Form 10-Q (Quarterly Report)
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

 


 

FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended September 30, 2005

 

Commission file number 1-71

 


 

HEXION SPECIALTY CHEMICALS, INC.

 


 

New Jersey   13-0511250

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

180 East Broad Street, Columbus, Ohio 43215

(Address of principal executive offices)

 

(614) 225-4000

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

 

Number of shares of common stock, $0.01 par value, outstanding as of the close of business on November 2, 2005: 82,629,906

 



Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

 

PART 1 – Financial Information

 

Introduction

 

On May 31, 2005, Borden Chemical, Inc. (“BCI”) was merged with two Apollo Management, L.P. (“Apollo”) controlled companies, Resolution Performance Products, LLC (“RPP”) and Resolution Specialty Materials, Inc. (“RSM Inc.”). Upon consummation of the merger (the “Combinations”), BCI changed its name to Hexion Specialty Chemicals, Inc. (“Hexion”).

 

For accounting purposes, RPP, RSM Inc. and BCI 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.” The financial statements of these entities are presented retroactively on a consolidated basis in a manner similar to a pooling of interests, and include the results of operations of each business only from the date of acquisition by the Apollo affiliates. Apollo acquired RPP on November 14, 2000, Resolution Specialty Materials, LLC (“RSM”) on August 2, 2004 and BCI on August 12, 2004.

 

Prior to the Combinations on April 29, 2005, a subsidiary of BCI completed the acquisition of Bakelite Aktiengesellschaft (“Bakelite”). The results for Bakelite as of and for the 5 months ended September 30, 2005 are consolidated into the Hexion results.

 

The financial data of Hexion for the three and nine months ended September 30, 2004 includes the results of operations of RPP for the full periods and of RSM and BCI from their respective dates of acquisition. The financial data for Hexion for the three and nine months ended September 30, 2005 include the consolidated results of operations of RPP, RSM and BCI. The balance sheets as of December 31, 2004 and September 30, 2005 represent the consolidated balance sheets of RPP, RSM and BCI as of each date, respectively. Bakelite 2005 results are included for the period subsequent to its acquisition. All adjustments that management considers necessary for a fair presentation of Hexion’s financial position and results of operations as of the date, and for the period indicated, have been included.

 

Accordingly, the results of operations and financial position of Hexion presented in this quarterly report on Form 10-Q are not comparable to previous quarterly and annual reports on Form 10-Q and Form 10-K, respectively, for BCI.

 

On April 25, 2005, the Company filed a registration statement, which is not yet effective, with the U.S. Securities and Exchange Commission (the “SEC”) for a proposed initial public offering (“IPO”) of its common stock. The Company subsequently filed five amendments to its registration statement on May 2, 2005, June 13, 2005, July 15, 2005, August 26, 2005 and September 19, 2005.

 

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Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

 

INDEX

 

Item 1. Hexion Specialty Chemicals, Inc. Condensed Consolidated Financial Statements     

Condensed Consolidated Statements of Operations and Comprehensive Loss,
three months ended September 30, 2005 and 2004

   4

nine months ended September 30, 2005 and 2004

   5

Condensed Consolidated Balance Sheets, September 30, 2005 and December 31, 2004

   6

Condensed Consolidated Statements of Cash Flows,
nine months ended September 30, 2005 and 2004

   8

Condensed Consolidated Statement of Common Stock and Other Shareholders’ Deficit,
nine months ended September 30, 2005

   9

Notes to Condensed Consolidated Financial Statements

   10
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations    39
Item 3. Quantitative and Qualitative Disclosures about Market Risk    53
Item 4. Controls and Procedures    53
PART II – OTHER INFORMATION     
Item 1. Legal Proceedings    55
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds    55
Item 3. Defaults upon Senior Securities    55
Item 4. Submission of Matters to a Vote of Security Holders    55
Item 5. Other Information    55
Item 6. Exhibits    55

 

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited)

HEXION SPECIALTY CHEMICALS, INC.

 

    

Three Months ended

September 30,


 

(In millions, except share and per share data)


   2005

    2004

 

Net sales

   $ 1,134     $ 618  

Cost of sales

     964       552  
    


 


Gross profit

     170       66  
    


 


Selling, general & administrative expense (See Note 12)

     104       53  

Transaction related costs (See Note 1)

     5       47  

Other operating expense

     6       1  
    


 


Operating income (loss)

     55       (35 )
    


 


Interest expense

     56       34  

Other non-operating income, net

     (4 )     —    
    


 


Income (loss) before income tax and minority interest

     3       (69 )

Income tax expense

     8       14  
    


 


Loss before minority interest

     (5 )     (83 )

Minority interest in net income (loss) of consolidated subsidiaries

     1       (4 )
    


 


Net loss

     (6 )     (79 )

Redeemable preferred stock accretion (See Note 9)

     13       —    
    


 


Net loss available to common shareholders

   $ (19 )   $ (79 )
    


 


Comprehensive loss

   $ (2 )   $ (65 )
    


 


Basic and Diluted Per Share Data

                

Net loss available to common shareholders

   $ (0.22 )   $ (0.96 )
    


 


Average number of common shares outstanding during the period – basic and diluted

     82,629,906       82,629,906  

 

See Notes to Condensed Consolidated Financial Statements

 

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited)

HEXION SPECIALTY CHEMICALS, INC.

