UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(AMENDMENT NO. 1)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2008
OR
| ¨ | 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 1-71
HEXION SPECIALTY CHEMICALS, INC.
(Exact name of registrant as specified in its charter)
| New Jersey | 13-0511250 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
| 180 East Broad St., Columbus, OH 43215 | 614-225-4000 | |
| (Address of principal executive offices including zip code) | (Registrant’s telephone number including area code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No x.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x.
Number of shares of common stock, par value $0.01 per share, outstanding as of the close of business on May 1, 2008: 82,556,847
Explanatory Note
Hexion Specialty Chemicals, Inc. (“we”, “us”, or the “Company”) is filing this Amendment No. 1 on Form 10-Q/A (this “Amendment”) to amend its Quarterly Report on Form 10-Q, initially filed with the Securities and Exchange Commission on May 14, 2008 (the “Original Filing”), for the quarter ended March 31, 2008 to restate the financial statements included therein. The restatement resulted from errors the Company discovered on November 10, 2008 in non-cash unrealized foreign exchange gains and losses on intercompany balances recorded in the Company’s results of operations during the three months ended March 31, 2008. The errors related to the misapplication of procedures for a newly-implemented system enhancement to record foreign exchange gains and losses on intercompany balances.
This Form 10-Q/A is being filed in connection with the restatement of our financial statements for the three months ended March 31, 2008. The information contained in this Amendment, including the financial statements and the notes thereto, amends Items 1, 2 and 4T of Part I of the Original filing to reflect the effects of this restatement on our financial statements for the period presented or as deemed necessary in connection with the completion of the restated financial statements. No other information in the Original filing has been amended. Currently dated certifications from our Chief Executive Officer and Chief Financial Officer have been included as exhibits to this Amendment. Except for the foregoing amended information, this Amendment continues to describe conditions as of the date of the Original filing, and we have not updated the disclosures contained herein to reflect events that occurred at a later date.
This correction resulted in an increase of $1 million in operating income, a decrease of $9 million in non-operating income, and a decrease of $6 million in net income for the three months ended March 31, 2008. For additional discussion and a summary of the effect of this restatement see Note 2 “Correction of an Error” to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q/A.
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HEXION SPECIALTY CHEMICALS, INC.
INDEX
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
HEXION SPECIALTY CHEMICALS, INC. (Unaudited)
| Three Months ended March 31, | ||||||||
(In millions) | 2008 | 2007 | ||||||
| (Restated, see Note 2) | ||||||||
Net sales | $ | 1,636 | $ | 1,438 | ||||
Cost of sales | 1,429 | 1,216 | ||||||
Gross profit | 207 | 222 | ||||||
Selling, general and administrative expense | 104 | 100 | ||||||
Pending merger costs | 9 | — | ||||||
Integration costs | 7 | 9 | ||||||
Other operating expense, net | 4 | 9 | ||||||
Operating income | 83 | 104 | ||||||
Interest expense, net | 78 | 76 | ||||||
Other non-operating expense, net | 6 | 2 | ||||||
(Loss) income before income tax, earnings from unconsolidated entities and minority interest | (1 | ) | 26 | |||||
Income tax expense | 11 | 21 | ||||||
(Loss) income before earnings from unconsolidated entities and minority interest | (12 | ) | 5 | |||||
Earnings from unconsolidated entities, net of taxes | 1 | 1 | ||||||
Minority interest in net income of consolidated subsidiaries | (1 | ) | (2 | ) | ||||
Net (loss) income | $ | (12 | ) | $ | 4 | |||
Comprehensive income | $ | 28 | $ | 18 | ||||
See Notes to Condensed Consolidated Financial Statements
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CONDENSED CONSOLIDATED BALANCE SHEETS
HEXION SPECIALTY CHEMICALS, INC. (Unaudited)
(In millions, except share data) | March 31, 2008 | December 31, 2007 | ||||||
| (Restated, see Note 2) | ||||||||
Assets | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | 191 | $ | 199 | ||||
Accounts receivable (net of allowance for doubtful accounts of $24 and $22, respectively) | 984 | 874 | ||||||
Inventories: | ||||||||
Finished and in-process goods | 471 | 418 | ||||||
Raw materials and supplies | 192 | 185 | ||||||
Other current assets | 78 | 78 | ||||||
Total current assets | 1,916 | 1,754 | ||||||
Other assets, net | 233 | 223 | ||||||
Property and equipment | ||||||||
Land | 110 | 105 | ||||||
Buildings | 337 | 325 | ||||||
Machinery and equipment | 2,293 | 2,231 | ||||||
| 2,740 | 2,661 | |||||||
Less accumulated depreciation | (1,099 | ) | (1,046 | ) | ||||
| 1,641 | 1,615 | |||||||
Goodwill | 213 | 206 | ||||||
Other intangible assets, net | 211 | 208 | ||||||
Total assets | $ | 4,214 | $ | 4,006 | ||||
Liabilities and Shareholder’s Deficit | ||||||||
Current liabilities | ||||||||
Accounts and drafts payable | $ | 791 | $ | 718 | ||||
Debt payable within one year | 86 | 85 | ||||||
Interest payable | 61 | 54 | ||||||
Income taxes payable | 62 | 47 | ||||||
Other current liabilities | 410 | 342 | ||||||
Total current liabilities | 1,410 | 1,246 | ||||||
Long-term liabilities | ||||||||
Long-term debt | 3,638 | 3,635 | ||||||
Long-term pension and post employment benefit obligations | 226 | 220 | ||||||
Deferred income taxes | 145 | 141 | ||||||
Other long-term liabilities | 140 | 138 | ||||||
Total liabilities | 5,559 | 5,380 | ||||||
Minority interest in consolidated subsidiaries | 12 | 12 | ||||||
Commitments and contingencies (See Note 6) | ||||||||
Shareholder’s Deficit | ||||||||
Common stock—$0.01 par value; 300,000,000 shares authorized, 170,605,906 issued and 82,556,847 outstanding at March 31, 2008 and December 31, 2007 | 1 | 1 | ||||||
Paid-in deficit | (12 | ) | (13 | ) | ||||
Treasury stock, at cost—88,049,059 shares | (296 | ) | (296 | ) | ||||
Accumulated other comprehensive income | 214 | 174 | ||||||
Accumulated deficit | (1,264 | ) | (1,252 | ) | ||||
Total shareholder’s deficit | (1,357 | ) | (1,386 | ) | ||||
Total liabilities and shareholder’s deficit | $ | 4,214 | $ | 4,006 | ||||
See Notes to Condensed Consolidated Financial Statements
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
HEXION SPECIALTY CHEMICALS, INC. (Unaudited)
| Three months ended March 31, | ||||||||
(In millions) | 2008 | 2007 | ||||||
| (Restated, see Note 2) | ||||||||
Cash flows provided by (used in) operating activities | ||||||||
Net (loss) income | $ | (12 | ) | $ | 4 | |||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 52 | 47 | ||||||
Minority interest in net income of consolidated subsidiaries | 1 | 2 | ||||||
Stock-based compensation expense | 1 | 1 | ||||||
Gain on sale of assets, net of tax | (5 | ) | — | |||||
Deferred tax provision | 10 | 5 | ||||||
Other non-cash adjustments | 7 | 5 | ||||||
Net change in assets and liabilities, excluding acquisitions: | ||||||||
Accounts receivable | (78 | ) | (62 | ) | ||||
Inventories | (36 | ) | (45 | ) | ||||
Accounts and drafts payable | 50 | 4 | ||||||
Income taxes payable | 12 | 1 | ||||||
Other assets, current and non-current | (1 | ) | 6 | |||||
Other liabilities, current and long-term | 17 | 10 | ||||||
Net cash provided by (used in) operating activities | 18 | (22 | ) | |||||
Cash flows used in investing activities | ||||||||
Capital expenditures | (22 | ) | (22 | ) | ||||
Acquisition of businesses, net of cash acquired | — | (63 | ) | |||||
Deferred acquisition costs | (1 | ) | — | |||||
Proceeds from the sale of assets | 8 | — | ||||||
Net cash used in investing activities | (15 | ) | (85 | ) | ||||
Cash flows (used in) provided by financing activities | ||||||||
Net short-term debt repayments | (2 | ) | (8 | ) | ||||
Borrowings of long-term debt | 179 | 665 | ||||||
Repayments of long-term debt | (190 | ) | (560 | ) | ||||
Payments of dividends on common stock | (1 | ) | — | |||||
Net cash (used in) provided by financing activities | (14 | ) | 97 | |||||
Effect of exchange rates on cash and cash equivalents | 3 | 1 | ||||||
Decrease in cash and equivalents | (8 | ) | (9 | ) | ||||
Cash and cash equivalents at beginning of period | 199 | 64 | ||||||
Cash and cash equivalents at end of period | $ | 191 | $ | 55 | ||||
Supplemental disclosures of cash flow information | ||||||||
Cash paid for: | ||||||||
Interest, net | $ | 69 | $ | 65 | ||||
Income taxes, net of cash refunds | 2 | 14 | ||||||
See Notes to Condensed Consolidated Financial Statements
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CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDER’S DEFICIT AND COMPREHENSIVE INCOME
HEXION SPECIALTY CHEMICALS, INC. (Unaudited)
(Restated, see Note 2)
(In millions) | Common Stock | Paid-in Deficit | Treasury Stock | Accumulated Other Comprehensive Income (a) | Accumulated Deficit | Total | |||||||||||||||||
Balance at December 31, 2007 | $ | 1 | $ | (13 | ) | $ | (296 | ) | $ | 174 | $ | (1,252 | ) | $ | (1,386 | ) | |||||||
Net loss | — | — | — | — | (12 | ) | (12 | ) | |||||||||||||||
Deferred losses on cash flow hedges | — | — | — | (21 | ) | — | (21 | ) | |||||||||||||||
Gain recognized in comprehensive income from pension and postretirement benefits, net of tax | — | — | — | 2 | — | 2 | |||||||||||||||||
Translation adjustments | — | — | — | 59 | — | 59 | |||||||||||||||||
Comprehensive income | — | — | — | — | — | 28 | |||||||||||||||||
Stock-based compensation expense | — | 1 | — | — | — | 1 | |||||||||||||||||
Balance at March 31, 2008 | $ | 1 | $ | (12 | ) | $ | (296 | ) | $ | 214 | $ | (1,264 | ) | $ | (1,357 | ) | |||||||
| (a) | Accumulated other comprehensive income at March 31, 2008 represents $275 of net foreign currency translation gains, net of tax, $46 of net deferred losses on cash flow hedges and a $15 loss, net of tax, related to net actuarial losses and prior service costs for the Company’s defined benefit pension and postretirement benefit plans. Accumulated other comprehensive income at December 31, 2007 represents $216 of net foreign currency translation gains, net of tax, $25 of net deferred losses on cash flow hedges, and a $17 loss, net of tax, related to net actuarial losses and prior service costs for the Company’s defined benefit pension and postretirement benefit plans. |
See Notes to Condensed Consolidated Financial Statements
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In millions, except share and common unit data)
1. Background, Basis of Presentation and Summary of Significant Accounting Policies
Based in Columbus, Ohio, Hexion Specialty Chemicals, Inc. (“Hexion” or the “Company”) serves global industrial markets through a broad range of thermoset technologies, specialty products and technical support for customers in a diverse range of applications and industries. Hexion is owned by an affiliate of Apollo Management, L.P. (“Apollo”).
