Amendment No. 1 to Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on May 2, 2005

Registration No. 333-124287


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Amendment No. 1

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 


 

BORDEN CHEMICAL, INC.

(Exact name of registrant as specified in charter)

 


 

New Jersey   2821   13-0511250

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 


 

180 East Broad Street

Columbus, Ohio 43215

(614) 225-4000

(Address, including zip code, and telephone number, including area code, of registrants’ principal executive offices)

 


 

Ellen German Berndt, Esq.

180 East Broad Street

Columbus, Ohio 43215

(614) 225-4000

(Name, address, including zip code, and telephone number, including area code, of agent for service of process)

 


 

With a copy to:

 

Rosa A. Testani, Esq.

William B. Kuesel, Esq.

O’Melveny & Myers LLP

7 Times Square

New York, New York 10036

(212) 326-2000

  

Kris F. Heinzelman, Esq.

LizabethAnn R. Eisen, Esq.

Cravath, Swaine & Moore LLP

825 Eighth Avenue

New York, New York 10019

(212) 474-1000

 


 

Approximate date of commencement of proposed sale to the public:    As soon as practicable after this Registration Statement becomes effective.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and the list Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   ¨

 

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

 

CALCULATION OF REGISTRATION FEE


Title of each Class of

Securities to be Registered

  

Proposed Maximum

Aggregate

Offering Price(1)

 

Amount of

Registration Fee(3)

Common Stock, par value $0.01 per share (2)

   $800,000,000   $94,160

(1) Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(o) under the Securities Act.
(2) Includes shares of common stock that the underwriters have the option to purchase to cover over-allotments, if any.
(3) Previously paid by wire transfer on April 22, 2005.

 


 

The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 



Table of Contents

The information in this prospectus is not complete and may be changed. We and the selling shareholder may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED MAY 2, 2005

 

             Shares

 

LOGO

 

HEXION SPECIALTY CHEMICALS, INC.

 

Common Stock

 


 

Prior to this offering, there has been no public market for our common stock. The initial public offering price of our common stock is expected to be between $             and $            . We intend to list our common stock on the New York Stock Exchange under the symbol “HXN.”

 

We are selling              shares of common stock and the selling shareholder is selling              shares. We will not receive any of the proceeds from the sale of the shares being sold by the selling shareholder. We intend to use approximately $             million of our net proceeds from the sale of the shares being sold by us to redeem our outstanding Series A Preferred Stock.

 

The underwriters have an option to purchase a maximum of              additional shares from the selling shareholder to cover over-allotments of shares.

 

Investing in our common stock involves risks. See “ Risk Factors” beginning on page 20.

 

       Price to
Public


     Underwriting
Discounts and
Commissions


    

Proceeds to

Hexion Specialty
Chemicals, Inc.


     Proceeds to
Selling
Shareholder


Per Share

     $      $      $      $

Total

     $              $              $              $        

 

Delivery of the shares of common stock will be made on or about                     , 2005.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

Credit Suisse First Boston           Goldman, Sachs & Co.
JPMorgan           Lehman Brothers

 

 

The date of this prospectus is                     , 2005.


Table of Contents

TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

   1

RISK FACTORS

   20

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

   38

USE OF PROCEEDS

   40

DIVIDEND POLICY

   41

CAPITALIZATION

   42

DILUTION

   43

UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION

   44

SELECTED HISTORICAL FINANCIAL AND OTHER INFORMATION

   54

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   56

BUSINESS

   83

MANAGEMENT

   104

PRINCIPAL AND SELLING SHAREHOLDERS

   117

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

   119

DESCRIPTION OF CERTAIN INDEBTEDNESS

   127

DESCRIPTION OF CAPITAL STOCK

   141

SHARES ELIGIBLE FOR FUTURE SALE

   145

MATERIAL U.S. FEDERAL TAX CONSEQUENCES

   147

UNDERWRITING

   150

LEGAL MATTERS

   155

EXPERTS

   155

WHERE YOU CAN FIND MORE INFORMATION

   156

INDEX TO FINANCIAL STATEMENTS

   F-1

 


 

You should rely only on the information contained in this document or to which we have referred you. We have not authorized anyone to provide you with information that is different. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document.

 


 

Market and Industry Data

 

This prospectus includes industry data that we obtained from periodic industry publications and internal company surveys. This prospectus includes market share and industry data that we prepared primarily based on management’s knowledge of the industry and industry data. Industry publications and surveys generally state that the information contained therein has been obtained from sources believed to be reliable. We and the underwriters have not independently verified any of the data from third-party sources nor have we or the underwriters ascertained the underlying economic assumptions relied upon therein. Statements as to our market position relative to our competitors are approximated and based on the above-mentioned third-party data and internal analysis and estimates and have not been verified by independent sources. Unless otherwise noted, all information regarding our market share is based on the latest available data, which in some cases may be several years old.

 

Dealer Prospectus Delivery Obligation

 

Until                     , 2005 (25 days after commencement of the offering), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligations to deliver a prospectus when acting as underwriters and with respect to unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

 

This summary highlights information about Hexion Specialty Chemicals, Inc. and the offering contained elsewhere in this prospectus. It is not complete and may not contain all the information that may be important to you. You should carefully read the entire prospectus before making an investment decision, especially the information presented under the heading “Risk Factors.” Borden Chemical will change its name to Hexion Specialty Chemicals, Inc. upon the final closing of the Combinations (as defined in “—Hexion Specialty Chemicals, Inc.—Overview”). In this prospectus, except as otherwise indicated herein, or as the context may otherwise require (i) all references to “Hexion,” “the Company,” “we,” “us” and “our” refer to Hexion Specialty Chemicals, Inc. and its subsidiaries, (ii) all references to “Borden Chemical” refer to Borden Chemical, Inc. and its subsidiaries prior to the Current Transactions (as defined in “—Hexion Specialty Chemicals, Inc.—The Prior and Current Transactions”), (iii) all references to “RPP” refer to Resolution Performance Products Inc. and its subsidiaries prior to the Current Transactions, (iv) all references to “RSM” refer to Resolution Specialty Materials Inc. and its subsidiaries prior to the Current Transactions, (v) all references to “Bakelite” refer to Bakelite Aktiengesellschaft and its subsidiaries prior to the Bakelite Transaction and (vi) all financial and other data for the year ended December 31, 2004 gives pro forma effect to this offering, including the application of the net proceeds to the Company therefrom and the other Transactions as if they each had occurred on January 1, 2004, and all financial and other data as of December 31, 2004 gives pro forma effect to this offering, including the application of the net proceeds to the Company therefrom and the Current Transactions as if they each had occurred on such date (with the financial statements and other data as of December 31, 2004 already giving effect to the combination of Borden Chemical (including Bakelite), RPP and RSM).

 

Hexion Specialty Chemicals, Inc.

 

Overview

 

We are the world’s largest producer of thermosetting resins (i.e., “thermosets”). Thermosets are a critical ingredient for virtually all paints, coatings, glues and other adhesives produced for consumer or industrial uses. We are focused on providing a broad array of thermosets and associated technologies, with leading market positions in all key markets served. Our breadth of related products provides us with significant advantages across our operations, technology and commercial organizations, while our scale provides us with significant efficiencies in our fixed and variable cost structure, allowing us to compete effectively throughout the value chain. Our value-added, technical service-oriented business model enables us to effectively participate in high-end specialty markets, while our scale enables us to extract value from higher volume applications.

 

Thermosets are developed to meet the performance characteristics required for each specific end use product. The type of thermoset used and how it is formulated, applied and cured determines the key attributes, such as durability, gloss, heat resistance, adhesion or strength of the final product. Hexion has the broadest range of thermoset resin technologies, with world class research, applications development and technical service capabilities. The global thermoset resins market is approximately $34 billion in annual sales, of which our primary markets represent approximately $19 billion in annual sales.

 

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. We have a history of product innovation and success in introducing new products to new markets. Our thermosets are sold under a variety of well-recognized brand names including Borden® (phenolic and amino resins), Epikote® (epoxy resins), Epikure® (epoxy curatives), Bakelite (phenolic and epoxy resins), Lawter (inks) and Cardura® (high-end automotive coatings).

 

As of December 31, 2004, we have 86 production and distribution sites globally, and produce many of our key products locally in North America, Latin America, Europe and Asia. Through our worldwide network of

 

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strategically located production facilities, we serve more than 5,000 customers in 96 countries. We believe our global scale provides us with significant advantages over many of our competitors. In areas where it is advantageous, we are vertically integrated backward into strategic raw materials, providing us a low-cost operating structure and security of supply. In other areas, where we can leverage our technical know-how and market presence to capture additional value, we are integrated downstream into product formulations. Our position in certain additives, complementary materials and services further enables us to leverage our core thermoset technologies and provide customers a full suite of product solutions. As a result of our focus on innovation and the high level of technical service that results from our “Total Systems Approach,” we have cultivated long-standing customer relationships. Our global customers include leading companies in their respective industries, such as 3M, BASF, Bayer, DuPont, GE, Halliburton, Honeywell, Owens Corning, PPG Industries, Sumitomo, Sun Chemicals, Valspar and Weyerhaeuser.

 

As of April 22, 2005, Borden Chemical entered into a transaction agreement with affiliates of RPP and RSM pursuant to which Borden Chemical agreed to combine with RPP and RSM (the “Combinations”). In addition, Borden Chemical acquired Bakelite (the “Bakelite Acquisition”) on April 29, 2005. Borden Chemical, RPP and RSM are each controlled by Apollo Management L.P. and its affiliates (“Apollo”). The Combinations are expected to be consummated during the second quarter of 2005. Upon the consummation of the Combinations, Borden Chemical will change its name to Hexion Specialty Chemicals, Inc. and BHI Acquisition LLC, Borden Chemical’s parent, will change its name to Hexion LLC. In 2004, on a pro forma combined basis, we generated pro forma net sales of $4.1 billion, Adjusted EBITDA (as defined) of $446 million, operating income of $26 million and a net loss of $369 million. In 2004, 51% of our net sales were derived from sales to North America, 32% to Western Europe and 17% to Asia-Pacific, Latin America, Eastern Europe and other emerging markets. We believe the consolidation of these entities will provide us with significant opportunities for growth through global product line management, in addition to opportunities for increasing operational efficiencies, reducing fixed costs, optimizing manufacturing assets and improving the efficiency of capital spending.

 

Our Business

 

Upon consummation of the Current Transactions, we will operate in two primary segments: Adhesive & Structural and Coating. The table below illustrates each segment’s net sales to external customers for the year ended December 31, 2004, as well as each segment’s major product lines, major industry sectors served, major end-use markets and key differentiating characteristics.

 

   

Adhesive & Structural


 

Coating


2004 Pro Forma Net Sales

  $2.9 billion   $1.2 billion

Major Products

 

•   Formaldehyde based resins and intermediates

•   Epoxy resins and intermediates

•   Composite resins

•   Phenolic encapsulated substrates

•   Molding compounds

 

•   Epoxy resins

•   Polyester resins

•   Alkyd resins

•   Acrylic resins

•   Ink resins and additives

•   Versatic acids and derivatives

Major Industry Sectors Served

 

•   Wood products and furniture

•   Transportation and industrial

•   Electrical equipment and appliances

•   Electronic products

•   Oil and gas field support

•   Marine and recreational (boats, RVs)

•   Chemical manufacturing

 

•   Home building and maintenance

•   Transportation and industrial

•   Electrical equipment and appliances

•   Furniture

•   Printing

•   Chemical manufacturing

 

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Adhesive & Structural


 

Coating


Major End-Use Markets

 

•   Plywood, particleboard, OSB, MDF

•   Carbon and glass fiber composites

•   Automotive friction materials

•   Furniture

•   Construction

•   Electrical laminates

•   Foundry

•   Oil and gas field proppants

 

•   Decorative paints

•   Auto coatings

•   Marine and industrial coatings

•   Construction and maintenance coatings

•   Printing inks

•   Specialty coatings

Key Characteristics of Resins

 

•   Strength

•   Adhesion

•   Resistance (heat, water, electricity)

 

•   Durability

•   Gloss and color retention

•   Resistance (water, UV, corrosion, temperature)

•   Strength

 

Adhesive & Structural Segment

 

Our Adhesive & Structural segment is a leading global supplier of thermosets used in adhesive and structural applications. These products are used in a variety of end-markets including residential, commercial and industrial construction and repair/remodeling, furniture manufacture, automotive, oil and gas, chemicals and electronics. In 2004, Adhesive & Structural contributed approximately $2.9 billion to our net sales. Our key products in the Adhesive & Structural segment include:

 

Formaldehyde Based Resins and Intermediates. We are the leading producer of formaldehyde based resins for the forest products industry in North America with a 44% market share by volume and also hold significant positions in Europe, Latin America and Australia. Our products are used in a wide range of applications in the construction, automotive, electronics and steel industries. We are also the world’s largest producer of specialty phenolic resins, which are used in applications that require extreme heat resistance and strength, such as automotive brake pads, foundry materials and oil field applications. In addition, we are the world’s largest producer of formaldehyde, a key building block chemical used in the manufacture of thousands of products. We internally consume approximately half of our formaldehyde production, giving us a significant competitive advantage versus our non-integrated competitors.

 

Epoxy Resins and Intermediates. We are the world’s largest supplier of epoxy resins. Epoxy resins comprise the fundamental building blocks of many types of materials, such as formulated composite resins and structural adhesives. Epoxy resins are often used in the auto, aerospace and electronics industries due to their unparalleled strength and durability. We also provide the industry with a variety of complementary products such as epoxy modifiers, curing agents, reactive diluents and specialty liquids. We are also a major producer of bisphenol-A (BPA) and epichlorohydrin (ECH), key precursors in the manufacture of epoxy resins. We internally consume the majority of our BPA and virtually all of our ECH, giving us a significant competitive advantage versus our non-integrated competitors.

 

Composite Resins. We are a leading producer of resins used in composites. Composites are a fast growing class of materials which are used in a wide variety of applications ranging from airframes to golf clubs. We supply epoxy resins to fabricators in the aerospace, sporting goods and pipe markets with a 44% market share in each of the United States and Europe. We leverage our leadership position in epoxy resins, along with our technology and service expertise, to selectively forward integrate into custom formulations for specialty

 

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composites, such as turbine blades used in the wind energy market. In addition to epoxy, we manufacture resins from unsaturated polyester (UPR), which are generally combined with fiberglass to produce cost-effective finished structural parts for applications ranging from boat hulls to recreational vehicles to bathroom fixtures.

 

Phenolic Encapsulated Substrates. We are a leading producer of phenolic encapsulated sand and ceramic substrates used in oil field services and foundry applications. Our highly specialized compounds are designed to perform under the extreme conditions, such as intense heat, high-stress and corrosive environments, that characterize the oil and gas drilling and foundry industries. In the oil field services industry we have a 45% global market share in resin encapsulated proppants, which are used to enhance oil and gas recovery rates and extend well life. We are also the leading producer by volume of foundry resins in North America with a 44% market share. Our foundry resin systems are used by major automotive and industrial companies for precision casting of engine blocks, transmissions, brake and drive train components. In addition to encapsulated substrates, our foundry resins business provides phenolic resin systems and ancillary products used to produce finished metal castings.

 

Molding Compounds. We are the leading producer of molding compounds in Europe, with an estimated market share of 69%. We formulate and produce a wide range of phenolic, polyester and epoxy compounds used to manufacture components requiring heat stability, electrical insulation, fire resistance and durability. Applications range from automotive underhood components to appliance knobs and cookware handles.

 

Coating Segment

 

We are a leading supplier of resins used in surface coating applications. Our coating products are used by customers in a variety of end-markets including architectural coatings, civil engineering, electronics, automotive and a wide variety of applications in the industrial and consumer markets. In 2004, Coating contributed approximately $1.2 billion to our net sales. Our key products in the Coating segment include:

 

Epoxy Resins. In addition to the adhesive uses mentioned previously, epoxy resins are used for a variety of high-end coating applications which require the superior strength and durability of epoxy. Examples include protective coating for industrial flooring, pipe, marine and construction applications, powder coatings and automotive coatings. Where advantageous, we leverage our position to supply custom resins for specialty coatings formulators.

 

Polyester Resins. We are a leading supplier of polyester coatings resins in North America with a market share of 10% and are also a major producer in Europe with a powder coatings market share of 10%. We provide custom polyester resins, both liquid and powder, to customers for use in industrial coatings requiring specific properties such as gloss and color retention, resistance to corrosion and flexibility. Polyester coatings are typically used in transportation, automotive, machinery, appliances and metal office furniture. Our polyester resins business shares an integrated production platform with our alkyd business, which allows for flexible sourcing, plant balancing and economies of scale.

 

Alkyd Resins. We share the leading position in alkyd resins in North America with a market share of 31% and are a major producer in Europe, specifically in Scandinavia and Italy. We provide alkyd resins to customers for use in the manufacture of professional grade paints and coatings. Alkyd resins are formulated and engineered according to customer specifications and can be modified with other raw materials to improve performance. Applications include industrial coatings (e.g., protective coatings used on machinery, metal coil, equipment, tools and furniture), special purpose coatings (e.g., highway-striping paints, automotive refinish coatings and industrial maintenance coatings) and decorative paints (e.g., house paint and deck stains). Our alkyd resins business shares an integrated production platform with our polyester business, which allows for flexible sourcing, plant balancing and economies of scale.

 

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Acrylic Resins. We are a supplier of acrylic resins (solvent and water-based) in North America and Europe. Acrylic resins are used for interior trim paints and exterior applications where weathering protection, color and gloss retention are critical. In addition, we produce a wide range of specialty acrylic resins for marine and maintenance paints and automotive topcoats. We are also a low cost producer of acrylic monomer, the key raw material for our acrylic resins. This backward integration gives us a competitive cost advantage relative to our competitors and ensures adequacy of supply.

 

Ink Resins and Additives. We are the world’s largest producer of ink resins and associated products with a market share of 15%. Ink resins are used to apply ink to a variety of different substrates including paper, cardboard, metal foil and plastic. We provide resins, liquid components and additives, sold primarily under the globally recognized LawterTM brand name to customers formulating inks for a variety of substrates and printing processes. Our products offer such performance enhancements as durability, printability, substrate application, drying speed and security. Typical end use applications include brochures, newspapers, magazines, food packages, beverage cans, food containers and flexible packaging. We are also a provider of formulated UV-cure coatings and inks. Our proprietary technology has enabled us to gain a leading position in the global fiber optic market.

 

Versatic Acids and Derivatives. We are the world’s largest producer of versatic acids and derivatives, with a market share of 74%. Versatic acids and derivatives are specialty monomers which provide significant performance advantages to finished coatings, including superior adhesion, flexibility, ease of application and other high performance characteristics. The products include basic versatic acids and derivatives sold under the Versatic, VeoVa® and Cardura® names. Applications for versatic acids include decorative, automotive and protective coatings as well as other uses, such as pharmaceuticals and personal care products. We manufacture versatic acids and derivatives using our integrated manufacturing sites and our internally produced ECH.

 

Industry

 

The thermoset resins industry is an approximately $34 billion market in annual sales, according to independent consultants. Thermoset resins include materials such as phenolic resins, epoxy resins, polyester resins, acrylic resins, alkyd resins and urethane resins. Thermoset resins are used for a wide variety of applications due to their superior adhesion and bonding properties, as well as their heat resistance, protective and aesthetic characteristics, compared to other materials. The key markets upon which we focus and in which we have leading market positions are estimated at $19 billion in annual sales. The thermoset resin market has grown at an estimated annual rate of over 4% by volume during the past five years. Certain segments of the thermoset resin industry, including composites and UV resins, are expected to grow at substantially faster rates.

 

Thermosets are sold into the global coatings, composites and adhesives markets, which have combined annual sales of over $100 billion. Thermoset resins are generally considered specialty chemical products because they are principally sold on the basis of performance, technical support, product innovation and customer service. The principal factors contributing to success in the specialty chemicals market are (i) consistent delivery of high-quality products, (ii) favorable process economics, (iii) the ability to provide value to customers through both product attributes and strong technical service and (iv) a presence in large and growing markets.

 

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Competitive Strengths

 

We are one of the leading specialty chemical companies in the world based on the following competitive strengths:

 

World’s Largest Thermoset Resins Producer. We are the world’s largest producer of thermoset resins with leading positions across various end-markets and geographies. Our global scale and breadth of product line provide us with significant advantages over many of our competitors. The following table illustrates our market position by volume in our key product areas, which collectively represent more than 75% of our 2004 net sales:

 

Key Product


  

Market Position


Forest Product Resins

   #1 Globally

Formaldehyde

   #1 Globally

Phenolic Resins

   #1 Globally

Epoxy Resins

   #1 Globally

Foundry Resins

   #1 in North America

Oil field Resins

   #2 Globally

Composite Resins (epoxy-based)

   #1 in Europe, #2 in North America

Molding Compounds

   #1 in Europe

Ink Resins

   #1 Globally

Alkyd Resins

   Co-leader in North America

Versatic Acids and Derivatives

   #1 Globally

 

Unique Selling Proposition. The majority of our customers require solutions that are tailored to their individual production needs and require a high degree of technical service and customized product formulations. Our diverse thermoset product offering allows us to leverage related technologies across geographies, customers and end-markets in order to provide a full suite of product solutions. As a result of our focus on developing innovative products with a high level of technical service and our “Total Systems Approach,” whereby we sell multiple components of a coating or adhesive resin system, we have cultivated stable, longstanding customer relationships. Our top ten customers have been using our products and services for an average of 21 years.

 

Global Infrastructure. We develop, manufacture and sell our products around the world. We believe our global scope and our selective backward integration give us an advantage compared with many of our smaller competitors. We believe that we are well positioned in higher growth regions and will continue to grow internationally by expanding our product sales to our multi-national customers and by entering new markets. We also have opportunities to increase sales of products by introducing them to new geographies; for example, we plan to introduce several resin products developed for the European market to our customer base in North America. We have a significant presence in the two fastest growing regions in the coating and adhesives industries, with 16 plants currently operating in Asia-Pacific and Latin America.

 

Low Cost Position. We support our leading global market presence with our strategically located, low cost manufacturing presence. Our low cost position is the result of our 86 production and distribution sites located throughout the world and our selectively integrated supply position in critical intermediate materials. We consume large amounts of our internally produced formaldehyde, BPA and ECH, and our polyester and alkyd businesses share an integrated production platform with each other. This backward integration provides us a significant cost advantage over our competitors, allowing us to eliminate certain finishing steps, reduce logistical costs, ensure reliable long-term supply of critical raw materials and improve our production scheduling and capacity utilization rates. Furthermore, our large market position and scale in each of our key product markets provides us with significant purchasing and manufacturing efficiencies. We are North America’s lowest cost producer of formaldehyde and formaldehyde-based resins. In addition, we operate two of the three largest epoxy resins manufacturing facilities in the world, including the world’s only continuous-flow manufacturing process facility.

 

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Well Positioned in Diverse End-Markets and Higher Growth Sectors. We have a diversified revenue and customer base in a variety of end-markets and geographies. Our products are used in a broad range of applications and are sold into stable markets such as those for forest products, architectural coatings, industrial coatings and automotive coatings, as well as higher growth markets such as composites, UV resins and electrical laminates. We have a strong position in products such as composites, which benefit from favorable product substitution demand as they replace traditional materials (i.e., wood and metal) in aerospace, automotive, recreational and sporting goods applications. In addition, no single customer accounted for more than 3% of our total annual sales in 2004. Our pro forma net sales by end-market for 2004 are illustrated below:

 

Hexion Pro Forma Net Sales By End-Market

 

LOGO

 

Strong Free Cash Flow. We expect to generate strong free cash flow (cash flow from operating activities less anticipated capital expenditures) due to our favorable operating characteristics and the nature of the industry in which we operate. This strength is due in large part to our size and position within the thermoset resins industry, and the industry leading cost structure we have in place. Our products are generally less capital intensive to manufacture than many other products in the chemical industry, and as a result, we have low maintenance capital and working capital requirements. Furthermore, due to our tax assets and other structuring considerations, we expect to have very low cash tax requirements for the foreseeable future. Additionally, we expect to realize in excess of $82 million in annual net cost synergies from the Current Transactions which should further improve free cash flow. We expect that these synergies will be implemented within 18 months of the consummation of the Current Transactions. We expect to incur a one-time cost of $50 million during the next two years in connection with implementing these synergies. We expect that all of these factors will enable us to generate strong free cash flow, which we anticipate will be available to reduce indebtedness or for other strategic purposes.

 

Strong Management Team. We believe that we have a world-class management team led by Craig O. Morrison, our President and Chief Executive Officer, and William H. Carter, our Chief Financial Officer. Our divisional management teams are comprised of experienced managers from Borden Chemical, RPP, RSM and Bakelite. Marvin O. Schlanger, former Chief Executive Officer of Arco Chemical and RPP, with over 30 years of chemical industry experience, will become Vice Chairman. Our management team has demonstrated expertise in growing our businesses organically, integrating acquisitions and executing on significant cost cutting programs.

 

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Strategy

 

We are focused on augmenting our growth, as well as increasing shareholder value, return on investment, cash flows and profitability. We believe we can achieve these related goals through the following strategies:

 

Leverage Our Integrated Platform. As the world leader in thermoset resins, we have an opportunity to provide our customers with a full suite of resins products on a global basis. We believe this provides us 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. We will also be able to offer a more diverse product line to all of our customers, utilizing the existing product lines of each of our acquired businesses. We believe we have substantial opportunities through global product line management to leverage these capabilities in order to increase our sales volumes and margins. Examples of the opportunity to leverage our integrated platform include:

 

    We produce many value-added, innovative products developed by Bakelite for the European market which we plan to introduce to our broader customer base.

 

    We expect to expand the sales of our versatic acid coatings product line, which has historically been nearly exclusively a European product, into the Americas by utilizing RSM’s existing coatings sales force.

