
    
    $
    34
    
    
    $
    (10
    )
    
    $
    17
    
    
    $
    (34
    )
    
    $
    8
    
    
    $
    11
    
    
    $
    45
    
    
    $
    (611
    )(Loss) earnings per shareBasic (loss) earnings per shareContinuing operations
    
    $
    0.13
    
    
    $
    (0.03
    )
    
    $
    0.30
    
    
    $
    (0.19
    )
    
    $
    0.16
    
    
    $
    (0.32
    )
    
    $
    0.10
    
    
    $
    0.10
    
    
    $
    0.69
    
    
    $
    (0.44
    )Discontinued operations
    
    $
    
    
    
    $
    (1.95
    )
    
    $
    0.02
    
    
    $
    0.10
    
    
    $
    
    
    
    $
    
    
    
    $
    0.02
    
    
    $
    
    
    
    $
    0.04
    
    
    $
    (1.85
    )Cumulative effect of change in accounting principle
    
    $
    (0.26
    )
    
    $
    (3.47
    )
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (0.05
    )
    
    $
    
    
    
    $
    (0.31
    )
    
    $
    (3.47
    )Net (loss) income
    
    $
    (0.13
    )
    
    $
    (5.45
    )
    
    $
    0.32
    
    
    $
    (0.09
    )
    
    $
    0.16
    
    
    $
    (0.32
    )
    
    $
    0.07
    
    
    $
    0.10
    
    
    $
    0.42
    
    
    $
    (5.76
    )Diluted (loss) earnings per shareContinuing operations
    
    $
    0.13
    
    
    $
    (0.03
    )
    
    $
    0.30
    
    
    $
    (0.19
    )
    
    $
    0.16
    
    
    $
    (0.32
    )
    
    $
    0.10
    
    
    $
    0.10
    
    
    $
    0.69
    
    
    $
    (0.44
    )Discontinued operations
    
    $
    
    
    
    $
    (1.95
    )
    
    $
    0.02
    
    
    $
    0.10
    
    
    $
    
    
    
    $
    
    
    
    $
    0.02
    
    
    $
    
    
    
    $
    0.04
    
    
    $
    (1.85
    )Cumulative effect of change in accounting principle
    
    $
    (0.26
    )
    
    $
    (3.47
    )
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (0.05
    )
    
    $
    
    
    
    $
    (0.31
    )
    
    $
    (3.47
    )Net (loss) income
    
    $
    (0.13
    )
    
    $
    (5.45
    )
    
    $
    0.32
    
    
    $
    (0.09
    )
    
    $
    0.16
    
    
    $
    (0.32
    )
    
    $
    0.07
    
    
    $
    0.10
    
    
    $
    0.42
    
    
    $
    (5.76
    )
   *
    
    Quarters prior to 4th quarter 2003 have been restated for the Companys change in accounting for its Employee Stock Ownership Plan (see Note 1). 75




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##### Table of Contents



Hercules Incorporated
Principal Consolidated Subsidiaries as of December 31, 2003 Argentina
    
    Hong KongHercules Argentina S.A.
    
    Hercules China LimitedAustralia
    
    IndiaLittle H Pty Ltd.
    
    Hercules Industrial Chemicals Private LimitedAustria
    
    IndonesiaHercules Austria GmbH
    
    P.T. Hercules Chemicals IndonesiaBahamas
    
    ItalyHercules International Trade Corporation Limited
    
    Hercules Italia SpABelgium
    
    JapanHercules Beringen B.V.B.A.
    
    Hercules Japan Ltd.Hercules Doel B.V.B.A.
    
    KoreaHercules Europe B.V.B.A.
    
    Hercules Korea Chemical Co. Ltd.Hercules Holding B.V./B.V.B.A.
    
    LiechtensteinBermuda
    
    Organa Trust, RegisteredCurtis Bay Insurance Co. Ltd.
    
    LuxembourgBrazil
    
    Hercules Investments S.a.r.l.Hercules do Brasil Produtos Quimicos Ltda.
    