Basis of Presentation—The unaudited Condensed Consolidated Financial Statements include the accounts of the Company and its majority-owned subsidiaries, in which minority shareholders hold no substantive participating rights, after eliminating intercompany accounts and transactions. In the opinion of management, all adjustments, consisting of normal, recurring adjustments considered necessary for a fair statement, have been included. Results for the interim periods are not necessarily indicative of results for the entire year.
Year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
Pursuant to the rules and regulations of the Securities and Exchange Commission, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These unaudited financial statements should be read in conjunction with the audited financial statements and the accompanying notes included in Hexion’s most recent Annual Report on Form 10-K.
Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. It also requires the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Pending Merger Costs—The Company incurred Pending merger costs totaling $9 for the three months ended March 31, 2008. These costs represent accounting, tax and miscellaneous costs related to the pending Huntsman Corporation (“Huntsman”) merger.
Integration Costs—The Company incurred Integration costs totaling $7 and $9 for the three months ended March 31, 2008 and 2007, respectively. These costs represent Hexion formation related redundancy and plant rationalization costs and incremental administrative costs from integration programs since the Hexion formation, as well as costs to implement a single, company-wide, management information and accounting system and a new consolidations and financial reporting system.
Reclassifications—Certain prior period balances have been reclassified to conform with current presentations.
Recently Issued Accounting Standard
In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 requires enhanced disclosures about derivative instruments and hedging activities to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 will be effective for the Company on January 1, 2009.
2. Correction of an Error
On November 10, 2008, the Company discovered errors in non-cash unrealized foreign exchange gains and losses on intercompany balances recorded in the Company’s results of operations during the three months ended March 31, 2008. The errors related to the misapplication of procedures for a newly-implemented system enhancement to record foreign exchange gains and losses on intercompany balances.
The following table summarizes the impact of the restatement on the balances originally reported on the Company’s condensed consolidated balance sheet at March 31, 2008 and the related condensed consolidated statements of operations and cash flows for the three months ended March 31, 2008:
| As Previously Reported | Adjustments | As Restated | ||||||||||
Condensed consolidated statement of operations for the three months ended March 31, 2008: | ||||||||||||
Other operating expense, net | $ | 5 | $ | (1 | ) | $ | 4 | |||||
Operating income | 82 | 1 | 83 | |||||||||
Other non-operating expense, net | (3 | ) | 9 | 6 | ||||||||
(Loss) income before income tax, earnings from unconsolidated entities and minority interest | 7 | (8 | ) | (1 | ) | |||||||
Income tax expense | 13 | (2 | ) | 11 | ||||||||
(Loss) income before earnings from unconsolidated entities and minority interest | (6 | ) | (6 | ) | (12 | ) | ||||||
Net (loss) income | (6 | ) | (6 | ) | (12 | ) | ||||||
Condensed consolidated balance sheet at March 31, 2008: | ||||||||||||
Accumulated other comprehensive income | 208 | 6 | 214 | |||||||||
Accumulated deficit | (1,258 | ) | (6 | ) | (1,264 | ) | ||||||
Condensed consolidated statement of cash flows for the three months ended March 31, 2008: | ||||||||||||
Net (loss) income | (6 | ) | (6 | ) | (12 | ) | ||||||
Other non-cash adjustments | (1 | ) | 8 | 7 | ||||||||
Other liabilities, current and long-term | 19 | (2 | ) | 17 | ||||||||
Footnotes contained elsewhere herein have been restated, where applicable, for the errors discussed above.
3. Acquisitions and Divestitures
Huntsman Agreement
On July 12, 2007, the Company announced the signing of an Agreement and Plan of Merger (the “Agreement”) to acquire Huntsman in an all-cash transaction initially valued at approximately $10,600, which includes the assumption of debt. Under the terms of the Agreement, Huntsman stockholders will receive $28.00 in cash for each outstanding share of Huntsman common stock. The Agreement also provides that the cash price per share to be paid by the Company will increase each day through the consummation of the merger at the equivalent of approximately 8% per annum (less any dividends or distributions declared or made) beginning April 6, 2008. In connection with the transaction, the Company has obtained financing commitments from affiliates of Credit Suisse and Deutsche Bank.
Huntsman is a global manufacturer and marketer of differentiated chemicals. Its operating companies manufacture products for a variety of global industries, including chemicals, plastics, automotives, aviation, textiles, footwear, paints and coatings, construction, technology, agriculture, health care, detergents, personal care, furniture, appliances and packaging. Huntsman has approximately 13,000 employees and operates from multiple locations worldwide. Huntsman had 2007 revenues of approximately $10,000.
Prior to entering into the Agreement, Huntsman terminated an Agreement and Plan of Merger with Basell AF. As a result, Huntsman paid Basell AF a break-up fee in the amount of $200, of which the Company funded $100 in July 2007. This amount has
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been recorded as a deferred acquisition cost and is included in Other assets, net in the unaudited Condensed Consolidated Balance Sheets. The Company has also recorded $28 of other deferred acquisition costs in Other assets, net in the unaudited Condensed Consolidated Balance Sheets.
The transaction was approved by Huntsman’s stockholders on October 16, 2007. The transaction is subject to regulatory approval in the United States, European Union and several other countries as well as other customary closing conditions. Under the Agreement, the Company is obligated to take any and all action necessary, including but not limited to selling assets or businesses of the Company to obtain the necessary regulatory approvals. In January 2008, the Company agreed to allow additional time for the Federal Trade Commission to review the proposed merger. To accommodate the extension, on April 5, 2008, the Company exercised its option to extend the termination date under the Agreement for 90 days, thereby extending the termination date to July 4, 2008. If the transaction is terminated, in certain circumstances, the Company would be required to pay Huntsman a termination fee of $325.
2008 Divestitures
The Company recognized a gain of $7 ($5 net of tax) during the three months ended March 31, 2008 for the sale of certain assets of a non-core product line. This amount is included in Other operating expense, net in the Company’s unaudited Condensed Consolidated Statements of Operations.
4. Related Party Transactions
Management Consulting Agreement
The Company is subject to a seven-year management consulting agreement with Apollo (the “Management Consulting Agreement”) under which the Company receives certain structuring and advisory services from Apollo and its affiliates. The terms of the Management Consulting Agreement provide for annual fees of $3. The Management Consulting Agreement provides indemnification to Apollo and its affiliates and their directors, officers and representatives for potential losses from the services contemplated under these agreements.
During each of the three months ended March 31, 2008 and 2007, the Company recognized expense of less than $1 for the Management Consulting Agreement. These amounts are included in Other operating expense, net in the Company’s unaudited Condensed Consolidated Statements of Operations.
Other Transactions
The Company sells finished goods to certain Apollo affiliates. These sales were $2 and $1 for the three months ended March 31, 2008 and 2007, respectively. Accounts receivable from these affiliates were $1 at March 31, 2008 and December 31, 2007. The Company also purchases raw materials and services from certain Apollo affiliates. These purchases were $1 and $3 for the three months ended March 31, 2008 and 2007, respectively. The Company had accounts payable to Apollo and affiliates of less than $1 at March 31, 2008 and December 31, 2007.
5. Fair Value Disclosures
On January 1, 2008, the Company adopted the provisions of SFAS No. 157,Fair Value Measurements for assets and liabilities measured or disclosed at fair value on a recurring basis. This statement establishes a standard definition of fair value, establishes a framework under generally accepted accounting principles to measure fair value and expands disclosure requirements for fair value measurements. The Company has not yet applied the provisions of SFAS No. 157 to its nonfinancial assets and liabilities measured on a non-recurring basis, in accordance with FSP 157-2,Effective Date of FASB Statement No. 157. SFAS No. 157 will be adopted for nonfinancial assets and liabilities measured on a non-recurring basis on January 1, 2009 and is not expected to have a material impact on the Company’s consolidated financial statements. The Company’s major classes of nonfinancial assets and liabilities measured on a non-recurring basis include reporting units, long-lived assets and intangible assets measured at fair value for impairment assessment as well as assets and liabilities initially measured at fair value in a business combination.
SFAS No. 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company is required to measure its derivative financial instruments at fair value on a recurring basis. The Company utilizes observable market data or assumptions that market participants would use in measuring the fair values of the derivative instruments.
SFAS No. 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
| • | Level 1: Inputs are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 1 primarily consists of financial instruments traded on exchange or futures markets. |
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| • | Level 2: Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes those derivative instruments transacted primarily in over the counter markets. |
| • | Level 3: Unobservable inputs, for example, inputs derived through extrapolation or interpolation that cannot be corroborated by observable market data. |
Following is a summary of assets and liabilities measured at fair value on a recurring basis as of March 31, 2008:
| Fair Value Measurements Using | ||||||||||
| Quoted Prices in Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Unobservable Inputs (Level 3) | Total | |||||||
Derivative assets (liabilities), net | 1 | (139 | ) | — | (138 | ) | ||||
6. Commitments and Contingencies
Environmental Matters
The Company’s operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials. The Company is subject to extensive environmental regulation at the federal, state and local levels as well as foreign laws and regulations, and is therefore exposed to the risk of claims for environmental remediation or restoration. In addition, violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.
The following table summarizes all probable environmental remediation, indemnification and restoration liabilities, including related legal expenses, at March 31, 2008 and December 31, 2007.
| Number of Sites | Liability | Range of Reasonably Possible Costs | ||||||||||||||
Site Description | March 31, 2008 | December 31, 2007 | March 31, 2008 | December 31, 2007 | Low | High | ||||||||||
Geismar, LA | 1 | 1 | $ | 18 | $ | 18 | $ | 11 | $ | 28 | ||||||
Superfund and offsite landfills – allocated share: | ||||||||||||||||
Less than 1% | 25 | 23 | 1 | 1 | 1 | 2 | ||||||||||
Equal to or greater than 1% | 12 | 12 | 8 | 8 | 5 | 15 | ||||||||||
Currently-owned | 14 | 15 | 7 | 7 | 5 | 14 | ||||||||||
Formerly-owned: | ||||||||||||||||
Remediation | 9 | 8 | 3 | 3 | 2 | 13 | ||||||||||
Monitoring only | 9 | 10 | 2 | 2 | 1 | 4 | ||||||||||
| 70 | 69 | $ | 39 | $ | 39 | $ | 25 | $ | 76 | |||||||
These amounts include estimates for unasserted claims that the Company believes are probable of loss and reasonably estimable. The estimate of the range of reasonably possible costs is less certain than the estimates upon which the liabilities are based. To establish the upper end of a range, assumptions less favorable to the Company among the range of reasonably possible outcomes were used. As with any estimate, if facts or circumstances change, the final outcome could differ materially from these estimates. At March 31, 2008 and December 31, 2007, $7 has been included in Other current liabilities in the unaudited Condensed Consolidated Balance Sheets with the remaining amount included in Other long-term liabilities.