 

    We expect to capitalize on Borden Chemical’s strength in forest product resins by expanding such product offerings into Bakelite’s European markets, including Russia’s wood products market, the largest market in the world.

 

    Upon the closing of the Current Transactions, we will be a leading resins supplier to many of the world’s largest coatings companies, allowing us to accelerate new and specialty product development for our customers, thereby further strengthening our relationships and enhancing our ability to retain and grow customers based on attributes other than price.

 

Develop and Market New Products. We will continue to expand our product offerings through internal innovation, joint research and development initiatives with our customers and research partnership formations. In 2004, on a pro forma basis, we incurred approximately $65 million in research and development expenses. We will continue to implement a systematic approach to new product development and have identified promising new technologies that have begun to yield significant results. Examples of new product development and our ability to leverage our technology base include:

 

    In 2003, Borden Chemical developed and began marketing XRT®, a family of proppants made for the oil field products end-market, which generated approximately $14 million in net sales in 2004.

 

    Both Borden Chemical and RSM have increased their investments in UV light-curable products for the display, ink jet and electronics products markets.

 

    Both Borden Chemical and RPP have increased their investments in specialty epoxidized phenolic products for the electronics market.

 

    RPP is developing a family of customized resins tailored for the high-end electrical lamination market. This family of products is expected to generate approximately $8 to $10 million in annual net sales by 2007.

 

    In 2004, RSM developed and began conducting customer trials with Archemis, a resin used to formulate quick-dry alkyd paint. These coatings will be targeted for the contractors market where their quick dry properties allow two coats of paint to be applied in one work shift. It is expected to generate approximately $5 to $10 million in annual net sales by 2007.

 

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Expand Our Global Reach In Faster Growing Regions. We will continue to grow internationally by expanding our product sales to our multi-national customers outside of North America and Western Europe, and by entering international new markets. Specifically, we are focused on growing our business in the Asia-Pacific, Eastern Europe and Latin American markets, where the usage of our products is increasing. Furthermore, by combining sales and distribution infrastructures, we expect to accelerate the penetration of our high-end, value-added products into new markets, thus further leveraging our research and applications efforts. Some examples of our increased presence in developing regions are as follows:

 

    Our twelve plants in Asia-Pacific represent most of our key product lines, give us critical mass to serve those markets and provide a platform for continued expansion in that region.

 

    We have significant operations in Eastern Europe through RSM and Bakelite, and expect to leverage this footprint to increase our business in Russia and Eastern Europe.

 

    We have expanded Borden Chemical’s Latin American presence over the past four years, growing its net sales by over 34% from 2001 to 2004, and expect to continue growing in this region.

 

Increase Margins Through Focus on Operational Excellence. Through the combination of four standalone global resin companies, we believe that there will be opportunities to extract substantial cost savings in the near future. We believe that the Current Transactions will yield in excess of $82 million in annual net cost synergies. We expect that these synergies will be implemented within 18 months of the consummation of the Current Transactions. We expect to incur a one-time cost of $50 million during the next two years in connection with implementing these synergies. Management has specifically identified a number of areas for savings and is actively pursuing key components of this strategy. Primary components are as follows:

 

    Manufacturing rationalization and optimization across the entire facility footprint.

 

    Reduction of fixed cost structure through the elimination of overhead redundancies.

 

    Raw material and other purchasing savings.

 

    Streamlined logistics processes.

 

    Efficient management of capital spending.

 

    Rollout of Borden Chemical’s Six Sigma management approach, and other operational best practices, throughout the organization.

 

In addition, each of our companies have significant experience in implementing cost reduction and working capital management programs, including ongoing programs at each of the companies.

 

Pursue Targeted Add-On Acquisitions and Joint Ventures. The global thermoset resin industry is highly fragmented and is comprised of numerous small and mid-sized specialty companies focusing on niche markets, as well as small non-core divisions of large chemical conglomerates. As the largest company focused primarily on the thermoset resins space, we have a significant advantage in pursuing add-on acquisitions and joint ventures in areas that allow us to build upon our core strengths, expand our product, technology and geographic portfolio, and better serve our customers. We believe we can consummate a number of these acquisitions at relatively low valuations due to the scalability of our existing global operations. Some examples of these opportunities include:

 

    RSM recently acquired a specialty coatings product line in the versatics market.

 

    We are currently pursuing several tuck-in acquisitions which, if consummated, should provide Hexion with product line extensions. We expect these acquisitions to be accretive in leveraging Hexion’s manufacturing footprint and existing corporate infrastructure.

 

    We are also pursuing various joint ventures to expand our geographic footprint.

 

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The Prior and Current Transactions

 

The Combinations. As of April 22, 2005, Borden Chemical entered into a transaction agreement with affiliates of RPP and RSM pursuant to which Borden Chemical agreed to combine with RPP and RSM. Borden Chemical, RPP and RSM are each controlled by Apollo. Upon the consummation of the Combinations, Borden Chemical will change its name to Hexion Specialty Chemicals, Inc. and BHI Acquisition LLC, Borden Chemical’s parent, will change its name to Hexion LLC. Immediately upon completion of this offering, Apollo, through Hexion LLC, will hold     % of the outstanding capital stock of Hexion. Completion of the Combinations is subject to customary closing conditions and Borden Chemical, RPP and RSM will continue to operate independently until those conditions are satisfied and the closing occurs. We expect that the completion of the Combinations will occur in the second quarter of 2005.

 

The Borden Transaction. On July 5, 2004, BHI Investment, LLC, an affiliate of Apollo, entered into a stock purchase agreement with BW Holdings, LLC, Borden Holdings, Inc., its wholly-owned subsidiary, Borden Chemical, Inc., and members of Borden Chemical’s management. BW Holdings, LLC is an affiliate of Kohlberg Kravis Roberts & Co. L.P., or KKR, which had controlled Borden Holdings, Inc. and Borden Chemical since 1995. On August 12, 2004, pursuant to the stock purchase agreement, BHI Investment, LLC acquired (the “Borden Acquisition”) all of the outstanding capital stock of Borden Holdings, Inc., and all of the outstanding capital stock of Borden Chemical, Inc. not otherwise owned by Borden Holdings, Inc. was redeemed. The Borden Acquisition, the related offering of second-priority senior secured floating rate notes and 9% second-priority senior secured notes and the related transactions are collectively referred to in this prospectus as the “Borden Transaction.”

 

The RPP Transaction. On November 14, 2000, RPP Holdings LLC, an affiliate of Apollo acquired control of RPP in a recapitalization transaction (the “RPP Transaction”). Prior the recapitalization, RPP was a wholly-owned subsidiary of the Royal Dutch/Shell Group of Companies (“Shell”).

 

The RSM Transaction. On August 2, 2004, pursuant to an acquisition agreement between RSM, on behalf of itself and certain affiliates, and Eastman Chemical Company (“Eastman”), RSM acquired (the “RSM Acquisition”) Eastman’s resins, inks and monomers division. The RSM Acquisition and the related transactions are collectively referred to in this prospectus as the “RSM Transaction.”

 

The Bakelite Transaction. On April 29, 2005, Borden Chemical acquired Bakelite. Upon the consummation of the Bakelite Acquisition, Bakelite became an indirect, wholly-owned subsidiary of Borden Chemical Canada, Inc. (“Borden Canada”). The acquisition was financed through a combination of available cash and borrowings under our bridge loan facility. We intend to use the proceeds of the issuance of senior secured debt to repay amounts outstanding under, and in connection therewith terminate, the bridge loan facility. We refer to the borrowings under the bridge loan facility, the issuance of our senior secured debt and the repayment of borrowings under our bridge loan facility collectively as the “Bakelite Financing.” The Bakelite Acquisition, the repayment or assumption of certain of Bakelite’s debt in connection therewith, the Bakelite Financing and the consent we have obtained from the lenders under our existing senior secured credit facilities are collectively referred to in this prospectus as the “Bakelite Transaction.”

 

We refer to the Borden Transaction, the RPP Transaction and the RSM Transaction collectively as the “Prior Transactions.” We refer to the borrowings under our new senior secured credit facilities, the issuance of our Series A Preferred Stock and the application of the net proceeds therefrom to repay existing debt and pay a dividend on our common stock as described elsewhere in this prospectus, collectively, as the “Financings.” We refer to the Combinations, the Financings and the Bakelite Transaction as the “Current Transactions.” We refer to the Prior Transactions, the Current Transactions and this offering, including the application of the net proceeds to the Company therefrom, as the “Transactions.”

 

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Ownership Structure

 

The chart below illustrates our ownership structure after giving effect to the Current Transactions and this offering. Our ownership is presented on a fully-diluted basis.

 

LOGO

 

We are a New Jersey corporation, with predecessors dating back to 1899. Our principal executive offices are located at 180 East Broad Street, Columbus, Ohio 43215. Our telephone number is (614) 225-4000. We maintain a website at www.bordenchem.com where general information about our business is available. The information contained on our website is not a part of this prospectus.

 

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The Offering

 

Common stock offered by us

             shares

 

Common stock offered by the selling shareholder

             shares

 

Common stock to be outstanding after this offering

             shares

 

Use of Proceeds

We estimate that we will receive net proceeds from our offering of our common stock, after deducting underwriting discounts, of approximately $                      million, assuming the shares are offered at $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus. We intend to use our net proceeds from this offering to redeem all of our outstanding Series A Preferred Stock. See “Use of Proceeds” and “Dividend Policy.”

 

 

We will not receive any proceeds for the sale of our common stock by the selling shareholder, including if the underwriters exercise their option to purchase additional shares. In the aggregate, the selling shareholder will receive approximately $                      million of the net proceeds of this offering, or approximately $                      million if the underwriters’ option to purchase additional shares is exercised in full, assuming the shares are offered at $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus.

 

Dividend Policy

We do not currently intend to pay any cash dividends on our common stock. See “Dividend Policy” and “Description of Capital Stock—Common Stock.”

 

Listing

We intend to list our common stock on the New York Stock Exchange under the symbol “HXN.”

 

All information in this prospectus, unless otherwise indicated or the context otherwise requires:

 

    does not give effect to the issuance of the following:

 

(1)              shares of common stock issuable upon the exercise of options outstanding as of             , at a weighted average exercise price of approximately $             per share; or

 

(2)              shares of common stock which may be issued upon the exercise of options reserved for future grant; and

 

    gives effect to the proposed             -for-1 split of our common stock.

 

Risk Factors

 

Investing in our common stock involves substantial risk. Before you invest in our common stock, you should carefully consider all the information in this prospectus including matters set forth under the heading “Risk Factors.”

 

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Summary Historical and

Pro Forma Financial and Other Data

 

The combination of Borden Chemical, RPP and RSM has been treated, for accounting purposes, as a combination of entities under common control due to Apollo’s controlling interest in each of the companies. The audited combined financial statements presented herein reflect the results of operations of each company from the date such company was acquired by Apollo.

 

The following table summarizes certain historical and pro forma financial and other data for Hexion. The summary historical and pro forma financial and other data for Hexion as of December 31, 2003 and 2004, and for the years ended December 31, 2002, 2003 and 2004 has been derived from the audited combined financial statements of Hexion, included elsewhere in this prospectus. The financial data of Hexion for the year ended December 31, 2004 includes:

 

    the results of operations of RPP for the year ended December 31, 2004, which reflect purchase accounting adjustments from the date of acquisition of RPP by Apollo on November 14, 2000;

 

    the results of operations of Borden Chemical for the period from August 12, 2004 to December 31, 2004, on a historical basis (because Borden Chemical is a public reporting registrant as a result of public debt that was outstanding prior to the Borden Transaction and which debt remains outstanding, Borden Chemical has elected to present its financial statements from the date of its acquisition by Apollo on the historical basis of accounting); and

 

    the results of operations of RSM for the period from August 2, 2004 to December 31, 2004, which reflect purchase accounting adjustments from the date of acquisition of RSM by Apollo on August 2, 2004.

 

The summary unaudited pro forma combined financial data of Hexion gives effect, in the manner described under “Unaudited Pro Forma Combined Financial Information,” to the Transactions. Our unaudited pro forma combined balance sheet as of December 31, 2004 gives pro forma effect to the Current Transactions and this offering, including the application of the net proceeds to the Company therefrom, as if they had each occurred on such date. Our unaudited pro forma combined statement of operations for the year ended December 31, 2004 gives pro forma effect to the Transactions (other than the RPP Transaction), as if they had each occurred on January 1, 2004 as described under “Unaudited Pro Forma Combined Financial Information.”

 

The pro forma adjustments relating to the Bakelite Transaction and the minority interest acquisitions of RPP and RSM as part of the Combinations are based on preliminary estimates of the fair value of the consideration provided, estimates of the fair values of assets acquired and liabilities assumed and available information and assumptions. The final determination of fair value could result in changes to the pro forma adjustments and the pro forma data included herein. The preliminary work performed by independent third-party appraisers has been considered in our estimates of the fair values reflected in the pro forma financial data.

 

The unaudited pro forma combined financial data for the year ended and as of December 31, 2004 is presented for informational purposes only, and does not purport to represent what our results of operations would actually have been if the transactions had occurred on the dates indicated, nor does it purport to project our results of operations or financial condition that we may achieve in the future.

 

You should read this summary historical and pro forma financial and other data in conjunction with “Selected Historical Financial and Other Information,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Unaudited Pro Forma Combined Financial Information,” together with all of the financial statements and related notes included in this prospectus.

 

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     Historical

       
     Year ended December 31,

   

Pro Forma

Year Ended
December 31,
2004


 
     2002

    2003(1)

    2004(1)

   
     (dollars in millions)  

Statement of Operations

                                

Net sales

   $ 740     $ 782     $ 2,019     $ 4,105  

Cost of sales

     601       714       1,785       3,564  
    


 


 


 


Gross profit

     139       68       234       541  
    


 


 


 


Selling, general & administrative expense

     82       81       163       386  

Transaction related compensation and other costs

     —         —         24       24  

Impairments

     —         33       2       86  

Other operating expense (income)

     16       (3 )     5       19  
    


 


 


 


Operating income (loss)

     41       (43 )     40       26  
    


 


 


 


Interest expense

     65       77       118       211  

Transaction costs

     —         —         32       41  

Other non-operating expense

     —         —         4       7  
    


 


 


 


Loss before income tax

     (24 )     (120 )     (114 )     (233 )

Income tax (benefit) expense

     (10 )     (37 )     —         136  
    


 


 


 


Net loss

   $ (14 )   $ (83 )   $ (114 )   $ (369 )
    


 


 


 


Cash Flow Data

                                

Cash flows from (used in) operating activities

   $ 64     $ (43 )   $ (32 )     N/A  

Cash flows (used in) from investing activities

     (45 )     7       (20 )     N/A  

Cash flows (used in) from financing activities

     (21 )     80       148       N/A  

Depreciation and amortization (2)

     47       58       86       145  

Capital expenditures

     48       18       57       122  

Other Financial Data

                                

EBITDA (3)

                           $ 123  

Transaction costs and impairments included in EBITDA (4)

                             151  

Unusual items included in EBITDA (5)

                             86  

Balance Sheet Data (at end of period)

                                

Cash and equivalents

           $ 49     $ 152     $ 59  

Working capital (6)

             177       433       456  

Total assets

             1,191       2,696       3,298  

Total debt

             683       1,850       2,360  

Total liabilities (7)

             994       2,958       3,752  

Total shareholders' equity (deficit)

             197       (262 )     (454 )

(1) We have restated our balance sheets dated as of December 31, 2003 and 2004 from the previously filed balance sheets included in our initial filing of the Registration Statement on Form S-1 filed on April 25, 2005. See Note 17 to our audited combined financial statements included elsewhere in this prospectus.
(2) Depreciation and amortization included in the combined pro forma statement of operations is comprised of:

 

     (dollars in millions)  

Hexion—For the year ended December 31, 2004

   $ 86  

Borden—For the period from January 1, 2004 to August 11, 2004

     30  

RSM—For the period from January 1, 2004 to August 1, 2004

     4  

Bakelite—For the year ended December 31, 2004

     33  

Total pro forma adjustment

     (8 )
    


Total combined pro forma depreciation and amortization expense for the year ended December 31, 2004

   $ 145  
    


 

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(3) EBITDA is not a defined term under GAAP and should not be considered as an alternative to operating income or net income as a measure of operating results or as an alternative to cash flows as a measure of liquidity. The following table is a reconciliation of pro forma net loss to pro forma EBITDA for Hexion:

 

     Pro Forma
Year Ended December 31, 2004


 
     (dollars in millions)  

Pro forma net loss

   $ (369 )

Pro forma interest expense, net

     211  

Pro forma income tax expense

     136  

Pro forma depreciation and amortization

     145  
    


Pro forma EBITDA

   $ 123  
    


 

(4) Transaction costs and impairments for Hexion are further detailed on the following table:

 

    

Pro Forma

Year Ended December 31, 2004


     (dollars in millions)

Transaction costs (a)

   $ 65

Non-cash impairments of fixed assets, goodwill and intangible assets

     86
    

     $ 151
    


      
  (a) Amount represents transaction costs related to the Borden Transaction and certain expenses related to terminated acquisition activities.

 

(5) Unusual items that do not relate to the core operations of Hexion are further detailed on the following table:

 

    

Pro Forma

Year Ended December 31, 2004


     (dollars in millions)

Legacy legal costs (a)

   $ 11

Legacy corporate expenses, net (b)

     30

Plant closure and employee costs (c)

     13

Business realignment expenses (d)

     29

Business interruption (e)

     3
    

Unusual items

   $ 86
    


      
  (a) Legacy legal costs relate to legal proceedings primarily involving divested businesses of Borden Chemical.

 

  (b) Corporate allocations of $38 and transition service fees of $4 charged to RSM by its former parent in excess of estimated incremental costs to replace such services of $12.

 

  (c) Plant closure and non-recurring severance and other one time benefits paid to employees.

 

  (d) Business realignment expenditures included in EBITDA for Hexion relate to the excess of historical costs over current business staffing levels, contractual commitments and current plant footprint and are comprised of:

 

Employee related costs

   $ 17

Non-employee related costs

     12
    

     $ 29
    

 

Employee related costs of $17 are comprised of (i) historical salaries and benefits of employees terminated in 2004 at RSM, Borden Chemical and Bakelite and (ii) the excess cost of employee benefit programs prior to the revision of such plans in 2004 at RSM and Borden Chemical.

 

Non-employee related costs of $12 are comprised of (i) costs of $3 related to closed sites included in the RSM predecessor financial statements which were not acquired by RSM and (ii) the excess distribution expense of $9 reflected in RSM’s predecessor’s income statement reduced in 2004 at the time of the RSM Transaction as a result of new agreements with vendors.

 

  (e) Incremental expenses incurred as a result of a mechanical failure at a Brazilian formaldehyde plant. Hexion expects to be reimbursed for this amount under its insurance policies in 2005.

 

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(6) Working capital is defined as current assets less current liabilities.

 

(7) In the event that the Combinations are not consummated on or prior to July 31, 2005, or the transaction agreement is terminated at any time prior thereto, we will be required to redeem, using escrowed funds, the Series A Preferred Stock at a redemption price equal to its liquidation preference including accrued and unpaid dividends to the redemption date. As the unaudited pro forma combined financial data has been prepared under the presumption that the Combinations have occurred and therefore the special mandatory redemption would not be operative, the Series A Preferred Stock is not presented as a liability.

 

Senior Secured Credit Facilities

 

Upon closing of the Combinations, we expect to enter into $675 million of new senior secured credit facilities. We expect that our new senior secured credit facilities will provide for a six-year $275 million revolving credit facility, subject to an earlier maturity date, under certain circumstances. In addition, we expect that our new senior secured credit facilities will provide for a seven-year $400 million term loan facility, subject to an earlier maturity date, under certain circumstances. Upon entering into these senior secured credit facilities, we intend to repay all amounts outstanding under the Borden Chemical Credit Agreement, RPP Credit Agreement and RSM Credit Agreement. See “Description of Certain Indebtedness—Senior Secured Credit Facilities.”

 

Covenant Compliance

 

Adjusted EBITDA as presented herein is a financial measure that is used in certain indentures governing our notes. Adjusted EBITDA is used to determine our compliance with certain covenants, such as those with respect to our incurrence of debt and ability to make future acquisitions.

 

Adjusted EBITDA is defined as EBITDA further adjusted to exclude certain non-cash, non-recurring and realized or expected future cost savings directly related to prior acquisitions and the Combinations. We believe that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors to demonstrate compliance with our financial covenants. Failure to comply with such covenants can result in limiting our long-term growth prospects by hindering our ability to incur future indebtedness or to make future acquisitions. Adjusted EBITDA is not a defined term under GAAP and should not be considered as an alternative to operating income or net income as a measure of operating results or as an alternative to cash flows as a measure of liquidity.

 

We are required to have an Adjusted EBITDA to fixed charge ratio of 2.25:1 under certain of our indentures to incur additional indebtedness (subject to certain exceptions set forth in our indentures). See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for further information on our indebtedness and covenants.

 

    

Year Ended

December 31,

2004


     (dollars in
millions)

Pro Forma EBITDA (1)

   $ 123

Transaction costs and impairments (1)

     151

Unusual items (1)

     86

Effect of acquisitions (2)

     4

Synergies from Current Transactions (3)

     82
    

Pro Forma Adjusted EBITDA

   $ 446
    


 

  (1) See footnotes (3) - (5) on page 15 for more information on EBITDA, transaction costs and impairments and unusual items.

 

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  (2) Represents the full year Adjusted EBITDA impact of a specialty coatings product line in the versatics market, acquired in November 2004 by RSM.

 

  (3) Represents $82 in estimated annual net cost synergies resulting from the Current Transactions. We expect that these synergies will be implemented within 18 months of the consummation of the Current Transactions. We expect to incur a one-time cost of $50 million during the next two years in connection with implementing these synergies. These estimated synergies include cost savings from rationalization of manufacturing facilities, removal of duplicative corporate and administrative functions, alignment of benefit plans and raw material purchasing initiatives. The estimated synergies by category are as follows:

 

Rationalization of manufacturing facilities

   $   23

Overhead synergies

     27

Raw material savings

     32
    

     $ 82
    

 

Executive Level Overview

 

Hexion is comprised of the businesses of RPP, Borden Chemical, RSM and Bakelite. The results of each of these four businesses are discussed below. The supplemental information presented includes the combination of predecessor and successor financial statements for individual entities and provides what management believes is a meaningful way of analyzing the results of the combined companies on a comparable period basis. In addition to net sales, we show historical Adjusted EBITDA (see —“Covenant Compliance”) for each of the legacy entities. We believe Adjusted EBITDA is a useful metric in managing the operations of the businesses and use Adjusted EBITDA to assess our operating performance and monitor our compliance with the indentures governing our notes. We believe this financial measure is helpful in highlighting trends in our businesses because the items excluded in calculating Adjusted EBITDA have little or no bearing on our day-to-day operating performance. It is also the most significant criterion in our performance-based cash bonuses and may be a triggering event of whether certain performance-based stock options vest. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a reconciliation of the Adjusted EBITDA of each of RPP, Borden Chemical, RSM and Bakelite to their respective net income (loss) for the periods presented.

 

RPP

             
     Year Ended December 31,

     2003

   2004

     (dollars in millions)

Net sales

   $ 782    $ 996

Adjusted EBITDA

     47      83

 

Net Sales

 

Net sales increased by $214, or 27%, to $996 for the year ended December 31, 2004. The increase in net sales is a result of higher average prices and volumes. The increase in average prices was primarily attributable to price increases on certain products and the impact of a weaker dollar on our Euro-denominated sales. Overall average prices increased by 18% from the prior year period; however, excluding the impact of a weaker dollar on our Euro-denominated sales, overall average prices increased 13%. Overall volumes increased by 7% from the prior year period primarily due to stronger demand. The $214 increase in revenues consists of a $157, or approximately 73%, increase in prices and a $57, or approximately 27%, increase in volume.

 

Total net sales in the U.S. increased by $82, or 23%, to $431 for the year ended December 31, 2004. Of the increase in U.S. revenues, $32, or approximately 40%, was due to price increases and $50, or approximately 60%, was due to volume increases. Overall average prices increased by 10% from the prior year period. Overall volumes increased by 14% from the prior year period primarily due to stronger demand.

 

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Table of Contents

Total net sales in Europe increased by $133, or 31%, to $563 for the year ended December 31, 2004. Of the $133 increase in Europe revenues, $101, or approximately 76%, was due to price increases and $32, or approximately 24%, was due to volume increases. Overall average prices increased by 22% from the prior year period; however, excluding the impact of a weaker dollar on our Euro-denominated sales, overall average prices increased 10%. Overall volumes increased by 7% from the prior year period primarily due to stronger demand.

 

Adjusted EBITDA

 

Adjusted EBITDA increased by $36 to $83 for the year ended December 31, 2004. The increase is primarily due to higher selling prices across all major product lines. Also contributing to the increase is higher overall volumes in 2004. Partially offsetting these improvements were increased cost of feedstocks due to the increasing price of crude oil and related petrochemical products.

 

Borden Chemical

             
     Year Ended December 31,

         2003    

       2004    

     (dollars in millions)

Net sales

   $ 1,435    $ 1,686

Adjusted EBITDA

     161      173

 

Net Sales

 

In 2004, net sales increased by $251, or 17%, to $1,686 for the year ended December 31, 2004. The pass through of raw material price increases and favorable product mix contributed approximately 39% of the increase. Volume increases in Forest Products, Performance Resins, Latin America and Europe accounted for approximately 38% of the increase. The improved volume in Forest Products was due to increased end-use consumption resulting from the continued strong housing market and increased demand for flooring on the resin side of the business and higher demand in the general chemical sector for formaldehyde. Improved volumes for oilfield products, foundry and industrial resins drove Performance Resin volume improvement. Volume improvements in Latin America were due to increased demand driven by increased exports of wood products. European volume increases were driven by increased demand for formaldehyde and performance resins. Favorable currency translation contributed approximately 19% of the net sales improvement and approximately 4% was due to the impact of acquisitions.