    MexicoBritish Virgin Islands
    
    Hercules Services Mexico S.A. de C.V.Ever Success Overseas Limited
    
    Hercules Mexico, S.A. de C.V.Canada
    
    NetherlandsHercules Canada (2002) Inc.
    
    Aqualon France B.V.Chile
    
    Hercules B.V.Hercules Chile Limitada
    
    Hercules Chemicals B.V.China
    
    Hercules Holding Specialty Materials B.V.FiberVisions (China) Textile Products Ltd.
    
    NorwayHercules Chemicals (Jiangmen) Company Limited
    
    Hercules Norway ASHercules Trading (Shanghai) Company Ltd.
    
    PeruShanghai Hercules Chemicals Co., Ltd. (1)
    
    Hercules Peru S.R.L.Colombia
    
    PolandHercules Americas (Colombia) Ltda.
    
    Hercules Polska Sp. z.o.o.Czech (Republic)
    
    PortugalHercules CZ s.r.o.
    
    Misan Portuguesa Lda.Denmark
    
    RussiaFiberVisions, A/S
    
    Hercules Russia L.L.C.Hercules Investments ApS
    
    SingaporeFinland
    
    Hercules Chemical Solutions Pte Ltd.Hercules Finland OY
    
    South AfricaFrance
    
    Hercules Chemicals South Africa (Proprietary) LimitedAqualon France B.V.
    
    SpainHercules SA
    
    Hercules Quimica S.A.Germany
    
    SwedenAbieta Chemie GmbH (1)
    
    Hercules ABHercules Deutschland GmbH
    
    SwitzerlandHercules GmbH
    
    FiberVisions A.G./FiberVisions Ltd.
 76




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##### Table of Contents



Hercules Incorporated
Principal Consolidated Subsidiaries as of December 31, 2003 TaiwanHercules Chemicals (Taiwan) Co., Ltd.ThailandHercules Chemical Solutions (Thailand) Ltd.United KingdomHercules Holding II LimitedHercules LimitedUnited StatesAqualon Company, DelawareAthens Holding Inc., DelawareCovington Holdings Inc., DelawareEast Bay Realty Services, Inc., DelawareFiberVisions Incorporated, DelawareFiberVisions, L.L.C., DelawareFiberVisions L.P., DelawareFiberVisions Products, Inc., GeorgiaHercules Country Club, Inc.Hercules Credit Inc., DelawareHercules Euro Holdings, L.L.C., DelawareHercules Finance Company, DelawareHercules Flavor, Inc., DelawareHercules Hydrocarbon Holdings, Inc.Hercules International Limited, L.L.C., DelawareHercules Paper Holdings, Inc.Hercules Shared Services Corporation, DelawareWSP, Inc., DelawareVirgin IslandsHercules Islands Corporation (1)
   (1)
    
    This entity is owned in part by Hercules with the remaining interest held
by a third party. 77