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Following is a discussion of the Company’s environmental liabilities and the related assumptions at March 31, 2008:
Geismar, LA Site—The Company formerly owned a basic chemicals and polyvinyl chloride business that was taken public as Borden Chemicals and Plastics Operating Limited Partnership (“BCPOLP”) in 1987. The Company retained a 1% interest, the general partner interest and the liability for certain environmental matters after BCPOLP’s formation. Under a Settlement Agreement approved by the United States Bankruptcy Court for the District of Delaware among the Company, BCPOLP, the United States Environmental Protection Agency and the Louisiana Department of Environmental Quality, the Company agreed to perform certain of BCPOLP’s obligations for soil and groundwater contamination at BCPOLP’s Geismar, Louisiana site. The Company bears the sole responsibility for these obligations because there are no other potentially responsible parties (“PRPs”) or third parties from whom the Company could seek reimbursement.
A groundwater pump and treat system to remove contaminants is operational, and natural attenuation studies are proceeding. If closure procedures and remediation systems prove to be inadequate, or if additional contamination is discovered, this could result in costs that would approach the higher end of the range of possible outcomes.
Due to the long-term nature of the project, the reliability of timing and the ability to estimate remediation payments, a portion of this liability was recorded at its net present value, assuming a 3% discount rate and a time period of thirty years. The range of possible outcomes is discounted in a similar manner. The undiscounted liability, which is expected to be paid over 30 years, is approximately $24. Over the next five years, we expect to make ratable payments totaling $6.
Superfund Sites and Offsite Landfills—The Company is currently involved in environmental remediation activities at a number of sites for which it has been notified that it is, or may be, a PRP under the United States Comprehensive Environmental Response, Compensation and Liability Act or similar state “superfund” laws. The Company anticipates approximately 50% of the estimated liability for these sites will be paid within the next five years, with the remainder over the next twenty-five years. The Company generally does not bear a significant level of responsibility for these sites, and as a result, has little control over the costs and timing of cash flows.
The Company’s ultimate liability will depend on many factors including its share of waste volume, the financial viability of other PRPs, the remediation methods and technology used, the amount of time necessary to accomplish remediation and the availability of insurance coverage. The range of possible outcomes takes into account the maturity of each project, resulting in a more narrow range as the project progresses. To estimate both its current reserves for environmental remediation at these sites and the possible range of additional costs, the Company has not assumed that it will bear the entire cost of remediation of every site to the exclusion of other known PRPs who may be jointly and severally liable. The Company has limited information to assess the viability of other PRPs and their probable contribution on a per site basis. The Company’s insurance provides very limited, if any, coverage for these environmental matters.
Sites Under Current Ownership—The Company is conducting environmental remediation at a number of locations that it currently owns, of which three sites are no longer in operation. As the Company is performing a portion of the remediation on a voluntary basis, it has some control over the costs to be incurred and the timing of cash flows. The Company expects to pay approximately $4 of these liabilities within the next three years, with the remainder over the next ten years. The factors influencing the ultimate outcome include the methods of remediation elected, the conclusions and assessment of site studies remaining to be completed, and the time period required to complete the work. No other parties are responsible for remediation at these sites.
Formerly-Owned Sites—The Company is conducting environmental remediation at a number of locations that it formerly owned. The final costs to the Company will depend on the method of remediation chosen and the level of participation of third parties.
In addition, the Company is responsible for a number of sites that require monitoring where no additional remediation is expected. The Company has established reserves for costs related to these sites. Payment of these liabilities is anticipated to occur over the next ten years. The ultimate cost to the Company will be influenced by fluctuations in projected monitoring periods or by findings that are different than anticipated.
Indemnifications—In connection with the acquisition of certain of the Company’s operating businesses, the Company has been indemnified by the sellers against certain liabilities of the acquired businesses, including liabilities relating to both known and unknown environmental contamination arising prior to the date of the purchase. The indemnifications may be subject to certain exceptions and limitations, deductibles and indemnity caps. While it is reasonably possible that some costs could be incurred, except for those sites identified above, the Company has inadequate information to allow it to estimate a potential range of liability, if any.
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Non-Environmental Legal Matters
The Company is involved in various legal proceedings in the ordinary course of business and has reserves of $9 and $15 at March 31, 2008 and December 31, 2007, respectively, for all non-environmental legal defense costs incurred and settlement costs that it believes are probable and estimable. At March 31, 2008 and December 31, 2007, $4 and $10, respectively, has been included in Other current liabilities in the unaudited Condensed Consolidated Balance Sheets with the remaining amount included in Other long-term liabilities.
Following is a discussion of significant non-environmental legal proceedings:
Brazil Tax Claim—In 1992, the State of Sao Paulo Administrative Tax Bureau issued an assessment against the Company’s Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes. These loans were characterized by the Tax Bureau as intercompany sales. Since that time, management and the Tax Bureau have held discussions and the subsidiary filed an administrative appeal seeking cancellation of the assessment. The Administrative Court upheld the assessment in December 2001. In 2002, the subsidiary filed a second appeal with the highest-level Administrative Court, again seeking cancellation of the assessment. In February 2007, the highest-level Administrative Court upheld the assessment. The Company requested a review of this decision. On April 23, 2008, the Brazilian Administrative Tax Tribunal issued its final decision upholding the assessment against the subsidiary. The Company will file an Annulment action in the Brazilian Judicial Courts in early May 2008 along with a request for an injunction to suspend the tax collection. The Company will pledge certain properties and assets in Brazil to support the injunction if so required by the Court. The Company continues to believe it has a strong defense against the assessment. At March 31, 2008, the amount of the assessment, including tax, penalties, monetary correction and interest, is 58 Brazilian reais, or approximately $33.
CTA Acoustics—From the third quarter 2003 to the first quarter 2004, six lawsuits were filed against the Company and others in the 27th Judicial District, Laurel County Circuit Court, in Kentucky, arising from an explosion at a customer’s plant where seven plant workers were killed and other workers were injured. Lawsuits seeking recovery for wrongful death, emotional and personal injury and loss of consortium were settled in the fourth quarter 2005. The Company’s share of these settlement amounts was covered by insurance. The litigation also included claims by the Company’s customer against the Company for property damage, which was tried April 2007. In May 2007, a jury awarded CTA Acoustics $122 in damages related to their loss of property, plant and equipment in the 2003 explosion. The Company’s insurance carriers are responsible for the current jury verdict, are appealing the verdict and will be responsible for legal fees and bond costs.
Formosa Plant—Several lawsuits were filed in Sangamon County, Illinois in May 2006 against the Company on behalf of individuals injured or killed in an explosion at a Formosa Plastics Corporation (“Formosa”) plant in Illiopolis, Illinois that occurred on April 23, 2004. The Company sold the facility in 1987. The facility was operated by BCPOLP until it was sold to Formosa out of BCPOLP’s bankrupt estate in 2002. In March 2007, an independent federal agency found that operator errors caused the explosion, but that current and former owners could have implemented systems to minimize the impacts from these errors. In March 2008, the Company filed a motion for summary judgment. At this time there is inadequate information from which to estimate a potential range of liability, if any.
Hillsborough County—The Company is named in a lawsuit filed in Hillsborough County, Florida Circuit Court, for an animal feed supplement processing site formerly operated by the Company and sold in 1980. The lawsuit is filed on behalf of multiple residents of Hillsborough County living near the site and it alleges various injuries from exposure to toxic chemicals. The Company does not have adequate information from which to estimate a potential range of liability, if any. The court dismissed a similar lawsuit brought on behalf of a class of plaintiffs in November 2005.
HAI Antitrust Class Action—In November 2003, HA-International, LLC (“HAI”) received a grand jury subpoena from the U.S. Department of Justice Antitrust Division relating to a foundry resins grand jury investigation. Between May and July 2004, eighteen lawsuits were filed in various jurisdictions alleging that the Company and HAI, along with various other entities, conspired to fix foundry resin prices and allocate markets. Subsequently, ten of the cases were dropped and the eight remaining cases were consolidated in the U.S. District Court for the Southern District of Ohio. In the fourth quarter of 2005, the grand jury investigation was closed without issuing indictments. On May 2, 2007, the District Court ruled that the plaintiffs’ proposed class of non-contract foundry resin purchasers would be certified. The defendants’ appeal of this decision to the 6th Circuit Court of Appeals was denied. HAI’s settlement negotiations with plaintiffs resulted in an agreement reached on October 29, 2007 to pay the class $6 with no admission of wrong doing. Payment was made in the first quarter of 2008. The action was dismissed as to all HAI defendants, including the Company, on March 28, 2008.
Other Legal Matters—The Company is involved in various other product liability, commercial and employment litigation, personal injury, property damage and other legal proceedings in addition to those described above, including actions that allege harm caused by products the Company has allegedly made or used, containing silica, vinyl chloride monomer and asbestos. The Company does not believe that it has a material exposure for these claims and believes it has adequate reserves and insurance to cover pending and foreseeable future claims.
11
7. Pension and Postretirement Expense
Following are the components of net pension and postretirement expense (benefit) recognized by the Company for the three months ended March 31, 2008 and 2007:
| Pension Benefits | ||||||||||||||||
| U.S. Plans | Non-U.S. Plans | |||||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||||
Service cost | $ | 1 | $ | 1 | $ | 2 | $ | 2 | ||||||||
Interest cost on projected benefit obligation | 4 | 4 | 4 | 3 | ||||||||||||
Expected return on assets | (4 | ) | (4 | ) | (2 | ) | (2 | ) | ||||||||
Amortization of prior service cost | — | — | — | — | ||||||||||||
Recognized actuarial loss | 2 | 2 | — | 1 | ||||||||||||
Net expense | $ | 3 | $ | 3 | $ | 4 | $ | 4 | ||||||||
| Non-Pension Postretirement Benefits | ||||||||||||||||
| U.S. Plans | Non-U.S. Plans | |||||||||||||||
| 2008 | 2007 | 2008 | 2007 | |||||||||||||
Service cost | $ | — | $ | — | $ | — | $ | — | ||||||||
Interest cost on projected benefit obligation | — | — | — | — | ||||||||||||
Amortization of prior service benefit | (3 | ) | (3 | ) | — | — | ||||||||||
Recognized actuarial gain | — | — | — | — | ||||||||||||
Settlement gain | — | — | — | — | ||||||||||||
Net benefit | $ | (3 | ) | $ | (3 | ) | $ | — | $ | — | ||||||
8. Segment Information
The Company’s business segments are based on the products that the Company offers and the markets that it serves. At March 31, 2008, the Company had four reportable segments: Epoxy and Phenolic Resins, Formaldehyde and Forest Products Resins, Coatings and Inks, and Performance Products. A summary of the major products of the Company’s reportable segments follows:
| • | Epoxy and Phenolic Resins: epoxy resins and intermediates, composite resins, molding compounds, versatic acids and derivatives, phenolic specialty resins and epoxy coating resins |
| • | Formaldehyde and Forest Products Resins: forest products resins and formaldehyde applications |
| • | Coatings and Inks: polyester resins, acrylic resins, and ink resins and additives |
| • | Performance Products: phenolic encapsulated substrates for oilfield and foundry applications |
The Company’s organizational structure continues to evolve. It is also continuing to refine its operating structure to more closely link similar products, minimize divisional boundaries and improve the Company’s ability to serve multi-dimensional common customers. These refinements, when complete, and the pending Huntsman merger may result in future changes to the Company’s reportable segments.