 

Adjusted EBITDA

 

Adjusted EBITDA improved by $12 to $173 for the year ended December 31, 2004. The improvement is due to higher volumes, favorable product mix, purchasing productivity, favorable currency translation and a reduction in corporate expenses related to the full year impact of the 2003 business realignment program. These improvements more than offset the unfavorable effect of a lag in passing along raw material price increases to customers.

 

RSM

             
     Year Ended December 31,

     2003

   2004 (a)

     (dollars in millions)

Net sales

   $ 678    $ 765

Adjusted EBITDA

     25      60
 
  (a) The results for 2004 for RSM include results for the period from January 1, 2004 through August 1, 2004, which is the period prior to Apollo’s acquisition of RSM, along with that of August 2, 2004 through December 31, 2004.

 

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Net Sales

 

In 2004, net sales increased by $87, or 13%, to $765 for the year ended December 31, 2004. Overall average price increases contributed approximately 65% of the increase, due mostly to increased raw material pass-throughs and a strong improvement in global acrylic demand. Overall volume increases accounted for approximately 35% of the growth, primarily due to heavier coatings demand associated with the general economic recovery. Growth was seen across all major technologies, including alkyds, polyesters, acrylics and ink resins.

 

Adjusted EBITDA

 

In 2004, Adjusted EBITDA improved by $35 to $60 for the year ended December 31, 2004. This improvement was driven by improved pricing and mix strategies, partially offset by increases in raw material costs. Adjusted EBITDA was also improved due to the realization of several fixed cost reduction initiatives enacted in late 2003 and early 2004. Management expects to see further cost improvements in 2005 due to the realization of cost improvements associated with Apollo’s acquisition of the business in late 2004.

 

Bakelite

             
     Year Ended December 31,

         2003    

       2004    

     (dollars in millions)

Net sales

   $ 588    $ 699

Adjusted EBITDA

     30      55

 

Net Sales

 

In 2004, net sales increased by $111, or 19%, to $699 for the year ended December 31, 2004. Changes in foreign exchange rates accounted for approximately 54% of the increase, while in constant-currency terms, net sales increased 9% compared to prior year. Overall average price increases contributed 60% of the increase (in constant-currency terms). Overall volume increases accounted for 40% of the increase (in constant-currency terms), driven by strong growth in epoxies of 12%.

 

Adjusted EBITDA

 

Adjusted EBITDA improved by $25 to $55 for the year ended December 31, 2004. This increase is primarily due to reductions in cost structure and overhead. Also contributing to the increase were price improvements. Partially offsetting these improvements were increased cost of feedstocks due to the increasing price of crude oil and related petrochemical products.

 

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RISK FACTORS

 

An investment in our stock involves a high degree of risk. You should carefully consider the following information, together with other information in this prospectus, before buying shares of our stock. If any of the following risks or uncertainties occurs, our business, financial condition and results of operations could be materially and adversely affected, the trading price of our stock could decline and you may lose all or a part of the money you paid to buy our stock. The risks described below are not the only ones facing our company. Additional risks not currently known to us or that we currently deem immaterial also may impair our business, financial condition and results of operations.

 

Risks Relating to Our Business

 

Borden Chemical, RPP, RSM and Bakelite have no history of working together as a single company. Should we fail to integrate the operations of Borden Chemical, RPP, RSM and Bakelite and achieve cost savings, our results of operations and profitability would be negatively impacted.

 

We may not be successful integrating Borden Chemical, RPP, RSM and Bakelite, and the combined company may not perform as we expect or achieve the net cost savings we anticipate. A significant element of our business strategy is the improvement of our operating efficiencies and a reduction of our operating costs. We anticipate annual net cost synergies of approximately $82 million from the Current Transactions, and a one-time cost of $50 million in connection with implementing such cost savings. A variety of factors could cause us not to achieve the benefits of the cost savings plan, or could result in harm to our business, including:

 

    delays in the anticipated timing of activities related to our cost savings plan;

 

    higher than expected or unanticipated costs to implement the plan and to operate the business;

 

    our inability to optimize manufacturing processes between the companies;

 

    our inability to obtain lower raw material prices;

 

    our inability to utilize new geographic distribution channels;

 

    our inability to reduce corporate and administrative expenses; and

 

    our inability to integrate our IT systems.

 

As a result, we may not achieve our expected cost savings in the time anticipated, or at all. In such case, our results of operations and profitability would be negatively impaired.

 

The Current Transactions may prove disruptive and could result in the combined business failing to meet our expectations.

 

The process of integrating the operations of Borden Chemical, RPP, RSM and Bakelite may require a disproportionate amount of resources and management attention. Our future operations and cash flows will depend largely upon our ability to operate Hexion efficiently, achieve the strategic operating objectives for our business and realize significant cost savings and synergies. Our management team may encounter unforeseen difficulties in managing the integration of our four businesses. In order to successfully combine and operate our businesses, our management team will need to focus on realizing anticipated synergies and cost savings on a timely basis while maintaining the efficiency of our operations.

 

Any substantial diversion of management attention or difficulties in operating the combined business could affect our sales and ability to achieve operational, financial and strategic objectives. For example, Bakelite’s original system of financial reporting was designed to comply with German GAAP, consistent with the GAAP applied in the financial statements of its former parent, and the records of its subsidiaries were kept in other local

 

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GAAP, and then consolidated into its former parent’s financial statements. The conversion of Bakelite’s system of financial reporting from German and local GAAP to US GAAP is a complex process and has required substantial management resources in order to prepare the financial statements included in this prospectus. In the future, we expect to devote substantial management attention in order to implement financial reporting and other systems that will permit Bakelite to timely report its results on a US GAAP basis for inclusion in our consolidated financial statements. In addition, we anticipate the necessity to devote substantial management resources to continuing the preparation of RPP’s and RSM’s financial statements in a manner consistent with SEC rules and regulations.

 

Our historical and pro forma financial information may not be representative of our results as a combined company.

 

The historical financial information included in this prospectus is constructed from the separate financial statements of RPP, Borden Chemical, RSM and Bakelite for periods prior to the consummation of the Current Transactions. Bakelite has historically prepared its consolidated financial statements in accordance with German GAAP, which differs in certain respects from US GAAP. The Bakelite financial statement presentation included in this prospectus has been converted from the local GAAP of Bakelite and its subsidiaries to US GAAP. The pro forma financial information presented in this prospectus is based in part on certain assumptions regarding the Current Transactions that we believe are reasonable. We cannot assure you that our assumptions will prove to be accurate over time. Accordingly, the historical and pro forma financial information included in this prospectus may not reflect what our results of operations and financial condition would have been had we been a combined entity during the periods presented, or what our results of operations and financial condition will be in the future.

 

Our limited operating history and the challenge of integrating previously independent businesses make evaluating our business and our future financial prospects difficult. Our potential for future business success and operating profitability must be considered in light of the risks, uncertainties, expenses and difficulties typically encountered by recently organized or combined companies.

 

Although EBITDA is derived from the financial statements (pro forma or historical, as the case may be) of Hexion, the calculation of Adjusted EBITDA contains a number of estimates and assumptions that may prove to be incorrect. For example, the synergies assume we can obtain improved raw materials pricing, the determination of legacy corporate expenses (net) contains an estimate as to the cost of replacement services, and business realignment expenses contains a number of assumptions as to excess costs. Although management of Hexion believes these estimates and assumptions are reasonable and correct and are consistent with the definition of Adjusted EBITDA in our indentures, investors should not place undue reliance upon Adjusted EBITDA as an indicator of current and future performance.

 

Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under our existing or future indebtedness.

 

We are a highly leveraged company. As of December 31, 2004, we would have had, after giving pro forma effect to the Current Transactions, $2,360 million principal amount of outstanding indebtedness. In fiscal 2005, after giving pro forma effect to the Current Transactions, our annual debt service payment obligations are expected to be approximately $203 million (excluding $47 million related to the maturity of current debt obligations), of which $165 million represents debt service on fixed-rate obligations, which excludes $10 million of Series A Preferred Stock accretion for one quarter. Our ability to generate sufficient cash flow from operations to make scheduled payments on our debt depends on a range of economic, competitive and business factors, many of which are outside our control. Our business may not generate sufficient cash flow from operations to meet our debt service and other obligations, and currently anticipated cost savings and operating improvements may not be realized on schedule, or at all. If we are unable to meet our expenses and debt service obligations, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or raise equity. We

 

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may not be able to refinance any of our indebtedness, sell assets or raise equity on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our obligations on commercially reasonable terms, would have a material adverse effect on our business, financial condition and results of operations.

 

Our substantial indebtedness could have important consequences for you, including the following:

 

    it may limit our ability to borrow money or sell stock for our working capital, capital expenditures, debt service requirements, strategic initiatives or other purposes;

 

    it may limit our flexibility in planning for, or reacting to, changes in our operations or business;

 

    it may increase the amount of our interest expense, because certain of our borrowings are at variable rates of interest, which if interest rates increase, could result in higher interest expense;

 

    we will be more highly leveraged than some of our competitors, which may place us at a competitive disadvantage;

 

    it may make us more vulnerable to downturns in our business or the economy;

 

    a substantial portion of our cash flow from operations will be dedicated to the repayment of our indebtedness and will not be available for other purposes;

 

    it may restrict us from making strategic acquisitions, introducing new technologies or exploiting business opportunities;

 

    it may make it more difficult for us to satisfy our obligations with respect to our existing indebtedness;

 

    it may limit, along with the financial and other restrictive covenants in our indebtedness, among other things, our ability to borrow additional funds or dispose of assets; and

 

    there would be a material adverse effect on our business and financial condition if we were unable to service our indebtedness or obtain additional financing, as needed.

 

Furthermore, our interest expense could increase if interest rates increase because all of the debt under our new senior secured credit facilities and our floating rate notes are at variable rates of interest. See “Description of Certain Indebtedness.” If we do not have sufficient earnings, we may be required to refinance all or a part of our existing debt, sell assets, borrow more money or sell securities, none of which we can guarantee we will be able to do.

 

Despite our substantial indebtedness we may still be able to incur significantly more debt. This could intensify the risks described above.

 

The terms of the indentures governing our notes, our new senior secured credit facilities and the instruments governing our other indebtedness and Series A Preferred Stock contain restrictions on our ability to incur additional indebtedness. These restrictions are subject to a number of important qualifications and exceptions and the indebtedness incurred in compliance with these restrictions could be substantial. Accordingly, we could incur significant additional indebtedness in the future. As of December 31, 2004, after giving pro forma effect to the Current Transactions, we would have had $215 million available for additional borrowing under our new senior secured credit facilities, including the subfacility for letters of credit, and the covenants under our debt agreements would allow us to borrow a significant amount of additional indebtedness. The more we become leveraged, the more we, and in turn our securityholders, become exposed to the risks described above under “—Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under our existing or future indebtedness.”

 

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Demand for many of our products is cyclical and we may experience prolonged depressed market conditions for our products, which may decrease our net sales and operating margins.

 

Many of our products are used in industries that are cyclical in nature, such as the new home construction, automotive, oil and gas, chemicals and electronics industries. We sell our products to manufacturers in those industries who incorporate them into their own products. Sales to the construction industry are driven by trends in commercial and residential construction, housing starts and trends in residential repair and remodeling. Consumer confidence, mortgage rates and income levels play a significant role in driving demand in the residential construction, repair and remodeling sector. A drop in consumer confidence or an increase in mortgage rates or unemployment could cause a slowdown in the construction industry, and in particular the residential construction, repair and remodeling industry. These and other similar adverse developments could cause a material decrease in our net sales and operating margins.

 

Downturns in one or more of the other businesses that use our products can adversely affect our net sales and operating margins. Many of our customers are in businesses that are cyclical in nature and sensitive to changes in general economic conditions. In 2002, sales of Borden Chemical’s oil field services products declined 29% as a result of reduced drilling activity. Demand for our products depends, in part, on general economic conditions, and a decline in economic conditions in the industries served by customers has, and may continue to have, a material adverse effect on our business. An economic downturn in one or more of the businesses or geographic regions in which we sell our products could cause a material decrease in our net sales and operating margins.

 

We rely significantly on raw materials in the production of our products and fluctuations in costs could adversely affect our financial condition, cash flows and profitability.

 

Our manufacturing operations depend upon obtaining adequate supplies of our raw materials on a timely basis. The loss of a key source of supply or a delay in shipments could have an adverse effect on our business. In addition, several of our feedstocks at various facilities are transported through a pipeline from one supplier. If we were unable to receive these feedstock through these pipeline arrangements, we may not be able to obtain them from other suppliers at competitive prices or in a timely manner. During the past three years, the prices of these materials have been volatile. We are exposed to price risks associated with these raw material purchases. The availability and prices of raw materials may be subject to curtailment or change due to, among other things, new laws or regulations, suppliers’ allocations to other purchasers, interruptions in production by suppliers, changes in exchange rates, cost components of raw materials and worldwide price levels. Our results of operations could be adversely affected if we were unable to obtain adequate supplies of raw materials in a timely manner or if the costs of raw materials increased significantly. From time to time, suppliers may extend lead times, limit supplies or increase prices due to capacity constraints or other factors. Although certain of our contracts include competitive price clauses that allow us to buy outside the contract if market pricing falls below contract pricing and other contracts have minimum-maximum monthly volume commitments that allow us to take advantage of spot pricing, we may not be able to purchase raw materials at market price. In addition, some of our customer contracts include selling price provisions that are indexed to publicly available indices for these commodity raw materials; however, we may not be able to immediately pass on raw material price increases to our customers, if at all. Due to differences in timing of the pricing mechanism trigger points between our sales and purchase contracts, there is often a “lead-lag” impact during which margins are negatively impacted for the short term in periods of rising raw material prices and positively impacted in periods of falling raw material prices. Raw material prices may not decrease from currently high levels or, if they do, we may not be able to capitalize on any such reductions in a timely manner, if at all. In addition, the fluctuation in price of our primary raw materials could have an adverse effect on our financial condition, cash flows and profitability.

 

Rising energy costs may result in increased operating expenses and reduced net income.

 

Natural gas is essential in our manufacturing processes, and its cost can vary widely and unpredictably. Energy costs have risen significantly over the past several years due to the increase in the cost of oil and natural

 

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gas and the recent shortages of energy in various states. Our operating expenses increased in 2004 and will continue to increase if these costs continue to rise or do not return to historical levels. Rising energy costs may also increase our raw material costs. If we cannot pass these costs through to our customers, our business, financial condition or results of operations may be adversely affected. In addition, rising energy costs also negatively impact our customers and the demand for our products. These risks will be exacerbated if our customers or production facilities are in locations experiencing severe energy shortages.

 

Environmental obligations and liabilities could have a substantial negative impact on our financial condition, cash flows and profitability.

 

Our operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials and are subject to extensive environmental laws and regulations at the national, state, local and international level. Such environmental laws and regulations include those governing the discharge of pollutants into the air and water, the management and disposal of hazardous materials and wastes, the cleanup of contaminated sites and occupational health and safety. We have incurred, and will continue to incur, significant costs and capital expenditures in complying with these laws and regulations. In 2004, we incurred $16 million in capital expenditures to comply with environmental laws and regulations, and for other environmental improvements. In addition, violations of environmental laws or permits may result in restrictions being imposed on our operating activities or in our being subjected to substantial fines, penalties, criminal proceedings, third party property damage or personal injury claims or other costs. In addition, future developments or increasingly stringent regulation could require us to make additional unforeseen environmental expenditures. For example, the Louisville Metro Air Pollution control district has proposed new regulations that, if promulgated in their current form, could result in increased costs at our Louisville, Kentucky facility. In addition, potential air compliance issues at the Louisville facility could adversely affect our ability to achieve operational synergies in a timely fashion.

 

Even if we fully comply with environmental laws, we are subject to liability associated with hazardous substances in soil, groundwater and elsewhere at a number of sites. These include sites that we formerly owned or operated, and sites where hazardous wastes and other substances from our current and former facilities and operations have been treated, stored or disposed of, as well as sites that we currently own or operate. Depending upon the circumstances, our liability may be joint and several, meaning that we may be held responsible for more than our proportionate share, or even all, of the liability involved. Environmental conditions at such sites can lead to claims against us for personal injury or wrongful death, property damages, and natural resource damage, as well as to claims and obligations for the investigation and cleanup of environmental conditions. The extent of any such liabilities can be difficult to predict.

 

We have been notified that we are or may be responsible for environmental remediation at a number of sites in the United States, Europe and South America, and we are also undertaking a number of voluntary cleanups. We believe the most significant of these and the site that makes up approximately half of our remediation accrual is the site formerly owned by us in Geismar, Louisiana. As a result of former, current or future operations, there are likely to be additional environmental remediation or restoration liabilities or claims of personal injury by employees or members of the public due to exposure or alleged exposure to hazardous materials in connection with our operations, properties or products. We are aware of several sites, sold by us over 20 years ago, that may have significant site closure or remediation costs. Actual costs at these sites, as well as our share, if any, are unknown to us at this time. In addition, we have been served in two tort actions relating to one of these sites. If we fail to mount a successful defense against legal proceedings involving former sites, any significant finding of liability could have a negative impact on our financial condition, cash flows and profitability.

 

These environmental liabilities or obligations, or any that may arise or become known to us in the future, could have a material adverse effect on our financial condition, cash flows and profitability.

 

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Because we manufacture and use materials that are known to be hazardous, we are subject to comprehensive product and manufacturing regulations, for which compliance can be costly and time consuming.

 

We produce hazardous chemicals that require care in handling and use and are subject to regulation by many U.S. and non-U.S. national, supra-national, state and local governmental authorities. In some circumstances, before we may sell some of our products these authorities must approve these products and our manufacturing processes and facilities. As our facilities grow, we may become subject to additional regulation or higher compliance standards. We are also subject to ongoing reviews of our products and manufacturing processes. For example, formaldehyde is an extensively regulated chemical, which various public health agencies continue to evaluate. The International Agency for Research on Cancer, or IARC, has recently reclassified formaldehyde as “carcinogenic to humans,” a higher classification than previous IARC evaluations, based principally on a study conducted by the National Cancer Institute (NCI) linking formaldehyde exposure to nasopharyngeal cancer, a rare form of cancer in humans. IARC also concluded that there was strong but not sufficient evidence for a finding of a causal association between leukemia and occupational exposure to formaldehyde, although IARC could not identify a mechanism for leukemia induction. IARC’s monograph reporting this decision has not yet been published. It is possible that this reclassification will lead to further federal and state governmental review of existing regulations and may result in additional costly requirements. In addition, BPA, which is used as an intermediate at our Deer Park and Pernis manufacturing facilities and is also sold directly to third parties, is currently under evaluation as an “endocrine disrupter.” Endocrine disrupters are chemicals that have been alleged to interact with the endocrine systems of humans and wildlife and disrupt normal processes. Pursuant to EU regulation 793/93/EC, BPA producers are currently conducting an extensive toxicology testing program of the chemical. In addition, new legislation in Europe will take effect in 2005 and require that risk labels be used for BPA indicating “possible risk of impaired fertility.” In the event that BPA is further regulated, additional operating costs would likely be incurred to meet more stringent regulation of the chemical.

 

In order to obtain regulatory approval of certain new products, we must, among other things, demonstrate to the relevant authority that the product is safe for its intended uses and that we are capable of manufacturing the product in accordance with current regulations. The process of seeking approvals can be costly, time consuming and subject to unanticipated and significant delays. Approvals may not be granted to us on a timely basis, or at all. Any delay in obtaining, or any failure to obtain or maintain, these approvals would adversely affect our ability to introduce new products and to generate revenue from those products. New laws and regulations may be introduced in the future that could result in additional compliance costs, seizures, confiscation, recall or monetary fines, any of which could prevent or inhibit the development, distribution or sale of our products. For example, we produce resin-coated sand. Because sand consists primarily of crystalline silica, it creates the potential for silica exposure, which is a recognized health hazard. The Occupational Safety and Health Administration, or OSHA, has indicated that it may propose a comprehensive occupational health standard for crystalline silica to provide for lower permissible exposure limits, exposure monitoring, medical surveillance and worker training. We may have to incur substantial additional costs over time to comply with any new OSHA regulations. In addition, the European Commission recently published a proposal, known as Registration, Evaluation and Authorization of Chemicals, or REACH, which would require manufacturers, importers and consumers of certain chemicals to register such chemicals and evaluate their potential impacts on human health and the environment. Based on the results of the evaluation, a newly created regulatory body would then determine if the chemical should be further tested, regulated, restricted or banned from use. If REACH is enacted in its current form, significant market restrictions could be imposed on the current and future uses of chemical products sold by us in the European Union. Because the timing and ultimate form of the potential REACH regulation is not yet known, we cannot accurately predict future compliance costs, which could be significant. If we fail to comply with applicable laws and regulations, we may be subject to civil remedies, including fines, injunctions, recalls or seizures, which would have an adverse effect on our financial condition, cash flows and profitability.

 

We are subject to numerous other legal actions that could have a negative impact on our financial condition.

 

In 1998, pursuant to a merger and recapitalization transaction sponsored by The Blackstone Group, which we refer to as Blackstone, and financed by The Chase Manhattan Bank, which we refer to as Chase, Borden

 

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Decorative Products Holdings, Inc., or BDPH, one of our wholly-owned subsidiaries, was acquired by Blackstone and subsequently merged with Imperial Wallcoverings to create Imperial Home Décor Group, or IHDG. Blackstone provided approximately $85 million in equity, a syndicate of banks funded $198 million of senior secured financing and $125 million of senior subordinated notes were privately placed. Borden Chemical received approximately $309 million in cash and 11% of IHDG common stock for its interest in BDPH. On January 5, 2000, IHDG filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The IHDG Litigation Trust, which we refer to as the Trust, was created pursuant to the plan of reorganization in the IHDG bankruptcy to pursue preference and other avoidance claims on behalf of the unsecured creditors of IHDG. In November 2001, the Trust filed a lawsuit against us and certain of our affiliates in U.S. Bankruptcy Court in Delaware seeking to have the IHDG recapitalization transaction voided as a fraudulent conveyance and asking for a judgment to be entered against us for approximately $314 million plus interest, costs and attorney fees. An effort to resolve this matter through non-binding mediation was unsuccessful, and the parties are moving forward with discovery in preparation for trial. We believe that we have strong defenses to the Trust’s allegations and we intend to defend the case vigorously. At this time, we are unable to estimate the amount of any judgment were we to lose such litigation, but such a judgment could be material.

 

We have sold various businesses and business lines and, in some instances, retained liability for those businesses pursuant to the sale contract or pursuant to applicable law. Although the majority of the contractual liabilities have expired, some remain in effect and could result in substantial claims against us.

 

While it is not feasible to predict the outcome of pending suits and claims, both the cost of defending such suits and the ultimate resolution of these matters could have an adverse effect on our financial condition, results of operations or reputation. For more information about these and other legal proceedings see the preceding risk factor, the next two risk factors and “Business—Legal Proceedings.”

 

Because we manufacture and use materials that are known to be hazardous, our production facilities are subject to significant operating hazards.

 

We are dependent on the continued operation of our 86 production and distribution facilities. These facilities are subject to hazards associated with the manufacture, handling, storage and transportation of chemical materials and products, including pipeline leaks and ruptures, explosions, fires, inclement weather and natural disasters, mechanical failure, unscheduled downtime, labor difficulties, transportation interruptions, and environmental hazards, such as spills, discharges or releases of toxic or hazardous substances and gases, storage tank leaks and remediation complications. These hazards can cause personal injury and loss of life, severe damage to, or destruction of, property and equipment and environmental contamination and other environmental damage and could have a material adverse effect on our financial condition. In addition, due to the nature of our business operations, we have been and may continue to be subject to scrutiny from environmental action groups. For example, currently there is an environmental group in the vicinity of our Louisville facility led by residents of the “Rubbertown” area, in which there are many chemical facilities, including our plant. As is typical for such groups, residents are claiming that the chemical facilities have caused health and property damage. In addition, in another state, we have been served in two lawsuits involving one of our divested facilities that alleges residents living nearby suffered health issues as a result of exposure to chemicals used at that plant. In addition, a group has challenged the use of toluene di-isocyanate (“TDI”) at our Môlndal, Sweden facility. As a result, a court has ruled that TDI use under the current permit must be reduced. Although we are appealing the court’s ruling, a limit on TDI use would restrict certain operations at that facility. The activities by the environmental groups could result in additional litigation or damage to our reputation. We may incur losses beyond the limits of, or outside the coverage of, our insurance policies, in particular for liabilities associated with environmental cleanup that may arise out of such hazards. In addition, from time to time, various types of insurance for companies in the chemical industry have not been available on commercially acceptable terms, such as coverage for silica claims or, in some cases, have been unavailable. In the future, we may not be able to obtain coverage at current levels, and our premiums may increase significantly on coverage that we maintain.

 

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We are subject to adverse claims from our customers and their employees as a result of the hazardous nature of our products.