 

     Nine Months ended
September 30,


 

(In millions, except share and per share data)


   2005

    2004

 

Net sales

   $ 3,317     $ 1,081  

Cost of sales

     2,831       968  
    


 


Gross profit

     486       113  
    


 


Selling, general & administrative expense (See Note 12)

     290       98  

Transaction related costs (See Note 1)

     34       47  

Other operating expense

     (4 )     —    
    


 


Operating income (loss)

     166       (32 )
    


 


Interest expense

     152       73  

Write-off of deferred financing fees (See Note 6)

     17       —    

Other non-operating expense, net

     14       —    
    


 


Loss from continuing operations before income tax and minority interest

     (17 )     (105 )

Income tax expense (benefit)

     43       (4 )
    


 


Loss from continuing operations before minority interest

     (60 )     (101 )

Minority interest in net income (loss) of consolidated subsidiaries

     3       (7 )
    


 


Loss from continuing operations

     (63 )     (94 )

Loss from discontinued operations (See Note 4)

     10       —    
    


 


Net loss

     (73 )     (94 )

Redeemable preferred stock accretion (See Note 9)

     18       —    
    


 


Net loss available to common shareholders

   $ (91 )   $ (94 )
    


 


Comprehensive loss

   $ (127 )   $ (90 )
    


 


Basic and Diluted Per Share Data

                

Loss from continuing operations (See Note 2)

   $ (0.98 )   $ (1.14 )

Loss from discontinued operations

     (0.12 )     —    
    


 


Net loss available to common shareholders

   $ (1.10 )   $ (1.14 )
    


 


Dividends (See Note 11)

   $ 6.66     $ —    
    


 


Average number of common shares outstanding during the period – basic and diluted

     82,629,906       82,629,906  

 

See Notes to Condensed Consolidated Financial Statements

 

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CONDENSED CONSOLIDATED BALANCE SHEETS

HEXION SPECIALTY CHEMICALS, INC. (Unaudited)

 

(In millions)


   September 30,
2005


   

December 31,

2004


 

ASSETS

                

Current Assets

                

Cash and equivalents

   $ 164     $ 152  

Accounts receivable (less allowance for doubtful accounts of $22 in 2005 and $15 in 2004)

     607       518  

Inventories:

                

Finished and in-process goods

     296       290  

Raw materials and supplies

     156       115  

Other current assets

     148       64  
    


 


       1,371       1,139  
    


 


Other Assets

     99       95  
    


 


Property and Equipment

                

Land

     56       44  

Buildings

     225       201  

Machinery and equipment

     1,747       1,706  
    


 


       2,028       1,951  

Less accumulated depreciation

     (617 )     (628 )
    


 


       1,411       1,323  

Goodwill

     146       51  

Other Intangible Assets, net

     170       88  
    


 


Total Assets

   $ 3,197     $ 2,696  
    


 


 

See Notes to Condensed Consolidated Financial Statements

 

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CONDENSED CONSOLIDATED BALANCE SHEETS

HEXION SPECIALTY CHEMICALS, INC. (Unaudited)

 

(In millions, except share and per share data)


   September 30,
2005


    December 31,
2004


 

LIABILITIES, REDEEMABLE PREFERRED STOCK, COMMON STOCK AND OTHER SHAREHOLDERS’ DEFICIT

                

Current Liabilities

                

Accounts and drafts payable

   $ 440     $ 488  

Debt payable within one year

     61       16  

Interest payable

     50       36  

Income taxes payable

     65       33  

Other current liabilities

     220       133  
    


 


       836       706  
    


 


Other Liabilities

                

Long-term debt

     2,306       1,834  

Non-pension postemployment benefit obligations

     137       142  

Deferred income taxes

     155       131  

Other long-term liabilities

     267       138  
    


 


       2,865       2,245  
    


 


Minority interest in consolidated subsidiaries

     11       54  

Commitments and Contingencies (See Note 8)

                

Redeemable Preferred Stock - $0.01 par value; liquidation preference $25 per share; 60,000,000 shares authorized, 14,000,000 issued and outstanding at September 30, 2005 (See Note 9)

     352       —    

Common Stock and Other Shareholders’ Deficit

                

Common stock - $0.01 par value; 300,000,000 shares authorized, 170,678,965 issued, 88,049,059 treasury and 82,629,906 outstanding at September 30, 2005 and December 31, 2004 (See Note 11)

     1       1  

Paid-in capital

     525       1,523  

Treasury stock

     (296 )     (296 )

Receivable from parent

     —         (561 )

Accumulated other comprehensive (loss) income

     (39 )     20  

Accumulated deficit

     (1,058 )     (996 )
    


 


       (867 )     (309 )
    


 


Total Liabilities, Redeemable Preferred Stock, Common Stock and Other Shareholders’ Deficit

   $ 3,197     $ 2,696  
    


 


 

See Notes to Condensed Consolidated Financial Statements

 

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

HEXION SPECIALTY CHEMICALS, INC.

 

     Nine months ended
September 30,


 

(In millions)


   2005

    2004

 

Cash Flows from (used in) Operating Activities

                

Net loss

   $ (73 )   $ (94 )

Adjustments to reconcile net loss to net cash from (used in) operating activities:

                

Depreciation and amortization

     111       54  

Unrealized translation loss

     5       —    

Minority interest in net loss (income) of consolidated subsidiaries

     3       (7 )

Stock based compensation expense (See Note 12)

     10       2  

Deferred tax benefit

     (4 )     (14 )

Write-off of deferred financing fees (See Note 6)

     11       —    

Other non-cash adjustments

     6       —    

Net change in assets and liabilities:

                

Accounts receivable

     (1 )     (75 )

Inventories

     61       (42 )

Accounts and drafts payable

     (93 )     92  

Income taxes

     74       9  

Other assets

     (11 )     9  

Other liabilities

     4       (11 )
    


 


       103       (77 )
    


 


Cash Flows (used in) from Investing Activities

                

Capital expenditures

     (63 )     (29 )

Acquisition of businesses, net of cash acquired

     (234 )     (152 )

Proceeds from the sale of business, net of cash

     3       —    

Cash combination of BCI

     —         185  

Proceeds from the sale of assets

     —         4  
    


 


       (294 )     8  
    


 


Cash Flows from (used in) Financing Activities

                

Net short-term repayments

     (12 )     (6 )

Borrowings of long-term debt

     1,194       183  

Repayments of long-term debt

     (754 )     (111 )

Payment of dividends

     (523 )     —    

Proceeds from issuance of preferred stock, net of issuance costs (See Note 9)

     334       —    

Long-term debt and credit facility financing fees paid

     (22 )     —    

IPO related costs (See Note 1)

     (8 )     —    

Proceeds from the issuance of common stock

     —         60  
    


 


       209       126  
    


 


Effect of exchange rates on cash and equivalents

     (6 )     1  

Increase in cash and equivalents

     12       58  

Cash and equivalents at beginning of period

     152       49  
    


 


Cash and equivalents at end of period

   $ 164     $ 107  
    


 


Supplemental Disclosures of Cash Flow Information

                

Cash paid:

                

Interest, net

   $ 134     $ 74  

Income taxes, net

     4       3  

Non-cash activity:

                

Settlement of note receivable from parent

   $ 581     $ —    

Unpaid common stock dividends declared

     27       —    

Redeemable preferred stock accretion (See Note 9)

     18       —    

Issuance of note in RSM Transaction

     —         50  

 

See Notes to Condensed Consolidated Financial Statements

 

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CONDENSED CONSOLIDATED STATEMENT OF COMMON STOCK AND OTHER SHAREHOLDERS’ DEFICIT (Unaudited)

HEXION SPECIALTY CHEMICALS, INC.