Reportable Segments
Following are net sales and Segment EBITDA (earnings before interest, income taxes, depreciation and amortization) by reportable segment. Segment EBITDA is defined as EBITDA adjusted to exclude certain non-cash and certain non-recurring expenses. Segment EBITDA is the primary performance measure used by the Company’s senior management, the chief operating decision-maker and the board of directors to evaluate operating results and allocate capital resources among segments. Segment EBITDA is also the profitability measure used to set management and executive incentive compensation goals. Corporate and Other is primarily corporate general and administrative expenses that are not allocated to the segments.
12
| Three months ended March 31, | ||||||||
| 2008 | 2007 | |||||||
Net Sales to Unaffiliated Customers(1)(2)(3): | ||||||||
Epoxy and Phenolic Resins | $ | 639 | $ | 567 | ||||
Formaldehyde and Forest Product Resins | 554 | 428 | ||||||
Coatings and Inks | 332 | 343 | ||||||
Performance Products | 111 | 100 | ||||||
| $ | 1,636 | $ | 1,438 | |||||
Segment EBITDA(2)(3): | ||||||||
Epoxy and Phenolic Resins | $ | 74 | $ | 95 | ||||
Formaldehyde and Forest Product Resins | 53 | 44 | ||||||
Coatings and Inks | 19 | 25 | ||||||
Performance Products | 21 | 18 | ||||||
Corporate and Other | (13 | ) | (12 | ) | ||||
(1) | Intersegment sales are not significant and, as such, are eliminated within the selling segment. |
(2) | Net sales and Segment EBITDA include the Orica Limited adhesives and resins business acquisition and the Arkema GmbH forest products resins and formaldehyde business acquisition from February 1, 2007 and November 1, 2007, respectively. |
(3) | Certain of the Company’s product lines have been realigned, resulting in reclassifications between segments. Prior period balances have been reclassified to conform to current presentations. |
Reconciliation of Segment EBITDA to Net (Loss) Income:
| Three months ended March 31, | ||||||||
| 2008 | 2007 | |||||||
Segment EBITDA: | ||||||||
Epoxy and Phenolic Resins | $ | 74 | $ | 95 | ||||
Formaldehyde and Forest Product Resins | 53 | 44 | ||||||
Coatings and Inks | 19 | 25 | ||||||
Performance Products | 21 | 18 | ||||||
Corporate and Other | (13 | ) | (12 | ) | ||||
Reconciliation: | ||||||||
Items not included in Segment EBITDA | ||||||||
Pending merger costs | (9 | ) | — | |||||
Integration costs | (7 | ) | (9 | ) | ||||
Non-cash items | (6 | ) | (6 | ) | ||||
Unusual items: | ||||||||
Gain on divestiture of assets | 7 | — | ||||||
Business realignments | (3 | ) | (6 | ) | ||||
Other | (7 | ) | (1 | ) | ||||
Total unusual items | (3 | ) | (7 | ) | ||||
Total adjustments | (25 | ) | (22 | ) | ||||
Interest expense, net | (78 | ) | (76 | ) | ||||
Income tax expense | (11 | ) | (21 | ) | ||||
Depreciation and amortization | (52 | ) | (47 | ) | ||||
Net (loss) income | $ | (12 | ) | $ | 4 | |||
13
Items not included in Segment EBITDA
For the three months ended March 31, 2008, Pending merger costs represent accounting, tax and miscellaneous costs related to the pending Huntsman merger.
For the three months ended March 31, 2008 and 2007, Integration costs represent redundancy and plant rationalization costs, incremental administrative costs for integration programs as a result of the Hexion formation and recent acquisitions as well as costs to implement a single, company-wide, management information and accounting system and a new consolidations and financial reporting system.
For the three months ended March 31, 2008 and 2007, Non-cash items represent stock-based compensation expense, impairments of property and equipment, and unrealized derivative and foreign exchange gains and losses.
Not included in Segment EBITDA are certain non-cash and certain non-recurring income or expenses that are deemed by management to be unusual in nature. For the three months ended March 31, 2008, these items consisted of a gain on the sale of certain assets of a non-core product line, business realignment costs, income related to the European solvent coating resins business (the “announced Alkyds Divestiture”), realized foreign exchange losses and management fees. For the three months ended March 31, 2007, these items consisted of business realignment costs, income related to the announced Alkyds Divestiture and management fees.
9. Guarantor/Non-Guarantor Subsidiary Financial Information
The Company and certain of its U.S. subsidiaries guarantee debt issued by its wholly owned subsidiaries Hexion Nova Scotia, ULC and Hexion U.S. Finance Corporation (together, the “Subsidiary Issuers”), which includes the $625 second-priority notes due 2014 and the $200 floating rate second-priority senior secured notes due 2014.
The following information contains the condensed consolidating financial information for Hexion (the parent), the subsidiary issuers, the combined subsidiary guarantors (Borden Chemical Investments, Inc., Borden Chemical Foundry, LLC, Lawter International, Inc., HSC Capital Corporation, Borden Chemical International, Inc., Hexion CI Holding Company and Oilfield Technology Group, Inc.) and the combined non-guarantor subsidiaries, which includes all of the Company’s foreign subsidiaries and HAI.
All of the subsidiary issuers and subsidiary guarantors are 100% owned by Hexion. All guarantees are full and unconditional, and are joint and several. There are no significant restrictions on the ability of the Company to obtain funds from its domestic subsidiaries by dividend or loan. While the Company’s Australian subsidiary and HAI are restricted in the payment of dividends and intercompany loans due to the terms of their credit facilities, there are no material restrictions on the Company’s ability to obtain cash from the remaining non-guarantor subsidiaries.
This information includes allocations of corporate overhead to the combined non-guarantor subsidiaries based primarily on net sales. Income tax expense has been provided on the combined non-guarantor subsidiaries based on actual effective tax rates. All other tax expense is reflected in the parent.
The following financial information for the three months ended March 31, 2008 has been restated for the errors discussed in Note 2 contained elsewhere herein.
14
HEXION SPECIALTY CHEMICALS, INC.
THREE MONTHS ENDED MARCH 31, 2008
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Restated) (Unaudited)
| Hexion Specialty Chemicals, Inc. | Subsidiary Issuers | Combined Subsidiary Guarantors | Combined Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||
Net sales | $ | 705 | $ | — | $ | — | $ | 1,058 | $ | (127 | ) | $ | 1,636 | |||||||||
Cost of sales | 630 | — | — | 926 | (127 | ) | 1,429 | |||||||||||||||
Gross profit | 75 | — | — | 132 | — | 207 | ||||||||||||||||
Selling, general and administrative expense | 39 | — | — | 65 | — | 104 | ||||||||||||||||
Pending merger costs | 7 | — | — | 2 | — | 9 | ||||||||||||||||
Integration costs | 4 | — | — | 3 | — | 7 | ||||||||||||||||
Other operating expense, net | 1 | — | — | 3 | — | 4 | ||||||||||||||||
Operating income | 24 | — | — | 59 | — | 83 | ||||||||||||||||
Interest expense, net | 42 | 20 | — | 16 | — | 78 | ||||||||||||||||
Intercompany interest expense (income) | 20 | (24 | ) | — | 4 | — | — | |||||||||||||||
Other non-operating (income) expense, net | (3 | ) | 3 | — | 6 | — | 6 | |||||||||||||||
(Loss) income before income tax, earnings from unconsolidated entities and minority interest | (35 | ) | 1 | — | 33 | — | (1 | ) | ||||||||||||||
Income tax expense | 1 | — | — | 10 | — | 11 | ||||||||||||||||
(Loss) income before earnings from unconsolidated entities and minority interest | (36 | ) | 1 | — | 23 | — | (12 | ) | ||||||||||||||
Earnings from unconsolidated entities, net of taxes | 25 | — | 1 | 1 | (26 | ) | 1 | |||||||||||||||
Minority interest in net loss of consolidated subsidiaries | (1 | ) | — | — | — | — | (1 | ) | ||||||||||||||
Net (loss) income | $ | (12 | ) | $ | 1 | $ | 1 | $ | 24 | $ | (26 | ) | $ | (12 | ) | |||||||
15
HEXION SPECIALTY CHEMICALS, INC.
THREE MONTHS ENDED MARCH 31, 2007
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)
| Hexion Specialty Chemicals, Inc. | Subsidiary Issuers | Combined Subsidiary Guarantors | Combined Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||
Net sales | $ | 617 | $ | — | $ | — | $ | 918 | $ | (97 | ) | $ | 1,438 | |||||||||
Cost of sales | 541 | — | — | 772 | (97 | ) | 1,216 | |||||||||||||||
Gross profit | 76 | — | — | 146 | — | 222 | ||||||||||||||||
Selling, general and administrative expense | 42 | — | — | 58 | — | 100 | ||||||||||||||||
Integration costs | 4 | — | — | 5 | — | 9 | ||||||||||||||||
Other operating expense, net | 1 | — | — | 8 | — | 9 | ||||||||||||||||
Operating income | 29 | — | — | 75 | — | 104 | ||||||||||||||||
Interest expense, net | 47 | 20 | — | 9 | — | 76 | ||||||||||||||||
Intercompany interest expense (income) | 15 | (22 | ) | — | 7 | — | — | |||||||||||||||
Other non-operating (income) expense, net | (1 | ) | 1 | — | 2 | — | 2 | |||||||||||||||
(Loss) income from continuing operations before income tax, earnings from unconsolidated entities and minority interest | (32 | ) | 1 | — | 57 | — | 26 | |||||||||||||||
Income tax expense | 2 | — | — | 19 | — | 21 | ||||||||||||||||
(Loss) income from continuing operations before earnings from unconsolidated entities and minority interest | (34 | ) | 1 | — | 38 | — | 5 | |||||||||||||||
Earnings from unconsolidated entities, net of taxes | 40 | — | 3 | 1 | (43 | ) | 1 | |||||||||||||||
Minority interest in net income of consolidated subsidiaries | (2 | ) | — | — | — | — | (2 | ) | ||||||||||||||
Net (loss) income | $ | 4 | $ | 1 | $ | 3 | $ | 39 | $ | (43 | ) | $ | 4 | |||||||||
16
HEXION SPECIALTY CHEMICALS, INC.