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##### Table of Contents



Hercules Incorporated 
 ITEM 9A. CONTROLS AND PROCEDURES (a) The Company maintains
disclosure controls and procedures that are designed to provide reasonable
assurance that information required to be disclosed in the Companys
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the periods specified in the rules and forms of
the Securities and Exchange Commission (the SEC) and that such
information is accumulated and communicated to the Companys management,
including its principal executive officer and principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure. As
a result of its June 24, 2004 settlement with the Internal Revenue Service
(IRS) for the tax years 1990 through 1992 that indicated additional
tax liabilities for such audit cycle, the Company initiated a review of the GAAP
accounting for income taxes for the tax years 1987 through 1995. In conjunction
with this review, the Company undertook an effort to analyze and reconcile the
various general ledger tax account balances relative to the tax years 1990
through 1992, which expanded to encompass the handling of adjustments that
should have occurred relative to the previously settled tax years 1987 through
1989 and the open tax years 1993 through 1995. In addition, the Company also
reviewed the tax years 1996 and forward to confirm that there were no further
implications in years subsequent to 1995 with respect to issues identified as a
result of the 1987 through 1995 analysis. The review indicated cumulative
additional tax liabilities for the years 1987 through 1995 that had not been
reconciled to the various general ledger tax account balances. Based
on this review, on November 9, 2004, the Companys Chief Financial Officer
determined that previously issued financial statements cannot be relied upon and
that restatement of such previously issued financial statements is required. The
Audit Committee of the Board of Directors (Audit Committee)
concurred with this determination. The adjustments reflected in this
Form 10-K/A
primarily relate to the computation and application of foreign tax credits and
reduce the tax deposit asset by $65 million, increase deferred income tax assets
by $17 million, and, as a result of the cumulative additional income tax expense
to be recorded for the restated periods, reduce retained earnings and
stockholders equity by $48 million as of January 1, 1996 and for
previously reported periods affected through December 31, 2003. The restatement
does not affect the previously reported results of operations for any period
subsequent to December 31, 1995. The
Company believes that the errors were attributable to material weaknesses in
internal control over financial reporting that (i) occurred
(a) during the
preparation and review of the U.S. federal income tax returns for the years 1987
through 1995, (b) prior and subsequent to entering into the settlement agreement
with the IRS relative to the 1987 through 1989 tax years and (c) prior to and
upon entering into the June 24, 2004 settlement agreement with the IRS for the
tax years 1990 through 1992, (ii) concern (a) the computation by the Company of
creditable foreign taxes and the utilization of such foreign tax
credits and (b) the reconciliation of tax returns and settlements to the GAAP general ledger tax
account balances. The material weaknesses, which existed through
September 30,
2004, related to (i) review of the foreign tax credits,
(ii) analysis prior to
and after entering into settlements with tax authorities and
(iii) analyses and
reconciliations of general ledger tax account balances. In
order to remediate these material weaknesses in internal control over financial
reporting, the Company is revising the procedures for collection and analysis of
information used to calculate available foreign tax credits. The Company is also
instituting new procedures over the tax settlement process. These procedures
include (i) detailed review by the responsible area tax manager of the year-end
tax reporting package for each foreign legal entity prior to finalization of the
United States federal income tax return; (ii) detailed analysis and
reconciliation of each legal entitys filed tax return to the general
ledger tax account balances upon finalization of such returns;
(iii) detailed
reconciliation and analysis of proposed and settled tax adjustments by taxing
authorities; and (iv) enhanced review and approval procedures to be used prior
to entering into any final tax settlement and (v) enhanced Company-wide
(including Tax) certification processes and procedures being implemented in
connection with the Companys Sarbanes-Oxley Section 404 efforts discussed
below. (b) The Company carried out
an evaluation, under the supervision and with the participation of the
Companys management, including the Companys President and Chief
Executive Officer and the Companys Vice President and
Controller (Principal Accounting Officer), of the effectiveness of the design and operation of the Companys
disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 as of
December 31, 2003. Based upon that evaluation, the Companys President and
Chief Executive Officer and the Companys Vice President and Controller (Principal Accounting Officer) concluded that the Companys disclosure controls and
procedures are effective, with the exception of the items disclosed above. In
addition, as more fully described in Note 2 of the Notes to Financial Statements
of the Companys Form 10-Q/A for the quarterly period ended
September 30,
2003, the Company had determined that a special pension benefit granted in the
quarter ended September 30, 2003 was deferred compensation that had
substantially vested as of September 30, 2003 and accordingly, restated its
previously reported financial statements. As more fully described
above and in Note 26, the Company is filing this
Form 10-K/A to reflect a restatement of its consolidated
financial statements for the fiscal year ended December 31,
2003. Disclosure controls and procedures are
controls and procedures that are designed to ensure that information required to
be disclosed in Company reports filed or submitted under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms. The Company
has reviewed its disclosure controls and procedures and has initiated changes in
2004 to such controls and procedures and internal controls which it believes
will reduce the possibility of a future restatement. There
were no significant changes in the Companys internal controls that
occurred during the last fiscal quarter of 2003, other than the improvements
noted above, that could significantly affect internal controls over financial
reporting. As a result of Section 404 of the Sarbanes-Oxley Act of 2002 and
the rules issued thereunder (SOX 404), the Company
will be required to include in its Annual Report on Form 10-K
for the year ending December 31, 2004 a report on
managements assessment of the effectiveness of the
Companys internal controls over financial reporting. As part of
the process for preparing for compliance with SOX 404, in 2003,
the Company initiated a review of its internal controls over
financial reporting. This review is being conducted under the
direction of senior management. As a result, management has made
improvements to the Companys internal controls through the date
of the filing of this Form 10-K/A as part of its normal process.
Except for those change described above, the Companys management
does not believe these changes have materially affected, or are
likely to materially affect the Companys internal controls over
financial reporting. The Company anticipates improvements will
continue to be made as part of the ongoing SOX 404 preparation. 78




