**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**Form 10-Q**

 
| **(Mark One)**                                                                                                                                                                                                     |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                         |
| **ý**                                                                                                                                                                                                         | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                         | ** ** |
| **For the quarterly period ended September 30,  2005**                                                                                                                                                        |
| ** **                                                                                                                                                                                                         |
| **OR**                                                                                                                                                                                                             |
| ** **                                                                                                                                                                                                         |
| **o**                                                                                                                                                                                                              | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                         | ** ** |
| **For the transition period from                  to                ** |

 

**Commission file number 333-115344**

 

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**HUNTSMAN ADVANCED MATERIALS LLC**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                     |   | **92-0194012**                       |
|------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or  organization) |   | (I.R.S. Employer Identification No.) |

 

**500 Huntsman Way**

**Salt Lake City, Utah 84108**

**(801) 584-5700**

(Address of principal executive offices andtelephone number)

 

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Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days. YES ý  NO o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act). YES o  NO ý

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). YES o  NO ý

 

On November 14, 2005, 4,672,047 units of membership interest ofthe registrant were outstanding. There is no established trading market for theregistrant’s units of membership interest. All of the registrant’s units ofmembership interest are held by affiliates.

 

 

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**HUNTSMAN ADVANCED MATERIALS LLC**

**QUARTERLY REPORT ON FORM 10-Q FOR THEQUARTERLY PERIOD**

**ENDED SEPTEMBER 30, 2005**

 

**TABLE OF CONTENTS**

 
| PART I  | FINANCIAL INFORMATION                                                                        |   |
|--------------|----------------------------------------------------------------------------------------------|--------|
| ITEM 1.      | Financial Statements                                                                         |   |
|         | Condensed Consolidated Balance Sheets  (Unaudited)                                           |   |
|         | Condensed Consolidated Statements of  Operations and Comprehensive Income (Loss) (Unaudited) |   |
|         | Condensed Consolidated Statements of  Members’ Equity (Unaudited)                       |   |
|         | Condensed Consolidated Statements of Cash  Flows (Unaudited)                                 |   |
|         | Notes to Condensed Consolidated Financial  Statements (Unaudited)                            |   |
| ITEM 2.      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations  |   |
| ITEM 3.      | Quantitative and Qualitative Disclosures  About Market Risk                                  |   |
| ITEM 4.      | Controls and Procedures                                                                      |   |
| PART II | OTHER INFORMATION                                                                            |   |
| ITEM 1.      | Legal Proceedings                                                                            |   |
| ITEM 6.      | Exhibits                                                                                     |   |

 

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS(UNAUDITED)**

 

**(Dollars in Millions)**

 
| ** **                                                                                         | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                         |       |                         |       |                        |       |
| **Current assets:**                                                                                |       |                         |       |                        |       |
| Cash and cash equivalents                                                                          |       | $                            | 51.0       |                        | $          | 93.8 |   |
| Trade accounts receivable (net of allowance  for doubtful accounts of $8.0 and $7.3, respectively) |       | 207.8                        |       | 235.1                       |       |
| Inventories, net                                                                                   |       | 194.6                        |       | 179.5                       |       |
| Deferred income taxes                                                                              |       | 1.1                          |       | 1.0                         |       |
| Other current assets                                                                               |       | 12.5                         |       | 13.4                        |       |
| **Total  current assets**                                                                          |       | 467.0                        |       | 522.8                       |       |
| Property, plant and equipment, net                                                                 |       | 325.3                        |       | 378.6                       |       |
| Deferred income taxes                                                                              |       | 36.4                         |       | 34.5                        |       |
| Other noncurrent assets                                                                            |       | 17.3                         |       | 17.4                        |       |
|                                                                                               |       |                         |       |                        |       |
| **Total  assets**                                                                                  |       | $                            | 846.0      |                        | $          | 953.3 |   |
| **LIABILITIES AND MEMBERS’ EQUITY**                                                           |       |                         |       |                        |       |
| **Current liabilities:**                                                                           |       |                         |       |                        |       |
| Accounts payable                                                                                   |       | $                            | 80.6       |                        | $          | 79.2 |   |
| Accounts payable to affiliates                                                                     |       | 4.3                          |       | 3.7                         |       |
| Accrued liabilities                                                                                |       | 92.3                         |       | 113.5                       |       |
| Deferred income taxes                                                                              |       | 6.1                          |       | 6.3                         |       |
| Short-term debt                                                                                    |       | 3.7                          |       | 1.7                         |       |
| **Total  current liabilities**                                                                     |       | 187.0                        |       | 204.4                       |       |
| Long-term debt                                                                                     |       | 274.8                        |       | 348.7                       |       |
| Other noncurrent liabilities                                                                       |       | 134.4                        |       | 142.2                       |       |
| **Total  liabilities**                                                                             |       | 596.2                        |       | 695.3                       |       |
| **Commitments and contingencies (Notes 9 & 10)**                                          |       |                         |       |                        |       |
| **Minority interest**                                                                              |       | 2.9                          |       | 2.4                         |       |
| **Members’ equity:**                                                                          |       |                         |       |                        |       |
| Members’ equity, 4,672,047 units                                                              |       | 222.1                        |       | 222.1                       |       |
| Retained earnings                                                                                  |       | 43.5                         |       | 38.9                        |       |
| Accumulated other comprehensive loss                                                               |       | (18.7                        | )          | (5.4                        | )          |
| **Total  members’ equity**                                                                    |       | 246.9                        |       | 255.6                       |       |
| **Total  liabilities and members’ equity**                                                    |       | $                            | 846.0      |                        | $          | 953.3 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

1

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS ANDCOMPREHENSIVE INCOME (LOSS) (UNAUDITED)**

 

**(Dollars in Millions)**

 
| ** **                                           | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | ** **                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues**                                         |       | $                                           | 289.5      |                                       | $          | 294.1 |   | $ | 911.5 |   | $ | 866.4 |   |
| **Cost of goods sold**                               |       | 219.0                                       |       | 227.9                                      |       | 690.5 |   | 662.9 |   |
| ** **                                           |       |                                        |       |                                       |       |   |   |   |   |
| **Gross profit**                                     |       | 70.5                                        |       | 66.2                                       |       | 221.0 |   | 203.5 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Expenses:**                                        |       |                                        |       |                                       |       |   |   |   |   |
| Selling, general and administrative                  |       | 33.2                                        |       | 36.2                                       |       | 103.7 |   | 113.8 |   |
| Research and development                             |       | 8.5                                         |       | 8.4                                        |       | 25.5 |   | 25.2 |   |
| Restructuring and plant closing credits,  net        |       | —                                      |       | —                                     |       | (0.6 | ) | — |   |
| Other operating expense (income)                     |       | 1.2                                         |       | (22.7                                      | )          | 23.4 |   | (16.9 | ) |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Total expenses                                       |       | 42.9                                        |       | 21.9                                       |       | 152.0 |   | 122.1 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Operating income**                                 |       | 27.6                                        |       | 44.3                                       |       | 69.0 |   | 81.4 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Interest expense, net                                |       | (10.5                                       | )          | (10.5                                      | )          | (31.6 | ) | (31.4 | ) |
| Other expense                                        |       | (6.7                                        | )          | —                                     |       | (6.1 | ) | — |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Income before income taxes and minority interest** |       | 10.4                                        |       | 33.8                                       |       | 31.3 |   | 50.0 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Income tax benefit (expense)                         |       | 1.6                                         |       | (36.4                                      | )          | (26.1 | ) | (48.1 | ) |
| Minority interest in subsidiaries’ income       |       | (0.1                                        | )          | (0.6                                       | )          | (0.6 | ) | (1.0 | ) |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Net income (loss)**                                |       | 11.9                                        |       | (3.2                                       | )          | 4.6 |   | 0.9 |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Other comprehensive loss                             |       | (0.5                                        | )          | (3.6                                       | )          | (13.3 | ) | (5.7 | ) |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |
| **Comprehensive income (loss)**                      |       | $                                           | 11.4       |                                       | $          | (6.8 | ) | $ | (8.7 | ) | $ | (4.8 | ) |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF MEMBERS’EQUITY (UNAUDITED)**

 

**(Dollars and Units in Millions)**

 
| ** **                       | ** ** | **Members’ Equity** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total**  | ** ** |
|----------------------------------|------------|--------------------------|------------|------------------------|------------|---------------------------------------------|------------|------------|------------|
| **Units**                        | ** ** | **Amount**               |
| ** **                       | ** ** | ** **               | ** ** | ** **             | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance, December 31, 2004  |       | 4.7                      |       | $                      | 222.1      |                                        | $          | 38.9       |       | $ | (5.4 | ) | $ | 255.6 |   |
|                             |       |                     |       |                   |       |                                        |       |       |       |   |   |
| Net income                       |       | —                   |       | —                 |       | 4.6                                         |       | —     |       | 4.6 |   |
| Other comprehensive loss         |       | —                   |       | —                 |       | —                                      |       | (13.3      | )          | (13.3 | ) |
|                             |       |                     |       |                   |       |                                        |       |       |       |   |   |
| Balance, September 30, 2005 |       | 4.7                      |       | $                      | 222.1      |                                        | $          | 43.5       |       | $ | (18.7 | ) | $ | 246.9 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS (UNAUDITED)**

 

**(Dollars in Millions)**

 
| ** **                                                                                   | ** ** | **Nine Months  Ended  September 30, 2005** | ** ** | **Nine Months  Ended  September 30, 2004** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| **Operating  Activities:**                                                                   |       |                                            |       |                                            |       |
| Net income                                                                                   |       | $                                               | 4.6        |                                            | $          | 0.9 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                                            |       |                                            |       |
| Depreciation and amortization                                                                |       | 35.3                                            |       | 40.9                                            |       |
| Noncash interest expense                                                                     |       | 2.7                                             |       | 2.2                                             |       |
| Unrealized loss (gain) on foreign currency  transactions                                     |       | 14.8                                            |       | (5.7                                            | )          |
| Loss on early extinguishment of debt                                                         |       | 6.7                                             |       | —                                          |       |
| Loss (gain) on sale of assets                                                                |       | 0.2                                             |       | (0.7                                            | )          |
| Deferred income taxes                                                                        |       | 15.1                                            |       | 46.4                                            |       |
| Minority interests in subsidiaries’ income                                              |       | 0.6                                             |       | 1.0                                             |       |
| Other                                                                                        |       | 1.9                                             |       | (0.3                                            | )          |
| Changes in operating assets and  liabilities:                                                |       |                                            |       |                                            |       |
| Accounts receivable, net                                                                     |       | 10.1                                            |       | (31.3                                           | )          |
| Inventories, net                                                                             |       | (26.4                                           | )          | (34.3                                           | )          |
| Accounts payable                                                                             |       | 10.0                                            |       | 2.4                                             |       |
| Other operating assets and liabilities                                                       |       | (23.6                                           | )          | (28.7                                           | )          |
| **Net cash  provided by (used in) operating activities**                                     |       | 52.0                                            |       | (7.2                                            | )          |
| **Investing  Activities:**                                                                   |       |                                            |       |                                            |       |
| Capital expenditures                                                                         |       | (15.4                                           | )          | (7.3                                            | )          |
| Proceeds from sale of assets                                                                 |       | 0.4                                             |       | 3.2                                             |       |
| Other                                                                                        |       | 0.3                                             |       | 0.4                                             |       |
| **Net cash  used in investing activities**                                                   |       | (14.7                                           | )          | (3.7                                            | )          |
| **Financing  Activities:**                                                                   |       |                                            |       |                                            |       |
| Decrease in short-term debt, net                                                             |       | (0.4                                            | )          | (1.9                                            | )          |
| Prepayment of long-term debt                                                                 |       | (75.0                                           | )          | —                                          |       |
| Costs of early extinguishment of debt                                                        |       | (3.8                                            | )          | —                                          |       |
| Other                                                                                        |       | (0.3                                            | )          | —                                          |       |
| **Net cash  used in financing activities**                                                   |       | (79.5                                           | )          | (1.9                                            | )          |
| Effect of exchange rate changes on cash                                                      |       | (0.6                                            | )          | (0.3                                            | )          |
| Decrease in cash and cash equivalents                                                        |       | (42.8                                           | )          | (13.1                                           | )          |
| Cash and cash equivalents at beginning of  period                                            |       | 93.8                                            |       | 73.2                                            |       |
| Cash and cash equivalents at end of period                                                   |       | $                                               | 51.0       |                                            | $          | 60.1 |   |
| **Supplemental  cash flow information:**                                                     |       |                                            |       |                                            |       |
| Cash paid for interest                                                                       |       | $                                               | 39.9       |                                            | $          | 39.8 |   |
| Cash paid for income taxes                                                                   |       | $                                               | 5.5        |                                            | $          | 2.4 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

 

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS (UNAUDITED)**

 

**1.****                                      General**

 

***Description ofBusiness***

 

Huntsman Advanced Materials LLC (including its subsidiaries, unless thecontext otherwise requires, the “Company,” “our,” “us,” or “we”) is a leadingglobal manufacturer and marketer of technologically advanced specialtychemicals used in a wide variety of industrial and consumer applications. Wehave 13 manufacturing facilities located around the world and employ over 2,000associates. Our business is characterized by its breadth in product offering,our expertise in complex chemistry, our long-standing relationships with ourcustomers and our ability to develop and adapt our technology and formulationsfor new markets and new applications. We are a leading producer of complexepoxy, acrylic and polyurethane-based formulations, epoxy resins,cross-linkers, matting and curing agents. We sell into a multitude of marketsincluding: construction; engineering adhesives; electric power generation,transmission and distribution; consumer and industrial electronics; automotive;appliance; aerospace; wind power generation; and recreational sports andequipment markets.  We operate in onereportable business segment.

 

***Company***

 

We are a Delaware limited liability company, 90.3% of our membershipinterests are indirectly owned by Huntsman Corporation through HuntsmanAdvanced Materials Holdings LLC, a Delaware limited liability company (“AdMatHoldings”) and Huntsman Advanced Materials Investment LLC, a Delaware limitedliability company (“AdMat Investment”) and the balance of the membershipinterests are held indirectly by third parties, including SISU Capital Limited(“SISU”), a private investment firm based in London, U.K.

 

On June 30, 2003, a predecessor of Huntsman Corporation, HuntsmanHoldings, LLC (“Huntsman Holdings”) and other equity affiliates of HuntsmanHoldings completed a restructuring and business combination involving VanticoGroup S.A. (collectively with its subsidiaries, unless the context otherwiserequires, “Vantico” or the “Predecessor Company”), whereby ownership of theequity of Vantico was transferred to us (the “AdMat Transaction”). We accountedfor the AdMat Transaction as a purchase business combination.

 

***Principles ofConsolidation***

 

Our consolidated financial statements include the accounts of ourwholly-owned and majority-owned subsidiaries and any variable interest entitiesfor which we are the primary beneficiary.

 

***Interim FinancialStatements***

 

Our unaudited interim condensed consolidated financial statements wereprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) and in management’s opinion, reflect alladjustments, consisting only of normal recurring adjustments necessary for afair presentation of results of operations, financial position and cash flowsfor the periods presented. Results for interim periods are not necessarilyindicative of those to be expected for the full year. These condensedconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements and notes to consolidated financialstatements for the year ended December 31, 2004 included in ourRegistration Statement on Form S-4 filed with the Securities and ExchangeCommission on April 5, 2005 (File No. 333-115344).