MARCH 31, 2008
CONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)
| Hexion Specialty Chemicals, Inc. | Subsidiary Issuers | Combined Subsidiary Guarantors | Combined Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||
Assets | ||||||||||||||||||||||||
Current assets | ||||||||||||||||||||||||
Cash and cash equivalents | $ | 27 | $ | — | $ | — | $ | 164 | $ | — | $ | 191 | ||||||||||||
Accounts receivable, net | 323 | 4 | — | 657 | — | 984 | ||||||||||||||||||
Inventories: | ||||||||||||||||||||||||
Finished and in-process goods | 197 | — | — | 274 | — | 471 | ||||||||||||||||||
Raw materials and supplies | 68 | — | — | 124 | — | 192 | ||||||||||||||||||
Other current assets | 14 | — | — | 64 | — | 78 | ||||||||||||||||||
Total current assets | 629 | 4 | — | 1,283 | — | 1,916 | ||||||||||||||||||
Other assets | ||||||||||||||||||||||||
Investment in subsidiaries | 958 | — | 22 | — | (980 | ) | — | |||||||||||||||||
Other assets, net | 167 | 14 | — | 52 | — | 233 | ||||||||||||||||||
| 1,125 | 14 | 22 | 52 | (980 | ) | 233 | ||||||||||||||||||
Property and equipment, net | 632 | — | — | 1,009 | — | 1,641 | ||||||||||||||||||
Goodwill | 101 | — | — | 112 | — | 213 | ||||||||||||||||||
Other intangible assets, net | 80 | — | — | 131 | — | 211 | ||||||||||||||||||
Total assets | $ | 2,567 | $ | 18 | $ | 22 | $ | 2,587 | $ | (980 | ) | $ | 4,214 | |||||||||||
Liabilities and Shareholder’s (Deficit) Equity | ||||||||||||||||||||||||
Current liabilities | ||||||||||||||||||||||||
Accounts and drafts payable | $ | 271 | $ | — | $ | — | $ | 520 | $ | — | $ | 791 | ||||||||||||
Accounts payable (receivable) to affiliates | 133 | (20 | ) | (14 | ) | (99 | ) | — | — | |||||||||||||||
Debt payable within one year | 23 | — | — | 63 | — | 86 | ||||||||||||||||||
Loans (receivable from) payable to affiliates | 104 | — | — | (104 | ) | — | — | |||||||||||||||||
Interest payable | 35 | 25 | — | 1 | — | 61 | ||||||||||||||||||
Income taxes payable | 12 | — | — | 50 | — | 62 | ||||||||||||||||||
Other current liabilities | 125 | 11 | 7 | 267 | — | 410 | ||||||||||||||||||
Total current liabilities | 703 | 16 | (7 | ) | 698 | — | 1,410 | |||||||||||||||||
Long-term liabilities | ||||||||||||||||||||||||
Long-term debt | 2,149 | 825 | — | 664 | — | 3,638 | ||||||||||||||||||
Intercompany loans payable (receivable) | 834 | (892 | ) | (13 | ) | 71 | — | — | ||||||||||||||||
Long-term pension and post employment benefit obligations | 76 | — | — | 150 | — | 226 | ||||||||||||||||||
Deferred income taxes | 40 | — | — | 105 | — | 145 | ||||||||||||||||||
Other long-term liabilities | 115 | — | — | 25 | — | 140 | ||||||||||||||||||
Total liabilities | 3,917 | (51 | ) | (20 | ) | 1,713 | — | 5,559 | ||||||||||||||||
Minority interest in consolidated subsidiaries | 7 | — | — | 5 | — | 12 | ||||||||||||||||||
Shareholder’s (deficit) equity | (1,357 | ) | 69 | 42 | 869 | (980 | ) | (1,357 | ) | |||||||||||||||
Total liabilities and shareholder’s (deficit) equity | $ | 2,567 | $ | 18 | $ | 22 | $ | 2,587 | $ | (980 | ) | $ | 4,214 | |||||||||||
17
HEXION SPECIALTY CHEMICALS, INC.
DECEMBER 31, 2007
CONDENSED CONSOLIDATING BALANCE SHEET
| Hexion Specialty Chemicals, Inc. | Subsidiary Issuers | Combined Subsidiary Guarantors | Combined Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||
Assets | ||||||||||||||||||||||||
Current assets | ||||||||||||||||||||||||
Cash and cash equivalents | $ | 107 | $ | — | $ | — | $ | 92 | $ | — | $ | 199 | ||||||||||||
Accounts receivable, net | 239 | 4 | — | 631 | — | 874 | ||||||||||||||||||
Inventories: | — | |||||||||||||||||||||||
Finished and in-process goods | 183 | — | — | 235 | — | 418 | ||||||||||||||||||
Raw materials and supplies | 71 | — | — | 114 | — | 185 | ||||||||||||||||||
Other current assets | 39 | — | — | 39 | — | 78 | ||||||||||||||||||
Total current assets | 639 | 4 | — | 1,111 | — | 1,754 | ||||||||||||||||||
Other assets | ||||||||||||||||||||||||
Investment in subsidiaries | 861 | — | 23 | — | (884 | ) | — | |||||||||||||||||
Other assets, net | 156 | 14 | — | 53 | — | 223 | ||||||||||||||||||
| 1,017 | 14 | 23 | 53 | (884 | ) | 223 | ||||||||||||||||||
Property and equipment, net | 641 | — | — | 974 | — | 1,615 | ||||||||||||||||||
Goodwill | 101 | — | — | 105 | — | 206 | ||||||||||||||||||
Other intangible assets, net | 82 | — | — | 126 | — | 208 | ||||||||||||||||||
Total assets | $ | 2,480 | $ | 18 | $ | 23 | $ | 2,369 | $ | (884 | ) | $ | 4,006 | |||||||||||
Liabilities and Shareholder’s (Deficit) Equity | ||||||||||||||||||||||||
Current liabilities | ||||||||||||||||||||||||
Accounts and drafts payable | $ | 279 | $ | — | $ | — | $ | 439 | $ | — | $ | 718 | ||||||||||||
Accounts payable to (receivable from) affiliates | 20 | (5 | ) | (8 | ) | (7 | ) | — | — | |||||||||||||||
Debt payable within one year | 29 | — | — | 56 | — | 85 | ||||||||||||||||||
Loans payable to (receivable from) affiliates | 413 | — | — | (413 | ) | — | — | |||||||||||||||||
Interest payable (receivable) | 43 | 10 | — | 1 | — | 54 | ||||||||||||||||||
Income taxes payable | 13 | — | — | 34 | — | 47 | ||||||||||||||||||
Other current liabilities | 144 | — | — | 198 | — | 342 | ||||||||||||||||||
Total current liabilities | 941 | 5 | (8 | ) | 308 | — | 1,246 | |||||||||||||||||
Long-term liabilities | ||||||||||||||||||||||||
Long-term debt | 2,153 | 825 | — | 657 | — | 3,635 | ||||||||||||||||||
Intercompany loans payable (receivable) | 529 | (901 | ) | (13 | ) | 385 | — | — | ||||||||||||||||
Long-term pension and post employment benefit obligations | 80 | — | — | 140 | — | 220 | ||||||||||||||||||
Deferred income taxes | 39 | — | — | 102 | — | 141 | ||||||||||||||||||
Other long-term liabilities | 116 | — | — | 22 | — | 138 | ||||||||||||||||||
Total liabilities | 3,858 | (71 | ) | (21 | ) | 1,614 | — | 5,380 | ||||||||||||||||
Minority interest in consolidated subsidiaries | 8 | — | — | 4 | — | 12 | ||||||||||||||||||
Shareholder’s (deficit) equity | (1,386 | ) | 89 | 44 | 751 | (884 | ) | (1,386 | ) | |||||||||||||||
Total liabilities and shareholder’s (deficit) equity | $ | 2,480 | $ | 18 | $ | 23 | $ | 2,369 | $ | (884 | ) | $ | 4,006 | |||||||||||
18
HEXION SPECIALTY CHEMICALS, INC.
THREE MONTHS ENDED MARCH 31, 2008
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)
| Hexion Specialty Chemicals, Inc. | Subsidiary Issuers | Combined Subsidiary Guarantors | Combined Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||
Cash flows (used in) provided by operating activities | $ | (14 | ) | $ | 11 | $ | — | $ | 21 | $ | — | $ | 18 | |||||||||
Cash flows (used in) provided by investing activities | ||||||||||||||||||||||
Capital expenditures | (9 | ) | — | — | (13 | ) | — | (22 | ) | |||||||||||||
Deferred acquisition costs | (1 | ) | — | — | — | — | (1 | ) | ||||||||||||||
Dividend from subsidiary | — | — | — | — | — | — | ||||||||||||||||
Proceeds from the sale of assets | — | — | — | 8 | — | 8 | ||||||||||||||||
| (10 | ) | — | — | (5 | ) | — | (15 | ) | ||||||||||||||
Cash flows (used in) provided by financing activities | ||||||||||||||||||||||
Net short-term debt (repayments) borrowings | (6 | ) | — | — | 4 | — | (2 | ) | ||||||||||||||
Borrowings of long-term debt | 34 | — | — | 145 | — | 179 | ||||||||||||||||
Repayments of long-term debt | (38 | ) | — | — | (152 | ) | — | (190 | ) | |||||||||||||
Affiliated loan borrowings (repayments) | (45 | ) | (11 | ) | — | 56 | — | — | ||||||||||||||
Dividends received (paid) | (1 | ) | — | — | — | — | (1 | ) | ||||||||||||||
| (56 | ) | (11 | ) | — | 53 | — | (14 | ) | ||||||||||||||
Effect of exchange rates on cash and cash equivalents | — | — | — | 3 | — | 3 | ||||||||||||||||
(Decrease) increase in cash and cash equivalents | (80 | ) | — | — | 72 | — | (8 | ) | ||||||||||||||
Cash and cash equivalents at beginning of period | 107 | — | — | 92 | — | 199 | ||||||||||||||||
Cash and cash equivalents at end of period | $ | 27 | $ | — | $ | — | $ | 164 | $ | — | $ | 191 | ||||||||||
19
HEXION SPECIALTY CHEMICALS, INC.
THREE MONTHS ENDED MARCH 31, 2007
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)
| Hexion Specialty Chemicals, Inc. | Subsidiary Issuers | Combined Subsidiary Guarantors | Combined Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||
Cash flows (used in) provided by operating activities | $ | (71 | ) | $ | — | $ | 4 | $ | 45 | $ | — | $ | (22 | ) | ||||||||
Cash flows (used in) provided by investing activities | ||||||||||||||||||||||
Capital expenditures | (13 | ) | — | — | (9 | ) | — | (22 | ) | |||||||||||||
Acquisition of businesses, net of cash acquired | — | — | — | (63 | ) | — | (63 | ) | ||||||||||||||
| (13 | ) | — | — | (72 | ) | — | (85 | ) | ||||||||||||||
Cash flows provided by (used in) financing activities | ||||||||||||||||||||||
Net short-term debt borrowings (repayments) | (7 | ) | — | — | (1 | ) | — | (8 | ) | |||||||||||||
Borrowings of long-term debt | 292 | — | — | 373 | — | 665 | ||||||||||||||||
Repayments of long-term debt | (307 | ) | — | — | (253 | ) | — | (560 | ) | |||||||||||||
Affiliated loan borrowings (repayments) | 100 | — | — | (100 | ) | — | — | |||||||||||||||
Dividends paid | 5 | — | (4 | ) | (1 | ) | — | — | ||||||||||||||
| 83 | — | (4 | ) | 18 | — | 97 | ||||||||||||||||
Effect of exchange rates on cash and cash equivalents | — | — | — | 1 | — | 1 | ||||||||||||||||
Decrease in cash and cash equivalents | (1 | ) | — | — | (8 | ) | — | (9 | ) | |||||||||||||
Cash and cash equivalents at beginning of period | 7 | — | — | 57 | — | 64 | ||||||||||||||||
Cash and cash equivalents at end of period | $ | 6 | $ | — | $ | — | $ | 49 | $ | — | $ | 55 | ||||||||||
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| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollar amounts in millions) |
The following commentary should be read in conjunction with the audited financial statements and the accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report on Form 10-K.