 

We produce hazardous chemicals that require appropriate procedures and care to be used in handling them or using them to manufacture other products. As a result of the hazardous nature of some of the products we use and produce, we may face exposure relating to incidents involving our customers’ handling, storage and use of our products. On February 20, 2003, an explosion occurred at the facility of one of our customers, CTA Acoustics, Inc., which we refer to as CTA. Seven plant workers were killed in the explosion and more than 40 workers were injured. There are six lawsuits in Laurel County, Kentucky, arising out of this incident, primarily seeking recovery for wrongful death, personal injury, emotional distress, loss of consortium, property damage and indemnity. Although we believe that we have adequate insurance coverage to address any payments and/or legal fees in excess of $5 million involved in any single incident, we could be subject to significant judgments given the nature of this litigation. We have historically faced a substantial number of lawsuits, including class action lawsuits, claiming liability for death, injury or property damage caused by products we manufacture or those that contain our components. These lawsuits, and any future lawsuits, could result in substantial damage awards against us, which in turn could encourage additional lawsuits. The re-classification of formaldehyde as “carcinogenic to humans” by IARC could become the basis for an increase in product liability litigation, in addition to the two cases we currently face, alleging injury from formaldehyde exposure, particularly if there are further studies demonstrating a casual association with leukemia. In addition, in large part as a result of the bankruptcies of many producers of asbestos containing products, plaintiffs’ attorneys are increasing their focus on peripheral defendants, including us, and asserting that even products that contained a small amount of asbestos caused injury. Plaintiffs’ attorneys are also focusing on alleged harm caused by other products we have made or used, including silica—containing resin coated sands and vinyl chloride monomer, or VCM. While we cannot predict the outcome of pending suits and claims, we believe that we have adequate reserves to address currently pending litigation and adequate insurance to cover currently pending and foreseeable future claims. The ultimate resolution of these litigation matters, however, could have an adverse effect on our ability to operate our business, profitability, and our financial condition, cash flows and reputation.

 

We are exposed to political, economic and other risks that are inherent in operating an international business. Our substantial international operations subject us to risks not faced by domestic competitors, which include unfavorable political, regulatory, labor and tax conditions in other countries.

 

We have significant manufacturing operations outside the United States. In 2004, our net sales outside the United States represented approximately 57% of our total sales. We have 49 production and distribution facilities located outside the United States, primarily concentrated in Australia, Brazil, Canada, China, Germany, Italy, Korea, Malaysia, the Netherlands and the United Kingdom. Accordingly, our business is subject to the differing legal, political, social and regulatory requirements and economic conditions of many jurisdictions. Risks are inherent in international operations, including, but not limited to, the following:

 

    difficulty in enforcing agreements through foreign legal systems;

 

    foreign customers may have longer payment cycles;

 

    foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade and investment, including currency exchange controls;

 

    fluctuations in exchange rates may affect product demand and may adversely affect the profitability in U.S. dollars of products and services provided by us in foreign markets where payment for our products and services is made in the local currency;

 

    increased costs of transportation or shipping;

 

    risk of nationalization of private enterprises;

 

    changes in general economic and political conditions in the countries in which we operate;

 

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    unexpected adverse changes in foreign laws or regulatory requirements, including those with respect to environmental protection, export duties and quotas;

 

    difficulty with staffing and managing widespread operations;

 

    theft of intellectual property rights; and

 

    required compliance with a variety of foreign laws and regulations.

 

In addition, intellectual property rights may be more difficult to enforce in foreign countries. We currently have joint ventures in China, where we license technology to our joint venture partners. We may not be able to adequately protect our intellectual property in China or elsewhere. Our business in emerging markets requires us to respond to rapid changes in market conditions in these countries. Our overall success as a global business depends, in part, upon our ability to succeed in differing legal, regulatory, economic, social and political conditions. We may not continue to succeed in developing and implementing policies and strategies that will be effective in each location where we do business. Furthermore, each of the foregoing risks is likely to take on increased significance as we implement our plans to expand our foreign operations.

 

Currency translation risk and currency transaction risk may adversely affect our financial condition, cash flows and profitability.

 

We conduct our business and incur costs in the local currency of most countries in which we operate. Accordingly, our results of operations are reported in the relevant local currency and then translated to U.S. dollars at the applicable currency exchange rate for inclusion in our financial statements. Changes in exchange rates between those foreign currencies and the U.S. dollar will affect our net sales, cost of sales and operating margins and could result in exchange losses. In addition to currency translation risks, we incur currency transaction risk whenever one of our operating subsidiaries enters into either a purchase or a sales transaction using a different currency from the currency in which it receives revenues. In an effort to mitigate the impact of exchange rate fluctuations we engage in exchange rate hedging activities. However, the hedging transactions we enter into may not be effective or could result in foreign exchange hedging loss. The impact of future exchange rate fluctuations on our results of operations cannot be accurately predicted. Given the volatility of exchange rates, we may not be able to effectively manage our currency transaction and/or translation risks, and any volatility in currency exchange rates may have an adverse effect on our financial condition, cash flows and profitability. Our currency translation risk will intensify as a result of Borden Chemical’s acquisition of Bakelite, all of whose material operations are outside the United States and generally transacted in foreign currencies.

 

We operate our business in countries that historically have been and may continue to be susceptible to recessions or currency devaluation, including Brazil and Malaysia. In addition, as we expand our business in emerging markets, particularly China and Russia, the uncertain regulatory environment relating to currency policy in these countries could have a negative impact on our operations there.

 

Our research and development activities may not be successful in developing the new products that we need to remain competitive.

 

Our results of operations depend to a significant extent on our ability to expand our product offerings, and to continue to develop our production processes to be a competitive producer. We are committed to remaining a competitive producer and believe that our portfolio of new or re-engineered products is strong. However, we may not be able to continue to develop new products, re-engineer our existing products successfully or bring them to market in a timely manner. For example, our historical research and development efforts generally have focused on customer service, and we may be unsuccessful in shifting our focus to the type of research that will lead to significant new product development. In addition, some of our research and development scientists are located at our individual plants rather than at a research facility, which may impede their ability to share ideas and create new products. While we believe that the products, pricing and services we offer customers are competitive, we may not be able to continue to attract and retain customers to which to sell our products.

 

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We face competition from other chemical companies, which could force us to lower our prices thereby adversely affecting our operating margins, financial condition, cash flows and profitability.

 

The markets in which we operate are highly competitive, and this competition could harm our business, results of operations, cash flow and financial condition. Our competitors include major international producers as well as smaller regional competitors. We believe that the most significant competitive factor for our products is selling price. We could be subject to adverse results caused by our competitors’ pricing decisions. In addition, current and anticipated future consolidation among our competitors and customers may cause us to lose market share as well as put downward pressure on pricing. Furthermore, there is a trend in the chemical industry toward relocation of manufacturing facilities to lower-cost regions such as Asia. Such relocation may permit some of our competitors to lower their costs and improve their competitive position. Some of our competitors are larger, have greater financial resources and have less debt than we do. As a result, those competitors may be better able to withstand a change in conditions within our industry and throughout the economy as a whole. If we do not compete successfully, our business, operating margins, financial condition, cash flows and profitability could be adversely affected.

 

Competition from producers of materials that are substitutes for formaldehyde-based resins could lead to declines in our net sales attributable to these products.

 

We face competition from a number of products that are potential substitutes for formaldehyde-based resins. Currently, we estimate that formaldehyde-based resins make up most of the resins used as panelboard resins, wood and specialty adhesives and industrial resins. Decreases in the average selling price of formaldehyde may have a material adverse effect on our profitability. For example, competition among producers of foundry and specialty resins has led to erosion in certain product prices in the past. Our ability to maintain or increase our profitability will continue to be dependent, in large part, upon our ability to offset decreases in average selling prices by improving production efficiency or by shifting to higher margin chemical products. If we are unable to do so, our business, financial condition and results of operations could be materially and adversely affected. In addition, in some markets, non-formaldehyde based resins may be an alternative to our formaldehyde-based resins. Considerable growth in these substitutes for formaldehyde-based resins could adversely affect our market share, net sales and profit margins. Furthermore, the movement towards substitute products could be exacerbated as a result of the IARC recent reclassification of formaldehyde from a “probable human carcinogen” to “carcinogenic to humans” based on studies linking formaldehyde exposure to nasopharyngeal cancer, a rare form of cancer in humans, and its conclusion that some studies have shown a strong but not sufficient evidence of a causal association between leukemia and occupational exposure to formaldehyde.

 

Acquisitions and joint ventures that we pursue may present unforeseen integration obstacles and costs, increase our leverage and negatively impact our performance.

 

We have made acquisitions of related businesses, and entered into joint ventures in the recent past and intend to selectively pursue acquisitions of, and joint ventures with, related businesses as one element of our growth strategy. We are evaluating several potential tuck-in acquisitions and are in various stages of due diligence and negotiations with respect thereto. We cannot assure you that these transactions will be consummated in the foreseeable future, if at all, or that we will not consummate significant acquisitions in the future. We may, in the future, pursue acquisitions of a significantly larger scale than in the past. If such acquisitions are consummated, the risk factors we describe below, and for our business generally, may be intensified.

 

Our ability to implement our growth strategy will be limited by covenants in our senior secured credit facilities and indentures, our financial resources, including available cash and borrowing capacity, and our ability to integrate or identify appropriate acquisition and joint venture candidates. Moreover, acquisitions of businesses may require us to assume or incur additional debt financing, resulting in additional leverage and complex debt structures.

 

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The expense incurred in consummating acquisitions of related businesses, or our failure to integrate such businesses successfully into our existing businesses, could result in our incurring unanticipated expenses and losses. Furthermore, we may not be able to realize any anticipated benefits from acquisitions or joint ventures. The process of integrating acquired operations into our existing operations may result in unforeseen operating difficulties and may require significant financial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the risks associated with our acquisition and joint venture strategy include:

 

    potential disruption of our ongoing business and distraction of management;

 

    unexpected loss of key employees or customers of the acquired company;

 

    conforming the acquired company’s standards, processes, procedures and controls with our operations;

 

    coordinating new product and process development;

 

    hiring additional management and other critical personnel; and

 

    increasing the scope, geographic diversity and complexity of our operations.

 

In addition, we may encounter unforeseen obstacles or costs in the integration of acquired businesses. For example, the preparation of the US GAAP financial statements for Bakelite required significant management resources. Also, the presence of one or more material liabilities of an acquired company that are unknown to us at the time of acquisition may have a material adverse effect on our business. Our acquisition and joint venture strategy may not be successfully received by customers, and we may not realize any anticipated benefits from acquisitions or joint ventures.

 

Our future success depends on our ability to retain our key employees.

 

We are dependent on the services of Craig O. Morrison, our President and Chief Executive Officer, William H. Carter, our Chief Financial Officer and other members of our senior management team to remain competitive in our industry. The loss of Mr. Morrison or any other member of our senior management team could have an adverse effect on us. There is a risk that we will not be able to retain or replace these key employees. All of our current key employees are subject to employment conditions or arrangements that contain post employment non-competition provisions. However, these arrangements permit the employees to terminate their employment with little or no notice.

 

Some of our employees are unionized, represented by workers’ councils or are employed subject to local laws that are less favorable to employers than the laws of the United States.

 

A significant number of our employees and the employees of certain of our subsidiaries are union members, some of whom are subject to collective bargaining agreements. Some of our employees are employed in countries in which employment laws provide greater bargaining or other rights to employees than the laws of the United States. Such favorable employment rights require us to expend greater time and expense in making changes to employees’ terms of employment or making staff reductions. For example, most of our employees in Europe are represented by workers’ councils which must approve any changes in conditions of employment, including salaries and benefits. “Protection against dismissal” claims have been brought by certain of such workers’ councils in connection with Bakelite’s cost-saving initiatives. While we believe that our relations with our employees are satisfactory, a significant dispute with our employees could have an adverse effect on our business, financial position, results of operations and cash flows.

 

We rely on patents and confidentiality agreements to protect our intellectual property. Our failure to protect our intellectual property rights could adversely affect our future performance and growth.

 

Protection of our proprietary processes, methods and compounds and other technology is important to our business. Failure to protect our existing intellectual property rights may result in the loss of valuable technologies

 

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or having to pay other companies for infringing on their intellectual property rights. We rely on patent, trade secret, trademark and copyright law as well as judicial enforcement to protect such technologies. A majority of our patents relate to the development of new products and processes for manufacturing and use thereof and expire at various times between 2005 and 2025. Some of our technologies are not covered by any patent or patent application. In addition, our patents could be challenged, invalidated, circumvented or rendered unenforceable. Furthermore, pending patent applications may not result in an issued patent, or if patents are issued to us, such patents may not provide meaningful protection against competitors or against competitive technologies.

 

Our production processes and products are specialized. However, we could face patent infringement claims from our competitors or others alleging that our processes or products infringe on their proprietary technology. If we were subject to an infringement suit, we may be required to change our processes or products or stop using certain technologies or producing the infringing product entirely. Even if we ultimately prevail in an infringement suit, the existence of the suit could cause our customers to seek other products that are not subject to infringement suits. Any infringement suit could result in significant legal costs and damages and impede our ability to produce key products, which could have a material adverse effect on our business, financial condition and results of operations.

 

In addition, effective patent, trademark, copyright and trade secret protection may be unavailable or limited in some foreign countries. In some countries we do not apply for patent, trademark or copyright protection. We also rely upon unpatented proprietary manufacturing expertise, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we generally enter into confidentiality agreements with our employees and third parties to protect our intellectual property, such confidentiality agreements are limited in duration and could be breached, and may not provide meaningful protection for our trade secrets or proprietary manufacturing expertise. Adequate remedies may not be available in the event of an unauthorized use or disclosure of our trade secrets and manufacturing expertise. In addition, others may obtain knowledge of our trade secrets through independent development or other access by legal means. The failure of our patents or confidentiality agreements to protect our processes, apparatuses, technology, trade secrets and proprietary manufacturing expertise, methods and compounds could have an adverse effect on our business by jeopardizing critical intellectual property.

 

Bakelite uses the Bakelite trademark in marketing epoxy resin products in the United States, but it does not hold a registered United States trademark to “Bakelite.” As a result, we could be required to discontinue use of the trademark in the United States, and we may be unable to prevent others from using the mark for similar goods in the United States.

 

Our operations require substantial capital, and we may not have adequate capital resources to provide for all of our cash requirements and our ability to satisfy our obligations under our notes may be impaired.

 

Our operations require substantial capital. Expansion or replacement of existing facilities or equipment and compliance with environmental laws and regulations may require substantial capital expenditures. Our capital resources may not be sufficient for these purposes. If our capital resources are inadequate to provide for our operating needs, capital expenditures and other cash requirements, this shortfall could have a material adverse effect on our business and liquidity and impact our ability to service our debt.

 

We rely on our subsidiaries to generate the funds necessary to meet our financial obligations.

 

Because Hexion conducts many of its operations through its subsidiaries, Hexion depends on those entities for dividends, distributions and other payments to generate the funds necessary to meet its financial obligations. Legal and contractual restrictions in certain agreements governing current and future indebtedness of Hexion’s subsidiaries, as well as the financial condition and operating requirements of Hexion’s subsidiaries, may limit Hexion’s ability to obtain cash from its subsidiaries. All of Hexion’s subsidiaries are separate and independent legal entities and have no obligation whatsoever to pay any dividends, distributions or other payments to Hexion.

 

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Significant changes in pension fund investment performance or assumptions relating to pension costs may have a material effect on the valuation of pension obligations, the funded status of pension plans and our pension costs.

 

Our funding policy for pension plans is to accumulate plan assets that, over the long run, will approximate the present value of projected benefit obligations. Our pension cost is materially affected by the discount rate used to measure pension obligations, the level of plan assets available to fund those obligations at the measurement date and the expected long-term rate of return on plan assets. Significant changes in investment performance or a change in the portfolio mix of invested assets can result in corresponding increases and decreases in the valuation of plan assets, particularly equity securities, or in a change of the expected rate of return on plan assets. A change in the discount rate would result in a significant increase or decrease in the valuation of pension obligations, affecting the reported funded status of our pension plans as well as the net periodic pension cost in the following financial years. Similarly, changes in the expected return on plan assets assumption can result in significant changes in the net periodic pension cost of the following financial years.

 

A pension plan of Borden Chemical is currently underfunded and we may have to make significant cash payments to the plan and/or incur a liability to the Pension Benefit Guaranty Corporation. Termination by the Pension Benefit Guaranty Corporation would further increase our pension expense and could result in liens on material amounts of our assets.

 

On April 14, 2005, Borden Chemical notified the Pension Benefit Guaranty Corporation, or PBGC, that Borden Chemical’s defined benefit pension plan (the “Borden Plan”) was underfunded by approximately $104 million on a termination basis. IRS regulations require us to increase our contributions to the Borden Plan to reduce this underfunding. Based on current IRS regulations, we expect that our total minimum funding requirements for the five years ended in 2009 for the Borden Plan will be approximately $60 million. If the performance of the assets in the Borden Plan does not meet our expectations, if the PBGC requires additional contributions to the Borden Plan as a result of the Current Transactions, or if other actuarial assumptions are modified, our contributions for those years could be higher than we expect.

 

The need to make these cash contributions may reduce the cash available to meet our other obligations or to meet the needs of our business. In addition, the PBGC may terminate the Borden Plan under limited circumstances, including in the event the PBGC concludes that its risk may increase unreasonably if the Borden Plan continues. In the event the Borden Plan is terminated for any reason while it is underfunded, we could be required to make an immediate payment to the PBGC of all or a substantial portion of the Borden Plan’s underfunding, as calculated by the PBGC based on its own assumptions (which might result in a larger pension obligation than that based on the assumptions we have used to fund the Borden Plan), and the PBGC could assert a lien on material amounts of our assets.

 

In addition, in 2003, the IRS notified Borden Chemical that cash balance plans such as the Borden Plan may be required to be amended because of recent ERISA rulings that found cash balance plans to be discriminatory. The IRS indicated that the Borden Plan should continue to operate as currently designed until new guidance is available. Although the effect of any future guidance is not known, it is possible that such guidance may increase our obligations under the Borden Plan.

 

Our equity sponsor controls us and its interests may conflict with or differ from your interests as a shareholder. Our equity sponsor will realize substantial benefits from the sale of shares in this offering.

 

After the consummation of this offering, our equity sponsor will beneficially own approximately         % of our common stock, assuming the underwriters do not exercise their over-allotment option. If the underwriters exercise in full their over-allotment option, our equity sponsor will beneficially own approximately         % of our common stock. In addition, representatives of our equity sponsors will have the ability to prevent any transaction that requires the approval of directors. As a result, our equity sponsor will have the ability to substantially

 

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influence all matters requiring shareholder approval, including the election of our directors and the approval of significant corporate transactions such as mergers, tender offers and the sale of all or substantially all of our assets. For example, the approval of two-thirds of the members of our board of directors will be required by our amended and restated certificate of incorporation under certain circumstances including, without limitation, amendments to our organizational documents in a manner that adversely affects Apollo. These provisions shall terminate at such time as affiliates of Apollo no longer beneficially own at least one-third of our outstanding common stock and have sold at least one share of our common stock other than in this offering. See “Management—Supermajority Board Approval of Certain Matters.” The interests of our equity sponsor and its affiliates could conflict with or differ from your interests as a holder of our common stock. For example, the concentration of ownership held by our equity sponsor could delay, defer or prevent a change of control of our company or impede a merger, takeover or other business combination which you as a shareholder, may otherwise view favorably. Our equity sponsor may also pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. Further, our equity sponsor will realize substantial benefits from the sale of their shares in this offering. A sale of a substantial number of shares of stock in the future by funds affiliated with our equity sponsor could cause our stock price to decline in the future.

 

We are a “controlled company” within the meaning of the New York Stock Exchange rules and, as a result, will qualify for, and intend to rely on, exemptions from certain corporate governance requirements.

 

Upon the closing of this offering, affiliates of Apollo will continue to control a majority of our outstanding common stock. As a result, we are a “controlled company” within the meaning of the New York Stock Exchange corporate governance standards. Under the New York Stock Exchange rules, a company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain New York Stock Exchange corporate governance requirements, including:

 

    the requirement that a majority of the board of directors consist of independent directors;

 

    the requirement that we have a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities;

 

    the requirement that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

    the requirement for an annual performance evaluation of the nominating/corporate governance and compensation committees.

 

Following this offering, we intend to utilize these exemptions. As a result, we will not have a majority of independent directors nor will our nominating/corporate governance and compensation committees consist entirely of independent directors. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all of the New York Stock Exchange corporate governance requirements.

 

Our internal controls over financial reporting may not be effective and our independent auditors may not be able to certify as to their effectiveness, which could have a significant and adverse effect on our business and reputation.

 

We are evaluating our internal controls over financial reporting in order to allow management to report on, and our independent auditors to attest to, our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 and rules and regulations of the SEC thereunder, which we refer to as Section 404. Borden Chemical and RPP previously performed the system and process evaluation and plan to begin the testing required later this year (and any necessary remediation) in an effort to comply with management certification and auditor attestation requirements of Section 404. Bakelite and RSM were not previously required to meet these requirements so a process has begun to assess readiness and begin the evaluation. In the course of our ongoing Section 404 evaluation, we have identified areas of internal controls that may need improvement,

 

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including the closing and consolidation procedures, and, in the case of Bakelite, procedures surrounding the conversion of the financial statements from local and German GAAP to US GAAP, and plan to design enhanced processes and controls to address these and any other issues that might be identified through this review.

 

As of December 31, 2004, RPP evaluated the effectiveness of the design and operation of its “disclosure controls and procedures” (“Disclosure Controls”). This evaluation (“Controls Evaluation”) was done under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer of RPP. Based upon the Controls Evaluation, RPP concluded that RPP’s Disclosure Controls were not effective as of December 31, 2004 at the reasonable assurance level, because of a material weakness regarding the valuation and completeness of RPP’s deferred income tax assets and liabilities (including the associated valuation allowance) and the income tax provision. Specifically, RPP did not have effective controls over the preparation and review of the valuation allowance and related deferred tax assets to ensure accuracy and completeness because it did not have accounting personnel with sufficient knowledge of generally accepted accounting principles related to income tax accounting and reporting. In light of this material weakness, RPP performed additional analysis and other post-closing procedures to ensure its consolidated financial statements were prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements of RPP included in this prospectus fairly present, in all material respects, the financial condition, results of operations and cash flows of RPP for the periods presented.

 

As noted above, while Bakelite and RSM have not completed a Section 404 evaluation, the companies have identified certain areas of internal controls that may need improvement. For example, Bakelite’s original system of financial reporting was designed to comply with German GAAP; accordingly, Bakelite’s management determined that Bakelite did not have sufficient internal controls and resources relating to the preparation of US GAAP financial statements. In addition, as RSM began the process of developing a standalone infrastructure, RSM’s management determined that RSM did not have sufficient internal controls and resources relating to the preparation of US GAAP financial statements. As a result of such determinations, the management of Bakelite and RSM utilized additional outside advisors, as appropriate, to assess and to assist with the US GAAP closing and consolidation processes associated with preparing the audited consolidated financial statements included herein, including the conversion of local and German GAAP to US GAAP. Accordingly, Bakelite and RSM believe that their respective financial statements included in this prospectus fairly present in all material respects, the financial condition, results of operations and cash flows of Bakelite and RSM for the periods presented. However, while we expect to have available additional resources to assist with the US GAAP closing and consolidation processes, for future reporting periods, we cannot assure you that such closing and consolidation process will not result in delays in reporting our results.

 

As we are still in the evaluation process, we may identify additional conditions that may be categorized as significant deficiencies or material weaknesses in the future. We cannot be certain as to the timing of completion of our evaluation, testing and any remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, our independent auditors may not be able to certify as to the effectiveness of our internal control over financial reporting and we may be subject to sanctions or investigation by regulatory authorities, such as the SEC. As a result, there could be a negative reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. In addition, we may be required to incur costs in improving our internal control system and the hiring of additional personnel. Any such action could negatively affect our results of operations.

 

Risks Relating to This Offering

 

There is no existing public market for our common stock, and we do not know if one will develop, which could impede your ability to sell your shares and depress the market price of our common stock.

 

Prior to this offering, there has been no public market for our common stock. We cannot predict the extent to which investor interest will lead to the development of an active and liquid trading market in our common stock. The failure of an active trading market to develop could affect your ability to sell your shares and depress

 

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the market price of your shares. The initial public offering price for our shares of common stock will be determined by negotiations among us and the representatives of the underwriters. The initial public offering price of our shares of common stock will be based on numerous factors and may not be indicative of the market price of the common stock that will prevail in the trading market. The market price of your shares may fall below the initial public offering price.

 

The market price of our common stock may be volatile, which could cause the value of your investment to decline.

 

The market price of our common stock could fluctuate significantly, in which case you may not be able to resell your shares at or above the initial public offering price. Some companies that have had volatile market prices for their securities have had securities class action suits filed against them. If a suit were to be filed against us, regardless of the outcome, it could result in substantial costs and a diversion of management’s attention and resources. This could have a material adverse effect on our business, results of operations and financial condition.

 

The market price of our common stock may fluctuate in response to a number of events, including:

 

    our quarterly operating results;

 

    future announcements concerning our business;

 

    changes in financial estimates and recommendations by securities analysts;

 

    the number of shares to be publicly traded after this offering;

 

    actions of competitors;

 

    our involvement in acquisitions, strategic alliances or joint ventures;

 

    market and industry perception of our success, or lack thereof, in pursuing our growth strategy;

 

    changes in government and environmental regulation;

 

    arrival and departure of key personnel;

 

    general market, economic and political conditions; and

 

    natural disasters, terrorist attacks and acts of war.

 

In addition, in recent years the stock market has experienced significant price and volume fluctuations. These fluctuations are often unrelated to the operating performance of particular companies. These broad market fluctuations may cause declines in the market price of our common stock. The price of our common stock could fluctuate based upon factors that have little or nothing to do with our company, and these fluctuations could materially reduce the market price of our common stock.

 

You will experience immediate and substantial dilution as the net tangible book deficit per share of common stock will be substantially lower than the initial public offering price.

 

The initial public offering price of the shares of common stock is substantially higher than the net tangible book deficit per share of the outstanding common stock. As a result, if we were liquidated immediately following this offering, you would experience immediate and substantial dilution of $             per share of common stock. Dilution is the difference between the initial public offering price per share and the net tangible book deficit per share of our common stock. See “Dilution” for a discussion about how net tangible book value is calculated.

 

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We may not pay dividends on our common stock at any time in the foreseeable future.