 

***Use of Estimates***

 

The preparation of financial statements in conformity with GAAPrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

 

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***Reclassifications***

 

Certain amounts in the condensed consolidated financial statements forprior periods have been reclassified to conform with the current presentation.

 

**2.****                                      RecentlyIssued Accounting Pronouncements**

 

In January 2003, the Financial Accounting Standards Board (“FASB”)issued Financial Interpretation No. (“FIN”) 46, “*Consolidation of Variable Interest Entities*.”FIN 46 addresses the requirements for business enterprises to consolidaterelated entities, for which they do not have controlling interests throughvoting or other rights, if they are determined to be the primary beneficiary asa result of variable economic interests. Transfers to a qualifying specialpurpose entity are not subject to this interpretation. In December 2003,the FASB issued a replacement of FIN 46 (FIN 46R) to clarify certaincomplexities. We adopted this financial interpretation on January 1, 2005.The adoption of the standard had no impact on our consolidated financialstatements.

 

In November 2004, the FASB issued Statement of FinancialAccounting Standards (SFAS) No. 151, “*InventoryCosts—an amendment of ARB No. 43*.” SFAS No. 151 requiresabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterial to be recognized as current-period charges. It also requires thatallocation of fixed production overhead to the costs of conversion be based onthe normal capacity of the production facilities. The requirements of thestandard will be effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. We are reviewing SFAS No. 151 todetermine the statement’s impact on our consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 153, “*Exchanges of Nonmonetary Assets—an amendment of APBOpinion No. 29*.” SFAS No. 153 addresses the measurement ofexchanges of nonmonetary assets and eliminates the exception from fair valuemeasurement for nonmonetary exchanges of similar productive assets in APBOpinion No. 29 and replaces it with an exception for exchanges that do nothave commercial substance. SFAS No. 153 specifies that a nonmonetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange. The provisions ofthis standard are effective for nonmonetary exchanges occurring in fiscalperiods beginning after June 15, 2005. We will apply this standardprospectively.

 

In December 2004, the FASB issued SFAS No. 123R, “*Share Based Payment*.” SFAS No. 123Rrequires entities to measure the cost of employee services received in exchangefor an award of equity instruments based on the grant-date fair value of theaward. That cost will be recognized over the period during which the employeeis required to provide services in exchange for the award. This standardeliminates the alternative to use the intrinsic value method of accounting forshare-based payments as previously provided in APB Opinion No. 25, “*Accounting for Stock Issued to Employees*.”We adopted SFAS No. 123R effective January 1, 2005, and have appliedthis standard prospectively to share-based awards issued to our employees inconnection with Huntsman Corporation’s initial public offering. In connectionwith Huntsman Corporation’s initial public offering of common stock on February 16,2005, certain of our employees received Huntsman Corporation stock options andrestricted stock. Accordingly, we were allocated share-based compensationexpense of $0.3 million and $0.7 million during the three and ninemonths ended September 30, 2005, respectively. We did not have share-basedawards prior to the awards issued in connection with Huntsman Corporation’sinitial public offering.

 

In March 2005, the FASB issued FIN 47, *“Accounting for Conditional Asset Retirement Obligations.”*FIN 47 clarifies the term *conditional assetretirement obligation* used in SFAS No. 143, *“Accounting for Asset Retirement Obligations,”*and clarifies when an entity would have sufficient information to reasonablyestimate the fair value of an asset retirement obligation. FIN 47 is effectiveno later than the end of December 2005. We are reviewing FIN 47 todetermine its impact on our consolidated financial statements.

 

In May 2005, the FASB issued SFAS No. 154, *“Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3.”*SFAS No. 154 requires retrospective application to prior periods’financial statements of changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change or unless specific transition provisions are proscribed inthe accounting pronouncements. SFAS No. 154 does not change the accountingguidance for reporting a correction of an error in previously issued financialstatements or a change in accounting estimate. SFAS No. 154 is effectivefor accounting changes and error corrections made after December 31, 2005.We will apply this standard prospectively.

 

In September 2005, the Emerging Issues Task Force (“EITF”) reacheda consensus on issue 04-13, “*Accounting forPurchases and Sales of Inventory with the Same Counterparty*,” thatrequires companies to recognize an exchange of finished

 

6

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goods for raw materials or work-in-process within the same line ofbusiness at fair value. All other exchanges of inventory should be reflected atthe recorded amount.  This consensus iseffective for transactions completed after March 31, 2006.   We are evaluating the impact of thisconsensus to determine its impact on our results of operations.

 

**3.****                                      Inventories**

 

Inventories consisted of the following (dollars in millions):

 
| ** **                                         | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials and supplies                         |       | $                            | 41.4       |                        | $          | 34.6 |   |
| Work in process                                    |       | 26.0                         |       | 29.4                        |       |
| Finished goods                                     |       | 138.3                        |       | 126.5                       |       |
| **Total**                                          |       | 205.7                        |       | 190.5                       |       |
| Allowance for obsolete and slow moving inventories |       | (11.1                        | )          | (11.0                       | )          |
| **Inventories,  net**                              |       | $                            | 194.6      |                        | $          | 179.5 |   |

 

**4.****                                      Restructuringand Plant Closing Costs**

 

As of December 31, 2004, accrued restructuring and plant closingcosts consisted of $33.0 million related to the restructuring programsimplemented in association with the AdMat Transaction, the realignment andsimplification of our commercial and technical organization and the closure ofour Kaohsiung, Taiwan production facility.

 

During the second quarter of 2005, we assessed the remaining restructuringreserves established in association with the AdMat Transaction and other 2004initiatives and concluded that $5.3 million and $1.0 million,respectively, were no longer necessary. Accordingly, we reversed theserestructuring reserves during the second quarter of 2005. The AdMat Transactionreserve reversal was recorded as a reduction to property, plant and equipmentin accordance with EITF 95-3, *“Recognitionof Liabilities in Connection with a Purchase Business Combination.”*The reversal of the restructuring reserve for the other 2004 initiatives wasrecorded as a credit to earnings. Also during 2005, we recorded restructuringand plant closing charges of $0.4 million for relocation and other costs.

 

During the nine months ended September 30, 2005, activity in ourrestructuring reserves consisted of the following (dollars in millions):

 
| ** **                                                             | ** ** | **Workforce  Reductions** | ** ** | **Plant  Closure Costs** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------|------------|--------------------------|------------|-----------|------------|-----------|------------|
| Accrued liabilities as of January 1,  2005                        |       | $                         | 28.1       |                     | $          | 1.1       |       | $         | 3.8        |   | $ | 33.0 |   |
| 2005 payments for AdMat Transaction opening  balance sheet initiatives |       | (7.3                      | )          | (0.2                     | )          | (1.1      | )          | (8.6      | )          |
| 2005 payments for 2004 initiatives                                     |       | (6.3                      | )          | —                   |       | (0.4      | )          | (6.7      | )          |
| Partial reversal of AdMat Transaction  opening balance sheet liability |       | (3.7                      | )          | (0.8                     | )          | (0.8      | )          | (5.3      | )          |
| Partial reversal of 2004 initiative  liability                         |       | (1.0                      | )          | —                   |       | —    |       | (1.0      | )          |
| 2005 charges for 2004 initiatives                                      |       | —                    |       | —                   |       | 0.4       |       | 0.4       |       |
| Foreign currency effect on reserve balance                             |       | (1.2                      | )          | —                   |       | (0.5      | )          | (1.7      | )          |
| Accrued liabilities as of September 30,  2005                     |       | $                         | 8.6        |                     | $          | 0.1       |       | $         | 1.4        |   | $ | 10.1 |   |

 

During the fourth quarter of 2005, we expect to initiate additionalrestructuring activities to consolidate our European research and developmentorganizations and to incur additional restructuring and plant closing costs of approximately$3 million.

 

7

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**5.****                                      Debt**

 

Outstanding debt consisted of the following (dollars in millions):

 
| ** **                 | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Debt:                      |       |                         |       |                        |       |
| AdMat Senior Secured Notes |       | $                            | 274.7      |                        | $          | 348.6 |   |
| Other debt                 |       | 3.8                          |       | 1.8                         |       |
| **Total debt**             |       | 278.5                        |       | 350.4                       |       |
| Less short-term debt       |       | (3.7                         | )          | (1.7                        | )          |
| ** **                 |       |                         |       |                        |       |
| **Total long-term debt**   |       | $                            | 274.8      |                        | $          | 348.7 |   |

 

***Revolving CreditFacility***

 

Our revolving credit facility (the “AdMat Revolving Credit Facility”)provides up to $60 million of borrowings and is secured by a first lien onsubstantially all of our assets and those of certain of our subsidiaries. Thecollateral includes substantially all real property and equipment relating toour manufacturing plants located at Bergkamen, Germany; Monthey, Switzerland;McIntosh, Alabama; and Duxford, U.K. The collateral also includes intercompanynotes of certain of our subsidiaries, and certain other assets, principallyincluding inventory and accounts receivable. Our obligations under the AdMatRevolving Credit Facility have been initially guaranteed by all of our U.S.subsidiaries and certain of our non-U.S. subsidiaries (collectively, the “AdMatGuarantors”). The agent for the lenders under the AdMat Revolving CreditFacility and the trustee under the indenture governing the Senior Secured Notes(as defined below) are parties to an intercreditor agreement (the “AdMatIntercreditor Agreement”).

 

On June 17, 2005, we amended the AdMat Revolving Credit Facility.This amendment included, among other things, the extension of the facility’smaturity date from June 30, 2007 to July 15, 2007, the reduction ininterest rate margins and the elimination of pledges of capital stock insubsidiaries as collateral under the facility. Interest rates, at our option,are based upon either a eurocurrency rate (LIBOR) or a base rate (prime), plusan applicable spread. The applicable spreads vary based on a pricing grid. Inthe case of the eurocurrency-based loans, spreads range from 1.25% to 1.5% perannum, depending on whether specified conditions have been satisfied, and, inthe case of base rate loans, from 0.25% to 0.5% per annum. As of September 30,2005, we had no amounts drawn on the AdMat Revolving Credit Facility and hadapproximately $2.6 million of letters of credit issued and outstandingunder the AdMat Revolving Credit Facility. The AdMat Revolving Credit Facilityallows us to issue up to $20 million in letters of credit; however, the$60 million revolving credit facility is reduced dollar-for-dollar by anyletters of credit outstanding. There are no scheduled debt amortizationpayments on the AdMat Revolving Credit Facility until its maturity date.

 

The agreement governing the AdMat Revolving Credit Facility containscustomary financial covenants; covenants relating to the incurrence of debt,the purchase and sale of assets, limitations on investments and affiliatetransactions; change in control provisions; events of default provisions; andacceleration provisions.

 

***Senior Secured Notes***

 

As of September 30, 2005, we had outstanding $250 million of fixedrate notes due 2010 (“Fixed Rate Notes”) and $25 million of floating ratenotes due 2008 ($100 million original aggregate principal amount) (“FloatingRate Notes,” and, collectively with the Fixed Rate Notes, the “Senior SecuredNotes”). The $250 million Fixed Rate Notes bear a per annum fixed rate ofinterest of 11%, and the Floating Rate Notes bear interest at a rate per annumequal to LIBOR plus 8.0%, subject to a floor with respect to LIBOR of 2.0%. Asof September 30, 2005, the interest rate on the Floating Rate Notes wasapproximately 11.8%. Interest on the Floating Rate Notes resets semiannually.The Floating Rate Notes were issued with an original issue discount of 2.0%.The discount is being amortized to interest expense over the term of theFloating Rate Notes. Interest is payable on the Senior Secured Notessemiannually on January 15 and July 15 of each year.

 

The Senior Secured Notes are secured by a second lien, subject to theAdMat Intercreditor Agreement, on substantially all of the assets that securethe AdMat Revolving Credit Facility. The Senior Secured Notes effectively ranksenior in right of payment to all existing and future obligations of ourCompany that are unsecured or secured by liens on the collateral junior to the

 

8

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liens securing the Senior Secured Notes. The Senior Secured Notes areinitially guaranteed on a senior basis by the AdMat Guarantors and are alsosupported by liens on substantially all of the assets of the AdMat Guarantors.

 

The Fixed Rate Notes are redeemable on or after July 15, 2007 atour option at a price declining ratably from 105.5% to 100.0% of par value bythe year 2009. At any time prior to July 15, 2007 for the Fixed RateNotes, we may redeem all or part of such notes at 100% of their principalamount, plus a “make whole” premium, as defined in the indenture. In addition,at any time prior to July 15, 2006 for the Fixed Rate Notes, we may redeemup to 35% of the original aggregate principal amount of such notes at aredemption price of 111% of the principal thereof with the net cash proceeds ofone or more qualified equity offerings, subject to certain conditions andlimitations. The Floating Rate Notes are currently redeemable at our option ata price declining ratably from 105.0% to 100.0% of par value by the year 2007.During the third quarter of 2005, we completed a partial redemption of $75million in aggregate principal amount of Floating Rate Notes and paid callpremiums in the amount of approximately $3.8 million. There are noscheduled debt amortization payments on the Senior Secured Notes until theirmaturity date.

 

The indenture governing the Senior Secured Notes contains covenantsrelating to the incurrence of debt and limitations on distributions, assetsales and affiliate transactions, among other things. The indenture alsocontains a change of control provision requiring us to offer to repurchase theSenior Secured Notes upon a change of control.

 

***Compliance withCovenants***

 

Our management believes that we are in compliance with the covenantscontained in the agreements governing the AdMat Revolving Credit Facility andthe indentures governing our notes.

 

**6.****                                      DerivativeInstruments and Hedging Activities**

 

On June 1, 2005, we entered into a cross-currency interest rateswap. The cross-currency swap requires us to pay euros and receive U.S. dollarson the maturity date of July 15, 2007. The U.S. dollar notional amount is$31.3 million and bears interest at a fixed rate of 11.0%, payablesemiannually on January 15 and July 15. The euro notional amount is€25.0 million and bears interest at a fixed rate of approximately 9.4%,payable semiannually on January 15 and July 15. As of September 30,2005, the swap was not designated as a hedge for reporting purposes and wasrecorded at fair value. As of September 30, 2005, an asset of$1.0 million was recorded in other noncurrent assets, with a correspondingdecrease in other operating expenses for the nine months ended September 30,2005.