Within the following discussion, unless otherwise stated, “the quarter ended March 31, 2008” and “the first quarter of 2008” refer to the three months ended March 31, 2008, and “the quarter ended March 31, 2007” and “the first quarter of 2007” refer to the three months ended March 31, 2007.
Forward-Looking and Cautionary Statements
Certain statements in this Quarterly Report on Form 10-Q/A including, without limitation, statements made under the caption “Overview and Outlook,” are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, the management of Hexion Specialty Chemicals, Inc. (which may be referred to as “Hexion,” “we,” “us,” “our” or the “Company”) may from time to time make oral forward-looking statements. Forward-looking statements may be identified by the words “believe,” “expect,” “anticipate,” “project,” “plan,” “estimate,” “will,” “intend” or similar expressions. Forward-looking statements contained herein reflect our current views about future events and are based on currently available financial, economic and competitive data and on our current business plans. Actual results could vary materially depending on risks and uncertainties that may affect our operations, markets, services, prices and other factors as discussed in our 2007 Annual Report on Form 10-K. Important factors that could cause actual results to differ materially from those contained in forward-looking statements include, but are not limited to: economic factors such as an interruption in the supply of or increased pricing of raw materials due to natural disasters, competitive factors such as pricing actions by our competitors that could affect our operating margins, and regulatory factors such as changes in governmental regulations involving our products that lead to environmental and legal matters as discussed in our 2007 Annual Report on Form 10-K.
Overview and Outlook
Hexion was formed on May 31, 2005 by combining three Apollo Management, L.P. (“Apollo”) controlled companies: Resolution Performance Products, LLC, Resolution Specialty Materials, Inc., and Borden Chemical, Inc., which included Bakelite Aktiengesellschaft. We refer to this combination as the “Hexion Formation.”
We are one of the world’s largest producers of thermosetting resins, or thermosets. Thermosets are a critical ingredient for virtually all paints, coatings, glues and other adhesives produced for consumer or industrial uses. We provide a broad array of thermosets and associated technologies and have leading market positions in all of the key markets that we serve.
Our products are used in thousands of applications and are sold into diverse markets, such as forest products, architectural and industrial paints, packaging, consumer products and automotive coatings, as well as higher growth markets, such as composites, UV cured coatings and electrical laminates. Major industry sectors that we serve include industrial/marine, construction, consumer/durable goods, automotive, wind energy, aviation, electronics, architectural, civil engineering, repair/remodeling, graphic arts, and oil and gas field support. Key drivers for our business include general economic and industrial conditions, including housing starts, auto build rates and active gas drilling rigs. As is true for many industries, our financial results are impacted by the effect on our customers of economic upturns or downturns, as well as the impact on our own costs to produce, sell and deliver our products. Our customers use most of our products in their production processes. As a result, factors that impact their industries could significantly affect our results.
Through our worldwide network of strategically located production facilities we serve more than 8,900 customers in 110 countries. Our global customers include leading companies in their respective industries, such as 3M, Ashland Chemical, BASF, Bayer, DuPont, GE, Halliburton, Honeywell, Huntsman, Louisiana Pacific, Owens Corning, PPG Industries, Sumitomo, Sun Chemicals, Valspar and Weyerhaeuser.
We believe that the Hexion Formation, as well as the pending merger with Huntsman Corporation (the “Huntsman Merger”), provide us with significant opportunities for growth through global product line management, as well as considerable opportunities to increase our operational efficiencies, reduce fixed costs, optimize manufacturing assets and improve capital spending efficiency. We are focused on increasing our revenues, cash flows and profitability. We believe we can achieve these goals through the following strategies:
| • | Providing our customers with a broad range of resins products on a global basis as one of the world’s largest producers of thermosetting resins. We have the opportunity to become a global, comprehensive solutions provider to our customers rather than simply offering a particular product, selling in a single geography or competing on price. |
| • | Expanding our product offerings through internal innovation, joint research and development initiatives with our customers and research partnership formations. |
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| • | Growing our business in the Asia-Pacific, Eastern Europe and Latin American markets, where the use of our products is increasing while continuing to review opportunities in other global markets. We also expect to accelerate the penetration of our high-end, value-added products into new markets by combining sales and distribution infrastructures. |
| • | Continuing to improve our profitability by realizing cost savings opportunities as a result of the Hexion Formation. |
| • | Leveraging the expanding global footprint that would result from the Huntsman Merger. |
Our business segments are based on the products that we offer and the markets that we serve. At March 31, 2008, we had four reportable segments: Epoxy and Phenolic Resins, Formaldehyde and Forest Products Resins, Coatings and Inks, and Performance Products. The major products of our reportable segments are as follows:
| • | Epoxy and Phenolic Resins: epoxy resins and intermediates, composite resins, molding compounds, versatic acids and derivatives, phenolic specialty resins and epoxy coating resins |
| • | Formaldehyde and Forest Products Resins: forest products resins and formaldehyde applications |
| • | Coatings and Inks: polyester resins, acrylic resins, and ink resins and additives |
| • | Performance Products: phenolic encapsulated substrates for oilfield and foundry applications |
First Quarter 2008 Highlights
| • | Net sales increased 14% compared to the first quarter of 2007. Despite experiencing significant volatility in our raw material costs, we have been able to pass along increased costs in higher selling prices in several of our product lines. |
| • | We are responding to changing market conditions and reducing excess capacity as part of our ongoing synergy and productivity initiatives. During the first quarter of 2008, we announced the closure of four facilities in our Epoxy and Phenolic Resins, Formaldehyde and Forest Products Resins, and Coatings and Inks segments. |
| • | We realized $6 of planned synergies in the first quarter ended March 31, 2008. We have realized $126 of cumulative planned synergies at March 31, 2008. We are progressing as planned towards the achievement of $175 in synergies from the Hexion Formation. |
| • | We are progressing towards the completion of the Huntsman Merger. Huntsman is a global manufacturer of differentiated chemicals, has approximately 13,000 employees and operates from multiple locations worldwide. Huntsman had 2007 revenues of approximately $10,000. |
2008 Outlook
Our business is impacted by general economic and industrial conditions, including housing starts, automotive builds, oil and natural gas drilling activity and general industrial production. Our business has both geographic and end market diversity which reduces the impact of any one of these factors on our overall performance. We anticipate an increase in demand in 2008 in certain of the markets that we serve in both industrialized and developing nations and we expect an upward trend in overall utilization rates for thermosetting resins. Specifically, we expect continued strength in U.S. oil and natural gas drilling activity, which would have a positive impact on volumes in our Performance Products segment. We also expect that worldwide epoxy demand will increase in 2008 due to growth in various epoxy markets. We expect some of these volume increases to be offset by lower volumes in other key markets. We anticipate that continued softness in 2008 in North American automotive build rates will continue to exert downward volume pressure on certain product lines that are included in our Epoxy and Phenolic Resins, Coatings and Inks and Performance Products segments. We also anticipate continued softness in U.S. housing starts in 2008 that will impact our volume, primarily for our forest product resins, which is included in our Formaldehyde and Forest Product Resins segment, and our phenolic specialty resins, epoxy coating, polyester and acrylic resin product lines, which are included in our Epoxy and Phenolic Resins and Coatings and Inks segments. However, we anticipate the growth in certain European, Russian and Latin American markets will help offset a portion of the softness in the North American automotive and housing markets.
We expect that raw material cost volatility will likely continue because of volatile pricing of key feedstocks. To help mitigate raw material volatility, we have purchase and sale contracts with many of our vendors and customers that contain periodic price adjustment mechanisms. Due to differences in the timing of pricing mechanism trigger points between our sales and purchase contracts, there is often a lead-lag impact during which margins are negatively impacted in the short term, when raw material prices increase, and are positively impacted when raw material prices fall. We experienced a negative lead-lag impact on operating income of $2 for the quarter ended March 31, 2008. However, in the first quarter of 2008 we were able to raise prices across several of our product lines to partially recover higher raw material costs, which increased net sales. We will continue to focus on maintaining margins where we have opportunities in certain markets to pass through raw material price increases.
We expect to generate increased free cash flow (which we define as cash flow from operating activities less anticipated capital expenditures) in 2008 from improved sales pricing, realizing planned synergies and continued focus on reducing working capital. However, we expect that higher one-time costs associated with the Huntsman Merger will partially offset increased free cash flow. We will continue to focus on reducing debt and the resulting cash paid for interest in 2008 through increased free cash flow.
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Under the Agreement and Plan of Merger to acquire Huntsman, we are obligated to take any and all action necessary, including but not limited to selling assets or businesses of the Company to obtain the necessary regulatory approvals. Upon completion of the Huntsman Merger, we will become one of the world’s largest specialty chemical producers with global size and scale, leading technology and industry positions, and significant opportunities to create value.
Matters Impacting Comparability of Results
Our unaudited Condensed Consolidated Financial Statements (the “Financial Statements”) include the accounts of the Company and its majority-owned subsidiaries, in which minority shareholders hold no substantive participating rights, after eliminating intercompany accounts and transactions.
Our financial data includes:
| • | The results of operations of the adhesives and resins business of Orica Limited (the “Orica A&R Acquisition”) since the acquisition date of February 1, 2007. |
| • | The results of operations of the German forest products resins and formaldehyde business of Arkema GmbH (the “Arkema Acquisition”) since the acquisition date of November 1, 2007. |
Raw materials comprise approximately 80% of our product cost. The three largest raw materials used in our production processes are phenol, methanol and urea. These materials represent almost half of our total raw material costs. Fluctuations in energy costs, such as volatility in the price of crude oil and related petrochemical products, as well as the cost of natural gas have caused significant volatility in our raw material costs. The average prices of phenol, methanol, and urea increased by approximately 5%, 31% and 20%, respectively, in the first quarter of 2008 compared to the first quarter of 2007. Passing through raw material price changes can result in significant variances in sales comparisons from year to year. We had a favorable impact on sales from passing through raw material price increases to our customers, as allowed by our customer contracts, in the first quarter of 2008 compared to the first quarter of 2007.
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Results of Operations
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
| Three Months ended March 31, | ||||||||
(In millions) | 2008 | 2007 | ||||||
Net sales | $ | 1,636 | $ | 1,438 | ||||
Cost of sales | 1,429 | 1,216 | ||||||
Gross profit | 207 | 222 | ||||||
Gross profit as a percentage of net sales | 13 | % | 15 | % | ||||
Selling, general and administrative expense | 104 | 100 | ||||||
Pending merger costs | 9 | — | ||||||
Integration costs | 7 | 9 | ||||||
Other operating expense, net | 4 | 9 | ||||||
Operating income | 83 | 104 | ||||||
Operating income as a percentage of net sales | 5 | % | 7 | % | ||||
Interest expense, net | 78 | 76 | ||||||
Other non-operating expense, net | 6 | 2 | ||||||
Total non-operating expenses | 84 | 78 | ||||||
Income before income tax, earnings from unconsolidated entities and minority interest | (1 | ) | 26 | |||||
Income tax expense | 11 | 21 | ||||||
(Loss) income before earnings from unconsolidated entities and minority interest | (12 | ) | 5 | |||||
Earnings from unconsolidated entities, net of tax | 1 | 1 | ||||||
Minority interest in net income of consolidated subsidiaries | (1 | ) | (2 | ) | ||||
Net (loss) income | $ | (12 | ) | $ | 4 | |||
Three months ended March 31, 2008 vs. 2007
Sales
In the first quarter of 2008, net sales increased by $198 or 14%, compared with the first quarter of 2007. Net acquisitions added $45 in incremental net sales while pricing and favorable product mix added $104. We passed through raw material price increases to customers in certain of our product lines, including forest products resins and formaldehyde, certain epoxy resins and phenolic specialty resins. Higher prices and favorable product mix in our epoxy business also contributed to higher net sales. Volume declines in several of our product lines, including certain epoxy resins, versatics, North American forest products resins and formaldehyde, coatings, phenolic specialty resins and foundry application businesses negatively impacted sales by $59. These declines were primarily driven by soft North American housing and automotive markets, as well as increased competition and raw material shortages in certain product lines. The volume declines were partially offset by higher volumes in our oilfield products, international forest products resins, and specialty epoxies businesses. In addition, a net favorable currency translation of $108 contributed to the sales increase as a result of the strengthening of the euro, Canadian dollar and Brazilian real against the U.S. dollar.