 

We currently do not intend to pay any cash dividends on our common stock and our board of directors may never declare a dividend. We are not legally or contractually required to pay any dividends. The decision to make any distribution is entirely at the discretion of our board of directors and future dividends with respect to shares of our capital stock, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant. The amount of dividends, if any, will also be subject to contractual restrictions under:

 

    the indentures governing our notes;

 

    the terms of our senior secured credit facilities; and

 

    the terms of any other outstanding indebtedness incurred by us or any of our subsidiaries after the completion of this offering.

 

Future sales or the possibility or perception of future sales of a substantial amount of our common stock could adversely affect the market price of our common stock.

 

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the public market after this offering or the perception that these sales could occur. The sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

 

Upon consummation of this offering, there will be              shares of our common stock outstanding. All shares of common stock sold in this offering will be freely transferable without restriction or further registration under the Securities Act of 1933, as amended (the “Securities Act”). The remaining              shares of common stock outstanding, including the shares owned by our equity sponsor, will be restricted securities within the meaning of Rule 144 under the Securities Act, but will be eligible for resale subject to applicable volume, manner of sale, holding period and other limitations of Rule 144. We and certain of our shareholders have agreed to a “lock-up,” pursuant to which neither we nor they will sell any shares without the prior consent of Credit Suisse First Boston LLC for 180 days after the date of this prospectus, subject to extension under certain circumstances. Following the expiration of the applicable lock-up period, all these shares of our common stock will be eligible for future sale, subject to the applicable volume, manner of sale, holding period and other limitations of Rule 144. In addition, our shareholders have certain registration rights with respect to the common stock that they will retain following this offering. See “Shares Eligible for Future Sale” for a discussion of the shares of common stock that may be sold into the public market in the future.

 

We may issue shares of our common stock or other securities from time to time as consideration for future acquisitions and investments. If any such acquisition or investment is significant, the number of shares of our common stock, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be substantial. We may also grant registration rights covering those shares of our common stock or other securities in connection with any such acquisitions and investments.

 

Our organizational documents may impede or discourage a takeover, which could deprive our investors of the opportunity to receive a premium for their shares.

 

We intend to amend and restate our certificate of incorporation and bylaws to incorporate provisions that may make it more difficult for, or prevent a third party from, acquiring control of us without the approval of our board of directors. These provisions will include:

 

    a classified board of directors;

 

    the sole power of a majority of the board of directors to fix the number of directors;

 

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    limitations on the removal of directors;

 

    the ability of our board of directors to designate one or more series of preferred stock and issue shares of preferred stock without shareholder approval;

 

    the inability of shareholders to act by written consent;

 

    advance notice requirements for nominating directors or introducing other business to be conducted at shareholder meetings; and

 

    the requirement to obtain approval of two-thirds of our directors to approve certain transactions, including a merger.

 

The foregoing factors could impede a merger, takeover or other business combination or discourage a potential investor from making a tender offer for our common stock, which, under certain circumstances, could reduce the market value of our common stock. Such provisions also may have the effect of preventing changes in our management. See “Description of Capital Stock.”

 

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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

 

This prospectus includes “forward-looking statements” that involve risks and uncertainties. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenue or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, business trends and other information that is not historical information and, in particular, appear under the headings “Prospectus Summary,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” When used in this prospectus, the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” “foresees,” “likely,” “may,” should,” “goal,” “target” and variations of such words or similar expressions are intended to identify forward-looking statements. All forward-looking statements are based upon information available to us on the date of this prospectus.

 

These forward-looking statements are subject to risks, uncertainties and other factors, many of which are outside of our control, that could cause actual results to differ materially from the results discussed in the forward-looking statements, including, among other things, the matters discussed in this prospectus in the sections captioned” “Prospectus Summary,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Such factors may include:

 

    our ability to combine and integrate Borden Chemical, RPP, RSM and Bakelite and achieve cost savings;

 

    general economic and business conditions including those influenced by international and geopolitical events such as the wars in Iraq and Afghanistan and any future terrorist attacks;

 

    industry trends;

 

    the highly cyclical nature of the end-use markets in which we participate;

 

    raw material costs and availability;

 

    restrictions contained in our debt agreements;

 

    our substantial leverage, including the inability to generate the necessary amount of cash to service our existing debt and the incurrence of substantial indebtedness in the future;

 

    the possibility of liability for pollution and other damage that is not covered by insurance or that exceeds our insurance coverage;

 

    increased competition in the markets in which we operate;

 

    changes in demand for our products;

 

    the loss of any of our major customers;

 

    our dependence on a limited number of key executives who we may not be able to adequately replace if they leave our company;

 

    changes in, or the failure or inability to comply with, government regulations, agricultural policy and environmental, health and safety requirements;

 

    changes in pension fund investment performance, required pension contributions or assumptions relating to pension costs or expected return on plan assets;

 

    changes in business strategy, development plans or cost savings plans;

 

    the loss of any of our major suppliers or the bankruptcy or financial distress of our customers;

 

    the ability to attain and maintain any price increases for our products;

 

    foreign currency fluctuations and devaluations and political instability in our foreign markets;

 

    the loss of our intellectual property rights;

 

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    availability, terms and deployment of capital; and

 

    other factors over which we have little or no control.

 

There may be other factors that could cause our actual results to differ materially from the results referred to in the forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this prospectus and are expressly qualified in their entirety by the cautionary statements included in this prospectus. We undertake no obligation to publicly update or revise forward-looking statements to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events, except as required by law.

 

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USE OF PROCEEDS

 

We estimate that we will receive net proceeds from our offering of our common stock, after deducting underwriting discounts and other expenses, of approximately $325 million, assuming the shares are offered at $             per share, which is the midpoint of the estimated offering price range set forth on the cover of this prospectus. We intend to use all of our net proceeds from this offering and available cash of $35 million to redeem all of our outstanding Series A Preferred Stock at its then-accreted value.

 

We will not receive any proceeds for the sale of our common stock by the selling shareholder, including if the underwriters exercise their option to purchase additional shares. In the aggregate, the selling shareholder will receive approximately $             million of the net proceeds of this offering, or approximately $             million if the underwriters’ option to purchase additional shares is exercised in full, assuming the shares are offered at $             per share, which is the midpoint of the estimated offering price range set forth on the cover of this prospectus.

 

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DIVIDEND POLICY

 

We do not currently intend to pay any cash dividends on our common stock, and instead intend to retain earnings, if any, for future operations and debt reduction. Our senior secured credit facilities and the indentures governing our notes impose restrictions on our ability to pay dividends, and thus our ability to pay dividends on our common stock will depend upon, among other things, our level of indebtedness at the time of the proposed dividend and whether we are in default under any of our debt instruments. See “Description of Certain Indebtedness.” Our future dividend policy will also depend on the requirements of any future financing agreements to which we may be a party and other factors considered relevant by our board of directors. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, cash requirements, financial condition, business opportunities, provision of applicable law and other factors that our board of directors may deem relevant. For a discussion of our cash resources and needs, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

On May     , 2005, we used the proceeds that we received from the offering of shares of our Series A Preferred Stock and a portion of the proceeds from our new senior secured credit facilities to pay a special dividend of approximately $             million to our parent, BHI Acquisition LLC, which in turn paid a pro rata special dividend to its equity holders, including Apollo, other investors and certain members of our management.

 

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CAPITALIZATION

 

The following table sets forth our cash and equivalents and our capitalization as of December 31, 2004 (i) on an actual combined basis for Hexion, (ii) on an as adjusted basis giving effect to the Current Transactions described below and (iii) on a pro forma, as adjusted basis giving effect to the Current Transactions described below and this offering. You should read this table in conjunction with “Selected Historical Financial and Other Information,” “Unaudited Pro Forma Combined Financial Information,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and all of the financial statements and the related notes included elsewhere in this prospectus.

 

    

Actual

Combined


   

As Adjusted for the

Current Transactions (1)


   

Pro Forma,
As Adjusted (2)


 
     (in millions)  

Cash and equivalents

   $ 152     $ 94     $ 59  
    


 


 


Debt:

                        

Senior credit facilities

   $ 153     $ 396     $ 396  

Senior secured notes (3)

     816       1,074       1,074  

Senior unsecured debentures

     440       440       440  

Senior subordinated notes (3)

     332       340       340  

Seller notes

     50       —         —    

Industrial revenue bonds

     34       34       34  

Other debt and capital leases

     16       36       36  

Short-term debt

     9       40       40  
    


 


 


Total debt

     1,850       2,360       2,360  
    


 


 


Preferred Stock:

                        

Series A Preferred Stock, par value $0.01 per share, initial liquidation preference $350 million actual: no shares authorized, issued and outstanding; as adjusted:              shares authorized,              shares issued and outstanding; pro forma, as adjusted:              shares authorized, no shares issued and outstanding (4)

     —         350       —    
    


 


 


Shareholders’ Deficit:

                        

Common stock, par value $0.01 per share: actual              pre-split shares authorized,              pre-split shares issued and outstanding; as adjusted:              shares authorized,              shares issued and outstanding; pro forma, as adjusted:              shares authorized,              shares issued and outstanding

     1       1       1  

Additional paid-in capital (5)

     1,587       538       853  

Treasury stock

     (296 )     (296 )     (296 )

Receivable from parent of Hexion

     (561 )     —         —    

Accumulated other comprehensive income

     50       50       50  

Accumulated deficit

     (1,043 )     (1,062 )     (1,062 )
    


 


 


Total shareholders’ deficit

     (262 )     (769 )     (454 )
    


 


 


Total capitalization

   $ 1,588     $ 1,941     $ 1,906  
    


 


 



(1) Reflects the following Current Transactions: (i) the exchange by minority shareholders of their interests and the payment of fees and expenses in connection therewith, (ii) the borrowings under our new senior secured credit facilities, (iii) the issuance of our Series A Preferred Stock, (iv) the repayment of existing debt and payment of a dividend to our shareholders and (v) the Bakelite Transaction.

 

(2) Reflects (i) the transactions described in (1) above and (ii) the sale of      shares of our common stock by us in this offering at an assumed initial public offering price of $     per share, the mid-point of the estimated offering price range shown on the cover of this prospectus, and the application of the net proceeds to the Company to redeem our Series A Preferred Stock as described further under “Use of Proceeds.”

 

(3) Includes a purchase accounting adjustment to reflect the fair value of the RPP senior secured notes and senior subordinated notes of $8 and $8, respectively.

 

(4) In the event that the Combinations are not consummated on or prior to July 31, 2005, or the transaction agreement is terminated at any time prior thereto, we will be required to redeem, using escrowed funds, the Series A Preferred Stock at a redemption price equal to its liquidation preference including accrued and unpaid dividends to the redemption date. As the unaudited pro forma combined financial data has been prepared under the presumption that the Combinations have occurred and therefore the special mandatory redemption would not be operative, the Series A Preferred Stock is not presented as a liability.

 

(5) Additional paid-in capital gives effect to the redemption of the Series A Preferred Stock, which will accrete from its issue date until redeemed, from the net proceeds to the Company from this offering. We estimate that the Series A Preferred Stock will be outstanding for one quarter and will result in the accretion of dividends of $10.

 

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DILUTION

 

Our net tangible book deficit as of                                 , after giving effect to the Current Transactions, was $             million, or $             per share of common stock. We have calculated this amount by:

 

    subtracting our total liabilities from our total tangible assets; and

 

    then dividing the difference by the number of shares of common stock outstanding.

 

If we give effect to our sale of              shares of common stock in this offering at the initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover of the prospectus, after deducting the underwriting discounts and commissions and the estimated offering expenses payable by us, our adjusted net tangible book value as of                                     would have been $             million, or $             per share. This amount represents an immediate dilution of $             per share to new investors. The following table illustrates this per share dilution:

 

     Per Share

Initial public offering price

          $             

Net tangible book deficit as adjusted

   $                    

Decrease in net tangible book value attributable to new investors

             
    

      

Pro forma net tangible book deficit after this offering

             
           

Dilution to new investors

          $             
           

 

The following table summarizes on the basis described above, as of                         , the difference between the number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid by existing shareholders and by new investors, at the initial public offering price of $             per share, before deducting underwriting discounts and commissions and estimated offering expenses payable by us:

 

     Shares Purchased

  Total Consideration

 

Average Price
Per Share


     Number

   Percent

  Amount

   Percent

 

Existing shareholders

                %   $                             %   $             

New investors

                       $  
    
  
 

  
     

Total

                %   $                             %      
    
  
 

  
     

 

The tables above assume no exercise of stock options outstanding on                                 . As of                                 , there were options outstanding to purchase              shares of common stock, at a weighted average exercise price of approximately $             per share. If all of these outstanding options had been exercised as of                                 , net tangible book value per share after this offering would have been $             and total dilution per share to new investors would have been $            . The tables above also assume no exercise of the underwriters’ over-allotment option. If the underwriters exercise their option to purchase additional shares of our common stock in this offering, there will be further dilution to investors.

 

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UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION

 

We derived the unaudited pro forma combined financial data set forth below by the application of the pro forma adjustments to the historical combined financial statements of Hexion, appearing elsewhere in this prospectus. The combined balance sheet and statement of operations of Hexion as of and for the year ended December 31, 2004, include (1) RPP as of and for the year ended December 31, 2004 and reflect purchase accounting adjustments from the date of acquisition by Apollo on November 14, 2000; (2) RSM as of and for the period from August 2, 2004 (effective date of Apollo acquisition) through December 31, 2004 and reflect the acquisition under the purchase method of accounting; and (3) Borden Chemical as of and for the period from August 12, 2004 (date of Apollo acquisition) to December 31, 2004 on a historical basis. Borden Chemical has elected not to apply push-down accounting because it is a public reporting registrant as a result of public debt that was outstanding prior to the acquisition and which remains outstanding.

 

The unaudited pro forma combined balance sheet as of December 31, 2004, gives pro forma effect to the following Transactions as if they each occurred on December 31, 2004:

 

    the exchange by minority shareholders of their interests as part of the Combinations, the payment of fees and expenses in connection therewith and the Bakelite Transaction;

 

    the borrowing under our new senior secured credit facilities, the issuance of our Series A Preferred Stock and the application of the net proceeds therefrom to repay existing debt and pay a dividend on our common stock (the “Financings”); and

 

    this offering, including the application of the net proceeds received by us to redeem our Series A Preferred Stock at its accreted value.

 

The unaudited pro forma combined statement of operations for the year ended December 31, 2004, gives pro forma effect to the Transactions (other than the RPP Transaction) as if they occurred on January 1, 2004. The unaudited pro forma combined financial data includes financial data for Bakelite which has been derived from the audited US GAAP financial statements of Bakelite included in this prospectus. The pro forma weighted average shares used to calculate pro forma basic net loss per share give effect to the shares expected to be issued in this offering.

 

The pro forma adjustments relating to the Bakelite Transaction and the minority interest acquisitions as part of the Combinations are based on preliminary estimates of the fair value of the consideration provided, estimates of the fair values of assets acquired and liabilities assumed and available information and assumptions. The final determination of fair value could result in changes to the pro forma adjustments and the pro forma data included herein. The preliminary work performed by independent third-party appraisers has been considered in our estimates of the fair values reflected in these unaudited pro forma combined financial statements.

 

The final purchase price allocations are also dependent on whether there are any post-closing adjustments on the finalization of asset and liability valuations. A final determination of these fair values will reflect our consideration of final valuations prepared by independent third-party appraisers. These final valuations will be based on the actual net tangible and intangible assets that existed as of the closing dates of the Bakelite Transaction and the Combinations. The Bakelite share purchase agreement provides for a working capital adjustment to the purchase price that was paid at closing. Any final adjustment may change the allocations of purchase price, which could affect the fair value assigned to the assets and liabilities and could result in a change to the unaudited pro forma combined financial statements, including the adjustment of goodwill.

 

The unaudited pro forma combined financial information is presented for informational purposes only and does not purport to represent what our results of operations would actually have been if the Transactions had occurred on the dates indicated nor do they purport to project our results of operations for any future period.

 

You should read our unaudited pro forma combined financial statements and the accompanying notes in conjunction with all of the historical financial statements and related notes included in this prospectus and other financial information appearing elsewhere in this prospectus, including information contained in “Capitalization” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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HEXION SPECIALTY CHEMICALS, INC.

Unaudited Pro Forma Combined Balance Sheet

as of December 31, 2004

(dollars in millions)

 

    Actual

 

Combinations

and the Bakelite
Transaction


    Financings

    Offering

       
    Hexion (1)

    Bakelite (2)

  Adjustments (3)

    Subtotal

    Adjustments (4)

    Subtotal

    Adjustments (5)

    Pro Forma

 

Assets

                                                             

Current assets:

                                                             

Cash and equivalents

  $ 152     $ 8   $ (36 )(a)   $ 124     $ (30 )(a)   $ 94     $ (35 )   $ 59  

Accounts receivable

    518       136     —         654       —         654       —         654  

Accounts receivable from affiliates

    —         23     (23 )(b)     —         —         —         —         —    

Inventories

    405       106     —         511       —         511       —         511  

Deferred tax asset

    14       2     —         16       —         16       —         16  

Other current assets

    50       6     —         56       —         56       —         56  
   


 

 


 


 


 


 


 


      1,139       281     (59 )     1,361       (30 )     1,331       (35 )     1,296  

Property and equipment

    1,323       233     45 (c)     1,601       —         1,601       —         1,601  

Goodwill

    51       12     70 (c)     133       —         133       —         133  

Other non-current assets

    95       7     10 (d)     112       5 (b)     117       —         117  

Other intangible assets

    88       15     48 (c)     151       —         151       —         151  
   


 

 


 


 


 


 


 


Total assets

  $ 2,696     $ 548   $ 114     $ 3,358     $ (25 )   $ 3,333     $ (35 )   $ 3,298  
   


 

 


 


 


 


 


 


Liabilities and shareholders’ equity (deficit)

                                                             

Current liabilities:

                                                             

Accounts and drafts payable

  $ 488     $ 72   $  —       $ 560     $  —       $ 560     $ —       $ 560  

Debt payable within one year

    16       34     (7 )(b)     43       4 (c)     47       —         47  

Other current liabilities

    202       31     —         233       —         233       —         233  
   


 

 


 


 


 


 


 


      706       137     (7 )     836       4       840       —         840  

Long-term debt

    1,834       38     248 (b)(c)     2,120       193 (c)     2,313       —         2,313  

Long-term pension obligations

    73       109     9 (c)     191       —         191       —         191  

Non-pension postemployment benefit obligations

    142       —       —         142       —         142       —         142  

Deferred tax liability

    131       26     29 (c)     186       —         186       —         186  

Other long-term liabilities

    72       8     —         80       —         80       —         80  
   


 

 


 


 


 


 


 


Total liabilities

    2,958       318     279       3,555       197       3,752       —         3,752  

Series A Preferred Stock

    —         —       —         —         350 (d)     350       (350 )     —    

Shareholders’ equity (deficit)

    (262 )     230     (165 )     (197 )     (572 )(e)     (769 )     315       (454 )
   


 

 


 


 


 


 


 


Total liabilities and shareholders’ equity (deficit)

  $ 2,696     $ 548   $ 114     $ 3,358     $ (25 )   $ 3,333     $ (35 )   $ 3,298  
   


 

 


 


 


 


 


 


 

 

 

See Notes to Unaudited Pro Forma Combined Balance Sheet

 

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Notes to Unaudited Pro Forma Combined Balance Sheet

 

(1) We have restated our balance sheets dated as of December 31, 2003 and 2004 from the previously filed balance sheets included in our initial filing of the Registration Statement on Form S-1 filed on April 25, 2005. See Note 17 to our audited combined financial statements included elsewhere in this prospectus.

 

(2) The historical combined balance sheet of Bakelite as of December 31, 2004 has been translated into dollars at the closing exchange rate on December 31, 2004 of 1.3538 U.S. dollars to one euro. The translations should not be construed as representations that the U.S. dollar amounts actually represent such euro amounts or could have been or will be converted into euros at the rate indicated or at all. The historical combined balance sheet of Bakelite as of December 31, 2004 in euros is as follows:

 

Assets

      

Current assets:

      

Cash and equivalents

     €6

Accounts receivable

     100

Accounts receivable from affiliates

     17

Inventories

     79

Deferred tax asset

     2

Other current assets

     4
    

       208

Property and equipment

     173

Goodwill

     8

Other non-current assets

     5

Other intangible assets

     11
    

Total assets

     €405
    

Liabilities and shareholders’ equity

      

Current liabilities:

      

Accounts and drafts payable

     €54

Debt payable within one year

     25

Other current liabilities

     23
    

       102

Long-term debt

     28

Long-term pension obligations

     80

Deferred tax liability

     19

Other long-term liabilities

     6
    

       235

Shareholders’ equity

     170
    

Total liabilities and shareholders’ equity

     €405
    

 

(3) Reflects the following Combinations: the exchange by minority shareholders of their interests and the payment of fees and expenses in connection therewith.

 

Set forth below are the estimated sources and uses of funds pertaining to the Bakelite Transaction assuming the Bakelite Transaction was consummated on December 31, 2004.

 

Sources


Cash on hand and assumed debt(i)

   $ 70

Senior secured debt (ii)

     250
    

Total Sources

   $ 320
    

Uses


Acquisition consideration(i) (iii)

   $ 279

Estimated transaction fees and expenses (iv)

     41
    

Total Uses

   $ 320
    

  (i) Acquisition consideration reflects our assumption of $48 million of Bakelite debt in connection with the Bakelite Acquisition, the assumption of which reduced the cash purchase price dollar-for-dollar. Actual balances as of the closing date were different from those presented herein.

 

  (ii) We intend to use the proceeds of the issuance of our senior secured debt to repay amounts outstanding under, and in connection therewith terminate, the bridge loan facility.

 

  (iii) The purchase price under the Bakelite share purchase agreement is subject to a post-closing adjustment based on working capital.

 

  (iv) Reflects the fees and expenses associated with the Bakelite Transaction, including placement and other financing fees, advisory fees and other transaction costs and professional fees. Approximately $10 million will be capitalized on the balance sheet as deferred financing fees.

 

The Bakelite Acquisition was financed through a combination of available cash and borrowings under our bridge loan facility. The proceeds from the issuance of the $250 senior secured debt will be used to repay all amounts outstanding under, and to terminate the $250 bridge loan financing.

 

  (a) Reflects adjustments for the following changes in cash:

 

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Bakelite Transaction

        

Issuance of senior secured debt, net of transaction costs of $13

   $ 237  

Bakelite debt assumed

     48  

Total cost of acquisition

     (307 )
    


Cash on hand

     (22 )

Bakelite cash not acquired

     (8 )
    


       (30 )

The Combinations

        

Certain Combinations and cost of those Combinations

     (6 )
    


Net adjustment to cash

   $ (36 )
    


 

  (b) Reflects the assumed issuance of senior secured debt in the amount of $250 and the settlement of Bakelite net debt not assumed, including accounts receivable from affiliates of $23, debt payable within one year of $7 and long-term debt of $18. The net change in long-term debt reflects the following:

 

Senior secured debt

   $ 250  

Less historical Bakelite debt not assumed

     (18 )

Purchase accounting adjustment to reflect the fair value of the RPP senior subordinated notes and senior secured notes of $8 and $8, respectively

     16  
    


Net change in long-term debt

   $ 248  
    


 

  (c) The acquisition of Bakelite will be accounted for using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” An allocation of the purchase price to reflect the estimated fair values of certain of Bakelite’s assets and liabilities has been reflected in the unaudited pro forma financial information. In addition, as part of the Combinations, common stock owned by minority shareholders of RPP and RSM will be exchanged, and such exchange will be accounted for using the purchase method of accounting. The acquisition cost of the minority interest has been based on the estimated relative fair values of the entities combined. An allocation of the purchase price to reflect the fair values of certain RPP and RSM assets and liabilities has been reflected in the unaudited pro forma combined financial information to step up the assets and liabilities of RPP and RSM.

 

     Bakelite

   RPP/RSM
Minority
Interests


Acquisition costs

   $ 279    $ 113

Acquisition related costs

     28      —  
    

  

Total cost of acquisition

     307      113

Estimated fair value of net assets acquired

     289      49
    

  

Goodwill

   $ 18    $ 64
    

  

 

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The following table summarizes the adjustments to assets acquired and liabilities assumed through purchase accounting.

 

     Bakelite

   RPP/RSM
Minority
Interests


   Total

Property and equipment

   $ 26    $ 19    $ 45

Goodwill

     6      64      70

Other intangible assets

     33      15      48

Long-term debt

     —        16      16

Long-term pension obligations

     9      —        9

Deferred tax liability

     22      7      29

 

For purposes of determining the deferred tax liability, the appropriate statutory tax rates of the respective tax jurisdictions to which adjustments relate have been applied.

 

The Bakelite share purchase agreement provides for a working capital adjustment to the purchase price which was estimated and paid at closing in the amount of $12 and may be adjusted, if necessary. The final purchase price allocations are also dependent on whether there are any post-closing adjustments on the finalization of asset and liability valuations. A final determination of these fair values will reflect our consideration of final valuations prepared by independent third-party appraisers. These final valuations will be based on the actual net tangible and intangible assets that existed as of the closing date of the Combinations. Any final adjustment may change the allocations of purchase price, which could affect the fair value assigned to the assets and liabilities and could result in a change to the unaudited pro forma combined financial statements, including adjustment of goodwill.

 

  (d) Of the $41 of the estimated transaction fees and expenses, $10 represents the expected amounts of financing fees which will be capitalized related to the Bakelite Acquisition.

 

(4) Set forth below are the estimated sources and uses of funds pertaining to the Financings assuming the Financings were consummated on December 31, 2004.

 

Sources


Proceeds from Series A Preferred Stock

   $ 350

Borrowing under new senior secured credit facilities

     400

Available cash

     30
        
        
        
        
    

Total sources

   $ 780
    

Uses


Repayment of senior secured credit facilities

   $ 153

Repayment of seller notes

     50

Common stock dividend

     550

Transaction costs—Series A Preferred Stock

     14

Transaction costs—new senior secured credit facilities

     13
    

Total uses

   $ 780
    

 

   (a) Reflects the use of available cash.