 

**7.****                                      EmployeeBenefit Plans**

 

Components of the net periodic benefit costs for the three and ninemonths ended September 30, 2005 and 2004 were as follows (dollars inmillions):

 
| ** **                                   | ** ** | **Defined Benefit Plans**                         | ** ** | **Other Postretirement  Benefit Plans**           | ** ** |
|----------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                   | ** ** | **Three Months  Ended  September 30,  2005** | ** ** | **Three Months  Ended  September 30,  2004** | ** ** | **Three Months  Ended  September 30,  2005** | ** ** | **Three Months  Ended  September 30,  2004** | ** ** |
| **Components  of net periodic benefit cost** | ** ** | ** **                                        | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                 |       | $                                                 | 2.4        |                                              | $          | 2.1 |   | $ | 0.1 |   | $ | 0.1 |   |
| Interest cost                                |       | 4.1                                               |       | 3.4                                               |       | 0.2 |   | 0.2 |   |
| Expected return on assets                    |       | (4.0                                              | )          | (3.4                                              | )          | — |   | — |   |
| Prior service cost amortization              |       | (0.8                                              | )          | —                                            |       | — |   | — |   |
| Actuarial loss amortization                  |       | 0.1                                               |       | —                                            |       | — |   | — |   |
| Net periodic benefit cost                    |       | $                                                 | 1.8        |                                              | $          | 2.1 |   | $ | 0.3 |   | $ | 0.3 |   |

 

9

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| ** **                                   | ** ** | **Defined Benefit Plans**                        | ** ** | **Other Postretirement  Benefit Plans**          | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **Nine Months  Ended  September 30,  2005** | ** ** | **Nine Months  Ended  September 30,  2004** | ** ** | **Nine Months  Ended  September 30,  2005** | ** ** | **Nine Months  Ended  September 30,  2004** | ** ** |
| **Components  of net periodic benefit cost** | ** ** | ** **                                       | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                 |       | $                                                | 8.6        |                                             | $          | 6.2 |   | $ | 0.3 |   | $ | 0.3 |   |
| Interest cost                                |       | 12.3                                             |       | 10.2                                             |       | 0.6 |   | 0.5 |   |
| Expected return on assets                    |       | (12.0                                            | )          | (10.1                                            | )          | — |   | — |   |
| Prior service cost amortization              |       | (2.4                                             | )          | —                                           |       | — |   | — |   |
| Actuarial loss amortization                  |       | 0.3                                              |       | —                                           |       | — |   | — |   |
| Net periodic benefit cost                    |       | $                                                | 6.8        |                                             | $          | 6.3 |   | $ | 0.9 |   | $ | 0.8 |   |

 

During the nine months ended September 30,2005 and 2004, we made contributions to our pension plans of $14.2 million and$5.9 million, respectively.

 

During the fourth quarter of 2005, we expect to accelerate the date foractuarial measurement of our pension and postretirement benefit obligationsfrom December 31 to November 30. We believe the one-monthacceleration of the measurement date is a preferred change as it improvesinternal control procedures by allowing more time to review the completenessand accuracy of the actuarial benefit obligation measurements. The effect ofthe change in measurement date on the respective obligations and assets of theplans is not expected to have a material cumulative effect on annual expense oraccrued benefit costs.

 

**8.****                                      OtherComprehensive Loss**

 

The components of other comprehensive loss were as follows (dollars inmillions):

 
| ** **                                                                                                                                         | ** ** | **Accumulated other**       | ** **                  | **Other  comprehensive loss** | ** **                  |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-----------------------------|-------------------------------|-----------------------------|
| ** **                                                                                                                                         | ** ** | **comprehensive loss**      | ** **                  | **Three Months Ended**        | ** **                  | **Nine Months Ended** | ** ** |
| **September 30,  2005**                                                                                                                       | ** ** | **December 31,  2004** | **September 30, 2005** | ** **                    | **September 30, 2004** | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| Foreign currency translation adjustments,  net of tax of $5.0 and $5.0 as of September 30, 2005 and December 31,  2004, respectively     |       | $                           | (17.3                       | )                             | $                           | (4.0 | ) | $ | (0.5 | ) | $ | (3.6 | ) | $ | (13.3 | ) | $ | (5.7 | ) |
| Additional minimum pension liability, net  of tax benefit of $0.3 and $0.3 as of September 30, 2005 and December 31,  2004, respectively |       | (1.4                        | )                           | (1.4                          | )                           | — |   | — |   | — |   | — |   |
| Total                                                                                                                                              |       | $                           | (18.7                       | )                             | $                           | (5.4 | ) | $ | (0.5 | ) | $ | (3.6 | ) | $ | (13.3 | ) | $ | (5.7 | ) |

 

Items of other comprehensive loss of our Company and our consolidatedaffiliates have been recorded net of tax, with the exception of the foreigncurrency translation adjustments related to subsidiaries with earningspermanently reinvested. The tax effect is determined based upon thejurisdiction where the income or loss was recognized and is net of valuationallowances that have been recorded.

 

**9.****                                      Commitmentsand Contingencies**

 

***Legal Matters***

 

Vantico, a predecessor entity, concluded that certain of the productsof its former Electronics division may have infringed patents owned by Taiyoand it entered into a license agreement in October 2001 with Taiyo toobtain the right to use the Taiyo patents. This license agreement requiredpayment of approximately $4.2 million in back royalties and agreement topay periodic royalties for future use. We believe that Ciba Specialty ChemicalsHoldings Inc. (“Ciba”) is liable under the indemnity provisions of certainagreements in connection with the leveraged buy-out transaction in 2000involving Ciba and Vantico for certain payments made under the licenseagreement and related costs and expenses, and we initiated an arbitrationproceeding against Ciba. In July 2004, we entered into a settlementagreement with Ciba with respect to this matter. In general, the settlementagreement provided that Ciba would pay us

 

10

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$11.1 million in 2004. We received additional consideration in theform of modifications to certain operating agreements between us and Ciba. In August 2004,we received payment of the $11.1 million settlement.

 

We are a party to various other proceedings instituted by privateplaintiffs, governmental authorities and others arising under provisions ofapplicable laws, including various environmental, products liability and otherlaws. Except as otherwise disclosed in this report, we do not believe that theoutcome of any of these matters will have a material adverse effect on ourfinancial condition, results of operations or liquidity. See Note 10 “Environmental,Health and Safety Matters” for a discussion of environmental proceedings.

 

**10.****                               Environmental,Health and Safety Matters**

 

***General***

 

We are subject to extensive federal, state, local and foreign laws,regulations, rules and ordinances relating to pollution, protection of theenvironment and the generation, storage, handling, transportation, treatment,disposal and remediation of hazardous substances and waste materials. In theordinary course of business, we are subject to frequent environmentalinspections and monitoring and occasional investigations by governmentalenforcement authorities. In addition, our production facilities requireoperating permits that are subject to renewal, modification and, in certaincircumstances, revocation. Actual or alleged violations of environmental lawsor permit requirements could result in restrictions or prohibitions on plantoperations, substantial civil or criminal sanctions, as well as, under someenvironmental laws, the assessment of strict liability and/or joint and severalliability. Moreover, changes in environmental regulations could inhibit orinterrupt our operations, or require us to modify our facilities or operations.Accordingly, environmental or regulatory matters may cause us to incursignificant unanticipated losses, costs or liabilities.

 

***Environmental,Health and Safety Systems***

 

We are committed to achieving and maintaining compliance with allapplicable environmental, health and safety (“EHS”) legal requirements, and wehave developed policies and management systems that are intended to identifythe multitude of EHS legal requirements applicable to our operations, enhancecompliance with applicable legal requirements, ensure the safety of ouremployees, contractors, community neighbors and customers and minimize theproduction and emission of wastes and other pollutants. Although EHS legalrequirements are constantly changing and are frequently difficult to complywith, these EHS management systems are designed to assist us in our compliancegoals while also fostering efficiency and improvement and minimizing overallrisk to us.

 

***EHS CapitalExpenditures***

 

We may incur future costs for capital improvements and generalcompliance under EHS laws, including costs to acquire, maintain and repairpollution control equipment. For the nine months ended September 30, 2005and 2004, our capital expenditures for EHS matters totaled $0.7 millionand $0.8 million, respectively. Since capital expenditures for these mattersare subject to evolving regulatory requirements and depend, in part, on thetiming, promulgation and enforcement of specific requirements, we cannotprovide assurance that our recent expenditures will be indicative of futureamounts required under EHS laws.

 

***GovernmentalEnforcement Proceedings***

 

On occasion, we receive notices of violation, enforcement and othercomplaints from regulatory agencies alleging non-compliance with applicable EHSlaw. By way of example, we are aware of the individual matters set out below,which we believe to be the most significant presently pending matters andunasserted claims. Although we may incur costs or penalties in connection withthe governmental proceedings discussed below, based on currently availableinformation and our past experience, we believe that the ultimate resolution ofthese matters will not have a material impact on our results of operations,financial position or liquidity.

 

By letter dated September 13, 2005, the Tamil Nadu PollutionControl Board (the “TNPCB”) issued an Order in follow-up to a Show Cause notice dated June 30, 2005**,**requiring a manufacturingfacility of Petro Araldite Private Limited, one of our subsidiaries in Chennai,India, to close for one week and to submit an action plan and timeline toreduce chemical oxygen demand in its wastewater effluent.  The facility complied with the order and hassubmitted an action plan to the TNPCB, which has been accepted pendinginstallation of assets to remedy the issue. If the TNPCB

 

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believes the plan is insufficient, it has the power to take furtherenforcement action, including shutting down the facility for a longer period orpermanently, initiating criminal sanctions or imposing fines.

 

***RemediationLiabilities***

 

We have incurred, and we may in the future incur, liability toinvestigate and clean up waste or contamination at our current or formerfacilities or facilities operated by third parties at which we may havedisposed of waste or other materials. Similarly, we may incur costs for thecleanup of wastes that were disposed of prior to the purchase of ourbusinesses. Under some circumstances, the scope of our liability may extend todamages to natural resources.

 

Some of our manufacturing sites have an extended history of industrialchemical manufacturing and use, including on-site waste disposal. We are awareof soil, groundwater and surface water contamination from past operations atsome of our sites, and we may find contamination at other sites in the future.For example, we are aware that there is significant contamination, largelyrelated to a landfill and lagoons, at our McIntosh, Alabama plant site. Further,soil and groundwater contamination have been identified at our plants inDuxford, U.K. and Monthey, Switzerland. Pursuant to certain agreements withrespect to these sites, we expect that Ciba will have primary financialresponsibility for such matters, although we may be required to contribute tothe costs of remediation in certain instances, and we believe that Ciba has theintention and ability to honor these agreements. Based on available informationand the indemnification rights we believe are likely to be available, webelieve that the costs to investigate and remediate known contamination willnot have a material adverse effect on our financial condition, results ofoperations or cash flows, and therefore we have made no accrual for such liabilitiesas of September 30, 2005. However, if such indemnities are unavailable ordo not fully cover the costs of investigation and remediation or we arerequired to contribute to such costs, and if such costs are material, then suchexpenditures may have a material adverse effect on our financial condition,results of operations or cash flows. At the current time, we are unable toestimate the full cost, exclusive of indemnification benefits, to remediateknown contamination sites.

 

***RegulatoryDevelopments***

 

Under the European Union (“EU”) Integrated Pollution Prevention andControl Directive (“IPPC”), EU member governments are to adopt rules andimplement a cross-media (air, water and waste) environmental permitting programfor individual facilities. While the EU countries are at varying stages intheir respective implementation of the IPPC permit program, we have submittedall necessary IPPC permit applications required to date, and in some casesreceived completed permits from the applicable government agency. We expect tosubmit all other IPPC applications and related documents on a timely basis asthe various countries implement the IPPC permit program. Although we do notknow with certainty what each IPPC permit will require, we believe, based uponour experience with the permits received to date, that the costs of compliancewith the IPPC permit program will not be material to our results of operations,financial position or liquidity.

 

In October 2003, the European Commission adopted a proposal for anew EU regulatory framework for chemicals. Under this proposed new systemcalled “REACH” (Registration, Evaluation and Authorization of Chemicals),companies that manufacture or import more than one ton of a chemical substanceper year would be required to register such manufacture or import in a centraldatabase. The REACH initiative, as proposed, would require risk assessment ofchemicals, preparations (e.g., soaps and paints) and articles (e.g., consumerproducts) before those materials could be manufactured or imported into EUcountries. Where warranted by a risk assessment, hazardous substances wouldrequire authorizations for their use. This regulation could impose risk controlstrategies that would require capital expenditures by us. As proposed, REACH wouldtake effect in three primary stages over the eleven years following the finaleffective date (assuming final approval). The impacts of REACH on the chemicalindustry and on us are unclear at this time because the parameters of theprogram are still being actively debated.

 

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**11.****                               OtherOperating Expense (Income)**

 

Other operating expense (income) consisted of the following (dollars inmillions):

 
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Foreign exchange losses (gains)        |       | $                                          | 1.1        |                                      | $          | (12.0 | ) | $ | 23.2 |   | $ | (7.5 | ) |
| Legal and contract settlements, net    |       | —                                     |       | (11.0                                     | )          | — |   | (8.8 | ) |
| Other, net                             |       | 0.1                                        |       | 0.3                                       |       | 0.2 |   | (0.6 | ) |
| Total other operating expense (income) |       | $                                          | 1.2        |                                      | $          | (22.7 | ) | $ | 23.4 |   | $ | (16.9 | ) |

 

**12.****                               OtherExpense**

 

Other expense consisted of the following (dollars in millions):

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loss on early extinguishment of debt |       | $                                          | (6.7       | )                                         | $          | — |   | $ | (6.7 | ) | $ | — |   |
| Other, net                           |       | —                                     |       | —                                    |       | 0.6 |   | — |   |
| Total other expense                  |       | $                                          | (6.7       | )                                         | $          | — |   | $ | (6.1 | ) | $ | — |   |

 

**13.****                               IncomeTaxes**

 

Income tax (benefit) expense was $(1.6)million and $26.1 million for the three and nine months ended September 30,2005, respectively, and was $36.4 million and $48.1 million for the three andnine months ended September 30, 2004, respectively.  Substantially all non-U.S.operations are treated as branches of our Company for U.S. income tax purposesand are, therefore, subject to both U.S. and non-U.S. income tax.  In addition, our tax obligations are affectedby the mix of income and losses in the tax jurisdictions in which weoperate.  Tax expense was primarily aresult of losses in jurisdictions where little or no tax benefit was providedand income in other jurisdictions where tax expense was recorded, as well as the recognition of tax benefits fromreleasing valuation allowances.

 

Our effective income tax rate was (15.4)% and83.4% for the three and nine months ended September 30, 2005,respectively, as compared to 107.7% and 96.2% for the same periods in2004.  Excluding the impact of foreignexchange losses of $1.1 million and $23.2 million, which did not provide abenefit for tax purposes, our effective income tax rate would have been (13.9)%and 47.9% for the three and nine months ended September 30, 2005,respectively.  Tax expensedifferent than the U.S. statutory rate of 35% was significantly a result ofincome earned in non-U.S. jurisdictions subject to incremental U.S. tax, aswell as the recognition of tax benefits from releasing valuation allowances.

 

We use the asset and liability method of accounting for income taxes.Deferred income taxes reflect the net tax effects of temporary differencesbetween the carrying amounts of assets and liabilities for financial and taxreporting purposes. We evaluate deferred tax assets to determine whether it ismore likely than not that they will be realized.  Valuation allowances have been establishedagainst the entire U.S. and a material portion of the non-U.S. deferred taxassets due to the uncertainty of realization. Valuation allowances are reviewed each period on a tax jurisdiction bytax jurisdiction basis to analyze whether there is sufficient positive ornegative evidence to support a change in judgment about the realizability ofthe related deferred tax asset.

 

**14.****                               CondensedConsolidating Financial Statements**

 

The following condensed consolidating financial statements present, inseparate columns, financial information for the following: our Company (on aparent only basis), with our investment in subsidiaries recorded under theequity method; the Guarantors on a combined, and where appropriate,consolidated basis and the non-guarantors on a combined, and where appropriate,consolidated basis. Additional columns present eliminating adjustments andconsolidated totals as of September 30, 2005 and December 31, 2004and for the three and nine months ended September 30, 2005 and September 30,2004. There are no contractual restrictions limiting transfers of cash fromguarantor subsidiaries to us. Each of the Guarantors is 100% owned by us andhas fully and unconditionally guaranteed the Senior Secured Notes on a jointand several basis.