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##### Table of Contents



Hercules Incorporated 
 PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K  (a)
    
    Documents filed as part of this Report:  1.
    
    Consolidated Financial Statements PageReport of
Independent Registered Public Accounting Firm
    
    
    17Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001
    
    
    18Consolidated Balance Sheets as of December 31, 2003 and 2002
    
    
    19Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001
    
    
    20Consolidated Statements of Stockholders Equity (Deficit) for the Years Ended December
31, 2003, 2002 and 2001
    
    
    21Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31,
2003, 2002 and 2001
    
    
    22Summary of Significant Accounting Policies and Notes to Consolidated Financial Statements.
    
    
    23
  2.
    
    Financial Statement Schedules: Schedule II  Valuation and Qualifying Accounts (Dollars in
millions)Col. A
    
    Col. B
    
    Col. C
    
    Col. D
    
    Col. EAdditionsBalance at
    
    Charged to costs
    
    Charged to other
    
    
    
    
    
    Balance at end ofDescription
    
    beginning of period
    
    and expenses
    
    accounts
    
    Deductions
    
    periodYear 2003Allowance for doubtful accounts
    
    $
    12
    
    
    
    4
    
    
    
    
    
    
    
    (11
    )
    
    $
    5Tax valuation allowance
    
    
    308
    
    
    
    (5
    )
    
    
    59
    
    
    
    
    
    
    
    362Year 2002Allowance for doubtful accounts
    
    $
    24
    
    
    
    4
    
    
    
    
    
    
    
    (16
    )
    
    $
    12Tax valuation allowance
    
    
    75
    
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    308Year 2001Allowance for doubtful accounts
    
    $
    27
    
    
    
    11
    
    
    
    
    
    
    
    (14
    )
    
    $
    24Tax valuation allowance
    
    
    28
    
    
    
    47
    
    
    
    
    
    
    
    
    
    
    
    75
 79




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##### Table of Contents



Hercules Incorporated All other schedules are omitted because they are not applicable, not
required or the information required is either presented in the Notes to
Financial Statements or has not changed materially from that previously
reported.  3.
    
    Exhibits: A complete listing of exhibits is included in the Exhibit Index that
precedes the exhibits filed with this Report.  (b)
    
    Reports on Form 8-K Date of Report
    
    Item Nos.
    
    Financial Statements IncludedOctober 6, 2003
    
    
    5,7
    
    
    NoDecember 11, 2003
    
    
    5,7
    
    
    NoDecember 16, 2003
    
    
    5,7
    
    
    No
 80




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##### Table of Contents



Hercules Incorporated 
 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on
November 22, 2004. HERCULES INCORPORATEDBy:
    
    /s/ Allen A. SpizzoVice President and Chief Financial Officer
 81




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##### Table of Contents



Hercules Incorporated EXHIBIT INDEX Number
    
    Description
    
    Incorporated by Reference To2-A
    
    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, 19983-A.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, 19933-A.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, 19983-B
    
    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, 20034-A
    
    Officers Certificate, dated as of March 17,
1999, pursuant to the Junior Subordinated
Debentures Indenture between Hercules and Chase
    
    Exhibit 4.1, Current Report on Form 8-K
dated March 17, 19994-B
    
    Form of Preferred Securities Guarantee by
Hercules and Chase, with respect to Hercules
Trust I
    
    Exhibit 4.28, Amendment No. 1 to
Registration Statement on Form S-3,
filed October 29, 19984-C
    