Gross Profit
In the first quarter of 2008, gross profit declined by $15, or 7%, compared with the first quarter of 2007. As a percentage of sales, gross profit declined 2%. The gross profit decrease was due primarily to the impact of increased raw material and utility costs that we could not pass through to our customers. These decreases were partially offset by the impact of net acquisitions, higher prices in certain of our product lines and synergies and productivity improvements that we realized from the Hexion Formation.
Operating Income
In the first quarter of 2008, operating income declined by $21, or 20%, compared with the first quarter of 2007. As a percentage of sales, operating income declined 2%. The decline in operating income was driven primarily by the decrease in gross profit as discussed above. In addition, Selling, general and administrative expenses increased by $4 primarily as a result of recent acquisitions,
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but declined as a percentage of sales. Pending merger costs of $9 in the first quarter of 2008 are related to the pending Huntsman Merger. Integration costs declined by $2 as we incurred lower costs to implement a single, company-wide, management information and accounting system in the first quarter of 2008. Other operating expense, net decreased $5 primarily due to the gain on the sale of certain assets of a non-core product line.
Non-Operating Expenses
In the first quarter of 2008, total non-operating expenses increased by $6, or 8%, compared with the first quarter of 2007. Other non-operating expense, net, increased primarily due to higher unrealized foreign exchange losses in 2008 as compared to the first quarter of 2007. In addition, net interest expense increased $2 from 2007 as a result of higher average debt levels.
Income Tax Expense
Income tax expense relates primarily to income from foreign operations and increases in the domestic valuation allowance due to continued domestic losses in the U.S. for which no benefit can be recognized.
In the first quarter of 2008, income tax expense decreased by $10 compared with 2007. This is primarily due to lower pre-tax income from operations and the effect of lower tax rates in certain foreign jurisdictions.
Results of Operations by Segment
Following are net sales and Segment EBITDA (earnings before interest, income taxes, depreciation and amortization) by reportable segment. Segment EBITDA is defined as EBITDA adjusted to exclude certain non-cash and certain non-recurring expenses. Segment EBITDA is the primary performance measure used by our senior management, the chief operating decision-maker and the board of directors to evaluate operating results and allocate capital resources among segments. Segment EBITDA is also the profitability measure used to set management and executive incentive compensation goals. Corporate and Other is primarily corporate general and administrative expenses that are not allocated to the segments.
| Three months ended March 31, | ||||||||
| 2008 | 2007 | |||||||
Net Sales to Unaffiliated Customers(1)(2)(3): | ||||||||
Epoxy and Phenolic Resins | $ | 639 | $ | 567 | ||||
Formaldehyde and Forest Product Resins | 554 | 428 | ||||||
Coatings and Inks | 332 | 343 | ||||||
Performance Products | 111 | 100 | ||||||
| $ | 1,636 | $ | 1,438 | |||||
Segment EBITDA(2) (3): | ||||||||
Epoxy and Phenolic Resins | $ | 74 | $ | 95 | ||||
Formaldehyde and Forest Product Resins | 53 | 44 | ||||||
Coatings and Inks | 19 | 25 | ||||||
Performance Products | 21 | 18 | ||||||
Corporate and Other | (13 | ) | (12 | ) | ||||
(1) | Intersegment sales are not significant and, as such, are eliminated within the selling segment. |
(2) | Net sales and Segment EBITDA include the Orica A&R Acquisition and Arkema Acquisition from February 1, 2007 and November 1, 2007, respectively. |
(3) | Certain of the Company’s product lines have been realigned, resulting in reclassifications between segments. Prior period balances have been reclassified to conform to current presentations. |
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Three Months Ended March 31, 2008 vs. Three Months Ended March 31, 2007 Segment Results
Following is an analysis of the percentage change in sales by segment from the three months ended March 31, 2007 to the three months ended March 31, 2008:
| Volume | Price/Mix | Currency Translation | Acquisitions/ Divestitures | Total | |||||||||||
Epoxy and Phenolic Resins | (1 | )% | 5 | % | 9 | % | — | 13 | % | ||||||
Formaldehyde and Forest Products Resins | (7 | )% | 16 | % | 7 | % | 13 | % | 29 | % | |||||
Coatings and Inks | (8 | )% | — | 9 | % | (4 | )% | (3 | )% | ||||||
Performance Products | 6 | % | 2 | % | 3 | % | — | 11 | % |
Epoxy and Phenolic Resins
Net sales in the first quarter of 2008 increased by $72, or 13%, as compared to the first quarter of 2007. Lower volumes in our base epoxies, versatics and phenolic specialty resins businesses negatively impacted sales by $6, primarily due to the decline in the North American automotive and housing markets as well as increased competition in certain international markets due to the impact of the strengthening euro. Our versatics volumes were impacted by a shortage of certain of our raw materials. These volume declines were partially offset by demand in the wind energy end market, which drove increased demand for our specialty epoxies. Favorable product mix resulting from the increased specialty epoxy volumes discussed above, the pass through of higher raw material costs to customers and selected pricing improvement initiatives contributed $30 to sales. Foreign currency translation had a positive impact of $48 as the euro strengthened against the U.S. dollar in 2008.
Segment EBITDA in the first quarter of 2008 declined by $21, to $74, compared to the first quarter of 2007. The decrease is due to the volume declines discussed above and increased manufacturing, raw material and utility costs that we could not fully pass through to our customers. In addition, Segment EBITDA decreased by $6 due to the impact of a shortage of certain raw materials used in production.
Formaldehyde and Forest Products Resins
Net sales in the first quarter of 2008 increased by $126, or 29%, as compared to the first quarter of 2007. The impact of acquisitions added $58 to net sales. Sales increased $71 as commercial contracts allowed the pass-through of higher raw material costs to our customers. Lower volumes negatively impacted sales by $31. The volume decrease primarily occurred in our North American forest products resins business due to the decline in the North American housing construction market. This volume decrease was partially offset by higher volumes in our international forest products resins business due to market growth in Latin America and new product development in Western Europe. Favorable currency translation of $28 also contributed to higher sales as the euro, Canadian dollar and the Brazilian real strengthened against the U.S. dollar in 2008.
Segment EBITDA in the first quarter of 2008 increased by $9, to $53, as compared to the first quarter of 2007. The impact of acquisitions added $9 to Segment EBITDA in 2008. The Segment EBITDA generated by our organic business was flat, as the significantly lower volumes in our North American forest products resins business and the negative lead-lag impact on gross margins were offset by increased Segment EBITDA in our international businesses as a result of price and volume improvements and favorable foreign currency translation.
Coatings and Inks
Net sales in the first quarter of 2008 declined by $11, or 3%, as compared to the first quarter of 2007. Our closure of alkyds facilities in parts of Europe accounted for $13 of the decline in 2008. Volume declines also negatively impacted sales by $28. Coatings volume declines were attributable to the downturn in the North American housing construction market and the slowing housing construction markets in the U.K., Spain and Italy. The decline in inks volumes was due to competitive pressures, primarily in North America, and our exit from certain low margin product lines. These inks volume decreases were partially offset by higher volumes in Europe due to increased market share. Pricing remained consistent with 2007 as it only added $1 to sales. Favorable currency translation added $29 to sales, primarily due to the strengthened euro against the U.S. dollar in 2008.
Segment EBITDA in the first quarter of 2008 declined by $6, to $19, as compared to the first quarter 2007. The decline is primarily the result of the volume declines, as discussed above, and increased raw material costs that we were unable to pass through to our customers.
Performance Products
Net sales in the first quarter of 2008 increased by $11, or 11%, as compared to the first quarter of 2007. Volume increases positively impacted sales by $6, driven primarily by our oilfield technology products. Volume improvement in our oilfield products was a result of increased U.S. natural gas drilling activities. This volume increase was partially offset by declines in foundry volumes resulting from decreased demand in the North American automotive sector. Pricing added $2 to net sales, primarily driven by the pass-through of raw material price increases to foundry customers. Favorable currency translation of $3 also contributed to the increased sales.
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Segment EBITDA in the first quarter of 2008 increased by $3, to $21, as compared to the first quarter of 2007. The increase was primarily driven by the effect of volume increases in our oilfield technology products and our focus on controlling operating costs.
Reconciliation of Segment EBITDA to Net (Loss) Income:
| Three months ended March 31, | ||||||||
| 2008 | 2007 | |||||||
Segment EBITDA: | ||||||||
Epoxy and Phenolic Resins | $ | 74 | $ | 95 | ||||
Formaldehyde and Forest Product Resins | 53 | 44 | ||||||
Coatings and Inks | 19 | 25 | ||||||
Performance Products | 21 | 18 | ||||||
Corporate and Other | (13 | ) | (12 | ) | ||||
Reconciliation: | ||||||||
Items not included in Segment EBITDA | ||||||||
Pending merger costs | (9 | ) | — | |||||
Integration costs | (7 | ) | (9 | ) | ||||
Non-cash items | (6 | ) | (6 | ) | ||||
Unusual items: | ||||||||
Gain on divestiture of assets | 7 | — | ||||||
Business realignments | (3 | ) | (6 | ) | ||||
Other | (7 | ) | (1 | ) | ||||
Total unusual items | (3 | ) | (7 | ) | ||||
Total adjustments | (25 | ) | (22 | ) | ||||
Interest expense, net | (78 | ) | (76 | ) | ||||
Income tax expense | (11 | ) | (21 | ) | ||||
Depreciation and amortization | (52 | ) | (47 | ) | ||||
Net (loss) income | $ | (12 | ) | $ | 4 | |||
Items not included in Segment EBITDA
For the three months ended March 31, 2008, Pending merger costs represent accounting, tax and miscellaneous costs related to the pending Huntsman merger.
For the three months ended March 31, 2008 and 2007, Integration costs represent redundancy and plant rationalization costs, incremental administrative costs for integration programs as a result of the Hexion Formation and recent acquisitions as well as costs to implement a single, company-wide, management information and accounting system and a new consolidations and financial reporting system.
For the three months ended March 31, 2008 and 2007, Non-cash items represent stock-based compensation expense, impairments of property and equipment, and unrealized derivative and foreign exchange gains and losses.