 

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATING BALANCE SHEETS(UNAUDITED)**

 

**AS OF SEPTEMBER 30, 2005 (Dollars inMillions)**

 
| ** **                                      | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated  Advanced  Materials LLC** | ** ** |
|-------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------------|------------|------------------|------------|-------------------------------------------|------------|
| **ASSETS**                                      |       |            |       |           |       |                 |       |             |       |                                      |       |
| **Current assets:**                             |       |            |       |           |       |                 |       |             |       |                                      |       |
| Cash and cash equivalents                       |       | $               | 10.5       |           | $          | 22.7                 |       | $                | 17.8       |                                      | $          | — |   | $ | 51.0 |   |
| Trade accounts receivable, net                  |       | 0.7             |       | 45.8           |       | 161.3                |       | —           |       | 207.8                                     |       |
| Intercompany receivables                        |       | (19.7           | )          | 160.4          |       | 23.9                 |       | (164.6           | )          | —                                    |       |
| Inventories, net                                |       | —          |       | 52.0           |       | 142.9                |       | (0.3             | )          | 194.6                                     |       |
| Deferred income taxes                           |       | —          |       | —         |       | 1.1                  |       | —           |       | 1.1                                       |       |
| Other current assets                            |       | 0.1             |       | 6.3            |       | 6.1                  |       | —           |       | 12.5                                      |       |
| **Total  current assets**                       |       | (8.4            | )          | 287.2          |       | 353.1                |       | (164.9           | )          | 467.0                                     |       |
|                                            |       |            |       |           |       |                 |       |             |       |                                      |       |
| Property, plant and equipment, net              |       | —          |       | 277.2          |       | 48.1                 |       | —           |       | 325.3                                     |       |
| Deferred income taxes                           |       | 17.6            |       | 23.8           |       | (5.0                 | )          | —           |       | 36.4                                      |       |
| Other noncurrent assets                         |       | 829.3           |       | 400.9          |       | 3.5                  |       | (1,216.4         | )          | 17.3                                      |       |
| **Total  assets**                               |       | $               | 838.5      |           | $          | 989.1                |       | $                | 399.7      |                                      | $          | (1,381.3 | ) | $ | 846.0 |   |
| **LIABILITIES  AND MEMBERS’ EQUITY**       |       |            |       |           |       |                 |       |             |       |                                      |       |
| **Current  liabilities:**                       |       |            |       |           |       |                 |       |             |       |                                      |       |
| Accounts payable                                |       | $               | —     |           | $          | 25.1                 |       | $                | 55.5       |                                      | $          | — |   | $ | 80.6 |   |
| Accounts payable to affiliates                  |       | 52.3            |       | 4.0            |       | 112.3                |       | (164.3           | )          | 4.3                                       |       |
| Accrued liabilities                             |       | 29.5            |       | 32.9           |       | 29.9                 |       | —           |       | 92.3                                      |       |
| Deferred income taxes                           |       | 5.2             |       | 0.8            |       | 0.1                  |       | —           |       | 6.1                                       |       |
| Short-term debt                                 |       | 1.5             |       | —         |       | 2.2                  |       | —           |       | 3.7                                       |       |
| **Total  current liabilities**                  |       | 88.5            |       | 62.8           |       | 200.0                |       | (164.3           | )          | 187.0                                     |       |
|                                            |       |            |       |           |       |                 |       |             |       |                                      |       |
| Long-term debt                                  |       | 489.0           |       | 386.4          |       | 122.8                |       | (723.4           | )          | 274.8                                     |       |
| Other noncurrent liabilities                    |       | 14.1            |       | 103.0          |       | 17.3                 |       | —           |       | 134.4                                     |       |
| **Total  liabilities**                          |       | $               | 591.6      |           | $          | 552.2                |       | $                | 340.1      |                                      | $          | (887.7 | ) | $ | 596.2 |   |
|                                            |       |            |       |           |       |                 |       |             |       |                                      |       |
| **Minority  interest**                          |       | —          |       | —         |       | —               |       | 2.9              |       | 2.9                                       |       |
|                                            |       |            |       |           |       |                 |       |             |       |                                      |       |
| **Members’  equity:**                      |       |            |       |           |       |                 |       |             |       |                                      |       |
| Members’ equity                            |       | 222.1           |       | 351.4          |       | 22.0                 |       | (373.4           | )          | 222.1                                     |       |
| Retained earnings                               |       | 43.5            |       | 89.3           |       | 35.5                 |       | (124.8           | )          | 43.5                                      |       |
| Accumulated other comprehensive (loss)  income  |       | (18.7           | )          | (3.8           | )          | 2.1                  |       | 1.7              |       | (18.7                                     | )          |
| **Total  members’ equity**                 |       | 246.9           |       | 436.9          |       | 59.6                 |       | (496.5           | )          | 246.9                                     |       |
| **Total  liabilities and members’ equity** |       | $               | 838.5      |           | $          | 989.1                |       | $                | 399.7      |                                      | $          | (1,381.3 | ) | $ | 846.0 |   |

 

14

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATING BALANCE SHEETS(UNAUDITED)**

 

**AS OF DECEMBER 31, 2004 (Dollars in Millions)**

 
| ** **                                      | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Non-  Guarantors** | ** ** | **Eliminations** | ** ** | **Consolidated  Advanced  Materials LLC** | ** ** |
|-------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------------|------------|------------------|------------|-------------------------------------------|------------|
| **ASSETS**                                      |       |            |       |           |       |                 |       |             |       |                                      |       |
| **Current assets:**                             |       |            |       |           |       |                 |       |             |       |                                      |       |
| Cash and cash equivalents                       |       | $               | 4.6        |           | $          | 70.8                 |       | $                | 18.4       |                                      | $          | — |   | $ | 93.8 |   |
| Trade accounts receivable, net                  |       | —          |       | 52.9           |       | 182.1                |       | 0.1              |       | 235.1                                     |       |
| Intercompany receivables                        |       | 76.7            |       | 228.0          |       | 176.9                |       | (481.6           | )          | —                                    |       |
| Inventories, net                                |       | —          |       | 47.1           |       | 133.4                |       | (1.0             | )          | 179.5                                     |       |
| Deferred income taxes                           |       | —          |       | —         |       | 1.0                  |       | —           |       | 1.0                                       |       |
| Other current assets                            |       | 0.1             |       | 8.9            |       | 4.4                  |       | —           |       | 13.4                                      |       |
| **Total  current assets**                       |       | 81.4            |       | 407.7          |       | 516.2                |       | (482.5           | )          | 522.8                                     |       |
| Property, plant and equipment, net              |       | —          |       | 329.9          |       | 48.7                 |       | —           |       | 378.6                                     |       |
| Deferred income taxes                           |       | 5.2             |       | 28.6           |       | 0.7                  |       | —           |       | 34.5                                      |       |
| Other noncurrent assets                         |       | 832.1           |       | 408.2          |       | 3.5                  |       | (1,226.4         | )          | 17.4                                      |       |
| **Total  assets**                               |       | $               | 918.7      |           | $          | 1,174.4              |       | $                | 569.1      |                                      | $          | (1,708.9 | ) | $ | 953.3 |   |
| **LIABILITIES  AND MEMBERS’ EQUITY**       |       |            |       |           |       |                 |       |             |       |                                      |       |
| **Current  liabilities:**                       |       |            |       |           |       |                 |       |             |       |                                      |       |
| Accounts payable                                |       | $               | —     |           | $          | 25.4                 |       | $                | 53.9       |                                      | $          | (0.1 | ) | $ | 79.2 |   |
| Accounts payable to affiliates                  |       | 33.6            |       | 146.9          |       | 304.5                |       | (481.3           | )          | 3.7                                       |       |
| Accrued liabilities                             |       | 25.8            |       | 51.0           |       | 36.7                 |       | —           |       | 113.5                                     |       |
| Deferred income taxes                           |       | 5.3             |       | 1.0            |       | —               |       | —           |       | 6.3                                       |       |
| Short-term debt                                 |       | 0.7             |       | —         |       | 1.0                  |       | —           |       | 1.7                                       |       |
| **Total  current liabilities**                  |       | 65.4            |       | 224.3          |       | 396.1                |       | (481.4           | )          | 204.4                                     |       |
| Long-term debt                                  |       | 597.7           |       | 420.6          |       | 111.3                |       | (780.9           | )          | 348.7                                     |       |
| Other noncurrent liabilities                    |       | —          |       | 123.7          |       | 18.5                 |       | —           |       | 142.2                                     |       |
| **Total  liabilities**                          |       | $               | 663.1      |           | $          | 768.6                |       | $                | 525.9      |                                      | $          | (1,262.3 | ) | $ | 695.3 |   |
| **Minority  interest**                          |       | —          |       | —         |       | —               |       | 2.4              |       | 2.4                                       |       |
| **Members’  equity:**                      |       |            |       |           |       |                 |       |             |       |                                      |       |
| Members’ equity                            |       | 222.1           |       | 351.4          |       | 23.4                 |       | (374.8           | )          | 222.1                                     |       |
| Retained earnings                               |       | 38.9            |       | 54.0           |       | 19.7                 |       | (73.7            | )          | 38.9                                      |       |
| Accumulated other comprehensive (loss)  income  |       | (5.4            | )          | 0.4            |       | 0.1                  |       | (0.5             | )          | (5.4                                      | )          |
| **Total  members’ equity**                 |       | 255.6           |       | 405.8          |       | 43.2                 |       | (449.0           | )          | 255.6                                     |       |
| **Total  liabilities and members’ equity** |       | $               | 918.7      |           | $          | 1,174.4              |       | $                | 569.1      |                                      | $          | (1,708.9 | ) | $ | 953.3 |   |

 

15

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS  (UNAUDITED)**

 

**THREE MONTHS ENDED SEPTEMBER 30, 2005(Dollars in Millions)**

 
| ** **                                            | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | **Consolidated**  | ** ** |
|-------------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|------------------|------------|-------------------|------------|
| ** **                                            | ** ** | ** **      | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | **Advanced**      | ** ** |
| ** **                                            | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Materials LLC** | ** ** |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Revenues:**                                         |       |            |       |           |       |           |       |             |       |              |       |
| Trade sales and services                              |       | $               | —     |           | $          | 70.0           |       | $                | 219.5      |              | $          | — |   | $ | 289.5 |   |
| Intercompany sales                                    |       | —          |       | 32.1           |       | 7.3            |       | (39.4            | )          | —            |       |
| **Total revenues**                                    |       | —          |       | 102.1          |       | 226.8          |       | (39.4            | )          | 289.5             |       |
| **Cost of goods sold**                                |       | —          |       | 81.9           |       | 177.4          |       | (40.3            | )          | 219.0             |       |
| **Gross profit**                                      |       | —          |       | 20.2           |       | 49.4           |       | 0.9              |       | 70.5              |       |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Expenses:**                                         |       |            |       |           |       |           |       |             |       |              |       |
| Selling, general and administrative                   |       | 0.9             |       | (10.1          | )          | 42.4           |       | —           |       | 33.2              |       |
| Research and development                              |       | —          |       | 7.6            |       | 0.9            |       | —           |       | 8.5               |       |
| Other operating (income) expense                      |       | (0.3            | )          | 2.2            |       | (0.7           | )          | —           |       | 1.2               |       |
| **Total  expense (income)**                           |       | 0.6             |       | (0.3           | )          | 42.6           |       | —           |       | 42.9              |       |
| **Operating (loss) income**                           |       | (0.6            | )          | 20.5           |       | 6.8            |       | 0.9              |       | 27.6              |       |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| Interest expense, net                                 |       | (4.0            | )          | (1.0           | )          | (5.5           | )          | —           |       | (10.5             | )          |
| Equity in earnings (losses) of affiliates             |       | 19.9            |       | (0.4           | )          | —         |       | (19.5            | )          | —            |       |
| Other expense                                         |       | (6.7            | )          | —         |       | —         |       | —           |       | (6.7              | )          |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Income  before income taxes and minority interest** |       | 8.6             |       | 19.1           |       | 1.3            |       | (18.6            | )          | 10.4              |       |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| Income tax benefit (expense)                          |       | 3.3             |       | (3.2           | )          | 1.5            |       | —           |       | 1.6               |       |
| Minority interest in subsidiaries’ income        |       | —          |       | —         |       | —         |       | (0.1             | )          | (0.1              | )          |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Net income**                                        |       | $               | 11.9       |           | $          | 15.9           |       | $                | 2.8        |              | $          | (18.7 | ) | $ | 11.9 |   |

 

16

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS (UNAUDITED)**

 

**THREE MONTHS ENDED SEPTEMBER 30, 2004(Dollars in Millions)**

 
| ** **                                                   | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | **Consolidated**  | ** ** |
|--------------------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|------------------|------------|-------------------|------------|
| ** **                                                   | ** ** | ** **      | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | **Advanced**      | ** ** |
| ** **                                                   | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Materials LLC** | ** ** |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Revenues:**                                                |       |            |       |           |       |           |       |             |       |              |       |
| Trade sales and services                                     |       | $               | —     |           | $          | 64.6           |       | $                | 229.5      |              | $          | — |   | $ | 294.1 |   |
| Intercompany sales                                           |       | —          |       | 31.5           |       | 7.3            |       | (38.8            | )          | —            |       |
| **Total revenues**                                           |       | —          |       | 96.1           |       | 236.8          |       | (38.8            | )          | 294.1             |       |
| **Cost of goods sold**                                       |       | —          |       | 79.6           |       | 187.1          |       | (38.8            | )          | 227.9             |       |
| **Gross profit**                                             |       | —          |       | 16.5           |       | 49.7           |       | —           |       | 66.2              |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Expenses:**                                                |       |            |       |           |       |           |       |             |       |              |       |
| Selling, general and administrative                          |       | 1.7             |       | 5.7            |       | 31.8           |       | (3.0             | )          | 36.2              |       |
| Research and development                                     |       | —          |       | 7.9            |       | 0.5            |       | —           |       | 8.4               |       |
| Other operating expense (income)                             |       | 0.5             |       | (21.4          | )          | (1.8           | )          | —           |       | (22.7             | )          |
| **Total  expense (income)**                                  |       | 2.2             |       | (7.8           | )          | 30.5           |       | (3.0             | )          | 21.9              |       |
| **Operating (loss) income**                                  |       | (2.2            | )          | 24.3           |       | 19.2           |       | 3.0              |       | 44.3              |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| Interest expense, net                                        |       | (2.1            | )          | (0.7           | )          | (4.7           | )          | (3.0             | )          | (10.5             | )          |
| Equity in earnings of affiliates                             |       | 23.5            |       | 6.4            |       | —         |       | (29.9            | )          | —            |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Income  (loss) before income taxes and minority interest** |       | 19.2            |       | 30.0           |       | 14.5           |       | (29.9            | )          | 33.8              |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| Income tax expense                                           |       | (22.4           | )          | (8.4           | )          | (5.6           | )          | —           |       | (36.4             | )          |
| Minority interest in subsidiaries’ income               |       | —          |       | —         |       | —         |       | (0.6             | )          | (0.6              | )          |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Net (loss) income**                                        |       | $               | (3.2       | )              | $          | 21.6           |       | $                | 8.9        |              | $          | (30.5 | ) | $ | (3.2 | ) |

 

17

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**HUNTSMAN ADVANCED MATERIALS LLC AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS (UNAUDITED)**