 

   (b) Reflects the difference between the expected amounts of financing fees which will be capitalized related to the refinancing of existing debt of $13 and the write-off of $8 of unamortized deferred debt issuance cost of debt repaid.

 

   (c) Reflects the assumed borrowings under our senior secured credit facilities of $400, the proceeds of which will be paid as a dividend to our shareholders of $200 and to settle certain RPP and RSM debt of $200. Of the net change in debt of $197, $4 is classified as debt payable within one year and $193 is classified as long-term debt.

 

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   (d) Reflects the issuance of $350 of Series A Preferred Stock, the proceeds of which will be held in escrow until the Combinations occur, at which time such proceeds will be paid as a dividend to our shareholders. In the event that the Combinations are not consummated on or prior to July 31, 2005, or the transaction agreement is terminated at any time prior thereto, we will redeem, using escrowed funds, the Series A Preferred Stock at a redemption price equal to its liquidation preference including accrued and unpaid dividends to the redemption date.

 

   (e) Reflects the payment of dividends to shareholders of $550, Series A Preferred Stock transaction costs of $14 and the write-off of unamortized capitalized debt issuance costs of $8.

 

(5) Set forth below are the estimated sources and uses of funds pertaining to this common stock offering.

 

Sources


Offering of common stock

   $ 360

Available cash

     35
    

Total sources

   $ 395
    

Uses


Redemption of Series A Preferred Stock

   $ 360

Transaction costs—common stock

     35
    

Total uses

   $ 395
    

 

The common stock offering is expected to raise proceeds of $325 (net of estimated fees and expenses) to the Company which, along with available cash, will be used to redeem the Series A Preferred Stock at its accreted amount which is estimated to be $360 at the time of this offering. The change in stockholders’ deficit of $315 is comprised of the net proceeds of $325 less assumed Series A Preferred Stock dividends of $10.

 

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HEXION SPECIALTY CHEMICALS

Unaudited Pro Forma Combined Statement of Operations

For the year ended December 31, 2004

(dollars in millions, except per share data)

 

    Actual

    Preacquisition

    Actual

   

Combinations,

Prior Transactions and
Bakelite Transaction


    Financings

    Offering

       
    Hexion

    Borden (1)

    RSM (2)

    Bakelite (3)

    Adjustments (4)

    Subtotal

    Adjustments (5)

    Adjustments(6)

    Pro Forma

 

Net sales

  $ 2,019     $ 984     $ 440     $ 699     $ (37 )(a)   $ 4,105     $ —       $ —       $ 4,105  

Cost of sales

    1,785       832       407       593       (53 )(a)     3,564       —         —         3,564  
   


 


 


 


 


 


 


 


 


Gross profit

    234       152       33       106       16       541       —         —         541  
   


 


 


 


 


 


 


 


 


Selling, general & administrative expense

    163       100       48       82       (5 )(b)     388       —         (2 )(a)     386  

Transaction related compensation and other costs

    24       —         —         —         —         24       —         —         24  

Impairments

    2       —         64       20       —         86       —         —         86  

Other operating expense

    5       4       7       3       —         19       —         —         19  
   


 


 


 


 


 


 


 


 


Operating income (loss)

    40       48       (86 )     1       21       24       —         2       26  

Interest expense

    118       31       5       4       42 (c)     200       11 (a)             211  

Affiliated interest expense, net

    —         —         —         (1 )     1 (d)     —         —         —         —    

Transaction costs

    32       9       —         —         —         41       —         —         41  

Other non-operating expense (income)

    4       2       1       —         —         7       —         —         7  
   


 


 


 


 


 


 


 


 


Income (loss) before tax

    (114 )     6       (92 )     (2 )     (22 )     (224 )     (11 )     2       (233 )

Income tax (benefit) expense

    —         143       1       1       (7 )(e)     138       (3 )(b)     1 (b)     136  
   


 


 


 


 


 


 


 


 


Net loss

  $ (114 )   $ (137 )   $ (93 )   $ (3 )   $ (15 )   $ (362 )   $ (8 )(c)   $ 1     $ (369 )
   


 


 


 


 


 


 


 


 


Pro Forma loss per share (7)

                                                                       

Basic and Diluted

                                                                       

Pro Forma average number of common shares outstanding (7)

                                                                       

Basic and Diluted

                                                                       

 

 

See Notes to Unaudited Pro Forma Combined Statements of Operations

 

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Notes to Unaudited Pro Forma Combined Statement of Operations

 

(1) The Borden Transaction occurred on August 12, 2004. The historical data with respect to Borden Chemical presented in the unaudited pro forma combined statement of operations for the year ended December 31, 2004 relates to the period from January 1, 2004 to August 11, 2004. From August 12, 2004, data with respect to Borden Chemical is included in the Hexion historical data.

 

(2) The RSM Transaction occurred on August 2, 2004. The historical data with respect to RSM presented in the unaudited pro forma combined statement of operations for the year ended December 31, 2004 relates to the period from January 1, 2004 to August 1, 2004. From August 2, 2004, data with respect to RSM is included in the Hexion historical data.

 

(3) The historical combined statement of operations of Bakelite for the year ended December 31, 2004 has been translated into U.S. dollars at the average exchange rate for the year of 1.2478 U.S. dollars to one euro. It should be noted that such translations should not be construed as representations that the U.S. dollar amounts actually represent such euros amounts, or could have been or will be converted into euros at the rate indicated or at all. The historical combined statement of operations of Bakelite for the year ended December 31, 2004 in euros is as follows:

 

 

Net sales

     €560  

Cost of sales

     475  
    


Gross profit

     85  

Selling, general and administrative expense

     66  

Impairments

     16  

Other operating expense

     2  
    


Operating income

     1  

Interest expense

     3  

Affiliated interest expense, net

     (1 )

Other non-operating expense (income)

     —    
    


Loss before income tax

     (1 )

Income tax expense

     (1 )
    


          

Net loss

   (2 )
    


 

To conform the presentation of Bakelite’s with Hexion’s statement of operations, Bakelite’s distribution expense of €15 and marketing expense of €34 have been included in costs of sales and selling, general and administrative expense, respectively.

 

(4) Reflects the following adjustments:

 

  (a) Elimination of intercompany activity resulted in the reduction of net sales and cost of sales by $37 and $38, respectively. Additionally, cost of sales reflects the adjustments to decrease depreciation and amortization expense resulting from fair value adjustments to certain property and equipment and amortizable intangible assets of $5, an adjustment to account for inventory on a first-in-first-out basis for both the pre- and post-acquisition periods of RSM of $1 and to reverse an amount of $9 which represents the write-up of inventory that was recorded as part of the RSM purchase price allocation and subsequently expensed through cost of sales.

 

  (b) Reflects the decrease in depreciation and amortization expense resulting from fair value adjustments to certain property and equipment and the amortizable intangible assets to be acquired of $4 and to eliminate management fees of $1.

 

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  (c) Represents the new debt issued in the Bakelite Transaction and the effect of a full year of interest related to the debt outstanding as a result of the Prior Transactions and the Combinations:

 

     Total

 

Bakelite Transaction

        

Senior secured debt

   $ 22  

Amortization of debt issuance costs

     1  

Less Bakelite historical interest expense on debt not assumed

     (2 )
    


       21  
    


The Prior Transactions and the Combinations

        

Second-priority senior secured notes

     41  

RSM seller subordinated notes due 2011

     4  

Term loans due 2010

     6  

Amortization of debt issuance costs

     4  

Less premium on RPP credit facility

     (3 )

Less historical interest expense

     (31 )
    


       21  
    


Net adjustment to interest expense

   $ 42  
    


 

The interest rates in effect at December 31, 2004 were used to compute the pro forma adjustments to interest expense except for newly issued variable rate debt for which the rate was based on the current rate. Each one-eighth point change in the assumed interest rates would result in a $1 change in interest expense.

 

  (d) Affiliated debt and the associated interest income are eliminated as part of the Bakelite Transaction.

 

  (e) The appropriate statutory tax rates of the respective tax jurisdictions to which adjustments relate have been applied.

 

(5) Reflects the following adjustments:

 

  (a) The adjustment represents the following change in interest expense related to the Financings:

 

New senior secured credit facilities

   $ 23  

Amortization of debt issuance costs

     2  

Less historical interest expense

     (14 )
    


Net adjustment to interest expense

   $ 11  
    


 

The interest rate used on the $400 drawn on the $675 new senior secured credit facility, which bears interest at a LIBOR plus 2.25% variable rate, was based on the current rate. Each one-eighth point change in the assumed interest rates would result in a $1 change in interest expense.

 

  (b) The appropriate statutory tax rates of the respective tax jurisdictions to which adjustments relate have been applied.

 

  (c) Net loss does not include the accretion on the Series A Preferred Stock as it is a non-recurring event. The Series A Preferred Stock will accrete from its issue date until redeemed from the net proceeds of this Offering. If the Series A Preferred Stock is outstanding for one quarter, it will result in the accretion of dividends of $20, $10 due to the dividend rate and $10 of net issuance costs, which will be a one-time charge to net loss.

 

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(6) Reflects the following adjustments:

 

  (a) Reflects the elimination of management fees of $2 in connection with the common stock offering.

 

 

  (b) The appropriate statutory tax rates of the respective tax jurisdictions to which adjustments relate have been applied.

 

(7) Pro forma basic and diluted loss per common share are computed by dividing loss available to common stockholders by the weighted average number of common shares outstanding during the period. Since we had a net loss for the year ended December 31, 2004, shares issuable upon the exercise of employee stock options have an antidilutive effect. Therefore, the unaudited pro forma diluted loss per share is the same as the unaudited pro forma basic loss per share. Unaudited pro forma basic and diluted loss per share have been calculated in accordance with the SEC rules for initial public offerings. These rules require that the weighted average share calculation give retroactive effect to any changes in our capital structure as well as the number of shares whose sale proceeds will be used to repay any debt or pay dividends as reflected in the pro forma adjustments. Therefore, pro forma weighted average shares for purposes of the unaudited pro forma basic loss per share calculation have been adjusted to reflect the sale of              shares by us in this offering.

 

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SELECTED HISTORICAL FINANCIAL AND OTHER INFORMATION

 

The combination of Borden Chemical, RPP and RSM has been treated, for accounting purposes, as a combination of entities under common control due to Apollo’s controlling interest in each of the companies. The audited combined financial statements presented herein reflect the results of operations of each company from the date such company was acquired by Apollo.

 

The following table presents selected historical financial and other data of Hexion. The selected historical financial and other data of Hexion as of December 31, 2003 and 2004, and for the years ended December 31, 2002, 2003 and 2004 has been derived from the audited combined financial statements of Hexion, included elsewhere in this prospectus. The financial data of Hexion for the years ended December 31, 2000 and 2001 represent the operating results of RPP, not included herein, which reflect purchase accounting adjustments following the acquisition of RPP by Apollo on November 14, 2000. The financial data for Hexion for the year ended December 31, 2004, includes:

 

    The results of operations of RPP for the full year ended December 31, 2004, which reflect purchase accounting adjustments from the date of acquisition of RPP by Apollo on November 14, 2000;

 

    The results of operations of Borden Chemical for the period from August 12, 2004 to December 31, 2004, on a historical basis (because Borden Chemical is a public reporting registrant as a result of public debt that was outstanding prior to the Borden Transaction and which debt remains outstanding, Borden Chemical has elected to present its financial statements from the date of its acquisition by Apollo on the historical basis of accounting permitted under the SEC’s public debt exemption); and

 

    The results of operations of RSM for the period from August 2, 2004 to December 31, 2004 which reflect purchase accounting adjustments following the acquisition of RSM by Apollo on August 2, 2004.

 

You should read this data in conjunction with “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” and all the financial statements and the related notes included elsewhere in this prospectus.

 

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     Predecessor

  

Successor


 
     10 months
ended
October 31,
2000


   2 months
ended
December 31,
2000(1)


    Year ended December 31,

 
          2001

    2002

    2003(2)

    2004(2)(3)

 
                (dollars in millions)  

Statement of Operations:

                                               

Net sales

   $ 797    $ 152     $ 863     $ 740     $ 782     $ 2,019  

Cost of sales

     642      153       695       601       714       1,785  
    

  


 


 


 


 


Gross profit (loss)

     155      (1 )     168       139       68       234  
    

  


 


 


 


 


Selling, general & administrative expense

     75      22       90       82       81       163  

Transaction related compensation and other costs

     —        —         —         —         —         24  

Impairments

     —        —         —         —         33       2  

Other operating expense (income)

     —        —         —         16       (3 )     5  
    

  


 


 


 


 


Operating income (loss)

     80      (23 )     78       41       (43 )     40  
    

  


 


 


 


 


Interest expense

     —        9       70       65       77       118  

Transaction costs

     —        —         —         —         —         32  

Other non-operating expense (income)

     6      (8 )     14       —         —         4  
    

  


 


 


 


 


Income (loss) before income tax

     74      (24 )     (6 )     (24 )     (120 )     (114 )

Income tax expense (benefit)

     27      (17 )     —         (10 )     (37 )     —    
    

  


 


 


 


 


Net income (loss)

   $ 47    $ (7 )   $ (6 )   $ (14 )   $ (83 )   $ (114 )
    

  


 


 


 


 


Cash Flow Data:

                                      

Cash flows from (used in) operating activities

                 $ 64     $ (43 )   $ (32 )

Cash flows (used in) from investing activities

                   (45 )     7       (20 )

Cash flows (used in) from financing activities

                   (21 )     80       148  

Balance Sheet Data (at end of period):

                                      

Cash and equivalents

   $ 19    $ 6    $ 5     $ 49     $ 152  

Working capital(4)

     208      142      99       177       433  

Total assets

     1,225      1,101      1,179       1,191       2,696  

Total long-term debt

     674      581      567       675       1,834  

Total net debt(5)

     673      587      572       634       1,698  

Total liabilities

     1,012      907      949       994       2,958  

Total shareholders’ equity (deficit)

     213      194      230       197       (262 )

Other Financial Data:

                                      

Ratio of earnings to fixed charges and preferred stock dividends(6)

     —        —        —         —         —    

(1) Data from date of acquisition by Apollo on November 14, 2000 through December 31, 2000.
(2) We have restated our balance sheets dated as of December 31, 2003 and 2004 from the previously filed balance sheets included in our initial filing of the Registration Statement on Form S-1 filed on April 25, 2005. See Note 17 to our audited combined financial statements included elsewhere in this prospectus.
(3) Includes data for RSM from August 2, 2004 and for Borden Chemical from August 12, 2004, their respective dates of acquisition by Apollo.
(4) Working capital is defined as current assets less current liabilities.
(5) Net debt is defined as long-term debt plus short-term debt less cash and equivalents.
(6) Due to the net losses in years 2000 to 2004, the ratio of earning to fixed charges and preferred stock dividends was less than 1. Our earnings were insufficient to cover fixed charges by $24, $6, $24, $120 and $114, for the 2 months ended December 31, 2000 and the years ended December 31, 2001, 2002, 2003 and 2004, respectively. Our earnings were insufficient to cover fixed charges and preferred stock dividends by $233 for the year ended December 31, 2004 on a pro forma basis.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our historical combined financial statements covers periods before consummation of the offering, including the application of the proceeds therefrom and the Current Transactions. Accordingly, the discussion and analysis of such periods does not reflect the significant impact these transactions have had and will have on the Company. See “Risk Factors,” “Unaudited Pro Forma Combined Financial Information” and “—Liquidity and Capital Resources” for further discussion relating to the impact of these transactions on the Company. The following discussion should be read in conjunction with “Selected Historical Financial and Other Information” and all the financial statements and the related notes included elsewhere in this prospectus. All dollar amounts are in millions, except where otherwise indicated. In addition, the statements in the discussion and analysis regarding industry outlook, our expectations regarding the performance of our business, our liquidity and capital resources and the other non-historical statements in the discussion and analysis are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Risk Factors.” Our actual results may differ materially from those contained in or implied by the forward-looking statements. You should read the following discussion together with the sections entitled “Risk Factors,” “Unaudited Pro Forma Combined Financial Information” and “Selected Historical Financial and Other Information.”

 

Overview

 

We are the world’s largest producer of thermosetting resins, or thermosets. Thermosets are the base ingredient for virtually all paints, coatings, glues and other adhesives produced for consumer or industrial uses. We are focused primarily on providing a broad array of thermosets and associated technologies, with leading market positions in all key markets served.

 

The global thermoset resins market is approximately $34 billion in annual sales, of which our primary markets represent approximately $19 billion in annual sales.

 

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, versatic acids, UV cured coatings and electrical laminates. As of December 31, 2004, we have 86 production and distribution sites globally (including Bakelite), and produce many of our key products locally in North America, Latin America, Europe and Asia. Through this worldwide network of strategically located production facilities, we serve more than 5,000 customers in 96 countries. We believe our global scale provides us with significant advantages over many of our competitors. In areas where it is advantageous, we are vertically integrated backward into strategic raw materials providing us a low-cost operating structure and security of supply. In other areas, where we can leverage our technical know-how and market presence to capture additional value, we are integrated downstream into product formulations. Our position in certain additives, complementary materials and services further enables us to leverage our core thermoset technologies and provide customers a full suite of product solutions. Our global customers include leading companies in their respective industries, such as 3M, BASF, Bayer, DuPont, GE, Halliburton, Honeywell, Owens Corning, PPG Industries, Sumitomo, Sun Chemicals, Valspar and Weyerhaeuser.

 

Industry Conditions. As is true for many industries, our results are impacted by the effect on our customers of economic upturns or downturns, as well as the impact on our own costs to produce, sell and deliver our products. Our customers use most of our products in their production processes; therefore, factors impacting their industries could significantly affect our results.

 

Major industry sectors served by us include industrial/marine, construction, consumer/durable goods, automotive, electronics, architectural, civil engineering, repair/remodeling, graphic arts and oil and gas field

 

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support. Key drivers for our business are general economic and industrial growth, housing starts, auto builds, furniture demand, active gas drilling rigs, print advertising demand and chemical intermediates sector operating conditions.

 

After a relatively flat demand for our epoxy resins in 2002 and 2003, demand for our epoxy resins in 2004 increased significantly. Similarly, the pricing environment for our epoxy resins was positively impacted by increased demand and lack of availability of raw materials in some segments of the market.

 

From 1997 to 2000, demand for bisphenol-A (“BPA”), a key precursor in the manufacture of epoxy resins, grew by approximately 13% per year driven primarily by the polycarbonate end-uses (electronics, computer, telecommunications and data equipment), whereas from 2000 to 2004, the average growth rate was approximately 6%. In 2004 there was a strong recovery in global BPA demand primarily driven by stronger production rates. Compared to 2003, the estimated demand growth has again approached 13%. More importantly, in the second half of 2004, the resulting tightness in supply and demand has allowed for margin expansion despite the fact that the prices for phenol (BPA’s key feedstock) have seen unprecedented increases in 2004.

 

In 2004, the continuing strong U.S. housing market positively impacted us. According to Resource Information Systems, Inc. (“RISI”), housing starts were up approximately 5% in 2004 compared to 2003, driving a 6% increase in structural panel consumption. Oriented strand board, or OSB, consumption was up 5% in 2004 compared to 2003, while plywood consumption was up 7%. The shift in our sales mix from plywood to OSB also benefited us, as OSB, on a per square foot basis, uses approximately twice the amount of our resins as plywood.

 

Raw Material Costs. In 2004, raw material costs made up approximately 80% of our product costs. The primary raw materials that we use are phenol, methanol, urea, propylene, chlorine and acetone. During the past four years, the prices of these raw materials have been volatile. During the year ended December 31, 2004, prices of our major feedstocks increased significantly relative to 2003. High energy costs such as the increasing price of crude oil and related petrochemical products and the higher cost of natural gas have translated into significant increases in raw material costs. For example, the average prices of phenol, methanol and urea increased by 48%, 7% and 19% respectively. To help mitigate this volatility, we have purchase and sale contracts with many of our vendors and customers with periodic price adjustment mechanisms. For example, in our North American forest products business, approximately 60% of our sales are to customers that have contracts that allow for the passing through of increases in raw material costs on average within 30 days. Due to differences in timing of the pricing mechanism trigger points between our sales and purchase contracts there is often a “lead-lag” impact during which margins are negatively impacted for the short term in periods of rising raw material prices and positively impacted in periods of falling raw material prices. In addition, the pass through of raw material price changes can result in significant variances in sales comparisons from year to year. In 2004, we had a favorable impact on sales as raw material price increases throughout 2003 and 2004 were passed through to customers.

 

Regulatory Environment. National and international laws regulate the production and marketing of chemical substances. Although almost every country has its own legal procedure for registration and import, laws and regulations in the European Union and the United States are most significant to our business, including the European inventory of existing commercial chemical substances, the European list of notified chemical substances, and the United States Toxic Substances Control Act inventory. Chemicals which are on one or more of the above lists can usually be registered and imported without additional testing in other countries, although additional administrative hurdles may exist.

 

We are also subject to extensive regulation under the environmental and occupational health and safety laws by federal, state and local governmental entities and foreign authorities, such as the European Union. These laws are designed to protect workers and the public from exposure to certain hazardous chemicals and dangerous work conditions, to protect natural resources and to limit discharges of hazardous substances to the environment from ongoing operations. They provide for substantial fines and potential criminal sanctions for violations. They also establish requirements to remediate contamination. The laws are complex, change frequently and have tended to become more stringent over time.

 

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For example, statutes such as the Federal Comprehensive Environmental Response, Compensation, and Liability Act and comparable state and foreign laws impose strict, joint and several liability for investigating and remediating the consequences of spills and other releases of hazardous materials, substances and wastes at current and former facilities, and at third-party disposal sites. In addition, other laws permit individuals to seek recovery of damages for alleged personal injury or property damage due to exposure to hazardous substances and conditions at our facilities or to hazardous substances otherwise owned, sold or controlled by us. Therefore, notwithstanding our commitment to environmental management, we cannot assure you that environmental, health and safety liabilities will not be incurred in the future, nor that such liabilities will not result in a material adverse effect on our financial condition, results of operations or business reputation.

 

Certain chemicals have been alleged to interact with the endocrine systems of humans and wildlife and disrupt normal processes (i.e., endocrine disrupters). BPA, which is used as an intermediate at our Deer Park and Pernis manufacturing facilities and is also sold directly to third parties, is currently under evaluation as an “endocrine disrupter.” Pursuant to EU regulation 793/93/EC, BPA producers are currently conducting an extensive toxicology testing program of the chemical. In addition, new legislation in Europe will take effect in 2005 and require that risk labels be used for BPA indicating “possible risk of impaired fertility.” In the event that BPA is further regulated, additional operating costs would likely be incurred to meet more stringent regulation of the chemical.

 

Various government agencies are conducting formaldehyde health research and evaluating the need for additional regulations. Although formaldehyde has been heavily regulated for several years, further regulation of formaldehyde could follow over time. In 2004, the International Agency for Research on Cancer (“IARC”) reclassified formaldehyde as “carcinogenic to humans,” a higher classification than previous IARC evaluations based principally on a study linking formaldehyde exposure to nasopharyngeal cancer, a rare form of cancer in humans. IARC also concluded that there was strong but not sufficient evidence for a finding of a causal association between leukemia and occupational exposure to formaldehyde, although IARC could not identify a mechanism for leukemia induction. We believe that our production facilities will be able to comply with any likely regulatory impact without any material impact on the business.

 

We support appropriate scientific research and risk-based policy decision-making, and we are working with industry groups, including the Formaldehyde Council, Inc., to ensure that governmental assessments and regulations are based on sound scientific information. We believe that we have credible stewardship programs and processes in place to provide compliant and cost-effective resin systems to our customers.

 

We also actively seek approvals from the U.S. Food and Drug Administration for certain specialty chemicals produced by us, principally where we believe that these specialty chemicals will or may be used by our customers in the manufacture of products that will come in direct or indirect contact with food.

 

Competitive Environment. The chemical industry has been historically competitive, and we expect this competitive environment to continue in the foreseeable future. We compete with companies of varying size, financial strength and availability of resources. Price, customer service and product performance are the primary areas in which we compete.

 

Other Factors Impacting Our Results. Other pressures on our profit margins include rising utility costs and increasing benefit, general insurance and legal costs. We are taking a number of steps to control these costs. In addition, we are continuing to analyze our business structure, consolidating plants and functions where we can realize significant cost savings and productivity gains. These consolidations have resulted in asset impairment charges and severance costs. Future consolidations or productivity initiatives may include additional asset impairment charges and severance costs.

 

We believe that these factors will continue in the foreseeable future. These market dynamics will require us to continue to focus on productivity improvements and risk mitigation strategies to enhance and protect our margins.

 

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Outlook for 2005

 

We have experienced an improvement in demand in the markets we serve and expect to see continued improvement in demand in 2005. Supply/demand fundamentals are expected to improve, both in industrialized and developing nations. We expect this trend to result in higher utilization rates for the resins industry, which in turn will lead to continued price increases. Furthermore, we feel that the formation of Hexion will lead to improved technical capabilities for the combined entities and an ability to service our customers better.

 

However, raw material volatility could continue through 2005 because of, among other things, political instability in the Middle East or supply disruptions elsewhere. There can be no assurances that (i) any global recovery will continue during 2005, (ii) we will be able to realize margins we have historically achieved as feedstock costs decline or (iii) our feedstock costs will not rise faster than our product prices and, therefore, reduce our margins.

 

We believe we will be able to mitigate such volatility due to a number of factors: (i) our actions taken in 2004 to implement monthly or quarterly pricing mechanisms in many product lines will improve our ability to react to changing market conditions in 2005; (ii) the value-added nature of many of our product lines will allow us to continue to pass through additional feedstock price increases; and (iii) the roll-off of several long-term raw material contracts should have a step-change effect in lowering our feedstock costs.