    Form of Amended and Restated Trust Agreement of
Hercules Trust I
    
    Exhibit 4.13, Amendment No. 1 to
Registration Statement on Form S-3,
filed October 29, 19984-D
    
    Form of 9.42% Trust Originated Preferred
Securities of Hercules Trust I
    
    Exhibit 4.2, Current Report on Form 8-K,
dated March 17, 19994-E
    
    Form of 9.42% Junior Subordinated Deferrable
Interest Debentures due 2029
    
    Exhibit 4.3, Current Report on Form 8-K,
dated March 17, 19994-F
    
    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, 19994-G
    
    Amended and Restated Trust Agreement of
Hercules Trust II, dated as of July 27, 1999,
together with Annex I thereto
    
    Exhibit 4.2, Current Report on Form 8-K,
dated July 27, 19994-H
    
    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, 19994-I
    
    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, 19994-J
    
    Form of Series A Junior Subordinated Deferrable
Interest Debentures
    
    Exhibit 4.5, Current Report on Form 8-K,
dated July 27, 19994-K
    
    Form of Trust II Preferred Securities
    
    Exhibit 4.6, Current Report on Form 8-K,
dated July 27, 19994-L
    
    Form of CRESTS Unit
    
    Exhibit 4.7, Current Report on Form 8-K,
dated July 27, 19994-M
    
    Form of Warrant
    
    Exhibit 4.8, Current Report on Form 8-K,
dated July 27, 19994-N
    
    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
 82




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##### Table of Contents



Hercules Incorporated Number
    
    Description
    
    Incorporated by Reference To4-O
    
    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 1/8% senior notes due
2007 included as Exhibit A thereto).
    
    Exhibit 4-A, Quarterly Report on Form
10-Q, filed November 14, 20004-P
    
    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, 20004-Q
    
    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, 20034-R
    
    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, 200310-A
    
    Hercules Executive Survivor Benefit Plan
    
    Exhibit 10-D, Annual Report on Form
10-K, filed March 27, 198110-B
    
    Hercules Phantom Stock Plan
    
    Exhibit E, Notice Annual Meeting and
Proxy Statement, dated February 14, 198610-C
    
    Hercules Deferred Compensation Plan
    
    Exhibit 10-I, Annual Report on Form
10-K, filed March 29, 198810-D
    
    Hercules Annual Management Incentive
Compensation Plan
    
    Exhibit 10-H, Annual Report on Form
10-K, filed March 26, 199310-E
    
    Hercules 1993 Non-employee Director Stock
Accumulation Plan
    
    Exhibit 4.1, Registration Statement on
Form S-8, filed July 16, 199310-F
    
    Hercules Deferred Compensation Plan for
Non-employee Directors
    
    Exhibit 10-J, Annual Report on Form
10-K, filed March 26, 199310-G
    
    Hercules Employee Pension Restoration Plan
    
    Exhibit 10-L, Annual Report on Form
10-K, filed March 26, 199310-H
    
    Form of Employment Contract between Hercules
and certain of its officers
    
    Exhibit 10-J, Annual Report on Form
10-K, filed March 29, 198810-I
    
    Form of Indemnification Agreement between
Hercules and certain officers and directors of
Hercules
    
    Annex II, Notice of Annual Meeting and
Proxy Statement, dated February 19, 198710-J
    
    Employment Agreement effective August 1, 1998,
between Hercules and Vincent J. Corbo
    
    Exhibit 10-T, Annual Report on Form
10-K, filed March 30, 199910-K
    
    Hercules Amended and Restated Long Term
Incentive Compensation Plan
    
    Exhibit 10-K, Annual Report on Form
10-K, filed March 29, 200010-L
    
    BetzDearborn Inc. Employee Stock Ownership and
401(k) Plan
    
    Exhibit 10-L, Annual Report on Form
10-K, filed March 29, 200010-M
    
    Underwriting Agreement, dated March 12, 1999,
among Hercules, Hercules Trust I and the
Underwriters named therein
    