 

(In millions)


   Common
Stock


   Paid-in
Capital


    Treasury
Stock


    Receivable
from
Parent


    Accumulated
Other
Comprehensive
Income (Loss) (a)


    Accumulated
Deficit


    Total

 

Balance, December 31, 2004

   $ 1    $ 1,523     $ (296 )   $ (561 )   $ 20     $ (996 )   $ (309 )
    

  


 


 


 


 


 


Net loss

     —        —         —         —         —         (73 )     (73 )

Translation adjustments

     —        —         —         —         (54 )     —         (54 )
                                                   


Comprehensive loss

     —        —         —         —         —         —         (127 )
                                                   


Interest accrued on notes from parent of BCI (See Note 11)

     —        20       —         (20 )     —         —         —    

Stock based compensation expense
(See Note 12)

     —        10       —         —         —         —         10  

Redeemable preferred stock accretion
(See Note 9)

     —        (18 )     —         —         —         —         (18 )

Purchase accounting related to acquisition of minority interests (See Note 3)

     —        121       —         —         (5 )     11       127  

Effect of Combinations (See Note 11)

     —        (581 )     —         581       —         —         —    

Dividends declared (See Note 11)

     —        (550 )     —         —         —         —         (550 )
    

  


 


 


 


 


 


Balance, September 30, 2005

   $ 1    $ 525     $ (296 )   $ —       $ (39 )   $ (1,058 )   $ (867 )
    

  


 


 


 


 


 



(a) Accumulated other comprehensive income (loss) at September 30, 2005 includes a $42 net gain on foreign currency translation, $5 net loss from purchase accounting adjustments related to acquisition of minority interests and a $76 net loss relating to the Company’s minimum pension liability adjustment. Accumulated other comprehensive income at December 31, 2004 represents $96 of net foreign currency translation gains and a $76 net loss relating to the Company’s minimum pension liability adjustment.

 

See Notes to Condensed Consolidated Financial Statements

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In millions, except share data)

 

1. Background and Nature of Operations

 

Hexion Specialty Chemicals, Inc. (“Hexion” or “the Company”) is engaged in the manufacture and marketing of resins, inks, coating and adhesive resins, formaldehyde, oilfield products and other specialty and industrial chemicals worldwide. Hexion was formed on May 31, 2005 upon the combination of three Apollo Management, L.P. (“Apollo”) controlled companies (the “Combinations”), Resolution Performance Products, LLC (“RPP”), Resolution Specialty Materials, Inc. (“RSM Inc.”) and Borden Chemical, Inc. (“BCI”). Apollo acquired RPP on November 14, 2000, formed RSM Inc. and purchased the Specialty Resins and Monomers and Ink business of Eastman Chemical Company (“Eastman”) on August 2, 2004 through a subsidiary (the “RSM Transaction”), Resolution Specialty Materials, LLC (“RSM”), and acquired BCI on August 12, 2004. Upon consummation of the Combinations, BCI changed its name to Hexion Specialty Chemicals, Inc., and BHI Acquisition LLC (“BHI Acquisition”), BCI’s parent, changed its name to Hexion LLC. Prior to the Combinations, on April 29, 2005, a subsidiary of BCI completed its acquisition of Bakelite Aktiengesellschaft (“Bakelite”) (See Note 3). At September 30, 2005, the Company, including Bakelite, has 86 production, manufacturing and distribution facilities, of which 37 are located in the U.S.

 

The Company has incurred costs totaling approximately $5 and $34 in connection with the Combinations, during the three months and nine months ended September 30, 2005, respectively, primarily for accounting, consulting, legal and contract termination fees. As this transaction is considered a merger of entities under common control, in accordance with FASB Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” (“ SFAS 141”), these costs have been expensed as incurred and are included in the 2005 Condensed Consolidated Statements of Operations as Transaction related costs.

 

In the third quarter of 2004, as a result of the acquisitions of RSM and BCI by Apollo, the Company incurred Transaction related costs of $47. This amount included charges for accounting and legal fees, fees paid to Apollo, payments for cancellation of restricted stock and management bonuses pertaining to the activity. See Note 3.

 

On April 25, 2005, the Company filed a registration statement, which is not yet effective, with the U.S. Securities and Exchange Commission (the “SEC”) for a proposed IPO of its common stock. The Company subsequently filed five amendments to its registration statement on May 2, 2005, June 13, 2005, July 15, 2005, August 26, 2005 and September 19, 2005.

 

The Company has incurred costs totaling approximately $1 and $8 in connection with the proposed IPO during the three months and nine months ended September 30, 2005, respectively, primarily for accounting and legal fees. As the costs of issuing common stock are considered a reduction of the related proceeds of the offering, these costs have been deferred within Other assets on the September 30, 2005 Condensed Consolidated Balance Sheet until the IPO is effected.

 

2. Basis of Presentation

 

Prior to the Combinations, RPP, RSM Inc. and BCI were considered entities under the common control of Apollo affiliates as defined in Emerging Issues Task Force Issue No. 02-5, Definition of Common Control in Relation to FASB Statement of Financial Accounting Standards No. 141, “Business Combinations”. As a result of the Combinations the financial statements of these entities are presented retroactively on a consolidated basis in a manner similar to a pooling of interests, and include the results of operations of each business only from the date of acquisition by the Apollo affiliates.