 

**NINE MONTHS ENDED SEPTEMBER 30, 2005(Dollars in Millions)**

 
| ** **                                            | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | **Consolidated**  | ** ** |
|-------------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|------------------|------------|-------------------|------------|
| ** **                                            | ** ** | ** **      | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | **Advanced**      | ** ** |
| ** **                                            | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Materials LLC** | ** ** |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Revenues:**                                         |       |            |       |           |       |           |       |             |       |              |       |
| Trade sales and services                              |       | $               | —     |           | $          | 214.4          |       | $                | 697.1      |              | $          | — |   | $ | 911.5 |   |
| Intercompany sales                                    |       | —          |       | 106.4          |       | 27.8           |       | (134.2           | )          | —            |       |
| **Total revenues**                                    |       | —          |       | 320.8          |       | 724.9          |       | (134.2           | )          | 911.5             |       |
| **Cost of goods sold**                                |       | —          |       | 256.4          |       | 568.9          |       | (134.8           | )          | 690.5             |       |
| **Gross profit**                                      |       | —          |       | 64.4           |       | 156.0          |       | 0.6              |       | 221.0             |       |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Expenses:**                                         |       |            |       |           |       |           |       |             |       |              |       |
| Selling, general and administrative                   |       | 0.8             |       | (17.9          | )          | 120.8          |       | —           |       | 103.7             |       |
| Research and development                              |       | —          |       | 23.0           |       | 2.5            |       | —           |       | 25.5              |       |
| Restrucuturing and plant closing credits,  net        |       | —          |       | (0.6           | )          | —         |       | —           |       | (0.6              | )          |
| Other operating (income) expense                      |       | (5.9            | )          | 34.3           |       | (5.0           | )          | —           |       | 23.4              |       |
| **Total  (income) expense**                           |       | (5.1            | )          | 38.8           |       | 118.3          |       | —           |       | 152.0             |       |
| **Operating income**                                  |       | 5.1             |       | 25.6           |       | 37.7           |       | 0.6              |       | 69.0              |       |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| Interest expense, net                                 |       | (14.7           | )          | (2.4           | )          | (14.5          | )          | —           |       | (31.6             | )          |
| Equity in earnings of affiliates                      |       | 33.7            |       | 17.6           |       | —         |       | (51.3            | )          | —            |       |
| Other (expense) income                                |       | (6.7            | )          | 0.2            |       | 0.4            |       | —           |       | (6.1              | )          |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Income  before income taxes and minority interest** |       | 17.4            |       | 41.0           |       | 23.6           |       | (50.7            | )          | 31.3              |       |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| Income tax expense                                    |       | (12.8           | )          | (5.7           | )          | (7.6           | )          | —           |       | (26.1             | )          |
| Minority interest in subsidiaries’ income        |       | —          |       | —         |       | —         |       | (0.6             | )          | (0.6              | )          |
|                                                  |       |            |       |           |       |           |       |             |       |              |       |
| **Net income**                                        |       | $               | 4.6        |           | $          | 35.3           |       | $                | 16.0       |              | $          | (51.3 | ) | $ | 4.6 |   |

 

18

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATING STATEMENTS OFOPERATIONS (UNAUDITED)**

 

**NINE MONTHS ENDED SEPTEMBER 30, 2004(Dollars in Millions)**

 
| ** **                                                   | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | ** **       | ** ** | **Consolidated**  | ** ** |
|--------------------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|------------------|------------|-------------------|------------|
| ** **                                                   | ** ** | ** **      | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **       | ** ** | **Advanced**      | ** ** |
| ** **                                                   | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Eliminations** | ** ** | **Materials LLC** | ** ** |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Revenues:**                                                |       |            |       |           |       |           |       |             |       |              |       |
| Trade sales and services                                     |       | $               | —     |           | $          | 183.6          |       | $                | 682.8      |              | $          | — |   | $ | 866.4 |   |
| Intercompany sales                                           |       | —          |       | 182.6          |       | 22.9           |       | (205.5           | )          | —            |       |
| **Total revenues**                                           |       | —          |       | 366.2          |       | 705.7          |       | (205.5           | )          | 866.4             |       |
| **Cost of goods sold**                                       |       | —          |       | 308.3          |       | 564.7          |       | (210.1           | )          | 662.9             |       |
| **Gross profit**                                             |       | —          |       | 57.9           |       | 141.0          |       | 4.6              |       | 203.5             |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Expenses:**                                                |       |            |       |           |       |           |       |             |       |              |       |
| Selling, general and administrative                          |       | 5.7             |       | (3.3           | )          | 115.5          |       | (4.1             | )          | 113.8             |       |
| Research and development                                     |       | —          |       | 23.6           |       | 1.6            |       | —           |       | 25.2              |       |
| Other operating expense (income)                             |       | 0.3             |       | (16.3          | )          | (0.9           | )          | —           |       | (16.9             | )          |
| **Total  expense**                                           |       | 6.0             |       | 4.0            |       | 116.2          |       | (4.1             | )          | 122.1             |       |
| **Operating (loss) income**                                  |       | (6.0            | )          | 53.9           |       | 24.8           |       | 8.7              |       | 81.4              |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| Interest (expense) income, net                               |       | (5.8            | )          | (9.1           | )          | (12.4          | )          | (4.1             | )          | (31.4             | )          |
| Equity in earnings (losses) of affiliates                    |       | 38.2            |       | (4.1           | )          | —         |       | (34.1            | )          | —            |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Income  (loss) before income taxes and minority interest** |       | 26.4            |       | 40.7           |       | 12.4           |       | (29.5            | )          | 50.0              |       |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| Income tax expense                                           |       | (25.5           | )          | (16.2          | )          | (6.4           | )          | —           |       | (48.1             | )          |
| Minority interest in subsidiaries’ income               |       | —          |       | —         |       | —         |       | (1.0             | )          | (1.0              | )          |
|                                                         |       |            |       |           |       |           |       |             |       |              |       |
| **Net income (loss)**                                        |       | $               | 0.9        |           | $          | 24.5           |       | $                | 6.0        |              | $          | (30.5 | ) | $ | 0.9 |   |

 

19

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATING STATEMENTS OF CASHFLOWS (UNAUDITED)**

 

**NINE MONTHS ENDED SEPTEMBER 30, 2005(Dollars in Millions)**

 
| ** **                                               | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | ** **      | ** ** | **Consolidated**  | ** ** |
|----------------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|-----------------|------------|-------------------|------------|
| ** **                                               | ** ** | ** **      | ** ** | ** **     | ** ** | **Non-**       | ** ** | ** **      | ** ** | **Advanced**      | ** ** |
| ** **                                               | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Elimination** | ** ** | **Materials LLC** | ** ** |
| ** **                                               | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | ** **      | ** ** | ** **        | ** ** |
| **Net cash  provided by (used in) operating activities** |       | $               | 86.3       |           | $          | (42.2          | )          | $               | 7.9        |              | $          | — |   | $ | 52.0 |   |
|                                                     |       |            |       |           |       |           |       |            |       |              |       |
| **Investing activities:**                                |       |            |       |           |       |           |       |            |       |              |       |
| Capital expenditures                                     |       | —          |       | (11.5          | )          | (3.9           | )          | —          |       | (15.4             | )          |
| Proceeds from sale of assets                             |       | —          |       | —         |       | 0.4            |       | —          |       | 0.4               |       |
| Other assets                                             |       | —          |       | 1.7            |       | —         |       | (1.4            | )          | 0.3               |       |
|                                                     |       |            |       |           |       |           |       |            |       |              |       |
| **Net cash used in investing activities**                |       | —          |       | (9.8           | )          | (3.5           | )          | (1.4            | )          | (14.7             | )          |
|                                                     |       |            |       |           |       |           |       |            |       |              |       |
| **Financing activities:**                                |       |            |       |           |       |           |       |            |       |              |       |
| (Decrease) increase in short-term debt, net              |       | (1.3            | )          | —         |       | 0.9            |       | —          |       | (0.4              | )          |
| Prepayment of long-term debt                             |       | (75.0           | )          | —         |       | —         |       | —          |       | (75.0             | )          |
| Costs of early extinguishment of debt                    |       | (3.8            | )          | —         |       | —         |       | —          |       | (3.8              | )          |
| Net borrowings (repayments) of intercompany debt         |       | —          |       | 3.9            |       | (5.3           | )          | 1.4             |       | —            |       |
| Other                                                    |       | (0.3            | )          | —         |       | —         |       | —          |       | (0.3              | )          |
|                                                     |       |            |       |           |       |           |       |            |       |              |       |
| **Net cash  (used in) provided by financing activities** |       | (80.4           | )          | 3.9            |       | (4.4           | )          | 1.4             |       | (79.5             | )          |
|                                                     |       |            |       |           |       |           |       |            |       |              |       |
| Effect of exchange rate changes on cash                  |       | —          |       | —         |       | (0.6           | )          | —          |       | (0.6              | )          |
|                                                     |       |            |       |           |       |           |       |            |       |              |       |
| Increase (decrease) in cash and cash equivalents         |       | 5.9             |       | (48.1          | )          | (0.6           | )          | —          |       | (42.8             | )          |
| Cash and cash equivalents at beginning of period         |       | 4.6             |       | 70.8           |       | 18.4           |       | —          |       | 93.8              |       |
|                                                     |       |            |       |           |       |           |       |            |       |              |       |
| Cash and cash equivalents at end of period               |       | $               | 10.5       |           | $          | 22.7           |       | $               | 17.8       |              | $          | — |   | $ | 51.0 |   |

 

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**HUNTSMAN ADVANCED MATERIALS LLC ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATING STATEMENTS OF CASHFLOWS (UNAUDITED)**

 

**NINE MONTHS ENDED SEPTEMBER 30, 2004(Dollars in Millions)**

 
| ** **                                              | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | **Consolidated**  | ** ** |
|---------------------------------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|-------------------|------------|
| ** **                                              | ** ** | ** **      | ** ** | ** **     | ** ** | **Non-**       | ** ** | **Advanced**      | ** ** |
| ** **                                              | ** ** | **Parent Only** | ** ** | **Guarantors** | ** ** | **Guarantors** | ** ** | **Materials LLC** | ** ** |
| ** **                                              | ** ** | ** **      | ** ** | ** **     | ** ** | ** **     | ** ** | ** **        | ** ** |
| **Net cash (used in) provided by operating activities** |       | $               | (24.1      | )              | $          | 93.7           |       | $                 | (76.8      | ) | $ | (7.2 | ) |
|                                                    |       |            |       |           |       |           |       |              |       |
| **Investing activities:**                               |       |            |       |           |       |           |       |              |       |
| Capital expenditures                                    |       | —          |       | (6.4           | )          | (0.9           | )          | (7.3              | )          |
| Proceeds from sale of assets                            |       | —          |       | 0.8            |       | 2.4            |       | 3.2               |       |
| Other assets                                            |       | —          |       | —         |       | 0.4            |       | 0.4               |       |
|                                                    |       |            |       |           |       |           |       |              |       |
| **Net cash (used in) provided by investing activities** |       | —          |       | (5.6           | )          | 1.9            |       | (3.7              | )          |
|                                                    |       |            |       |           |       |           |       |              |       |
| **Financing activities:**                               |       |            |       |           |       |           |       |              |       |
| Decrease in short-term debt, net                        |       | (0.4            | )          | —         |       | (1.5           | )          | (1.9              | )          |
| Net borrowings (repayments) of intercompany debt        |       | 21.0            |       | (91.9          | )          | 70.9           |       | —            |       |
|                                                    |       |            |       |           |       |           |       |              |       |
| **Net cash provided by (used in) financing activities** |       | 20.6            |       | (91.9          | )          | 69.4           |       | (1.9              | )          |
|                                                    |       |            |       |           |       |           |       |              |       |
| Effect of exchange rate changes on cash                 |       | —          |       | (0.1           | )          | (0.2           | )          | (0.3              | )          |
|                                                    |       |            |       |           |       |           |       |              |       |
| Decrease in cash and cash equivalents                   |       | (3.5            | )          | (3.9           | )          | (5.7           | )          | (13.1             | )          |
| Cash and cash equivalents at beginning of period        |       | 9.8             |       | 45.8           |       | 17.6           |       | 73.2              |       |
|                                                    |       |            |       |           |       |           |       |              |       |
| Cash and cash equivalents at end of period              |       | $               | 6.3        |           | $          | 41.9           |       | $                 | 11.9       |   | $ | 60.1 |   |

 

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**ITEM 2.****               MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Forward-looking Statements**

 

Some of the statements contained in this report are forward-looking innature. In some cases, you can identify forward-looking statements byterminology such as “believes,” “expects,” “may,” “will,” “should,” “anticipates”or “intends” or the negative of such terms or other comparable terminology, orby discussions of strategy. You are cautioned that our business and operationsare subject to a variety of risks and uncertainties, and, consequently, ouractual results may materially differ from those projected by any forward-lookingstatements. Some of the risks and uncertainties are discussed below in “—CautionaryStatement for Forward Looking Information” and elsewhere in this report.

 

**Certain Defined Terms**

 

For convenience in this report, the terms “Company,” “our,” “us” or “we”may be used to refer to Huntsman Advanced Materials LLC and, unless the contextotherwise requires, its subsidiaries. In this report, “Vantico” or “PredecessorCompany” refers to Vantico Group S.A. and, unless the context otherwiserequires, its subsidiaries, and “Ciba” refers to Ciba Specialty ChemicalsHoldings Inc.

 

**Overview**

 

We are a leading global manufacturer and marketer of technologicallyadvanced epoxy, acrylic and polyurethane-based polymer products. We focus onformulations and systems that are used to address customer-specific needs in awide variety of specialized industrial and consumer applications. Our productsare used either as replacements for traditional materials such as metal, wood,clay, glass, stone and ceramics, or in applications where traditional materialsdo not meet demanding engineering specifications. Our business is characterizedby the breadth of our product offering, our expertise in complex chemistry, ourlong-standing relationships with our customers and our ability to develop andadapt our technology and our applications expertise for new markets and newapplications. We operate 13 manufacturing facilities located around the world.During the first quarter of 2005, we restructured our marketing organization,reducing our total market groups from five to three. We currently market over6,000 products to more than 5,000 customers in the following market groups:Coatings, Construction and Adhesives; Power and Electronics; Design and CompositesEngineering, as described below. Our operations have one reportable businesssegment.

 

**Coatings, Construction and Adhesives**

 

We produce formulated polymer systems, additives, basic and advancedepoxy resin compounds to provide structural stability and broad applicationfunctionality, combined with overall economic efficiency, for a broad range ofindustrial coatings, construction and consumer applications. These products areused to make coatings for the protection of steel and concrete substrates, suchas floorings, metal furniture and appliances, buildings, linings of storagetanks and food and beverage cans, and the primer coat of automobile bodies andships, among other applications. We are a leading producer of basic liquid-epoxyresin and its basic derivatives, the building blocks for epoxy-based productsin coating applications. In addition, we are a leading manufacturer of complexchemicals and additives, such as curing agents, matting agents, accelerators,cross-linkers, reactive diluents and thermoplastic polyamides, which are usedin combination with epoxy resins to impart properties such as chemical andabrasion resistance and improved surface appearance.