Not included in Segment EBITDA are certain non-cash and certain non-recurring income or expenses that are deemed by management to be unusual in nature. For the three months ended March 31, 2008, these items consisted of a gain on the sale of certain assets of a non-core product line, business realignment costs, income related to the European solvent coating resins business (the “announced Alkyds Divestiture”), realized foreign exchange losses and management fees. For the three months ended March 31, 2007, these items consisted of business realignment costs, income related to the announced Alkyds Divestiture and management fees.
Liquidity and Capital Resources
Sources and Uses of Cash
We are a highly leveraged company. Our liquidity requirements are significant, primarily due to our debt service requirements. At March 31, 2008, we had $3,724 of debt, including $86 of short-term debt and capital lease maturities. In addition, we had $191of cash and cash equivalents.
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Our primary source of liquidity is cash flow generated from operations. We also have availability under our senior secured credit facilities, subject to certain conditions. Our primary liquidity requirements are working capital requirements, debt service, one-time synergy program-related obligations, contractual obligations and capital expenditures. We expect to have adequate liquidity to fund our primary liquidity requirements over the remainder of the term of our credit facilities from cash flows provided by operating activities and amounts available for borrowings under our credit facilities.
At March 31, 2008, we had additional borrowing capacity under our senior secured revolving credit facilities of $213. We have additional credit facilities at certain domestic and international subsidiaries with various expiration dates through 2008. As of March 31, 2008, we had $72 available for borrowing under these facilities.
Following are highlights from our unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31:
| 2008 | 2007 | |||||||
Operating activities | $ | 18 | $ | (22 | ) | |||
Investing activities | (15 | ) | (85 | ) | ||||
Financing activities | (14 | ) | 97 | |||||
Effect of exchange rates on cash flow | 3 | 1 | ||||||
Net change in cash and equivalents | $ | (8 | ) | $ | (9 | ) | ||
Operating Activities
In the first quarter of 2008, operations provided $18. Net loss of $12 included $66 of non-cash items, of which $52 was for depreciation and amortization. Working capital (defined as accounts receivable and inventories less accounts and drafts payable) and changes in other liabilities and income taxes payable used $36 due to the growth of the business, increased raw material costs, and timing of cash collections and expense recognition versus cash payments.
In the first quarter of 2007, operations used $22 of cash. Net income of $4 included $60 of non-cash charges of which $47 was for depreciation and amortization. Working capital used cash of $103 due to the growth of the business, timing of cash collection versus cash payments, and increased inventory levels due to higher raw material costs and planned inventory builds in anticipation of manufacturing turnarounds scheduled for later in the year.
Investing Activities
In the first quarter of 2008, investing activities used $15. We spent $22 for capital expenditures, primarily for plant expansions and improvements. We generated cash of $8, primarily from the divestiture of a non-core product line.
In the first quarter of 2007, investing activities used $85 of cash. We spent $63 for acquisitions and $22 for capital expenditures, primarily for plant expansions and improvements.
Financing Activities
In the first quarter of 2008, financing activities used $14. Net short-term debt repayments were $2 and net long-term debt repayments were $11.
In the first quarter of 2007, financing activities provided $97 of cash. Net short-term debt repayments were $8. Net long-term borrowings were for acquisitions of $63 and working capital needs of $42.
Huntsman Transaction Funding Requirements
In connection with the pending Huntsman Merger, Huntsman terminated an Agreement and Plan of Merger with Basell AF. As a result, Huntsman paid Basell AF a break-up fee in the amount of $200, of which we funded $100 in July 2007. We also have capitalized $28 of additional deferred acquisition costs at March 31, 2008.
The pending Huntsman Merger was initially valued at approximately $10,600, which includes the assumption of debt. Lenders have committed, subject to certain customary conditions, to finance this merger when the transaction closes. Beginning on April 6, 2008, the cash price per share to be paid by the Company increases each day through the consummation of the merger at the equivalent of approximately 8% per annum (less any dividends or distributions declared or made). If the transaction is terminated, in certain circumstances, we will be required to pay Huntsman a termination fee of $325.
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Covenant Compliance
Certain covenants contained in the credit agreement that govern our senior secured credit facilities and/or the indentures that govern our Second-Priority Senior Secured Notes (i) require us to maintain a senior secured debt to Adjusted EBITDA ratio and (ii) restrict our ability to take certain actions such as incurring additional debt or making acquisitions if we are unable to meet this ratio and a defined Adjusted EBITDA to Fixed Charges ratio. The covenant to incur additional indebtedness and our ability to make future acquisitions requires us to have an Adjusted EBITDA to Fixed Charges ratio (measured on a last twelve months, or LTM, basis) of at least 2.0:1. Failure to comply with these covenants could limit our long-term growth prospects by hindering our ability to obtain future debt or make acquisitions.
Fixed charges are defined as net interest expense excluding the amortization or write-off of deferred financing costs. Adjusted EBITDA is defined as EBITDA adjusted to exclude certain non-cash and certain non-recurring items. Adjusted EBITDA also includes expected future cost savings directly related to acquisitions, including the Hexion Formation, and the incremental EBITDA impact of acquisitions as if they had taken place at the beginning of the year. As we are highly leveraged, we believe that including the supplemental adjustments that are made to calculate Adjusted EBITDA provides additional information to investors about our ability to comply with our financial covenants and our ability to obtain additional debt in the future. Adjusted EBITDA and Fixed Charges are not defined terms under accounting principles generally accepted in the United States of America. Adjusted EBITDA should not be considered an alternative to operating income or net income as a measure of operating results or an alternative to cash provided by operations as a measure of liquidity. Fixed Charges should not be considered an alternative to interest expense. At March 31, 2008, we were in compliance with all of the financial covenants and restrictions that are contained in the indentures that govern our notes and all of our credit facilities.
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| March 31, 2008 LTM Period | ||||
Reconciliation of Net Loss to Adjusted EBITDA | ||||
Net loss | $ | (81 | ) | |
Income taxes | 34 | |||
Interest expense, net | 312 | |||
Depreciation and amortization expense | 203 | |||
EBITDA | 468 | |||
Adjustments to EBITDA: | ||||
Acquisitions EBITDA(1) | 31 | |||
Pending merger and transaction costs(2) | 10 | |||
Integration costs(3) | 36 | |||
Non-cash items(4) | 54 | |||
Unusual items: | ||||
Gain on sale of assets | (15 | ) | ||
Purchase accounting effects/inventory step up | 1 | |||
Business realignments(5) | 18 | |||
Other(6) | 26 | |||
Total unusual items | 30 | |||
In process Synergies(7) | 49 | |||
Adjusted EBITDA | $ | 678 | ||
Fixed charges(8) | $ | 270 | ||
Ratio of Adjusted EBITDA to Fixed Charges(9) | 2.51 | |||
(1) | Represents the incremental EBITDA impact of the Arkema Acquisition as if it had taken place at the beginning of the period. Also includes the impacts of in process synergies related to our 2007 and 2006 acquisitions. |
(2) | Primarily represents accounting, tax and miscellaneous costs related to the pending Huntsman Merger. |
(3) | Represents redundancy and plant rationalization costs and incremental administrative costs associated with integration programs. Also includes costs to implement a single, company-wide management information and accounting system and a new consolidations and financial reporting system. |
(4) | Includes non-cash charges for impairments of property and equipment, stock-based compensation and unrealized foreign exchange and derivative activity. |
(5) | Represents plant rationalization, headcount reduction and other costs associated with business realignments. |
(6) | Includes the impact of the announced Alkyds Divestiture, management fees, costs to settle a lawsuit, realized foreign currency activity and costs for unplanned plant outages. |
(7) | Represents estimated net unrealized synergy savings resulting from the Hexion Formation. |
(8) | The charges reflect pro forma interest expense based on interest rates at May 6, 2008 as if the Arkema Acquisition and the amendment of our senior secured credit facilities had taken place at the beginning of the period. |
(9) | We are required to maintain an Adjusted EBITDA to Fixed Charges ratio of greater than 2.0 to 1.0 to be able to incur additional indebtedness under our indenture for the Second Priority Senior Secured Notes. As of March 31, 2008, the Company was able to satisfy this covenant and incur additional indebtedness under this indenture. |
Contractual Obligations
There have been no material changes during the first three months of 2008 in the contractual obligations previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.
Off Balance Sheet Arrangements
We had no off-balance sheet arrangements as of March 31, 2008.
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Recently Issued Accounting Standard
In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 requires enhanced disclosures about derivative instruments and hedging activities to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 will be effective for the Company on January 1, 2009.
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
There have been no material developments during the first three months of 2008 on the matters we have previously disclosed about quantitative and qualitative market risk in our Annual Report on Form 10-K for the year ended December 31, 2007.
| Item 4T. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
On November 10, 2008, we discovered errors in non-cash unrealized foreign exchange gains and losses on intercompany balances recorded in our results of operations for the three months ended March 31, 2008. The errors related to the misapplication of procedures for a newly-implemented system enhancement to record foreign exchange gains and losses on intercompany balances. Following analysis of both quantitative and qualitative risk factors, we concluded that the control deficiency that resulted in the restatement does not constitute a material weakness over internal control over financial reporting at March 31, 2008.
In response, we have provided additional training for the impacted Finance personnel regarding foreign exchange translations and system functionality, reissued foreign exchange written instructions, and are enhancing monitoring controls at the regional shared service centers to review foreign exchange gains and losses.
As of the end of the period covered by this Amended Quarterly Report on Form 10-Q/A, we, under the supervision and with the participation of our Disclosure Committee and our management, including our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e). Based on that evaluation, our President and Chief Executive Officer and Executive Vice President and Chief Financial Officer concluded that as of March 31, 2008, our disclosure controls and procedures were effective.
Changes in Internal Controls
Management continues to evaluate resources, change and expand roles and responsibilities of key personnel, and make changes to certain processes related to financial close, shared services and financial reporting. In connection with these activities, we migrated to a new consolidations and financial reporting system. This change is intended to further enhance our internal control over financial reporting and our reporting capabilities. No other changes occurred in the Company’s internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Part II
| Item 1. | Legal Proceedings |
There have been no material developments during the first quarter 2008 in the ongoing legal proceedings that are included in our Annual Report on the Form 10-K for the year ended December 31, 2007.
| Item 1A. | Risk Factors |
There have been no material changes during the first quarter 2008 in the risk factors that are included in our Annual Report on Form 10-K for the year ended December 31, 2007.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
| Item 3. | Defaults upon Senior Securities |
There were no defaults upon senior securities during the first three months of 2008.
| Item 4. | Submission of Matters to a Vote of Security Holders |
None.
| Item 5. | Other Information |
None.
| Item 6. | Exhibits |
| 31.1 | Rule 13a-14 Certifications |
(a) Certificate of the Chief Executive Officer
(b) Certificate of the Chief Financial Officer
| 32.1 | Section 1350 Certifications |
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SIGNATURE
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 the undersigned thereunto duly authorized.
| HEXION SPECIALTY CHEMICALS, INC. | ||||
| Date: November 21, 2008 | /s/ William H. Carter | |||
| William H. Carter | ||||
| Executive Vice President and Chief Financial Officer | ||||
| (Principal Financial Officer) | ||||
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