 

The accompanying unaudited Hexion Financial Statements include the following entities: RPP and its majority-owned subsidiaries as of September 30, 2005 and December 31, 2004 and for the three and nine months ended September 30, 2005 and 2004; RSM Inc. and its majority-owned subsidiaries as of September 30, 2005 and December 31, 2004, for the three and nine months ended September 30, 2005, and from the date of acquisition for 2004; and BCI and its majority-owned subsidiaries (which includes Bakelite since the date of acquisition) as of September 30, 2005 and December 31, 2004, for the three and nine months ended September 30, 2005, and from the date of acquisition for 2004. RPP, RSM Inc. and Bakelite reflect the purchase method of accounting. BCI elected not to apply push-down accounting because it was a public reporting registrant as a result of public debt that was outstanding prior and subsequent to the acquisition by Apollo. In the opinion of management, all adjustments, consisting only of normal, recurring adjustments considered necessary for a fair presentation, have been included. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. It is suggested that these unaudited Financial Statements be read in conjunction with the financial statements, accounting policies and notes included in the Company’s audited financial statements for the year ended December 31, 2004. Results for the interim periods are not necessarily indicative of results for the full year.

 

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The following is an update of the significant accounting policies followed by the Company:

 

Principles of Consolidation—The Consolidated financial statements include the accounts of RPP, RSM Inc., BCI and Bakelite and their majority-owned subsidiaries in which no substantive participating rights are held by minority shareholders, after elimination of intercompany accounts and transactions. The Company’s share of the net earnings of 20% to 50% owned companies, for which it has the ability to exercise significant influence over operating and financial policies, are included in income on an equity basis. Investments of other companies are carried at cost.

 

The Company has recorded a minority interest for the equity interests in subsidiaries that are not 100% owned by the Company. At December 31, 2004, the minority interest primarily reflected the equity interest in RPP and RSM held by management and other third-parties. On May 31, 2005, the RPP and RSM minority interests were purchased in connection with the Combinations and recorded as a step acquisition (See Note 3). At September 30, 2005, the minority interest primarily reflects the Company’s ownership interest in HA-International, LLC (“HAI”), a joint venture between the Company and Delta-HA, Inc.

 

Loss Per Share – As a result of the Combinations, the Company’s capital structure consists of 82,629,906 shares outstanding (See Note 11). For purposes of calculating loss per share, 82,629,906 was used as the number of outstanding shares for all periods presented as no new shares were issued as a result of the legal merger of RPP, RSM and BCI. This presentation reflects the post-merger capital structure of the Company for all periods on a consistent basis. The Company did not have any potentially dilutive instruments outstanding for any periods.

 

The Company’s loss per share is calculated as follows:

 

     Three Months ended
September 30,


    Nine Months ended
September 30,


 
     2005

    2004

    2005

    2004

 

Loss from continuing operations

   $ (6 )   $ (79 )   $ (63 )   $ (94 )

Deduct: Redeemable preferred stock accretion

     (13 )     —         (18 )     —    
    


 


 


 


Loss from continuing operations available to common shareholders

   $ (19 )   $ (79 )   $ (81 )   $ (94 )
    


 


 


 


Per share – Loss from continuing operations available to common shareholders

   $ (0.22 )   $ (0.96 )   $ (0.98 )   $ (1.14 )
    


 


 


 


Average number of common shares outstanding during the period – basic and diluted

     82,629,906       82,629,906       82,629,906       82,629,906  

 

Stock-Based Compensation—Effective January 1, 2005, the Company elected to adopt SFAS No. 123(R) (revised 2004), Share-Based Payment. Under the provisions of SFAS No. 123(R), stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the requisite service period. As the Company was considered a nonpublic entity, at the date of adoption, that used the minimum value method for pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation, the Company is required to apply the prospective transition method. As such, the Company applies the statement to any new awards and to any awards modified, repurchased or cancelled since January 1, 2005. The adoption of SFAS No. 123(R) had no initial impact on the Company’s financial condition and results of operations.

 

Previously, the Company accounted for stock based awards under APB No. 25 and applied the minimum value method to determine fair value for disclosure requirements under SFAS No. 123. As of September 30, 2005, all awards outstanding are accounted for under SFAS No. 123(R). See Note 12.

 

The following tables sets forth the required reconciliation of reported and proforma net loss and earnings per share (“EPS”) under SFAS No. 148:

 

     Three Months ended
September 30, 2004


    Nine Months ended
September 30, 2004


 

Net loss, as reported

   $ (79 )   $ (94 )
    


 


Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

     6       6  

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effect

     (3 )     (3 )
    


 


Pro forma net loss

   $ (76 )   $ (91 )
    


 


Average number of common shares outstanding – basic and diluted

     82,629,906       82,629,906  

Per share, as reported (basic and diluted)

   $ (0.96 )   $ (1.14 )

Per share, pro forma (basic and diluted)

   $ (0.92 )   $ (1.10 )

 

To determine pro forma compensation cost for the plans in accordance with SFAS No. 123, the fair value of each option grant was estimated at the date of the grant using the minimum value method and the Black-Scholes options pricing model with the following weighted average rates, dividend rates and expected lives for each of the Company’s respective plans:

 

     2004

 
     RPP

    RSM

    BCI

 

Risk-free weighted average interest rate

     4.50 %     3.90 %     3.54 %

Dividend Rate

     0 %     0 %     0 %

Expected life

     7.0 years       6.3 years       5.0 years  

Estimated fair value of option grants (a)

   $ —       $ 0.77     $ 1.01  

(a) Fair value of option grants reflects the post-combination equivalent Hexion LLC common units giving effect to the reverse split (Note 12)

 

Recently Issued Accounting Standards

 

In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143. This Interpretation clarifies that the term “conditional asset retirement obligation” as used in FASB No. 143, Accounting for Asset Retirement Obligations, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation, when incurred, if the fair value of the liability can be reasonably estimated. The Interpretation is effective for the Company no later than the end of the fiscal year ending on December 31, 2005. The Company does not expect this Interpretation to have a material effect on its financial condition or results of operations.

 

In June 2005, the FASB staff issued FASB Staff Position 143-1, Accounting for Electronic Equipment Waste Obligations (FSP 143-1), to address the accounting for obligations associated with the Directive 2002/96/EC on Waste Electrical and Electronic Equipment (the “Directive”) adopted by the European Union. The Directive effectively obligates a commercial user to incur costs associated with the retirement of a specified asset that qualifies as historical waste equipment. The commercial user should apply the provisions of SFAS 143 and FIN 47 discussed above. FSP 143-1 shall be applied the later of the first reporting period ending after June 8, 2005 or the date of the adoption of the law by the applicable EU-member country. We adopted the FSP at certain of our European operations where applicable legislation was adopted. The impact of the adoption on the consolidated financial statements was not significant.