 

There can be no assurances that (i) demand for our products will increase during 2005 or (ii) past or future price increases by us or our competitors will be accepted by our customers or that we will not lose any significant customers or volumes in the future as a result of these price increases.

 

Transactions

 

The Combinations. As of April 22, 2005, Borden Chemical entered into a transaction agreement with affiliates of RPP and RSM pursuant to which Borden Chemical agreed to combine with RPP and RSM. The Combinations are subject to customary closing conditions and Borden Chemical, RPP and RSM will continue to operate independently until those conditions are satisfied and the closing occurs. We expect that the closing of the Combinations will occur in the second quarter of 2005. Upon the consummation of the Combinations, Borden Chemical will change its name to Hexion Specialty Chemicals, Inc.

 

The Borden Transaction. On July 5, 2004, BHI Investment, LLC, an affiliate of Apollo, entered into a stock purchase agreement with BW Holdings, LLC, Borden Holdings, Inc., its wholly-owned subsidiary, Borden Chemical, Inc., and members of Borden Chemical’s management. BW Holdings, LLC is an affiliate of Kohlberg Kravis Roberts & Co. L.P., or KKR, which had controlled Borden Holdings, Inc. and Borden Chemical since 1995. On August 12, 2004, pursuant to the stock purchase agreement, BHI Investment, LLC acquired (the “Borden Acquisition”) all of the outstanding capital stock of Borden Holdings, Inc., and all of the outstanding capital stock of Borden Chemical not otherwise owned by Borden Holdings, Inc. was redeemed. The Borden Acquisition, the related offering of second-priority senior secured floating rate notes and 9% second-priority senior secured notes and the related transactions are collectively referred to in this prospectus as the “Borden Transaction.”

 

The RPP Transaction. On November 14, 2000, RPP Holdings LLC, an affiliate of Apollo Management, L.P. (“Apollo”) acquired control of Resolution Performance Products, Inc. (“RPP”) in a recapitalization transaction. Prior to the recapitalization, RPP was a wholly owned subsidiary of the Royal Dutch/Shell Group of Companies (“Shell”).

 

The RSM Transaction. On August 2, 2004, pursuant to an acquisition agreement between Resolution Specialty Materials, Inc. (“RSM”), on behalf of itself and certain affiliates, and Eastman Chemical Company (“Eastman”), RSM acquired (the “RSM Acquisition”) Eastman’s resins, inks and monomers division. The RSM Acquisition and the related transactions are collectively referred to in this prospectus as the “RSM Transaction.”

 

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The Bakelite Transaction. On April 29, 2005, Borden Chemical acquired all of the outstanding share capital of Bakelite. Upon the consummation of the Bakelite Acquisition, Bakelite became an indirect, wholly owned subsidiary of Borden Canada. The acquisition was financed through a combination of available cash and borrowings under our bridge loan facility.

 

Critical Accounting Policies

 

In preparing our financial statements in conformity with US GAAP, we have to make estimates and assumptions about future events that affect the amounts of reported assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities in the financial statements and accompanying notes. Some of our accounting policies require the application of significant judgment by management in the selection of appropriate assumptions for determining these estimates. By their nature, these judgments are subject to an inherent degree of uncertainty; therefore, we cannot assure you that actual results will not differ significantly from estimated results. We base these judgments on our historical experience, advice from experienced consultants, management’s forecasts and other available information, as appropriate. Our significant accounting policies are more fully described in Note 2 to the Combined Financial Statements included elsewhere in this prospectus.

 

Our most critical accounting policies, which reflect significant management estimates and judgment in determining reported amounts in the Combined Financial Statements included elsewhere in this prospectus, are as follows:

 

Basis of Presentation. The Combined Financial Statements include the accounts of the Company and its majority-owned subsidiaries, in which minority shareholders hold no substantive participating rights, after elimination of intercompany accounts and transactions. The Company’s share of the net earnings of 20% to 50% owned companies, which it has the ability to exercise significant influence over operating and financial policies, are included in income on an equity basis. Investments in the other companies are carried at cost.

 

RPP, Borden Chemical and RSM are considered entities under the common control of Apollo as defined in EITF 02-5 “Definition of Common Control in Relation to FASB Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” As a result of the Combinations, the financial statements of these entities are presented on a combined basis and include the results of operations of each business only from the date of acquisition by Apollo.

 

The financial data for Hexion for the years ended December 31, 2002 and 2003 include the results of operations of RPP only. The financial data for Hexion for the year ended December 31, 2004, includes:

 

    The results of operations of RPP for the full year ended December 31, 2004, which reflect purchase accounting adjustments from the date of acquisition of RPP by Apollo on November 14, 2000,

 

    The results of operations of Borden Chemical for the period from August 12, 2004 to December 31, 2004, on a historical basis (because Borden Chemical is a public reporting registrant as a result of public debt that was outstanding prior to the Borden Transaction and which debt remains outstanding, Borden Chemical has elected to present its financial statements from the date of its acquisition by Apollo on the historical basis of accounting permitted under the SEC’s public debt exemption), and

 

    The results of operations of RSM for the period from August 2, 2004 to December 31, 2004, which reflect purchase accounting adjustments from the date of the acquisition of RSM by Apollo on August 2, 2004.

 

Accordingly, the results of operations of Hexion for periods prior to the Borden Chemical and RSM acquisitions are not comparable to results for subsequent periods. In order to enhance comparability, management’s discussion and analysis of financial condition and results of operations includes additional supplemental data provided for the individual entities for the years ended December 31, 2003 and 2004.

 

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Environmental remediation and restoration liabilities. Accruals for environmental matters are recorded when we believe it is probable that a liability has been incurred and we can reasonably estimate the amount of the liability. Our accruals are established following the guidelines of Statement of Position 96-1, “Environmental Remediation Liabilities.” We have accrued approximately $0 and $41 at December 31, 2003 and 2004, respectively, for all probable environmental remediation and restoration liabilities, which is our best estimate of these liabilities. Based on currently available information and analysis, we believe that it is reasonably possible that the costs associated with such liabilities may fall within a range of $27 to $84. This estimate of the range of reasonably possible costs is less certain than the estimates upon which reserves are based, and in order to establish the upper limit of this range, we used assumptions that are less favorable to Hexion among the range of reasonably possible outcomes, but we did not assume we would bear full responsibility for all sites, to the exclusion of other potentially responsible parties (“PRPs”).

 

For environmental conditions that existed prior to the acquisition of RPP, environmental remediation liability is influenced by agreements associated with the transactions whereby Shell generally will indemnify us for environmental damages associated with environmental conditions that occurred or existed before the closing date of the acquisition, subject to certain limitations. In addition, for incidents occurring after the closing date of the acquisition, management believes that we maintain adequate insurance coverage, subject to deductibles, for environmental remediation activities.

 

For environmental conditions that existed prior to the acquisition of RSM, the RSM Transaction Agreement provides for a seller indemnification (“Eastman Indemnification”), whereby Eastman agreed to indemnify RSM and its affiliates for certain losses and associated expenses occurring within specified time periods. Items covered by the Eastman Indemnification include: (i) breaches by Eastman of its representations, warranties or covenants in the acquisition agreement; (ii) product liability claims brought against RSM that relate to the manufacture, distribution, marketing or sale of any products by the predecessor business that were manufactured prior to the Closing Date and sold within ninety (90) days following the Closing Date (except to the extent that such claims relate to the actions or negligent omissions of RSM or any of its Affiliates following the Closing Date); and (iii) liabilities of Eastman or the predecessor business that were not assumed by RSM in connection with its purchase of the predecessor business.

 

Factors influencing the possible range of costs for environmental remediation include:

 

    The success of the selected method of remediation / closure procedures

 

    The development of new technology and improved procedures

 

    The possibility of discovering additional contamination during monitoring / remediation process

 

    The financial viability of other PRPs, if any, and their potential contributions

 

    The time period required to complete the work, including variations in anticipated monitoring periods

 

    For projects in their early stages, the outcome of negotiations with governing regulatory agencies regarding plans for remediation

 

Income tax assets and liabilities. Deferred income taxes represent the tax effect of temporary differences between amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. We currently have significant deferred tax assets resulting primarily from net operating loss carry forwards and deductible temporary differences, which will reduce taxable income in future periods. We provided a valuation allowance on future tax benefits for certain net operating losses. A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses and losses in the most recent year.

 

In estimating accruals necessary for tax exposures, including estimating the outcome of audits by governing tax authorities, we apply the guidance of Statement of Financial Accounting Standards (“SFAS”) No. 5,

 

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Accounting for Contingencies,” as well as SFAS No. 109, “Accounting for Income Taxes.” These estimates require significant judgment and, in the case of audits by tax authorities, may often involve negotiated settlements.

 

Factors influencing the final determination of tax liabilities include:

 

    Future taxable income;

 

    Execution of business strategies; and

 

    Negotiations of tax settlements with taxing authorities.

 

We believe our reserves established for probable tax liabilities are appropriate at December 31, 2004. See Note 14 to the Combined Financial Statements for additional information.

 

Pension assets, liabilities and costs. The amounts recognized in our financial statements related to pension benefit obligations are determined from actuarial valuations of our various plans. Inherent in these valuations are certain assumptions, including:

 

    Rate to use for discounting the liability (between 3.5%–6.75% for 2003 and between 2%–6% for 2004);

 

    Expected long-term rate of return on pension plan assets (between 8%–9% for 2003 and 2004);

 

    Rate of salary increases (between 2%–4% for 2003 and 2%–4.42% for 2004); and

 

    Mortality rate table (used 1983 GAM Table).

 

The most significant of these estimates is the expected long-term rate of return on pension plan assets. The actual return of our domestic pension plan assets in 2004 was approximately 8.6%. Future returns on plan assets are subject to the strength of the financial markets, which we cannot predict with any accuracy.

 

These assumptions are updated annually. Actual results that differ from our assumptions are accumulated and amortized over future periods; therefore, these variances affect our expenses and obligations recorded in future periods. Future pension expense and required contributions will also depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in our pension plans.

 

Long-Lived Assets and Depreciation and Amortization. With respect to long-lived assets, key assumptions include the estimate of useful lives and the recoverability of carrying values of fixed assets, and other intangible assets. The recovery of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset, which is subject to considerable judgment. If the useful lives of the assets were found to be shorter than originally estimated, depreciation and amortization charges would be accelerated.

 

Impairment. As events warrant, but at least annually, the Company evaluates the recoverability of long-lived assets by assessing whether the carrying value can be recovered over their remaining useful lives through the expected future undiscounted operating cash flows of the underlying business. Any impairment loss required is determined by comparing the carrying value of the assets to operating cash flows on a discounted basis.

 

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Results of Operations

 

     2002 (a)

    2003 (a)

    2004

 
         RPP

    RSM (b)

    Borden
Chemical (c)


    Elim (d)

    Total

 

Net Sales

   $ 740     $ 782     $ 996     $ 325     $ 702     $   (4 )   $ 2,019  

Gross Profit

     139       68       112       25       97             234  

Operating Income (Loss)

     41       (43 )     21       (6 )     25             40  

Net Loss

     (14 )     (83 )     (40 )     (17 )     (43 )     (14 )     (114 )

(a) Represents only the results of RPP as RSM and Borden Chemical were not acquired until August 2004.
(b) Represents the results of operations of RSM for the period from August 2, 2004 to December 31, 2004.
(c) Represents the results of operations of Borden Chemical for the period from August 12, 2004 to December 31, 2004.
(d) Entries to eliminate transactions between RPP, RSM and Borden Chemical and the tax effect of the Combinations.

 

Comparison of 2004 to 2003 Results

 

Net Sales

 

In 2004 total net sales increased by $1,237 to $2,019. The increase in net sales is primarily a result of the impact of the Borden Transaction and RSM Transaction and of higher average prices and volumes. Excluding the impact of the acquisitions, net sales increased $214, or 27%. Increases in average prices contributed $157 of this increase and was primarily attributable to price increases on certain products and the impact of a weaker dollar on our Euro-denominated sales. Average prices increased by 18% from the prior year period; 13% when excluding the impact of a weaker dollar on our Euro-denominated sales. Overall volumes increased by 7% from the prior year period primarily due to stronger demand.

 

Gross Profit

 

Gross profit increased in 2004 by $166 to $234. The increase in gross profit is a result of the impact of the Borden Transaction and RSM Transaction and higher pricing and volumes. Excluding the impact of the acquisitions, gross margin increased $44, or 65%. The increase in selling prices discussed above was significantly offset by higher prices for feedstocks and the higher cost of natural gas. The $44 increase in gross profit consists primarily of the net impact of higher selling prices of $27 and of higher volumes of $17.

 

Operating Income

 

Operating income increased by $83 to $40 in 2004 from an operating loss of $43 in 2003. The Borden Transaction and RSM Transaction added $19 of incremental operating income in 2004. Excluding the impact of the acquisitions, operating income increased $64, reflecting increased gross profit partially offset by increased selling, general and administrative expenses, research and development costs and the impact of foreign currency translation. These cost increases were the result additional marketing and sales activity related to the volume increase and product safety studies undertaken in conjunction with various industry groups.

 

Net Loss

 

Net loss increased by $31 to $114 in 2004. The increase in net loss is primarily a result of $66 of costs associated with the Borden Chemical acquisition, higher interest expense, reduced income from equity investment and an increase in income tax expense, partially offset by increased operating income.

 

Comparison of 2003 to 2002 Results

 

Net Sales

 

In 2003 total net sales increased by $42, or 6%, to $782 compared to 2002. The increase in net sales is a result of increased average prices, partially offset by lower volumes. The increase in average prices was primarily

 

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attributable to the impact of a weaker dollar on our Euro-denominated sales and, to a lesser extent, due to modest price increases on certain products. Overall average prices increased by 10% from the prior year, however, excluding the impact of a weaker dollar on our Euro-related sales, overall average prices were flat. Overall volumes decreased by 3% from the prior year as a result of soft demand.

 

Gross Profit

 

Gross profits declined in 2003 by $71 to $68. The decrease in gross profit is largely driven by higher prices for feedstocks due to the increasing price of crude oil and related petrochemical products and the higher cost of natural gas. Also contributing to the decline is the decrease in overall volumes. Gross profit was positively impacted by a $9 decrease in other manufacturing costs resulting from a cost reduction program instituted in the beginning of 2003.

 

Operating Income

 

Operating income decreased by $84, to a $43 loss. The decrease was primarily due to the decrease in gross profit discussed above and goodwill impairments of $33. These amounts were partially offset by lower selling, general and administrative expense and research and development costs as well as the absence of $6 of restructuring charges and $8 of transition costs incurred in 2002. The 2003 cost reduction program drove the lower costs. The transition activities for 2002 consisted of one-time transition expenses related to stand-alone IT and accounting systems.

 

Net Loss

 

Net loss increased by $69 to $83 in 2003. The increase was due primarily to the decrease in operating income and increase in interest expense, partially offset by a $3 gain on sale of a portion of a joint venture interest and increased income tax benefit primarily related to an increase in our deferred tax assets. The increase in interest expense of $12 resulted from a $7 write-off of deferred financing costs related to the prepayments, refinancing and credit agreement amendment as well as higher average outstanding debt balances and interest rates.

 

Non-Operating Expenses and Income Tax Expense

 

Non-operating expense.

 

     2002

   2003

   2004

Interest expense

   $ 65    $ 77    $ 118

Transaction costs

     —        —        32

Other non-operating expense

     —        —        4
    

  

  

     $ 65    $ 77    $ 154
    

  

  

 

Our total non-operating expenses increased $77 in 2004 as compared to 2003. Interest expense increased $41 over 2003 due to higher average debt balances and interest rates resulting from our issuance of the Second Priority Notes in August 2004 as part of the Borden Transaction and RSM Transaction (see “—Liquidity and Capital Resources”), the April 2003 issuance of $200 of senior second secured notes and the refinancing of the credit agreement in the second and fourth quarters of 2003. We incurred non-operating expenses totaling $32 for Transaction related costs during 2004.

 

Interest expense, net, increased by $12, or 18%, to $77 in 2003 compared to 2002. The increase is primarily due to a $7 write-off of deferred financing costs related to the prepayments, refinancing and credit agreement amendment. In addition, the increase is also due to higher average outstanding debt balances and higher average interest rates.

 

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Income tax benefit.

 

     2002

   2003

   2004

Income tax benefit

   $ 10    $ 37    $ 0

Effective tax rate

     N/M      N/M      N/M

 

The 2004 consolidated tax rate reflects a Federal income tax benefit of $40, computed at the Federal statutory tax rate, offset by a provision of $61 for taxes associated with the unrepatriated earnings of Borden Chemical’s foreign subsidiaries based on management’s decision that after the Borden Transaction the foreign earnings could no longer be considered permanently reinvested. This additional provision allowed Borden Chemical to release $33 of previously provided valuation reserves against its deferred tax assets. The provision also reflects a $17 write-off of net operating losses, offset by a benefit of $10 relating to a change in enacted tax rate.

 

The 2002 and 2003 consolidated tax rates reflect a Federal income tax benefit computed at the Federal statutory tax rate.

 

Tax Legislation. In 2004, the American Jobs Creation Act of 2004 was signed into law. This Act effectively phases out benefits from the utilization of foreign sales corporations, reduces the number of foreign tax credit limitation categories, creates a temporary incentive for U.S. companies to repatriate foreign earnings at a significantly reduced effective U.S. tax rate and domestically provides a number of revenue enhancing and reducing provisions in the taxation of corporations. Our management does not anticipate a material impact on the Company as a result of this legislation.

 

Supplemental Historical Data

 

Hexion is comprised of the businesses of RPP, Borden Chemical, RSM and Bakelite. The results of each of these four businesses are discussed below. The supplemental information presented includes the combination of predecessor and successor financial statements for individual entities and provides what management believes is a meaningful way of analyzing the results of the combined companies on a comparable period basis. In addition to net sales, we show historical Adjusted EBITDA (see “—Covenant Compliance”) for each of the legacy entities. We believe Adjusted EBITDA is a useful metric in managing the operations of the businesses and use Adjusted EBITDA to assess our operating performance and monitor our compliance with the indentures governing our notes. We believe this financial measure is helpful in highlighting trends in our businesses because the items excluded in calculating Adjusted EBITDA have little or no bearing on our day-to-day operating performance. It is also the most significant criterion in our performance-based cash bonuses and may be a triggering event of whether certain performance-based stock options vest.

 

RPP

             
     Year Ended December 31,

     2003

   2004

     (dollars in millions)

Net sales

   $ 782    $ 996

Adjusted EBITDA (a)

     47      83

             

(a) Set forth below is a reconciliation of Net loss to Adjusted EBITDA:

 

     2003

     2004

 

Net loss

   $ (83 )    $ (40 )

Interest expense, net

     76        79  

Income tax benefit

     (37 )      (18 )

Depreciation & amortization

     58        62  
    


  


EBITDA

     14        83  

Impairments

     33        —    
    


  


Adjusted EBITDA

   $ 47      $ 83  
    


  


 

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Net Sales

 

Net sales increased by $214, or 27%, to $996 for the year ended December 31, 2004. The increase in net sales is a result of higher average prices and volumes. The increase in average prices was primarily attributable to price increases on certain products and the impact of a weaker dollar on our Euro-denominated sales. Overall average prices increased by 18% from the prior year period; however, excluding the impact of a weaker dollar on our Euro-denominated sales, overall average prices increased 13%. Overall volumes increased by 7% from the prior year period primarily due to stronger demand. The $214 increase in revenues consists of a $157, or approximately 73%, increase in prices and a $57, or approximately 27%, increase in volume.

 

Total net sales in the U.S. increased by $82, or 23%, to $431 for the year ended December 31, 2004. Of the increase in U.S. revenues, $32, or approximately 40%, was due to price increases and $50, or approximately 60%, was due to volume increases. Overall average prices increased by 10% from the prior year period. Overall volumes increased by 14% from the prior year period primarily due to stronger demand.

 

Total net sales in Europe increased by $133, or 31%, to $563 for the year ended December 31, 2004. Of the $133 increase in Europe revenues, $101, or approximately 76%, was due to price increases and $32, or approximately 24%, was due to volume increases. Overall average prices increased by 22% from the prior year period; however, excluding the impact of a weaker dollar on our Euro-denominated sales, overall average prices increased 10%. Overall volumes increased by 7% from the prior year period primarily due to stronger demand.

 

Adjusted EBITDA

 

Adjusted EBITDA increased by $36 to $83 for the year ended December 31, 2004. The increase is primarily due to higher selling prices across all major product lines. Also contributing to the increase is higher overall volumes in 2004. Partially offsetting these improvements were increased cost of feedstocks due to the increasing price of crude oil and related petrochemical products.

 

Borden Chemical

             
     Year Ended December 31,

         2003    

       2004    

     (dollars in millions)

Net sales

   $ 1,435    $ 1,686

Adjusted EBITDA (a)

     161      173
 
  (a) Set forth below is a reconciliation of Net income (loss) to Adjusted EBITDA:

 

     2003

    2004

 

Net income (loss)

   $ 23     $ (180 )

Depreciation and amortization

     47       50  

Interest expense

     47       64  

Income tax expense (benefit) loss

     (5 )     146  
    


 


EBITDA

     112       80  

Transaction and impairment costs (1)

     3       58  

Synergies (2)

     7       7  

Effect of acquisitions (3)

     4       —    

Unusual items (4)

     35       28  
    


 


Adjusted EBITDA

   $ 161     $ 173  
    


 


 
  (1) Transaction costs and impairments represents $56 of transaction costs relating to the acquisition of Borden Chemical by Apollo in 2004 and impairments of $3 and $2 in 2003 and 2004, respectively.
  (2) Synergies of $7 in 2003 and 2004 represent the estimated raw material cost savings resulting from the Borden Transaction.

 

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  (3) Acquisitions of $4 in 2003 represent the full year EBITDA impact of two acquisitions that closed in the fourth quarter of 2003.
  (4) Unusual items of $35 and $28 in 2003 and 2004, respectively, primarily relates to $6 and $11 in 2003 and 2004, respectively, of legacy legal costs related to legal proceedings primarily involving divested businesses; $5 and $4 in 2003 and 2004, respectively, in plant closure and non-recurring severance and other one-time benefits paid to employees; $20 and $6 in 2003 and 2004, respectively, of business realignment expenses due to plant closure costs and headcount reductions, $3 in 2004 for incremental costs incurred as a result of a mechanical failure at a Brazilian formaldehyde plant in 2004 which the Company expects to be reimbursed for this amount under its insurance policies in 2005; and $4 and $4 in 2003 and 2004, respectively, in various other unusual or non-recurring items, primarily the (gain) loss on sales of assets, terminations (receipts) for discontinued contracts.

 

Borden Chemical recorded $56 of transaction costs relating to the acquisition of Borden Chemical by Apollo in 2004 and impairments of $3 and $2 in 2003 and 2004, respectively. Borden Chemical recorded $6 and $11 in 2003 and 2004, respectively, of legacy legal costs related to legal proceedings primarily involving divested businesses; $5 and $4 in 2003 and 2004, respectively, in plant closure and non-recurring severance and other one-time benefits paid to employees.

 

Net Sales

 

In 2004, net sales increased by $251, or 17%, to $1,686 for the year ended December 31, 2004. The pass through of raw material price increases and favorable product mix contributed approximately 39% of the increase. Volume increases in Forest Products, Performance Resins, Latin America and Europe accounted for approximately 38% of the increase. The improved volume in Forest Products was due to increased end-use consumption resulting from the continued strong housing market, increased demand for flooring on the resin side of the business and higher demand in the general chemical sector for formaldehyde. Improved volumes for oilfield products, foundry and industrial resins drove Performance Resin volume improvement. Volume improvements in Latin America were due to increased demand driven by increased exports of wood products. European volume increases were driven by increased demand for formaldehyde and performance resins. Favorable currency translation contributed approximately 19% of the net sales improvement and 4% was due to the impact of acquisitions.

 

Adjusted EBITDA

 

Adjusted EBITDA improved by $12 to $173 for the year ended December 31, 2004. The improvement is due to higher volumes, favorable product mix, purchasing productivity, favorable currency translation and a reduction in corporate expenses related to the full year impact of the 2003 business realignment program. These improvements more than offset the unfavorable effect of a lag in passing along raw material price increases to customers.

 

RSM

             
     Year Ended December 31,

     2003

   2004 (a)

     (dollars in millions)

Net sales

   $ 678    $ 765

Adjusted EBITDA (b)

     25      60
 
  (a)

The results for 2004 for RSM include results for the period from January 1, 2004 through August 1, 2004, which is the period prior to Apollo’s acquisition of RSM, along with that of August 2, 2004 through December 31, 2004.

 

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  (b) Set forth below is a reconciliation of Net loss to Adjusted EBITDA:

 

     2003

     2004

 

Net loss

   $ (502 )    $ (110 )

Interest expense, net

     11        10  

Income tax (benefit) expense

     (64 )      3  

Depreciation & amortization

     24        8  
    


  


EBITDA

     (531 )      (89 )

Transaction and impairment costs

     473        74  

Legacy corporate expenses, net(1)

     64        30  

Plant closure and business realignment expenses(2)

     8        29  

Effect of acquisitions(3)

     4        4  

Purchase accounting effects(4)

     2        10  

Other(5)

     5        2  
    


  


Adjusted EBITDA

   $ 25      $ 60  
    


  


 
  (1) Represents corporate allocations and transition service fees charged to RSM by its former parent in excess of estimated incremental costs to replace such services.
  (2) Plant closure and non-recurring severance and other one-time benefits paid to employees, as well as the excess of historical costs over current business staffing levels, contractual commitments and the current plant footprint.
  (3) Represents the full year EBITDA impact of a specialty coatings product line in the versatics market acquired in November 2004 by RSM.
  (4) Reflects the adjustment to depreciation and amortization expense resulting from fair value adjustments to certain property and equipment and amortizable intangible assets of $2 and $2 in 2003 and 2004, respectively, as well as non-recurring adjustments to inventory of $9 in 2004.
  (5) Various unusual or non-recurring items including one time costs relating to the transactions and one-time system implementation costs related to the carve out of RSM as a stand-alone entity.