 

We produce innovative formulated polymer systems used as industrial andconsumer adhesives based upon epoxy, polyurethane, acrylic and other materials,primarily marketed under the *Araldite®*brand name. Our adhesives are used to bond materials such as steel, aluminum,and engineering plastics. The sales of our adhesive systems have experiencedrapid growth due to the continued substitution of adhesives for traditionaljoining techniques, such as welding and soldering, and the use of metalfasteners and clamps. We sell our adhesive products into industry-specificmarkets, the general industrial bonding market and the consumer do-it-yourselfmarket. Our primary industry-specific markets are DVD, printing inks,engineering adhesives, and liquefied natural gas transport markets.

 

**Power and Electronics**

 

We produce formulated polymer systems based on epoxy and polyurethaneresins which are used to insulate, protect or shield either the environmentfrom electrical current or electrical devices from the environment, such astemperature or humidity. We primarily sell our electrical products to customersin the electric power generation, transmission and distribution, consumer 

 

22

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and industrial electronics, automotive and appliance markets. Webelieve we have a leading market position globally in epoxy-based electricalinsulating materials.

 

We produce liquid formulated polymer systems used in the manufacture ofelectrolaminates, soldermasks, inner layer resists and dielectric materials forprinted circuit boards. Soldermasks are permanent coatings, resistant to heat,chemicals and the environment, that allow various components and circuitry tobe soldered to the surface of a printed circuit board. Inner layer resists aretemporary photo-imageable materials that enable the generation of circuitry onthe inner layers of printed circuit boards. Dielectric materials are materialswith electrical insulation properties that constitute an insulating layer inhigh-density, multi-layer printed circuit boards.

 

We also produce electronic adhesive products for printed circuit boardcomponent assembly, hard disk drive gaskets and LED applications.

 

**Design and Composites Engineering**

 

We produce formulated polymer systems, complex chemicals and additivesand basic and advanced epoxy resin compounds which are used to manufacture avariety of fiber-reinforced materials with enhanced structural properties,known as structural composites. Structural composites are lightweight,high-strength, rigid materials with high resistance to chemicals, moisture andhigh temperatures. We primarily sell our products to customers in theaerospace, automotive, wind power generation, and recreational sports equipmentmarkets.

 

We produce and market mainly polyurethane-based and epoxy formulatedpolymer systems used in the production of models, prototypes, patterns, moldsand a variety of related products for design, prototyping and short-runmanufacture. Our products are used in the automotive, aerospace and industrialmarkets as productivity tools to quickly and efficiently create accurate prototypesand develop experimental models, and to lower the cost of manufacturing itemsin limited quantities primarily using computer-aided-design techniques. Theseproducts are valued for their strength, resilience, heat resistance,dimensional stability, low shrinkage, ease of curing and ability to simulatethe look and feel of a variety of materials. These characteristics have allowedour tooling and modeling materials to replace other materials traditionallyused in these applications, such as wood, clay and engineering thermoplastics.Our products include photopolymers used in stereolithography, a process thatcombines computer-aided-design, laser technology and chemistry to permit acomplex three-dimensional design to be rapidly replicated in finely-finishedsolid form.

 

23

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**Results of Operations**

 

The following sets forth the consolidated results of operations for thethree and nine months ended September 30, 2005 and 2004 (dollars inmillions).

 
| ** **                                           | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Percent  Change** | ** ** |
| ** **                                           | ** ** | ** **                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues**                                         |       | $                                           | 289.5      |                                       | $          | 294.1 |   | (2 | )% | $ | 911.5 |   | $ | 866.4 |   | 5 | % |
| **Cost of goods sold**                               |       | 219.0                                       |       | 227.9                                      |       | (4 | )% | 690.5 |   | 662.9 |   | 4 | % |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Gross profit**                                     |       | 70.5                                        |       | 66.2                                       |       | 6 | % | 221.0 |   | 203.5 |   | 9 | % |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Expenses:**                                        |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Operating expenses                                   |       | 42.9                                        |       | 21.9                                       |       | 96 | % | 152.0 |   | 122.1 |   | 24 | % |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Operating income**                                 |       | 27.6                                        |       | 44.3                                       |       | (38 | )% | 69.0 |   | 81.4 |   | (15 | )% |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Interest expense, net                                |       | (10.5                                       | )          | (10.5                                      | )          | — |   | (31.6 | ) | (31.4 | ) | 1 | % |
| Other expense                                        |       | (6.7                                        | )          | —                                     |       | NM |   | (6.1 | ) | — |   | NM |   |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Income before income taxes and minority interest** |       | 10.4                                        |       | 33.8                                       |       | (69 | )% | 31.3 |   | 50.0 |   | (37 | )% |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Income tax benefit (expense)                         |       | 1.6                                         |       | (36.4                                      | )          | NM |   | (26.1 | ) | (48.1 | ) | (46 | )% |
| Minority interests in subsidiaries’ income      |       | (0.1                                        | )          | (0.6                                       | )          | (83 | )% | (0.6 | ) | (1.0 | ) | (40 | )% |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Net income (loss)**                                |       | 11.9                                        |       | (3.2                                       | )          | NM |   | 4.6 |   | 0.9 |   | 411 | % |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Interest expense, net                                |       | 10.5                                        |       | 10.5                                       |       | — |   | 31.6 |   | 31.4 |   | 1 | % |
| Income tax (benefit) expense                         |       | (1.6                                        | )          | 36.4                                       |       | NM |   | 26.1 |   | 48.1 |   | (46 | )% |
| Depreciation and amortization                        |       | 11.5                                        |       | 12.4                                       |       | (7 | )% | 35.3 |   | 40.9 |   | (14 | )% |
|                                                 |       |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **EBITDA (1)**                                       |       | $                                           | 32.3       |                                       | $          | 56.1 |   | (42 | )% | $ | 97.6 |   | $ | 121.3 |   | (20 | )% |

 

----

NM= Not Meaningful.

 

Included in EBITDA are the following items of expense (income) (dollarsin millions):

 
| ** **                                   | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loss on early extinguishment of debt         |       | $                                           | 6.7        |                                       | $          | — |   | $ | 6.7 |   | $ | — |   |
| Legal and contract settlements, net          |       | —                                      |       | (11.0                                      | )          | — |   | (8.8 | ) |
| Restructuring and plant closing credits, net |       | —                                      |       | —                                     |       | (0.6 | ) | — |   |
|                                         |       |                                        |       |                                       |       |   |   |   |   |
| Total                                        |       | $                                           | 6.7        |                                       | $          | (11.0 | ) | $ | 6.1 |   | $ | (8.8 | ) |

 

----

(1)                                  EBITDA is defined asnet income (loss) before interest, income taxes, depreciation and amortization.We believe that EBITDA enhances an investor’s understanding of our financialperformance and our ability to satisfy principal and interest obligations withrespect to our indebtedness. However, EBITDA should not be considered inisolation or viewed as a substitute for net income, cash flow from operationsor other measures of performance as defined by generally accepted accountingprinciples in the U.S. (“GAAP”). Moreover, EBITDA as used herein is notnecessarily comparable to other similarly titled measures of other companiesdue to potential inconsistencies in the method of calculation. Our managementuses EBITDA to assess financial performance and debt service capabilities. Inassessing financial performance, our management reviews EBITDA as a generalindicator of economic performance compared to prior periods. Because EBITDAexcludes interest, income taxes, depreciation and amortization, EBITDA providesan indicator of general economic performance that is not affected by debtrestructurings, fluctuations in interest rates or effective tax rates, orlevels of depreciation and amortization. Accordingly, our management believesthis type of measurement is useful for comparing general operating performancefrom period to period and making certain related management decisions. EBITDAis also used by securities analysts, lenders and others in their evaluation ofdifferent 

 

24

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companies because it excludes certain items that can vary widely acrossdifferent industries or among companies within the same industry. For example,interest expense can be highly dependent on a company’s capital structure, debtlevels and credit ratings. Therefore, the impact of interest expense onearnings can vary significantly among companies. In addition, the tax positionsof companies can vary because of their differing abilities to take advantage oftax benefits and because of the tax policies of the various jurisdictions inwhich they operate. As a result, effective tax rates and tax expense can varyconsiderably among companies. Finally, companies employ productive assets ofdifferent ages and utilize different methods of acquiring and depreciating suchassets. This can result in considerable variability in the relative costs ofproductive assets and the depreciation and amortization expense amongcompanies. Our management also believes that our investors use EBITDA as ameasure of our ability to service indebtedness as well as to fund capitalexpenditures and working capital requirements. Nevertheless, our managementrecognizes that there are material limitations associated with the use ofEBITDA in the evaluation of our Company as compared to net income, whichreflects overall financial performance, including the effects of interest,income taxes, depreciation and amortization. EBITDA excludes interest expense.Because we have borrowed money in order to finance our operations, interestexpense is a necessary element of our costs and ability to generate revenue.Therefore, any measure that excludes interest expense has material limitations.EBITDA also excludes taxes. Because the payment of taxes is a necessary elementof our operations, any measure that excludes tax expense has materiallimitations. Finally, EBITDA excludes depreciation and amortization expense.Because we use capital assets, depreciation and amortization expense is anecessary element of our costs and ability to generate revenue. Therefore, anymeasure that excludes depreciation and amortization expense has materiallimitations. Our management compensates for the limitations of using EBITDA byusing it to supplement GAAP results to provide a more complete understanding ofthe factors and trends affecting the business than GAAP results alone. Ourmanagement also uses other metrics to evaluate capital structure, tax planningand capital investment decisions. For example, our management uses credit ratingsand net debt ratios to evaluate capital structure, effective tax rate byjurisdiction to evaluate tax planning, and payback period and internal rate ofreturn to evaluate capital investments. Our management also uses trade workingcapital to evaluate its investment in accounts receivable and inventory, net ofaccounts payable.

 

We believe that net income is the performance measure calculated andpresented in accordance with GAAP that is most directly comparable to EBITDAand that cash provided by (used in) operating activities is the liquiditymeasure calculated and presented in accordance with GAAP that is most directlycomparable to EBITDA. The following table reconciles EBITDA to our net incomeand to our cash provided by (used in) operating activities:

 
| ** **                                              | ** ** | **Nine Months  Ended  September 30, 2005** | ** ** | **Nine Months  Ended  September 30, 2004** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| EBITDA                                                  |       | $                                               | 97.6       |                                            | $          | 121.3 |   |
| Depreciation and amortization expense                   |       | (35.3                                           | )          | (40.9                                           | )          |
| Interest expense, net                                   |       | (31.6                                           | )          | (31.4                                           | )          |
| Income tax expense                                      |       | (26.1                                           | )          | (48.1                                           | )          |
| Net income                                              |       | 4.6                                             |       | 0.9                                             |       |
|                                                    |       |                                            |       |                                            |       |
| Depreciation and amortization expense                   |       | 35.3                                            |       | 40.9                                            |       |
| Noncash interest expense                                |       | 2.7                                             |       | 2.2                                             |       |
| Deferred income taxes                                   |       | 15.1                                            |       | 46.4                                            |       |
| Loss on early extinguishment of debt                    |       | 6.7                                             |       | —                                          |       |
| Unrealized loss (gain) on foreign currency transactions |       | 14.8                                            |       | (5.7                                            | )          |
| Other, net                                              |       | 2.7                                             |       | —                                          |       |
| Changes in operating assets and liabilities             |       | (29.9                                           | )          | (91.9                                           | )          |
|                                                    |       |                                            |       |                                            |       |
| Net cash provided by (used in) operating activities     |       | $                                               | 52.0       |                                            | $          | (7.2 | ) |
|                                                         |            |                                                 |            |                                                 |            |  |  |  |  |

 

**Three Months Ended September 30, 2005Compared to the Three Months Ended September 30, 2004**

 

Revenues for the three months ended September 30, 2005 decreasedby $4.6 million, or 2%, to $289.5 million from $294.1 million, as compared tothe same period in 2004, primarily attributable to an 11% decrease in salesvolumes, partially offset by a 10% increase in average selling prices. Ourongoing portfolio re-alignment activities resulted in higher sales volumes insome of our markets, which were more than offset by lower sales volumes ofbasic epoxy resins in the coatings, construction and adhesives markets andreduced volumes of electronic laminates products. Average selling prices werehigher due to price increase initiatives in certain markets in response tohigher raw material costs, and due to a better product mix. By market group, ourrevenues were as follows:

 

25

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| •     CCA  (Coatings, Construction and Adhesives) |   | $155.4 million, up $5.3 million or 3.5%  |
|----------------------------------------------------------------------------|--------|------------------------------------------|
| •     P&E  (Power and Electronics)            |   | $59.2 million, down $14.9 million or 20% |
| •     DCE  (Design and Composite Engineering)     |   | $74.9 million, up $5.0 million or 7.2%   |

 

Gross profit for the three months ended September 30, 2005increased by $4.3 million, or 6%, to $70.5 million from $66.2 million in thesame period in 2004. The increase mainly resulted from stronger contributionmargins in the third quarter of 2005. Margins improved on an improved productmix resulting from increased sales volumes of higher margin applications, andlower indirect costs which more than offset higher raw material costs.

 

Operating expenses for the three months ended September 30, 2005increased by $21.0 million, or 96%, to $42.9 million from $21.9 million in thesame period in 2004.  The increaseresulted primarily from $13.1 million higher foreign currency transaction lossesprimarily related to intercompany financing and a decrease of $11.0 million inlegal and contract settlement gains, partially offset by lower selling, generaland administrative expenses resulting from our cost reduction initiatives.

 

Other expense for the three months ended September 30, 2005included a loss on early extinguishment of debt of $6.7 million.

 

Income tax expense for the three months endedSeptember 30, 2005 decreased by $38.0 million to a benefit of $1.6 millionfrom expense of $36.4 million for the same period in 2004.  Decreased income tax expense was primarilydue to decreases in pre-tax income, as well as the recognition of tax benefitsfrom releasing valuation allowances.  Substantiallyall of our non-U.S. operations are treated as branches of our Company for U.S.income tax purposes and are, therefore, subject to both U.S. and non-U.S.income tax.  In addition, our taxobligations are affected by the mix of income and losses in the taxjurisdictions in which we operate.

 

Our effective income tax rate was (15.4)% forthe three months ended September 30, 2005 as compared to 107.7% for thesame period in 2004.  Excluding theimpact of foreign exchange losses of $1.1 million, for which we received no taxbenefit, our effective income tax rate would have been (13.9)% for the threemonths ended September 30, 2005.

 

**Nine Months Ended September 30, 2005Compared to the Nine Months Ended September 30, 2004**

 

Revenues for the nine months ended September 30, 2005 increased by$45.1 million, or 5%, to $911.5 million from $866.4 million, as compared to thesame period in 2004, primarily attributable to a 10% increase in averageselling prices, with sales volumes down 5%. Average selling prices were higherdue to price increase initiatives in certain markets in response to higher rawmaterial costs and due to higher value product mix. Our ongoing portfoliore-alignment activities resulted in higher sales volumes in some of ourmarkets, which were more than offset by lower sales volumes of basic epoxy resinsin the coatings, construction and adhesives markets and reduced volumes ofelectronic laminates products. By market group, our revenues were as follows:

 
| •     CCA  (Coatings, Construction and Adhesives) |   | $479.2 million, up $48.7 million or 11%   |
|----------------------------------------------------------------------------|--------|-------------------------------------------|
| •     P&E  (Power and Electronics)            |   | $186.9 million, down $33.7 million or 15% |
| •     DCE  (Design and Composite Engineering)     |   | $245.4 million, up $30.1 million or 14%   |

 

Gross profit for the nine months ended September 30, 2005increased by $17.5 million, or 9%, to $221.0 million from $203.5 million in thesame period in 2004. The increase mainly resulted from stronger contributionmargins in the 2005 period. Margins improved on higher revenues, improvedproduct mix resulting from increased sales volumes of higher margin Adhesives,Power and Composite Engineering applications and reduced indirect costs, whichmore than offset higher raw material costs.