 

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3. Business Acquisitions and Divestitures

 

Acquisition of RSM

 

On August 2, 2004 (the Closing Date), RSM, as assignee of RSM Inc., purchased the Specialty Resins and Monomers and Ink businesses of Eastman Chemical Company (“Eastman”) for $192, including direct acquisition costs (“RSM Transaction”).

 

The RSM Transaction has been accounted for under the purchase method of accounting. The cost of the RSM Transaction was allocated to the assets acquired and liabilities assumed based on estimates of their respective fair values at the date of Acquisition. Fair values were determined based upon appraisals and internal studies. As the fair value of net assets acquired exceeded cost, no goodwill was recorded in the transaction.

 

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 the Company 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.

 

In connection with the RSM Transaction, RSM Inc. 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 Inc. to Eastman that are due and payable in 2011. Such notes were delivered to Eastman as partial consideration of the RSM Transaction. These notes were subsequently repaid when the Company entered a new senior secured credit facility. See Note 6.

 

The following table summarizes the assets acquired and liabilities assumed at the date of acquisition of RSM.

 

    

RSM at

August 1, 2004


Current assets

   $ 196

Property, plant and equipment

     89

Other assets

     1

Intangible assets

     —  

Goodwill

     —  
    

Total assets acquired

     286

Current liabilities

     80

Long-term debt

     3

Other liabilities

     11
    

Total liabilities assumed

     94
    

Net assets acquired

   $ 192
    

 

Acquisition of BCI by Apollo

 

On August 12, 2004, BHI Investment, LLC, an affiliate of Apollo, acquired all of the outstanding capital stock of Borden Holdings, Inc. (“BHI”), BCI’s parent at that time, for total consideration of approximately $1.2 billion, including assumption of debt.

 

The acquisition of BHI, and the payment of transaction fees and expenses, was financed with the net proceeds of a $475 second-priority senior secured private debt offering (the “Second Priority Notes”) by two newly formed, wholly owned subsidiaries of BCI and certain equity contributions to BHI Acquisition from Apollo. Collectively, these transactions are referred to as the “BCI Transaction.”

 

Acquisition of Bakelite

 

On April 29, 2005, Hexion Specialty Chemicals Canada, Inc., a subsidiary of Hexion, through its wholly owned subsidiary, National Borden Chemical Germany GmbH, completed its acquisition of Bakelite pursuant to a share purchase agreement with RÜTGERS AG and RÜTGERS Bakelite Projekt GmbH (collectively, the “Sellers”) dated October 6, 2004 (the “Bakelite Acquisition”) for a net purchase price of approximately €201, or approximately $259, subject to certain adjustments. The Company incurred direct costs associated with the acquisition of $39, which have been capitalized as part of the purchase in accordance with SFAS 141 and are included in the net purchase price. Based in Iserlohn-Letmathe, Germany, Bakelite is a producer of phenolic and epoxy thermosetting resins and molding compounds with 13 manufacturing facilities and 1,700 employees, primarily in Europe and Asia. The acquisition provides the Company with additional phenolic resin technology and products and a new epoxy resin technology platform.

 

The Company financed the Bakelite Acquisition through a combination of available cash and a second-priority senior secured bridge loan facility in the amount of $250. The bridge financing arrangement had a variable interest rate equal to LIBOR plus an applicable margin and had a final maturity date of July 15, 2014. The bridge financing arrangement was settled and cancelled on May 31, 2005 using proceeds from the $150 Second-priority senior secured floating rate notes due 2010 and $100 of term loan debt borrowed under the Company’s credit facility (See Note 6). The Bakelite Acquisition has been accounted for under the purchase method of accounting. As such, Bakelite’s results of operations are included in the Company’s Condensed Consolidated Financial Statements (the “Financial Statements”) since the date of acquisition.

 

On December 14, 2004, in order to mitigate the risk of foreign currency exposure related to the Bakelite Acquisition, the Company entered into a foreign currency forward position of $235 to purchase Euros with U.S. Dollars at a rate of $1.3430, contingent upon the close of the transaction. On March 31, 2005, the Company adjusted the contract to have a target settlement date of April 29, 2005 and a new exchange rate of $1.3446. In conjunction with the consummation of the Bakelite Acquisition, the Company realized an aggregate loss of approximately $9 on this contract, the current year portion of which is included as Other non-operating expense in the Condensed Consolidated Statement of Operations.

 

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. Fair values are based upon preliminary appraisals and internal studies and are subject to final adjustments.

 

    

Fair value at

April 29, 2005


Current assets

   $ 290

Property, plant and equipment

     166

Other assets

     4

Intangible assets

     72

Goodwill

     46
    

Total assets acquired

     578

Current liabilities

     158

Long-term debt

     21

Other liabilities

     140
    

Total liabilities assumed

     319
    

Net assets acquired

   $ 259
    

 

Of the $72 of acquired intangible assets, $19 was assigned to trade names, $16 was assigned to technology and $37 was assigned to customer relationships. The acquired intangible assets with finite lives have a weighted average useful life of approximately 14 years. The trade names have a 30-year useful life, technology has a 13-year useful life and customer relationships have a 14-year weighted average useful life.

 

The $46 of goodwill was assigned to the Bakelite reportable segment, none of which is expected to be deductible for tax purposes.

 

Pacific Epoxy Polymers Acquisition

 

During the second quarter of 2005, the Company acquired certain assets and assumed certain liabilities from Pacific Epoxy Polymers, Inc., a domestic manufacturer of epoxy resins, for an estimated total purchase price of $7. At closing, the Company paid $5 from available cash and issued a note for the remaining $2. This acquisition was accounted for under the purchase method of accounting and the Company has made a preliminary allocation of the purchase price resulting in goodwill of $4 million. The pro forma effects of the acquisition are not material.

 

Acquisition of RPP and RSM Minority Interests

 

Upon the Combinations, shares of RPP Inc., the former parent of RPP, and RSM Inc. held by minority shareholders and management were exchanged for shares in Hexion LLC. The minority shareholders and management held ownership interests of 28.2% and 5% for RPP and RSM, respectively, on a fully diluted basis. The acquisition of these ownership interests was accounted for under the purchase method of accounting and pushed-down to the respective acquired businesses.