 

Net Sales

 

In 2004, net sales increased by $87, or 13%, to $765 for the year ended December 31, 2004. Overall average price increases contributed approximately 65% of the increase, due mostly to increased raw material pass-throughs and a strong improvement in global acrylic demand. Overall volume increases accounted for approximately 35% of the growth, primarily due to heavier coatings demand associated with the general economic recovery. Growth was seen across all major technologies, including alkyds, polyesters, acrylics and ink resins.

 

Adjusted EBITDA

 

In 2004, Adjusted EBITDA improved by $35 to $60 for the year ended December 31, 2004. This improvement was driven by improved pricing and mix strategies, partially offset by increases in raw material costs. Adjusted EBITDA was also improved due to the realization of several fixed cost reduction initiatives enacted in late 2003 and early 2004. Management expects to see further cost improvements in 2005 due to the realization of cost improvements associated with Apollo’s acquisition of the business in late 2004.

 

The Bakelite financial information presented herein is converted from euros to dollars at the applicable rate.

 

Bakelite

             
     Year Ended December 31,

         2003    

       2004    

     (dollars in millions)

Net sales

   $ 588    $ 699

Adjusted EBITDA (a)

     30      55

 

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  (a) Set forth below is a reconciliation of Net income (loss) to Adjusted EBITDA:

 

     2003

    2004

 

Net income (loss)

   $ (28 )   $ (3 )

Interest expense, net

     4       3  

Income tax expense/(benefit)

     (13 )     1  

Depreciation & amortization

     41       33  
    


 


EBITDA

     4       34  

Non-cash impairment

     24       20  

Plant closure and business realignment expenses(1)

     2       1  
    


 


Adjusted EBITDA

   $ 30     $ 55  
    


 


 
  (1) Plant closure and business realignment expenses consists of plant closure costs, restructuring charges, historical salaries of terminated employees, contract termination costs, and elimination of intercompany transactions with RPP.

 

Net Sales

 

In 2004, net sales increased by $111, or 19%, to $699 for the year ended December 31, 2004. Changes in foreign exchange rates accounted for approximately 54% of the increase, while in constant-currency terms, net sales increased 9% compared to prior year. Overall average price increases contributed approximately 60% of the increase (in constant-currency terms). Overall volume increases accounted for approximately 40% of the increase (in constant-currency terms), driven by strong growth in epoxies of 12%.

 

Adjusted EBITDA

 

In 2004, Adjusted EBITDA improved by $25 to $55 for the year ended December 31, 2004. The increase is primarily due to reductions in cost structure and overhead. Also contributing to the increase were price improvements. Partially offsetting these improvements were increased cost of feedstocks due to the increasing price of crude oil and related petrochemical products.

 

Cash Flows

 

Cash provided by (used in):

                        
     2002

    2003

    2004

 

Operating activities

   $ 64     $ (43 )   $ (32 )

Investing activities

     (45 )     7       (20 )

Financing activities

     (21 )     80       148  

Effect of exchange rates on cash flow

     —         1       7  
    


 


 


Net change in cash and cash equivalents

   $ (2 )   $ 45     $ 103  
    


 


 


 

Operating Activities. In 2004, we used net cash for operating activities of $32. This includes cash used by operations of $24 primarily pertaining to $46 of transaction related costs related to the Borden Transaction.

 

Our 2003 operating activities used cash of $43. This includes cash used by operations of $34 and by net trading capital (accounts receivable, inventory and accounts payable) of $27. Our negative cash flow in net trading capital resulted from increasing raw material costs in 2003.

 

Our 2002 operating activities provided cash of $64 in 2002. This includes cash generated by operations of $21 and by net trading capital of $30.

 

Investing Activities. Our 2004 net investing activities used cash of $20. We used cash of $57 for capital expenditures primarily for plant expansions, SAP implementation at RSM and other improvements. We paid $152 relating to RSM acquisition activity, net of cash acquired, and received $185 upon the combination of Borden Chemical.

 

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Our 2003 net investing activities provided cash of $7. We spent $18 for capital expenditures, primarily for plant expansions and improvements. We realized proceeds of $23 on the sale of forty percent of the outstanding shares in Japan Epoxy Resins Co., Ltd to RPP joint venture partner, Mitsubishi Chemical Company.

 

Our 2002 cash outflow from investing activities of $45 primarily consisted of expenditures for property, plant and equipment of $48, offset by proceeds from the sale of non-productive assets of $2.

 

Financing Activities. Our financing activities in 2004 provided cash of $148. Net cash generated by financing activities was primarily due to the issuance of debt related to the RSM Transaction of $121, offset by net debt repayments by RPP and Borden Chemical of $23. We received proceeds of $60 from the issuance of common stock related to the RSM Transaction.

 

Our 2003 financing activities provided cash of $80. This amount includes net debt borrowing of $103, offset by the payment of a constructive distribution related to certain pension costs to Shell on behalf of RPP Inc.

 

Our 2002 financing activities used cash of $21, which primarily represents net repayments on our long-term debt of $24.

 

Liquidity and Capital Resources

 

Our primary source of liquidity is cash flow generated from operations. We also have availability under our senior secured credit facilities (see below), subject to certain conditions. Our primary liquidity requirements are debt service, working capital requirements, contractual obligations and capital expenditures.

 

We are a highly leveraged company. Our liquidity requirements are significant, primarily due to our debt service requirements. At December 31, 2004, we had $1,850 principal amount of outstanding indebtedness, of which $378 constituted floating rate debt and $1,472 constituted fixed rate indebtedness.

 

Senior Credit Facilities

 

The following descriptions of the RPP Credit Facility, the RSM Credit Facility and the Borden Credit Facilities describe the principal and certain other credit facilities of RPP, RSM and Borden Chemical, respectively, prior to the Combinations. In connection with the Combinations, we intend to repay all amounts outstanding under the RPP Credit Agreement, the RSM Credit Agreement and the Amended Borden Chemical Credit Facility described below, and terminate such agreements. We expect to enter into new senior secured credit facilities at the closing of the Combinations. See “Description of Certain Indebtedness—Senior Secured Credit Facilities.”

 

RPP Credit Facility

 

In 2000, RPP Inc., RPP, Resolution Performance Products Capital Corporation (“RPP CC”) and Resolution Nederland B.V., “Other RPP Borrowers” entered into a $600 credit agreement (“the RPP Credit Agreement”) with a syndicate of financial institutions. The RPP Credit Agreement provides for a six-year $75 revolving credit facility, the euro equivalent of which is also available, to be used for, among other things, working capital and general corporate purposes of RPP and its subsidiaries, including without limitation, certain permitted acquisitions. The revolving credit facility also includes a sub-limit for letters of credit (“LOCs”) in an amount not to exceed $50. At December 31, 2004, RPP had $28 of outstanding borrowings under the revolving credit facility and $2 in outstanding LOCs. At December 31, 2004, RPP had additional borrowing capacity under the RPP Credit Agreement of $45.

 

In January 2005, RPP entered into a new credit agreement to refinance the credit agreement that was in existence at December 31, 2004. See Note 7 of the Combined Financial Statements for more information on the new credit agreement.

 

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RSM Credit Facility

 

In 2004, RSM and one of its subsidiaries entered into a $155 credit agreement (“RSM Credit Agreement”) with a syndicate of financial institutions. The RSM Credit Agreement provides for term loans (“Term Loans”) totaling $125 and revolving facility loans and LOCs (“Revolving Facility Loans”) of up to $30, subject to certain restrictions.

 

The Revolving Facility Loans provide for a five-year $30 revolving credit facility due August 2, 2009 to be used for working capital, general corporate purposes and acquisitions. Borrowings under the Revolving Facility Loans are subject to a maximum permitted amount based on a formula for interest rate determination purposes, loans under the RSM Credit Agreement are defined as either ABR (alternative base rate) Loans or Eurocurrency Loans and are tied to the prime rate, Base CD rate or Federal Funds Rate for ABR Loans or adjusted LIBOR for Eurocurrency Loans. Incremental interest rates ranging from 1.75% to 3.00% are applied to these interest rates based on the type of loan, currency, time period and RSM’s consolidated leverage ratio. Commitment fees under the Revolving Facility Loans are payable quarterly at an annual rate of 0.5% on the available unused commitment. LOCs are subject to participation, fronting and issuing bank fees. As of December 31, 2004, RSM had $1 in outstanding in LOCs, none of which had been drawn against.

 

RSM borrowed the full amount of the $125 under the Term Loans to partially fund the acquisition and for working capital and other corporate purposes. The Term Loans are payable in quarterly principal installments through June 30, 2010, with a balloon payment of $118 on the term facility maturity date of August 2, 2010.

 

The RSM Credit Agreement contains, among other provisions, restrictive covenants regarding indebtedness, payments and distributions, mergers and acquisitions, asset sales, affiliate transactions, capital expenditures, and the maintenance of certain financial ratios. Payment of borrowings under the RSM Credit Agreement may be accelerated in the event of a default. Events of default include the failure to pay principal and interest when due, a material breach of representation or warranty, covenant defaults, events of bankruptcy and a change of control.

 

RSM’s obligations under the RSM Credit Agreement are guaranteed, on a joint and several basis, by RSM and each of RSM’s domestic subsidiaries. The RSM Credit Agreement is secured by substantially all current and future assets of RSM, including a pledge of the equity in its domestic subsidiaries and 65% of the equity of its ‘first tier’ foreign subsidiaries, totaling $394.

 

Borden Chemical Credit Facilities

 

Borden Chemical entered into a three-year asset based revolving credit facility in the third quarter of 2002 (the “Borden Chemical Credit Facility”), which provides for a maximum borrowing of $175, including LOCs. Borden Chemical amended the Borden Chemical Credit Facility (the “Amended Borden Chemical Credit Facility”) on August 12, 2004 as part of the Borden Transaction. The Amended Borden Chemical Credit Facility is a five-year asset based revolving credit facility with the same borrowing capacity as the Borden Chemical Credit Facility.

 

The Amended Borden Chemical Credit Facility is secured with inventory and accounts receivable in the U.S., Canada and the U.K., a portion of property and equipment in Canada and the U.K. and the stock of certain subsidiaries. At December 31, 2004, the net book value of the collateral securing the Amended Borden Chemical Credit Facility, excluding the stock of foreign subsidiaries, was approximately $266. Maximum borrowing allowable under the Amended Borden Chemical Credit Facility is calculated monthly (quarterly, if availability is greater than $100) and is based upon specific percentages of eligible accounts receivable, inventory and fixed assets. The Amended Borden Chemical Credit Facility contains restrictions on dividends, capital expenditures ($38 from August 12, 2004 to December 31, 2004; $75 in 2005) and payment of management fees ($3 per year or 2% of Segment EBITDA). It also includes a minimum trailing twelve-month fixed charge coverage ratio of 1.1 to 1.0 if aggregate availability is less than $50. The trailing twelve-month fixed charge coverage ratio

 

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requirement does not apply when aggregate availability exceeds $50. At December 31, 2004, the maximum borrowing allowable under the Amended Borden Chemical Credit Facility was approximately $175, of which approximately $128, after outstanding LOCs and other draws, was unused and available. As a result, Borden Chemical has no fixed charge coverage ratio requirements at the end of 2004.

 

Under the terms of the Amended Borden Chemical Credit Facility, Borden Chemical has the ability to borrow funds at either the prime rate plus an applicable margin (“the prime rate option”) or at LIBOR plus an applicable margin. Borden Chemical must designate which option it chooses at the time of the borrowing. Currently, the applicable margin for any prime rate borrowing is 50 basis points and for any LIBOR borrowing is 200 basis points. For LOCs issued under the Amended Borden Chemical Credit Facility, Borden Chemical pays a per annum fee equal to the LIBOR applicable margin, or 2.00%, plus a fronting fee of 0.125%. In addition, Borden Chemical pays a 0.375% per annum fee on the amount of the revolving loan commitment less any borrowings or outstanding LOCs. Borden Chemical incurred commitment fees of $0.2 in the period from August 12, 2004 to December 31, 2004, related to the Amended Borden Chemical Credit Facility.

 

Borden Chemical’s Australian subsidiary entered into a five-year secured credit facility in the fourth quarter of 2003 (the “Australian Facility”), which provides for a maximum borrowing of AUD$20, or approximately $16. At December 31, 2004, outstanding debt under this facility was $11, of which $7 is classified as long-term. In addition, there was approximately $3 of short-term debt under the facility. The Australian Facility provided the funding for the Fentak acquisition made in the fourth quarter of 2003 and is secured by liens against substantially all of the assets of the Australian business including the stock of the Australian subsidiaries. At December 31, 2004, the net book value of the collateral securing the Australian Facility was approximately $30. In addition, Borden Chemical pledged the stock of the Australian subsidiaries as collateral for borrowing under the Australian Facility. This facility includes a fixed rate facility used for the acquisition, as well as a revolver. At December 31, 2004, $8 was outstanding under the fixed rate facility at an interest rate of 6.4%. The Australian Facility contains restrictions relative to the Australian businesses on dividends, the sale of assets and additional borrowings. The Australian Facility also contains financial covenants applying to the Australian subsidiaries including current ratio, interest coverage, debt service coverage and leverage. The fixed portion of the Australian Facility requires minimum quarterly principal reductions totaling AUD$0.5 (approximately $0.4). The Australian Facility requires semi-annual principal reductions based on a portion of excess cash as defined in the agreement. At December 31, 2004, the maximum borrowing allowable under the Australian Facility was AUD$18 (approximately $14), of which about AUD$4 (approximately $3), after outstanding LOCs and other draws, was unused and available.

 

Additional international credit facilities provide availability totaling approximately $26. Of this amount, approximately $12 (net of $4 of borrowings, LOCs and other guarantees of approximately $5 and $5 of other draws) was available to fund working capital needs and capital expenditures at December 31, 2004. These credit facilities have various expiration dates ranging from 2006 through 2008. Of the total $4 of outstanding debt, $1 was classified as long-term. While these facilities are primarily unsecured, portions of the lines are secured by equipment. At December 31, 2004, the net book value of collateral securing a portion of these facilities was approximately $1. Borden Chemical guarantees up to $7 of the debt of one of its Brazilian subsidiaries, included in these facilities.

 

HAI entered into a three-year asset based revolving credit facility in 2004, which provides for a maximum borrowing of $15 (the “HAI Facility”). Maximum borrowing allowable under the HAI Facility is based upon specific percentages of eligible accounts receivable and inventory and is secured with inventory, accounts receivable and property and equipment of HAI. At December 31, 2004, the net book value of collateral securing the HAI Facility was approximately $34. The HAI Facility provides up to $2 for LOCs. The HAI Facility contains restrictions relative to HAI on dividends, affiliate transactions, minimum availability ($2), additional debt and capital expenditures ($2 in 2005). In addition, HAI is required to maintain a minimum trailing twelve-month debt coverage ratio of 1.5 to 1.0 and a monthly debt to tangible capital ratio of less than 2.5 to 1.0. At December 31, 2004, borrowing allowable under the HAI Facility was approximately $14, of which approximately $12 was unused and available, after the minimum availability requirement.

 

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At December 31, 2004 and 2003, we were in compliance with the covenants and restrictions in all credit facilities, with the exception of the RSM credit facility, for which we have received a waiver.

 

Senior Secured Notes

 

In 2003, RPP and RPP CC issued $200 aggregate principal amount of 9 1/2% Senior Second Secured Notes due 2010 in private offerings then converted them to public offerings. The $200 of 9 1/2% Senior Second Secured Notes are senior secured obligations ranking equal in right of payment to all of RPP’s existing and future senior debt and senior in right of payment with all existing and future subordinated indebtedness. The 9 1/2% Senior Second Secured Notes are secured by a second priority lien, subject to permitted liens, on all of domestic assets (subject to certain exceptions) that secure obligations under the RPP Credit Agreement and a portion of the capital stock of direct and indirect domestic subsidiaries and direct foreign subsidiaries. Interest is payable semi-annually in cash on April 15 and October 15, beginning October 15, 2003. The proceeds from the offering were used to repay borrowings and for general corporate purposes, including working capital. The 9 1/2% Senior Second Secured Notes mature on April 15, 2010 and may be redeemed in whole at any time or in part from time to time, on and after April 15, 2006, at the specified redemption prices set forth under the related indenture.

 

In 2003, RPP and RPP CC issued $140 aggregate principal amount of 8% Senior Secured Notes due 2009 in private offerings. The $140 of 8% Senior Second Secured Notes are senior secured obligations ranking equal in right of payment to all of RPP’s existing and future senior debt and senior in right of payment with all existing and future subordinated indebtedness. The 8% Senior Second Secured Notes are secured with the same collateral as the 9 1/2% notes. By virtue of lien priority, the 8% notes are effectively senior to the 9 1/2% notes. Interest is payable semi-annually in cash on December 15 and June 15, beginning June 15, 2004. The proceeds from the offering were used to repay borrowings and for general corporate purposes, including working capital. The 8% Senior Second Secured Notes mature on December 15, 2009 and may be redeemed in whole at any time or in part from time to time, on and after December 15, 2006, at the specified redemption prices set forth under the related indenture.

 

As discussed in Note 3 of the Combined Financial Statements, in conjunction with the Borden Chemical Transaction, Borden Chemical formed two wholly owned finance subsidiaries that borrowed a total of $475 through a private debt offering. Of the debt, $325 is second-priority senior secured notes due 2014 (the “Fixed Rate Notes”), which bear an interest rate of 9%. The remaining $150 of debt is second-priority senior secured floating rate notes due 2010 (the “Floating Rate Notes”). On February 14, 2005, Borden Chemical filed a registration statement with respect to this private debt.

 

The Floating Rate Notes and Fixed Rate Notes and guarantees rank equally with all of Borden Chemical’s existing and future senior indebtedness, including debt under Borden Chemical’s new senior secured credit facilities and the guarantees thereof. The Floating Rate Notes and Fixed Rate Notes will be effectively subordinated to such senior secured credit facilities, the existing RPP 8% Senior Secured Notes and any other future obligations secured by a first priority lien (as defined in the indentures governing such notes) on the collateral to the extent of the value of the collateral securing such obligations. The Floating Rate Notes and Fixed Rate Notes will rank senior to all of Borden Chemical’s and its guarantors’ existing and future subordinated indebtedness, except as described in the preceding sentence. The Floating Rate Notes and Fixed Rate Notes will also be effectively junior to the liabilities of the non-guarantor subsidiaries, which includes HAI.

 

Interest on the Floating Rate Notes will be paid each January 15, April 15, July 15 and October 15. Interest on the Floating Rate Notes accrues at an annual rate, reset quarterly, equal to LIBOR plus 475 basis points. At December 31, 2004, the interest rate on the Floating Rate Notes was 6.82%. The notes mature July 15, 2010. These notes may be redeemed at any time on or after July 15, 2006 at the applicable redemption price set forth in the indenture for the notes. In addition, up to 35% of these notes may be redeemed prior to July 15, 2006 with cash proceeds from certain equity offerings at the applicable redemption price set forth in the indenture for the notes. Prior to July 15, 2009, the Floating Rate Notes may be redeemed at a price equal to 100% of the principal

 

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amount plus accrued interest plus the “make-whole” premium as defined in the indenture for the notes. The Floating Rate Notes may also be redeemed upon certain changes in tax laws or upon a change in control. There is no sinking fund for the Floating Rate Notes.

 

Interest on the Fixed Rate Notes will be paid each January 15 and July 15. The notes mature July 15, 2014. These notes may be redeemed at any time on or after July 15, 2009 at the applicable redemption price set forth in the indenture for the notes. In addition, up to 35% of these notes may be redeemed prior to July 15, 2007 with cash proceeds from certain equity offerings at the applicable redemption price set forth in the indenture for the notes. Prior to July 15, 2009, the Fixed Rate Notes may be redeemed at a price equal to 100% of the principal amount plus accrued interest plus the “make-whole” premium as defined in the indenture for the notes. The Fixed Rate Notes may also be redeemed upon certain changes in tax laws or upon a change in control. There is no sinking fund for the Fixed Rate Notes.

 

Debentures

 

In 2000, $328 aggregate principal amount of 13 1/2% Senior Subordinated Notes due 2010 were issued in private offerings by RPP and RPP CC. These notes were subsequently exchanged with public offerings. The $328 of 13 1/2% Senior Subordinated Notes are senior subordinated unsecured obligations ranking junior in right of payment to all of existing and future senior debt and all liabilities of subsidiaries that do not guarantee the notes. The proceeds from the issuance of $200 of the 13 1/2% Senior Subordinated Notes in November 2000 were used to finance in part the recapitalization and related transaction costs and expenses. Interest on the 13 1/2% Senior Subordinated Notes is payable semi-annually in cash on each May 15 and November 15. The 13 1/2% Senior Subordinated Notes mature on November 15, 2010 and may be redeemed in whole at any time or in part from time to time, on and after November 15, 2005, at the specified redemption prices set forth under the related indenture.

 

As discussed in Note 3 of the Combined Financial Statements, in connection with the RSM Transaction, RSM executed a Senior Subordinated Note Purchase Agreement (“Seller Note Financing”) with Eastman on August 2, 2004, which provided for the sale of $50 aggregate principal amount of Senior Subordinated Notes of RSM to Eastman due and payable in 2011. Such notes were delivered to Eastman as partial consideration of the RSM Transaction. Interest is payable at a base rate equal to the seven year Treasury plus additional basis points ranging from 350 to 550, payable semi-annually on February 1 and August 1. The Seller Note Financing provides for payments-in-kind, whereby RSM may pay interest in either dollars or Notes until the third anniversary. The Seller Note Financing is subordinate to the Credit Agreement, and contains restrictive covenants which could trigger acceleration of repayment in the event of default absent a waiver. Such restrictive covenants include, among other provisions, restrictions on payments and distributions, mergers and acquisitions and transactions with affiliates. We expect to repay the Senior Subordinated Notes of RSM to Eastman in connection with the consummation of the Combinations.

 

The 9 1/5% debentures due in 2021, the 7 7/8% debentures due in 2023 and the 8 3/8% sinking fund debentures due in 2016 were outstanding prior to the Borden Transaction.

 

Other Borrowings

 

In addition, the Company finances certain insurance premiums. Short-term borrowings under this arrangement include $6 at December 31, 2004 and $8 at December 31, 2003.

 

The $34 Parish of Ascension Industrial Revenue Bonds (IRBs) are related to the purchase, construction and installation of air and water pollution control facilities that are no longer owned by Borden Chemical. The tax-exempt status of the IRBs is based upon their being no change in the use of the facilities, as defined by the Internal Revenue Code. Borden Chemical continues to monitor the use of the facilities by the current owner. If a

 

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change in use were to occur, Borden Chemical could be required to take remedial action, including redeeming all of the bonds.

 

As discussed in Note 3 to the Combined Financial Statements, on October 6, 2004, we entered into an agreement to acquire Bakelite Aktiengesellschaft (“Bakelite”). We consummated the Bakelite Acquisition on April 29, 2005. We financed the acquisition through a combination of borrowings under our bridge loan facility and cash. We believe we will continue to have adequate cash available from operations and our Amended Borden Chemical Credit Facility subsequent to the completion of this acquisition despite the additional debt to be incurred.

 

Capital Expenditures

 

We plan to spend approximately $120 on capital expenditures in 2005 and approximately $110 annually thereafter. Of the $110 anticipated future capital expenditures, we expect approximately $65 will be used for maintenance projects and approximately $45 for plans to continue increasing plant production capacity as necessary to meet demand and ROI projects. We plan to fund capital expenditures through operations and, if necessary, through available lines of credit.

 

Contractual Obligations

 

The following table presents our contractual cash obligations as adjusted for the Transactions (“Pro Forma Contractual Obligations”). Our actual contractual cash obligations consist of legal commitments at December 31, 2004, requiring us to make fixed or determinable cash payments, regardless of the contractual requirements of the vendor to provide future goods or services. This table does not include information on our recurring purchases of materials for use in production, as our raw materials purchase contracts do not meet this definition because they do not require fixed or minimum quantities. Contracts with cancellation clauses are not included, unless such cancellation would result in major disruption to our business. For example, we have contracts for information technology support that are cancelable, but this support is essential to the operation of our business and administrative functions; therefore, amounts payable under these contracts are included.

 

Our Pro Forma Contractual Obligations give effect to the Current Transactions.

 

     Payments Due By Year As Adjusted For the Current Transactions (a)

Contractual Obligations As Adjusted
For the Current Transactions


   2005

   2006

   2007

   2008

   2009

   2010 and
beyond


   Total

Long-term debt, including current maturities (b)

   $ 46    $ 14    $ 12    $ 18    $ 4    $ 2,262    $ 2,356

Operating leases

     26      22      19      17      12      39      135

Unconditional purchase obligations (c)

     421      246      195      164      339      —        1,365

Interest expense on fixed rate debt (d)

     161      160      160      160      159      660      1,460

Capital lease obligations

     1      1      1      —        —        1      4
    

  

  

  

  

  

  

Total

   $ 655    $ 443    $ 387    $ 359    $ 514    $ 2,962    $ 5,320
    

  

  

  

  

  

  


(a) This table includes the following amounts assumed from the Bakelite Transaction:

 

     Total

Long-term debt, including current maturities

   $ 47

Operating leases

     13

Unconditional purchase obligations

     233

Annual interest expense on fixed rate debt

     1

 

(b) Amounts include additional financing of $250 for the Bakelite Transaction, additional financing of $400 term loan and repayment of the $28 outstanding revolving credit facility balance, the $125 term loan balance and the $50 seller notes balance and $16 of purchase price adjustments.

 

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