    Exhibit 1.1, Current Report on Form 8-K,
dated March 17, 199910-N
    
    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, 199910-O
    
    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
 83




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##### Table of Contents



Hercules Incorporated Number
    
    Description
    
    Incorporated by Reference To10-P
    
    Share Purchase Agreement, dated as of August
10, 2000, among CP Kelco ApS (formerly known as
Hercules Copenhagen ApS), Hercules Investment
ApS, Hercules Incorporated, Lehman FG Newco,
Inc., WSP, Inc. and Hercules Holding BV/BVBA
    
    Exhibit 2-1, Current Report on Form 8-K,
dated September 28, 200010-Q
    
    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, 200110-R
    
    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, 200110-S
    
    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, 200110-T
    
    Letter Agreement, dated November 1, 2000,
between Hercules Incorporated and Thomas L.
Gossage
    
    Exhibit 10-B, Quarterly Report on Form
10-Q, filed May 16, 200110-U
    
    Employment Agreement, effective as of May 8,
2001, between Hercules Incorporated and William
H. Joyce
    
    Exhibit 10-A, Quarterly Report on Form
10-Q, filed May 16, 200110-V
    
    Change-of-Control Employment Agreement, dated
as of May 8, 2001, by and between Hercules
Incorporated and William H. Joyce
    
    Exhibit 10-24, Registration Statement on
Form S-4, filed August 9, 200110-W
    
    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, 200110-X
    
    Separation Agreement and General Release of
Claims, dated June 22, 2001, between Hercules
Incorporated and June B. Barry
    
    Exhibit 10-26, Registration Statement on
Form S-4, filed August 9, 200110-Y
    
    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, 200110-Z
    
    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, 200110-Aa
    
    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, 200210-Bb
    
    Amendment 2002-1 to Amended and Restated Long
Term Incentive Compensation Plan
    
    Exhibit I, Proxy Statement, dated May
15, 200210-Cc
    
    Amendment 2002-1 to Non-Employee Director Stock
Accumulation Plan
    
    Exhibit II, Proxy Statement, dated May
15, 200210-Dd
    
    Credit Agreement, dated December 20, 2002,
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-Dd, Annual Report on Form
10-K, filed March 31, 200310-Ee
    
    Hercules Incorporated Compensation Benefits
Grantor Trust Agreement for Management
Employees
    
    Exhibit 10-Ee, Annual Report on Form
10-K/A, filed May 1, 2003
 84




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##### Table of Contents



Hercules Incorporated Number
    
    Description
    
    Incorporated by Reference To10-Ff
    
    Hercules Incorporated Compensation Benefits
Grantor Trust Agreement for Non-employee
Directors
    
    Exhibit 10-Ff, Annual Report on Form
10-K/A, filed May 1, 200310-Gg
    
    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, 200310-Hh
    
    Hercules Deferred Compensation Plan, restated
December 1995
    
    Exhibit 10-B, Quarterly Report on Form
10-Q, filed May 15, 200310-Ii
10-Jj
    
    Employment Offer Letter  Fred G. Aanonsen,
dated June 27, 2001
Employment Offer Letter  Robert C. Flexon,
dated May 12, 2000
    
    Exhibit 10-C, Quarterly Report on Form
10-Q, filed May 15, 2003
Exhibit 10-D, Quarterly Report on Form
10-Q, filed May 15, 200310-Kk
    
    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, 200310-Ll
    
    First Amendment of Employment Agreement,
effective on May 1, 2003, between Hercules
Incorporated and William H. Joyce
    
    Exhibit 10.1, Quarterly Report on Form
10-Q, filed November 7, 200310-Mm*
    
    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 agent10-Nn*
    
    Change of Control Employment Agreement, dated
April 15, 2002, by and between Hercules
Incorporated and John Y. Televantos14
18*
    
    Directors Code of Business Conduct and Ethics
Letter Regarding Change in Accounting Principles
    
    Appendix VII, Proxy Statement dated June
20, 200321.1
    
    Subsidiaries of Registrant
    
    See Part II, Item 8 on page 76 of this
Form 10-K/A23.1*
    
    Consent of Independent Registered
Public Accounting Firm31.1*
    
    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 200231.2*
    
    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 200232.1*
    
    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 200232.2*
    
    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
 *Filed herewith 85