 

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The following table summarizes the step-up to fair value of the assets acquired and liabilities assumed at the date of acquisition based upon the percentage ownership acquired from the minority shareholders. Fair values are based upon preliminary third party appraisals and internal studies and are subject to final adjustments.

 

    

Incremental

fair value at

May 31, 2005


Current assets

   $ 9

Property, plant and equipment

     26

Intangible assets

     15

Goodwill

     50

Other assets

     15
    

Total asset step-up

     115

Current liabilities

     3

Long-term debt

     8

Other liabilities

     14
    

Total liability step-up

     25
    

Net assets stepped-up

   $ 90
    

 

As a result of the exchange of minority interest shares, Shareholders’ Deficit was adjusted by $127, consisting of the $90 step-up to fair value of net assets and a $37 reclassification from minority interest to Paid-in capital. Additionally, $5 and $11 of Accumulated other comprehensive income and Accumulated deficit were reclassified to Paid-in capital to recognize an accumulated negative basis by minority interest holders whose shares were exchanged.

 

Of the $15 of acquired intangible assets, approximately $13 was assigned to patents and $2 was assigned to trademarks. The acquired intangible assets have a weighed average useful life of 20 years.

 

Of the $50 of goodwill, $5 was assigned to the RSM-SRM reportable segment, $1 was assigned to the RSM-Inks segment, $22 was assigned to the RPP-Americas segment and $22 was assigned to the RPP-Europe segment. No goodwill is expected to be deductible for tax purposes.

 

The following unaudited pro forma financial information combines the consolidated results of operations as if the Bakelite Acquisition and the combination of RPP, RSM Inc. and BCI had occurred as of the beginning of the periods presented. Pro forma adjustments include only the effects of events directly attributable to the acquisitions. The pro forma adjustments reflected in the tables below include amortization of intangibles, depreciation adjustments due to the write-up of property, plant and equipment to estimated fair market value, and interest expense on the acquisition debt for the Bakelite Acquisition and related income tax effects.

 

     Three months ended
September 30,


    Nine months ended
September 30,


 
     2005

    2004

    2005

    2004

 

Net sales

   $ 1,134     $ 1,036     $ 3,564     $ 2,983  

Loss from continuing operations

     (8 )     (109 )     (71 )     (340 )

Net loss

     (8 )     (109 )     (81 )     (340 )

Basic and Diluted Share Data

                                

Loss from continuing operations

   $ (0.25 )   $ (1.32 )   $ (1.08 )   $ (4.11 )

Net loss

     (0.25 )     (1.32 )     (1.20 )     (4.11 )

 

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The following are included in the pro forma Loss from continuing operations:

 

     Three months ended
September 30,


   Nine months ended
September 30,


     2005

   2004

   2005

   2004

Payment to Apollo to cancel fee agreements

     —        —        —        —  

Cost of sales related to inventory sold that was stepped-up at the acquisition date

   $ 7    $ 9      16      9
    

  

  

  

     $ 7    $ 9    $ 27    $ 9

 

The pro forma financial information does not necessarily reflect the operating results that would have occurred had the acquisitions been consummated as of the beginning of the periods presented, nor is such information indicative of future operating results.

 

4. Discontinued Operations

 

In 1998, pursuant to a merger and recapitalization transaction sponsored by The Blackstone Group (“Blackstone”) and financing arranged by The Chase Manhattan Bank (“Chase”), Borden Decorative Products Holdings, Inc. (“BDPH”), a wholly owned subsidiary of the Company, was acquired by Blackstone, which subsequently merged with Imperial Wallcoverings to create Imperial Home Décor Group (“IHDG”). The Company received approximately $309 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. IHDG emerged from bankruptcy in April 2001. The IHDG Litigation Trust (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 the Company and certain of its affiliates seeking to have the IHDG transaction voided as a fraudulent conveyance and asking for a judgment to be entered against the Company for $314 plus interest, costs and attorney fees. On June 8, 2005, the Company reached an agreement with the parties to settle and release all claims against the Company for $15. This amount was subsequently paid by the Company in July 2005. As the settlement directly related to a divested business which was accounted for as a discontinued operation in 1997, the Company has included the settlement cost in Loss from discontinued operations in its Financial Statements.

 

In 1996 and 1997, the Company sold its Dairy and Foods businesses. Both disposals were accounted for as discontinued operations in those years. In 2005, the Company received $5 as settlement from a class action suit related to raw material purchases by the divested businesses between July 21, 1991 and June 30, 1995. As the settlement directly related to the previously divested businesses, the Company has included the settlement proceeds in Loss from discontinued operations in its Financial Statements.

 

Typically, losses from discontinued operations are recorded in the Financial Statements net of tax; however, because the Company has a full valuation allowance on its domestic deferred tax assets and is unable to realize an income tax benefit from these losses, the corresponding benefit has been offset by a full valuation allowance.

 

5. Related Party Transactions

 

Administrative Service, Management and Consulting Arrangements

 

In connection with their respective acquisitions by Apollo, RPP, RSM and BCI entered into certain management, consulting and transaction fee agreements with Apollo and its affiliates for the provision of certain structuring and advisory services. These agreements allowed Apollo and its affiliates to provide certain advisory services to the companies for terms up to ten years. The companies also agreed to indemnify Apollo and its affiliates and their directors, officers and representatives for potential losses relating to the services contemplated under these agreements. In addition, upon the closing of the RSM and BCI transactions in the third quarter of 2004, the Company paid $12 for transaction and advisory services, and reimbursed expenses of $1. Prior to the Combinations, on May 31, 2005, RPP and RSM terminated their agreements with Apollo, thereby releasing any and all obligations and liabilities by all parties under the respective agreements. In consideration of the terminations, RPP and RSM paid Apollo $4 and $7, respectively. These amounts are included within Transaction related costs in the Company’s Consolidated Statements of Operations.

 

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At the time of the Combinations, the Company entered into a seven-year, amended and restated version of the former BCI management consulting agreement with Apollo (the “Amended Management Consulting Agreement”). The terms of the Amended Management Consulting Agreement currently provide for annual fees of approximately $3 and provide for a lump-sum settlement equal to the net present value of the remaining annual management fees payable under the remaining term of the agreement in connection with a sale of the Company or an IPO.