 

Operating expenses for the nine months ended September 30, 2005increased by $29.9 million, or 24%, as compared to the same period in2004, as a result of $30.7 million higher foreign currency transaction lossesprimarily related to an intercompany financing and a reduction of $8.8 millionin legal and contract settlement gains, partially offset by savings from ourcost reduction initiatives related to selling, general and administrativeexpenses.

 

Other expense for the nine months ended September 30, 2005included a loss on early extinguishment of debt of $6.7 million.

 

Income tax expense for the nine months ended September 30,2005 decreased by $22.0 million to $26.1 million from $48.1 million in the sameperiod in 2004.  Decreased income taxexpense was primarily due to decreases in pre-tax income, as 

 

26

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well as the recognition of tax benefits fromreleasing valuation allowances.  Substantiallyall of our non-U.S. operations are treated as branches of our Company for U.S.income tax purposes and are, therefore, subject to both U.S. and non-U.S.income tax.  In addition, our tax obligationsare affected by the mix of income and losses in the tax jurisdictions in whichwe operate.  Tax expense wassignificantly a result of losses in jurisdictions where little or no taxbenefit was provided and income in other jurisdictions where tax expense wasrecorded.

 

Our effective income tax rate was 83.4% forthe nine months ended September 30, 2005 as compared to 96.2% for the sameperiod in 2004.  Excluding the impact offoreign exchange losses of $23.2 million, which did not provide a benefit fortax purposes, our effective income tax rate would have been 47.9% for the ninemonths ended September 30, 2005. The effective tax rate of 47.9%, 12.9% above the U.S. statutory rate of35%, was significantly a result of income earned in non-U.S. jurisdictionssubject to incremental U.S. tax.

 

**Liquidity and Capital Resources**

 

**Cash**

 

Net cash provided by operating activities for the nine months ended September 30,2005 was $52.0 million as compared to $7.2 million used in operations duringthe comparable period in 2004. The increase of $59.2 million in cash flow fromoperating activities during the 2005 period was primarily attributable to a netdecrease in changes in operating assets and liabilities of $62.0 million and afavorable variance in adjustments to reconcile net income to net cash fromoperating activities attributed to unrealized loss on foreign currencytransactions of $20.5 million, which were partially offset by an unfavorablevariance in deferred income taxes of $31.3 million.

 

Net cash used in investing activities for the nine months ended September 30,2005 was $14.7 million as compared to $3.7 million used in investing activitiesduring the comparable period in 2004. Capital expenditures increased $8.1million from $7.3 million in the nine months ended September 30, 2004 to$15.4 million in the comparable period in 2005 largely due to increased capitalspending on projects associated with our restructuring activities.

 

Net cash used in financing activities for the nine months ended September 30,2005 was $79.5 million as compared to $1.9 million during the comparable periodin 2004.  The increase of $77.6 millionin cash used in financing activities was primarily attributable to partialredemptions of $75.0 million of our Floating Rate Notes (as defined below),whereby we paid approximately $3.8 million in call premiums.

 

**Changes in Financial Condition**

 

The following information summarizes our working capital position as ofSeptember 30, 2005 and December 31, 2004 (dollars in millions):

 
| ** **                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | ** **     | ** ** | **Percentage** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|
| ** **                     | ** ** | **2005**               | ** ** | **2004**              | ** ** | **Difference** | ** ** | **Change**     | ** ** |
| **Current assets:**            |       |                   |       |                  |       |           |       |           |       |
| Cash and cash equivalents      |       | $                      | 51.0       |                  | $          | 93.8           |       | $              | (42.8      | ) | (46 | )% |
| Trade accounts receivable, net |       | 207.8                  |       | 235.1                 |       | (27.3          | )          | (12            | )%         |
| Inventories, net               |       | 194.6                  |       | 179.5                 |       | 15.1           |       | 8              | %          |
| Deferred income taxes          |       | 1.1                    |       | 1.0                   |       | 0.1            |       | 10             | %          |
| Other current assets           |       | 12.5                   |       | 13.4                  |       | (0.9           | )          | (7             | )%         |
| Total current assets           |       | 467.0                  |       | 522.8                 |       | (55.8          | )          | (11            | )%         |
|                           |       |                   |       |                  |       |           |       |           |       |
| **Current liabilities:**       |       |                   |       |                  |       |           |       |           |       |
| Accounts payable               |       | 84.9                   |       | 82.9                  |       | 2.0            |       | 2              | %          |
| Accrued liabilities            |       | 92.3                   |       | 113.5                 |       | (21.2          | )          | (19            | )%         |
| Deferred income taxes          |       | 6.1                    |       | 6.3                   |       | (0.2           | )          | (3             | )%         |
| Short-term debt                |       | 3.7                    |       | 1.7                   |       | 2.0            |       | 118            | %          |
| Total current liabilities      |       | 187.0                  |       | 204.4                 |       | (17.4          | )          | (9             | )%         |
|                           |       |                   |       |                  |       |           |       |           |       |
| **Working capital**            |       | $                      | 280.0      |                  | $          | 318.4          |       | $              | (38.4      | ) | (12 | )% |

 

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As of September 30, 2005, our working capital decreased by$38.4 million as a result of the net impact of the following significantchanges:

 

•                  The decrease in cash and cash equivalents of$42.8 million was due to matters identified in the Condensed ConsolidatedStatements of Cash Flows (unaudited) contained elsewhere in this report.

 

•                  The decrease in trade accounts receivable of$27.3 million was largely attributable to a decline in European currenciesversus the U.S. dollar and improved accounts receivable collections managementduring the nine months ended September 30, 2005.

 

•                  The increase in inventories of $15.1 millionwas mainly due to increased raw material and energy costs, and higherinventories in certain locations due to seasonality, partially offset by adecline in European currencies versus the U.S. dollar.

 

•                  The decrease in accrued liabilities of $21.2 millionwas primarily due to a decrease in accrued restructuring and plant closingcosts of $22.9 million and a decrease in accrued interest of $10.8 million,partially offset by an increase in current taxes payable of $8.7 million.

 

**Debt and Liquidity**

 

***Revolving CreditFacility***

 

Our revolving credit facility (the “AdMat Revolving Credit Facility”)provides up to $60 million of borrowings and is secured by a first lien onsubstantially all of our assets and those of certain of our subsidiaries. Thecollateral includes substantially all real property and equipment relating toour manufacturing plants located at Bergkamen, Germany; Monthey, Switzerland;McIntosh, Alabama; and Duxford, U.K. The collateral also includes intercompanynotes of certain of our subsidiaries, and certain other assets, principallyincluding inventory and accounts receivable. Our obligations under the AdMatRevolving Credit Facility have been initially guaranteed by all of our U.S.subsidiaries and certain of our non-U.S. subsidiaries (collectively, the “AdMatGuarantors”). The agent for the lenders under the AdMat Revolving CreditFacility and the trustee under the indenture governing the Senior Secured Notes(as defined below) are parties to an intercreditor agreement (the “AdMatIntercreditor Agreement”).

 

On June 17, 2005, we amended the AdMat Revolving Credit Facility.This amendment included, among other things, the extension of the facility’smaturity date from June 30, 2007 to July 15, 2007, the reduction ininterest rate margins and the elimination of pledges of capital stock insubsidiaries as collateral under the facility. Interest rates, at our option,are based upon either a eurocurrency rate (LIBOR) or a base rate (prime), plusan applicable spread. The applicable spreads vary based on a pricing grid. Inthe case of the eurocurrency-based loans, spreads range from 1.25% to 1.5% perannum, depending on whether specified conditions have been satisfied, and, inthe case of base rate loans, from 0.25% to 0.5% per annum. As of September 30,2005, we had no amounts drawn on the AdMat Revolving Credit Facility and hadapproximately $2.6 million of letters of credit issued and outstandingunder the AdMat Revolving Credit Facility. The AdMat Revolving Credit Facilityallows us to issue up to $20 million in letters of credit; however, the$60 million revolving credit facility is reduced dollar-for-dollar by anyletters of credit outstanding. There are no scheduled debt amortizationpayments on the AdMat Revolving Credit Facility until its maturity date.

 

The agreement governing the AdMat Revolving Credit Facility containscustomary financial covenants; covenants relating to the incurrence of debt,the purchase and sale of assets, limitations on investments and affiliatetransactions; change in control provisions; events of default provisions; andacceleration provisions.

 

***Senior Secured Notes***

 

We have outstanding $250 million of fixed rate notes due 2010 (“FixedRate Notes”) and $25 million of floating rate notes due 2008 ($100 millionoriginal aggregate principal amount) (“Floating Rate Notes,” and, collectivelywith the Fixed Rate Notes, the “Senior Secured Notes”). The $250 millionFixed Rate Notes bear a per annum fixed rate of interest of 11%, and theFloating Rate Notes bear interest at a rate per annum equal to LIBOR plus 8.0%,subject to a floor with respect to LIBOR of 2.0%. As of September 30,2005, the interest rate on the Floating Rate Notes was approximately 11.8%.Interest on the Floating Rate Notes resets semiannually. The Floating RateNotes were issued with an original issue discount of 2.0%. The discount is 

 

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being amortized to interest expense over the term of the Floating RateNotes. Interest is payable on the Senior Secured Notes semiannually on January 15and July 15 of each year.

 

The Senior Secured Notes are secured by a second lien, subject to theAdMat Intercreditor Agreement, on substantially all of the assets that securethe AdMat Revolving Credit Facility. The Senior Secured Notes effectively ranksenior in right of payment to all existing and future obligations of ourCompany that are unsecured or secured by liens on the collateral junior to theliens securing the Senior Secured Notes. The Senior Secured Notes are initiallyguaranteed on a senior basis by the AdMat Guarantors and are also supported byliens on substantially all of the assets of the AdMat Guarantors.

 

The Fixed Rate Notes are redeemable on or after July 15, 2007 atour option at a price declining ratably from 105.5% to 100.0% of par value bythe year 2009. At any time prior to July 15, 2007 for the Fixed RateNotes, we may redeem all or part of such notes at 100% of their principalamount, plus a “make whole” premium, as defined in the indenture. In addition,at any time prior to July 15, 2006 for the Fixed Rate Notes, we may redeemup to 35% of the original aggregate principal amount of such notes at aredemption price of 111% of the principal thereof with the net cash proceeds ofone or more qualified equity offerings, subject to certain conditions andlimitations. The Floating Rate Notes are currently redeemable at our option ata price declining ratably from 105.0% to 100.0% of par value by the year 2007.During the third quarter of 2005, we completed a partial redemption of $75million in aggregate principal amount of Floating Rate Notes and paid callpremiums in the amount of approximately $3.8 million. There are noscheduled debt amortization payments on the Senior Secured Notes until theirmaturity date.

 

The indenture governing the Senior Secured Notes contains covenantsrelating to the incurrence of debt, limitations on distributions, asset salesand affiliate transactions, among other things. The indenture also contains achange of control provision requiring us to offer to repurchase the SeniorSecured Notes upon a change of control.

 

***Short-Term andLong-Term Liquidity***

 

As of September 30, 2005, we had $108.4 million of cash andunused borrowing capacity, including $51.0 million of cash and$57.4 million in undrawn commitments on the AdMat Revolving Credit Facility.During the third quarter we partially redeemed $75 million aggregateprincipal amount of our Floating Rate Notes and paid approximately $3.8 millionin call premiums. We believe our current available liquidity, together withfunds generated by our businesses, will be sufficient to meet the short-termand long-term needs of our businesses, including the funding of our operationsand capital expenditures and the servicing of our debt obligations in theordinary course.

 

***Compliance withCovenants***

 

Our management believes that we are in compliance with the covenantscontained in the agreements governing the AdMat Revolving Credit Facility andthe indentures governing our notes.

 

**Off-Balance Sheet Arrangements**

 

We issue certain letters of credit and guarantees of certain short-termdebt facilities and other obligations for some of our consolidatedsubsidiaries. The maximum exposure under these letters of credit and guaranteesis approximately $2.6 million as of September 30, 2005. We do notexpect any material amounts to be drawn on these instruments.

 

Other than certain operating leases that are not material and theletter of credit arrangements noted above, all of which have been entered intoin the normal course of business, we do not have any off-balance sheetfinancing arrangements such as synthetic leases or securitization agreements.As such, we believe that we are not materially exposed to any financing,liquidity, market or credit risk that may arise if we had engaged in suchfinancing agreements.

 

**Restructuring and Plant Closing Costs**

 

As of December 31, 2004, accrued restructuring and plant closingcosts consisted of $33.0 million related to the restructuring programsimplemented in association with the AdMat Transaction, the realignment and simplificationof our commercial and technical organization and the closure of our Kaohsiung,Taiwan production facility.

 

During the second quarter of 2005, we assessed the remainingrestructuring reserves established in association with the AdMat Transactionand other 2004 initiatives and concluded that $5.3 million and$1.0 million, respectively, were no longer 

 

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necessary. Accordingly, we reversed these restructuring reserves duringthe second quarter of 2005. The AdMat Transaction reserve reversal was recordedas a reduction to property, plant and equipment in accordance with EITF 95-3, *“Recognition of Liabilities in Connection with aPurchase Business Combination.”* The reversal of the restructuringreserve for the other 2004 initiatives was recorded as a credit to earnings.Also during 2005, we recorded restructuring and plant closing charges of$0.4 million for relocation and other costs.

 

During the nine months ended September 30, 2005, activity in our restructuringreserves consisted of the following (dollars in millions):

 
| ** **                                                             | ** ** | **Workforce**  | ** ** | **Plant**         | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------|------------|----------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                                             | ** ** | **Reductions** | ** ** | **Closure Costs** | ** ** | **Other**  | ** ** | **Total**  | ** ** |
| Accrued liabilities as of January 1, 2005                         |       | $              | 28.1       |              | $          | 1.1        |       | $          | 3.8        |   | $ | 33.0 |   |
| 2005 payments for AdMat Transaction opening  balance sheet initiatives |       | (7.3           | )          | (0.2              | )          | (1.1       | )          | (8.6       | )          |
| 2005 payments for 2004 initiatives                                     |       | (6.3           | )          | —            |       | (0.4       | )          | (6.7       | )          |
| Partial reversal of AdMat Transaction  opening balance sheet liability |       | (3.7           | )          | (0.8              | )          | (0.8       | )          | (5.3       | )          |
| Partial reversal of 2004 initiative  liability                         |       | (1.0           | )          | —            |       | —     |       | (1.0       | )          |
| 2005 charges for 2004 initiatives                                      |       | —         |       | —            |       | 0.4        |       | 0.4        |       |
| Foreign currency effect on reserve balance                             |       | (1.2           | )          | —            |       | (0.5       | )          | (1.7       | )          |
| Accrued liabilities as of September 30, 2005                      |       | $              | 8.6        |              | $          | 0.1        |       | $          | 1.4        |   | $ | 10.1 |   |

 

During the fourth quarter of 2005, we expect to initiate additionalrestructuring activities to consolidate our European research and developmentorganizations and to incur additional restructuring and plant closing costs of approximately$3 million.