 

Pursuant to the agreements in effect, during each of the three months ended September 30, 2005 and 2004, the Company paid fees of less than $1. For each of the nine months ended September 30, 2005 and 2004, the Company paid fees of $3 and $1, respectively. These amounts are included within Other operating expense in the Company’s Consolidated Statements of Operations. There were no amounts payable to Apollo at September 30, 2005 or December 31, 2004.

 

In connection with the Bakelite Acquisition, in exchange for deal structuring and negotiating provided by Apollo, the Company made payments to Apollo in the amount of $4. These amounts are considered direct costs of the acquisition and have been capitalized as part of the purchase.

 

Other Transactions and Arrangements

 

The Company sells finished goods to an unconsolidated joint venture of the Company and certain Apollo affiliates. These sales totaled $6 and $1 for the three months ended September 30, 2005 and 2004, respectively, and totaled $20 and $7 for the nine months ended September 30, 2005 and 2004, respectively. Accounts receivable from these affiliates totaled $4 and $1 at September 30, 2005 and December 31, 2004, respectively. The Company also purchases raw materials and services from certain Apollo affiliates. These purchases totaled less than $1 and $2 for the three months ended September 30, 2005 and 2004, respectively, and totaled $4 and $5 for the nine months ended September 30, 2005 and 2004, respectively. The Company had accounts payable to Apollo affiliates of less than $1 at September 30, 2005 and December 31, 2004 related to these purchases.

 

Upon closing the BCI Transaction, BCI paid transaction-related costs of $9 on behalf of BHI Investment LLC, $22 on behalf of BW Holdings, LLC and shared compensation costs of $12. These amounts are included in Transaction related costs.

 

In the first quarter of 2005, BCI received a payment of $8 from its previous owner, Kohlberg Kravis Roberts & Co., for adjustments made to the purchase price of the Apollo acquisition of BCI. This amount was subsequently paid to BCI’s parent, BHI Acquisition, in the second quarter of 2005.

 

6. Debt

 

Debt outstanding at September 30, 2005 and December 31, 2004 consisted of the following:

 

     September 30, 2005

   December 31, 2004

    

Long -

Term


   Due Within
One Year


  

Long -

Term


   Due Within
One Year


Revolving Credit facilities

   $ —      $ —      $ 28    $ —  

Senior Secured Notes:

                           

8% Senior secured notes due 2009 (includes $1 of unamortized debt premium at September 30, 2005 and $0 at December 31, 2004) (a)

     141      —        140      —  

9.5% Senior second secured notes due 2010 (includes $2 of unamortized debt premium at September 30, 2005 and $1 at December 31, 2004) (a)

     202      —        201      —  

9% Second-priority senior secured notes due 2014

     325      —        325      —  

Floating rate second-priority senior secured notes due 2010 (includes $2 of unamortized debt discount at September 30, 2005 and $0 at December 31, 2004)

     298      —        150      —  

Credit Agreement: term loans due 2010

     494      5      123      2

Unsecured Debentures:

                           

9.2% debentures due 2021

     115      —        115      —  

7.875% debentures due 2023

     247      —        247      —  

Sinking fund debentures: 8.375% due 2016

     78      —        78      —  

13.5% Senior subordinated notes due 2010 (includes $9 of unamortized debt premium at September 30, 2005 and $4 at December 31, 2004) (a)

     337      —        332      —  

Seller senior subordinated notes due 2011

     —        —        50      —  

Other:

                           

Industrial revenue bonds due 2009

     34      —        34      —  

Other

     24      9      7      5

Capital Leases

     11      1      4      —  
    

  

  

  

Total current maturities of long-term debt

     —        15      —        7

Short-term debt (primarily foreign bank loans)

     —        46      —        9
    

  

  

  

Total debt

   $ 2,306    $ 61    $ 1,834    $ 16
    

  

  

  


(a) September 30, 2005 balance includes purchase accounting adjustments as a result of the acquisition of RPP’s minority interests (See Note 3). These adjustments have been reflected as unamortized debt premiums.

 

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Credit Facility

 

In May 2005, the Company entered into a new $775 senior secured credit facility (“Hexion Credit Facility”) and replaced and repaid the RPP and RSM credit facilities, including the RPP $150 revolving credit facility entered into on January 24, 2005, $100 of the Bakelite bridge loan facility (See Note 3) and the Seller senior subordinated notes. The Hexion Credit Facility has a $225 revolving credit facility and $500 term loan facility. The facility will also provide a $50 synthetic letters of credit facility (“LOCs”). Repayment of 1% of the term loan per annum must be made quarterly with the balance payable upon the final maturity date. Further, the Company may be required to make additional repayments on the term loan beginning in the second quarter of 2007 if the Company generates excess cash flow, as defined in the agreement. Interest on the term and revolving loan facilities is LIBOR plus 2.5% or the higher of prime rate plus 1% or the Federal Funds Rate plus 1.5%. Loans made in Canadian dollars will carry interest at the Canadian Bankers’ Acceptance rate plus 2.5% or the higher of prime rate plus 1% or average banker’s acceptance rate plus 1.5%. Loans made in sterling will carry interest at LIBOR plus 2.5% or the rate quoted by JPMorgan Chase Bank, N.A. (“JPMCB”) as its base rate for such loans plus 1%. Loans denominated in euros will carry interest at EURO LIBOR plus 2.5% or the rate quoted by JPMCB as its base rate for such loans plus 1%. Interest rates are subject to reduction based on an improved leverage ratio. The Hexion Credit Facility has commitment fees (other than with respect to the synthetic LOC facility) equal to 0.5% per annum of the unused line fee plus a fronting fee of 0.25% of the aggregate face amount of outstanding LOCs. The synthetic LOC facility has a commitment fee of 0.1% per annum. The Hexion Credit Facility is secured by substantially all the assets of Hexion, subject to certain exceptions. The Hexion Credit Facility 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 Hexion Credit Facility 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. On May 31, 2005, the Company issued $500 term loans under the facility of which approximately $300 of the proceeds were used to repay existing debt including borrowings under the RPP $150 revolving credit facility entered into January 24, 2005, $125 term note under the RSM facility, $100 of the Bakelite bridge loan facility (See Note 3) and the Seller senior subordinated notes. The remainder was used to pay a dividend to the Company’s parent and transaction expenses. The Company incurred financing costs of $18 related to the Hexion Credit Facility. These costs are included within Other assets on the Financial Statements and will be amortized over the life of the related debt.