 

**Capital Expenditures**

 

Capital expenditures for the nine months ended September 30, 2005were $15.4 million. We expect to spend approximately $25 million in2005 on capital expenditures, including approximately $13.2 million incapital projects associated with our restructuring efforts.

 

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**Environmental, Health and Safety Matters**

 

***General***

 

We are subject to extensive federal, state, local and foreign laws,regulations, rules and ordinances relating to pollution, protection of theenvironment and the generation, storage, handling, transportation, treatment,disposal and remediation of hazardous substances and waste materials. In theordinary course of business, we are subject to frequent environmentalinspections and monitoring and occasional investigations by governmentalenforcement authorities. In addition, our production facilities requireoperating permits that are subject to renewal, modification and, in certaincircumstances, revocation. Actual or alleged violations of environmental lawsor permit requirements could result in restrictions or prohibitions on plantoperations, substantial civil or criminal sanctions, as well as, under someenvironmental laws, the assessment of strict liability and/or joint and severalliability. Moreover, changes in environmental regulations could inhibit orinterrupt our operations, or require us to modify our facilities or operations.Accordingly, environmental or regulatory matters may cause us to incursignificant unanticipated losses, costs or liabilities.

 

***Environmental,Health and Safety Systems***

 

We are committed to achieving and maintaining compliance with allapplicable environmental, health and safety (“EHS”) legal requirements, and wehave developed policies and management systems that are intended to identifythe multitude of EHS legal requirements applicable to our operations, enhancecompliance with applicable legal requirements, ensure the safety of ouremployees, contractors, community neighbors and customers and minimize theproduction and emission of wastes and other pollutants. Although EHS legalrequirements are constantly changing and are frequently difficult to complywith, these EHS management systems are designed to assist us in our compliancegoals while also fostering efficiency and improvement and minimizing overallrisk to us.

 

***EHS CapitalExpenditures***

 

We may incur future costs for capital improvements and generalcompliance under EHS laws, including costs to acquire, maintain and repairpollution control equipment. For the nine months ended September 30, 2005and 2004, our capital expenditures for EHS matters totaled $0.7 millionand $0.8 million, respectively. Since capital expenditures for these mattersare subject to evolving regulatory requirements and depend, in part, on thetiming, promulgation and enforcement of specific requirements, we cannotprovide assurance that our recent expenditures will be indicative of futureamounts required under EHS laws.

 

***GovernmentalEnforcement Proceedings***

 

On occasion, we receive notices of violation, enforcement and othercomplaints from regulatory agencies alleging non-compliance with applicable EHSlaw. By way of example, we are aware of the individual matters set out below,which we believe to be the most significant presently pending matters andunasserted claims. Although we may incur costs or penalties in connection withthe governmental proceedings discussed below, based on currently availableinformation and our past experience, we believe that the ultimate resolution ofthese matters will not have a material impact on our results of operations,financial position or liquidity.

 

By letter dated September 13, 2005, the Tamil Nadu PollutionControl Board (the “TNPCB”) issued an Order in follow-up to a Show Cause notice dated June 30, 2005**,**requiring a manufacturingfacility of Petro Araldite Private Limited, one of our subsidiaries in Chennai,India, to close for one week and to submit an action plan and timeline toreduce chemical oxygen demand in its wastewater effluent.  The facility complied with the order and hassubmitted an action plan to the TNPCB, which has been accepted pendinginstallation of assets to remedy the issue. If the TNPCB believes the plan is insufficient, it has the power to takefurther enforcement action, including shutting down the facility for a longerperiod or permanently, initiating criminal sanctions or imposing fines.

 

***RemediationLiabilities***

 

We have incurred, and we may in the future incur, liability toinvestigate and clean up waste or contamination at our current or formerfacilities or facilities operated by third parties at which we may havedisposed of waste or other materials. Similarly, we may incur costs for thecleanup of wastes that were disposed of prior to the purchase of our businesses.Under some circumstances, the scope of our liability may extend to damages tonatural resources.

 

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Some of our manufacturing sites have an extended history of industrialchemical manufacturing and use, including on-site waste disposal. We are awareof soil, groundwater and surface water contamination from past operations atsome of our sites, and we may find contamination at other sites in the future.For example, we are aware that there is significant contamination, largelyrelated to a landfill and lagoons, at our McIntosh, Alabama plant site.Further, soil and groundwater contamination have been identified at our plantsin Duxford, U.K. and Monthey, Switzerland. Pursuant to certain agreements withrespect to these sites, we expect that Ciba will have primary financialresponsibility for such matters, although we may be required to contribute tothe costs of remediation in certain instances, and we believe that Ciba has theintention and ability to honor these agreements. Based on available informationand the indemnification rights we believe are likely to be available, webelieve that the costs to investigate and remediate known contamination willnot have a material adverse effect on our financial condition, results ofoperations or cash flows, and therefore we have made no accrual for suchliabilities as of September 30, 2005. However, if such indemnities areunavailable or do not fully cover the costs of investigation and remediation orwe are required to contribute to such costs, and if such costs are material,then such expenditures may have a material adverse effect on our financialcondition, results of operations or cash flows. At the current time, we areunable to estimate the full cost, exclusive of indemnification benefits, toremediate known contamination sites.

 

***RegulatoryDevelopments***

 

Under the European Union (“EU”) Integrated Pollution Prevention andControl Directive (“IPPC”), EU member governments are to adopt rules andimplement a cross-media (air, water and waste) environmental permitting programfor individual facilities. While the EU countries are at varying stages intheir respective implementation of the IPPC permit program, we have submittedall necessary IPPC permit applications required to date, and in some casesreceived completed permits from the applicable government agency. We expect tosubmit all other IPPC applications and related documents on a timely basis asthe various countries implement the IPPC permit program. Although we do notknow with certainty what each IPPC permit will require, we believe, based uponour experience with the permits received to date, that the costs of compliancewith the IPPC permit program will not be material to our results of operations,financial position or liquidity.

 

In October 2003, the European Commission adopted a proposal for anew EU regulatory framework for chemicals. Under this proposed new systemcalled “REACH” (Registration, Evaluation and Authorization of Chemicals),companies that manufacture or import more than one ton of a chemical substanceper year would be required to register such manufacture or import in a centraldatabase. The REACH initiative, as proposed, would require risk assessment ofchemicals, preparations (e.g., soaps and paints) and articles (e.g., consumerproducts) before those materials could be manufactured or imported into EUcountries. Where warranted by a risk assessment, hazardous substances wouldrequire authorizations for their use. This regulation could impose risk controlstrategies that would require capital expenditures by us. As proposed, REACHwould take effect in three primary stages over the eleven years following thefinal effective date (assuming final approval). The impacts of REACH on the chemicalindustry and on us are unclear at this time because the parameters of theprogram are still being actively debated.

 

**Recently Issued Accounting Pronouncements**

 

See Note 2 “Recently Issued Accounting Pronouncements” to ourCondensed Consolidated Financial Statements (unaudited) for a discussion ofrecently issued accounting pronouncements.

 

**Critical Accounting Policies**

 

There have been no changes in the nine months ended September 30,2005 with respect to our critical accounting policies as presented inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations included in our Registration Statement on Form S-4 filed withthe SEC on April 5, 2005 (File No. 333-115344).

 

**Cautionary Statement for Forward-LookingInformation**

 

Certain information set forth in this report contains “forward-lookingstatements” within the meaning of the federal securities laws. Forward-lookingstatements include statements concerning our plans, objectives, goals,strategies, future events, future revenues or performance, capitalexpenditures, financing needs, plans or intentions relating to acquisitions andother information that is not historical information. In some cases, forward-lookingstatements can be identified by terminology such as “believes,” “expects,” “may,”“will,” “should,” “anticipates,” or “intends” or the negative of such terms orother comparable terminology, or by discussions of strategy. We may also makeadditional forward-looking statements from time to time. All such 

 

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subsequent forward-looking statements, whether written or oral, by usor on our behalf, are also expressly qualified by these cautionary statements.

 

All forward-looking statements, including without limitation, management’sexamination of historical operating trends, are based upon our currentexpectations and various assumptions. Our expectations, beliefs and projectionsare expressed in good faith and we believe there is a reasonable basis forthem, but there can be no assurance that management’s expectations, beliefs andprojections will result or be achieved. All forward-looking statements applyonly as of the date made. We undertake no obligation to publicly update orrevise forward-looking statements which may be made to reflect events orcircumstances after the date made or to reflect the occurrence of unanticipatedevents.

 

There are a number of risks and uncertainties, including thosediscussed elsewhere in this report, that could cause our actual results todiffer materially from the forward-looking statements contained in orcontemplated by this report. Any forward-looking statements should beconsidered in light of all such factors and the risks specified in ourRegistration Statement on Form S-4 filed with the SEC on April 5,2005 (File No. 333-115344).

 

**ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are exposed to market risk, including changes in currency exchangerates, interest rates and certain commodity prices. To manage the volatilityrelating to these exposures, from time to time, we enter into variousderivative transactions. We hold and issue derivative financial instruments foreconomic hedging purposes only.

 

**Currency Exchange Rates**

 

Our cash flows and earnings are subject to fluctuations due to exchangerate variation. Our sales prices are typically denominated in euros or U.S.dollars. From time to time, we may enter into foreign currency derivativeinstruments to minimize the short-term impact of movements in foreign currencyrates. Short-term exposures to changing foreign currency exchange rates at oursubsidiaries are generally netted where practicable. Remaining exposures may bemanaged, from time to time, through financial market transactions, principallythrough the purchase of spot or forward foreign exchange contracts (generallywith maturities of nine months or less). We do not hedge our currency exposuresin a manner that would entirely eliminate the effect of changes in exchangerates on our cash flows and earnings. As of September 30, 2005, ouroutstanding forward foreign exchange contracts were not material.

 

We finance certain of our non-U.S. subsidiaries with intercompany loansthat are, in some cases, denominated in currencies other than the entities’ functionalcurrency.  We attempt to manage the netforeign currency exposure created by this debt through various means, includingcross-currency swaps, the designation of certain intercompany loans asPermanent Loans (as defined below) and the designation of debt and swaps ashedges.

 

On June 1, 2005, we entered into a cross-currency interest rateswap. The cross-currency swap requires us to pay euros and receive U.S. dollarson the maturity date of July 15, 2007. The U.S. dollar notional amount is$31.3 million and bears interest at a fixed rate of 11.0%, payablesemiannually on January 15 and July 15. The euro notional amount is€25.0 million and bears interest at a fixed rate of approximately 9.4%,payable semiannually on January 15 and July 15. The swap is notdesignated as a hedge for reporting purposes and is recorded at fair value. Asof September 30, 2005, an asset of $1.0 million was recorded in othernoncurrent assets, with a corresponding decrease in other operating expensesfor the nine months ended September 30, 2005.

 

Foreign currency transaction gains and losses on intercompany loans thatare expected to be repaid in the foreseeable future are recorded in earnings.Foreign currency transaction gains and losses on intercompany loans that arenot expected to be repaid in the foreseeable future (as so designated by us, “PermanentLoans”) are recorded in other comprehensive income. From time to time, wereview such designation of intercompany loans, and, during the nine monthsended September 30, 2005, we have increased the amount of our PermanentLoans. We believe this will result in less volatility reported in foreigncurrency gains and losses reflected in earnings.

 

**Interest Rates**

 

As of September 30, 2005, we had outstanding $250 millionaggregate principal amount of 11% Fixed Rate Notes due 2010 and we had$25 million aggregate principal amount (issued with an original issuediscount of 2%) of Floating Rate Notes due 2008 that bear an annual interestrate equal to LIBOR plus 8%, with a LIBOR floor of 2%. The undrawn AdMatRevolving 

 

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Credit Facility due in 2007 is subject to variable rates of interestbased upon either a eurocurrency rate (LIBOR) or a base rate (prime), plus anapplicable spread. As of September 30, 2005, except for the cross-currencyinterest rate swap discussed above, we had not entered into any interest rateagreements and we do not hedge our interest rate exposure in a manner thatwould eliminate the effects of changes in market interest rates on our cashflow and earnings.  Assuming a 1.0% (100basis points) increase in interest rates, the effect on the annual interestexpense relative to the Floating Rate Notes would be an increase ofapproximately $0.3 million.

 

**Commodity Prices**

 

We do not hedge our commodity exposure in a manner that would entirelyeliminate the effects of changes in commodity prices on our cash flows andearnings. At September 30, 2005, we had no outstanding forward purchasecontracts.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

Our management, with the participation of our chief executive officerand chief financial officer, has evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30,2005. Based on this evaluation, our chief executive officer and chief financialofficer have concluded that, as of September 30, 2005, our disclosurecontrols and procedures were effective, in that they ensure that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is (1) recorded, processed, summarized and reported withinthe time periods specified in the Commission’s rules and forms, and (2) accumulatedand communicated to our management, including our chief executive officer andchief financial officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

No changes to our internal control over financial reporting occurredduring the three months ended September 30, 2005 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act). Huntsman Corporation and its subsidiaries, including ourCompany, have engaged Ernst & Young LLP to assist management in itsdocumentation and evaluation of our internal controls in preparation for theperiodic management evaluations and annual auditor attestation reportsregarding the effectiveness of our “internal control over financial reporting”that will be required when the SEC’s rules under Section 404 of theSarbanes-Oxley Act of 2002 become applicable to Huntsman Corporation beginningwith its Annual Report on Form 10-K for the year ending December 31,2006 to be filed in the first quarter of 2007 and to us beginning with ourAnnual Report on Form 10-K for the year ending December 31, 2007 tobe filed in the first quarter of 2008. We cannot give any assurance, however,that our internal controls over financial reporting will be effective when Section 404becomes applicable. Ineffective internal controls over financial reportingcould cause investors to lose confidence in our reported financial informationand could result in a lower trading price for our securities.

 

**PART II. OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

SeeNote 9 “Commitments and Contingencies—Legal Matters” and Note 10“Environmental, Health and Safety Matters” to our Condensed ConsolidatedFinancial Statements (unaudited), which are incorporated herein by reference,for a discussion of legal proceedings.

 

**ITEM6.  EXHIBITS**

 
| 31.1   |   | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
|--------|--------|----------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                     |
| 31.2   |   | Certification of Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                     |
| 32.1   |   | Certification of Chief Executive Officer pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                     |
| 32.2   |   | Certification of Chief Financial Officer pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

Dated: November 14, 2005

 
|   | HUNTSMAN ADVANCED MATERIALS LLC |
|--------|---------------------------------|
|   |                            |   |
|   | By:                             | /s/ J. KIMO ESPLIN  |
|   |                            | J. Kimo Esplin  |
|   |                            | *Executive Vice President and Chief  Financial  Officer**(Authorized Signatory and Principal  Financial  Officer)* |
|   |                            |   |
|   | By:                             | /s/ L. RUSSELL HEALY |
|   |                            | L. Russell Healy |
|   |                            | *Vice President and Controller**(Authorized Signatory and Principal  Accounting  Officer)* |

 

35

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**EXHIBIT INDEX**

 
| **Number** | ** ** | **Description**                                                                                          |
|------------|------------|----------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                     |
| 31.1       |       | Certification of Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                     |
| 31.2       |       | Certification of Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                     |
| 32.1       |       | Certification of Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                     |
| 32.2       |       | Certification of Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

36

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