 

In the second quarter of 2005, the Company incurred a charge for the write-off of deferred financing costs totaling $17. Of this amount, $6 was related to the Bakelite Acquisition bridge loan facility, which was entered into and repaid during the quarter, and $11 was related to the early termination of the RPP, RSM and BCI credit facilities. The $17 expense is included in Write-off of deferred financing fees on the Condensed Consolidated Statements of Operations.

 

For the three and nine months ended September 30, 2005, the Company incurred an unrealized loss of $1 and $10, respectively, related to a foreign subsidiary’s $290 U.S. dollar denominated term loan. The loss is included as Other non-operating expense on the Condensed Consolidated Statements of Operations. On October 11, 2005, the Company entered into a three-year swap agreement to offset balance sheet and interest rate exposures and cash flow variability associated with exchange rate fluctuations on the term loan.

 

Senior Secured Notes

 

In May 2005, the Company issued $150 Second-Priority Senior Secured Floating Rate Notes due 2010. The notes were issued at a discount of 98.846%. Interest on the notes accrues at a rate per annum, reset quarterly, equal to LIBOR plus 5.5% and is payable on January 15, April 15, July 15 and October 15, commencing on July 15, 2005. 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. The notes are collateralized by a second-priority security interest in the same collateral as the remaining $150 of Floating rate second-priority senior secured notes, the 9% Second-priority senior secured notes and the 9.5% Senior second secured notes, which are all second in priority (subject to Permitted Liens) to the Hexion Credit Facility and the 8% Senior secured notes. The proceeds from the notes were used to repay in part the bridge loan facility used to finance the Bakelite Acquisition (See Note 3). The Company incurred financing costs of $4 related to the issuance of the Senior Secured Notes. These costs are included within Other assets on the Financial Statements and will be amortized over the life of the notes.

 

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Following the Combinations, the Company, certain of its U.S. subsidiaries and Hexion U.S. Finance Corporation (formerly known as Borden U.S. Finance) guarantee the senior secured debt previously issued by RPP (See Note 15).

 

7. Guarantees, Indemnifications and Warranties

 

Standard Guarantees / Indemnifications

 

In the ordinary course of business, the Company enters into numerous agreements that contain standard guarantees and indemnities whereby the Company indemnifies another party for, among other things, breaches of representations and warranties. Such guarantees or indemnifications are granted under various agreements, including those governing (i) purchases and sales of assets or businesses, (ii) leases of real property, (iii) licenses of intellectual property, (iv) long-term supply agreements and (v) agreements with public authorities on subsidies received for designated research and development projects. The guarantees or indemnifications issued are for the benefit of the (i) buyers in sale agreements and sellers in purchase agreements, (ii) landlords or lessors in lease contracts, (iii) licensors or licensees in license agreements, (iv) vendors or customers in long-term supply agreements and (v) governments or agencies subsidizing research or development. In addition, the Company guarantees certain payables of its subsidiaries for the purchase of raw materials in the ordinary course of business.

 

These parties may also be indemnified against any third party claim resulting from the transaction that is contemplated in the underlying agreement. Additionally, in connection with the sale of assets and the divestiture of businesses, the Company may agree to indemnify the buyer with respect to liabilities related to the pre-closing operations of the assets or businesses sold. Indemnities related to pre-closing operations generally include tax liabilities, environmental liabilities and employee benefit liabilities not assumed by the buyer in the transaction.

 

Indemnities related to the pre-closing operations of sold assets normally do not represent additional liabilities to the Company, but simply serve to protect the buyer from potential liability associated with the Company’s existing obligations at the time of sale. As with any liability, the Company has accrued for those pre-closing obligations that are considered probable and reasonably estimable. Amounts recorded are not significant at September 30, 2005.

 

While some of these guarantees extend only for the duration of the underlying agreement, many survive the expiration of the term of the agreement or extend into perpetuity (unless subject to a legal statute of limitations). There are no specific limitations on the maximum potential amount of future payments that the Company could be required to make under its guarantees nor is the Company able to develop an estimate of the maximum potential amount of future payments to be made under these guarantees as the triggering events are not predictable. With respect to certain of the aforementioned guarantees, the Company maintains limited insurance coverage that mitigates potential payments to be made.

 

Warranties

 

The Company does not make express warranties on its products, other than that they comply with the Company’s specifications; therefore, the Company does not record a warranty liability. Adjustments for product quality claims are not material and are charged against sales revenues.

 

8. Commitments and Contingencies

 

Environmental Matters

 

Because the Company’s operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials, the Company is subject to extensive environmental regulation at the Federal, state and local levels as well as foreign laws and regulations, and therefore is exposed to the risk of claims for environmental remediation or restoration. In addition, violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

 

Accruals for environmental matters are recorded following the guidelines of Statement of Position 96-1, “Environmental Remediation Liabilities,” when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Environmental accruals are reviewed on an interim basis and as events and developments warrant.

 

The Company has recorded liabilities, relating to 69 locations (63 at December 31, 2004), of approximately $39 and $41 at September 30, 2005 and December 31, 2004, respectively, for all probable environmental remediation, indemnification and restoration liabilities. These amounts include estimates of unasserted claims the Company believes are probable of loss and reasonably estimable. Based on the factors discussed below and currently available information and analysis, the Company believes that it is reasonably

 

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possible that costs associated with such sites may fall within a range of $27 to $80, in the aggregate, at September 30, 2005. This estimate of the range of reasonably possible costs is less certain than the estimates upon which the liabilities are based, and in order to establish the upper end of such range, assumptions less favorable to the Company among the range of reasonably possible outcomes were used. As with any estimate, if facts or circumstances change, the final outcome could differ materially from these estimates.

 

Following is a more detailed discussion of the Company’s environmental liabilities and related assumptions at September 30, 2005:

 

BCP Geismar Site—BCI formerly owned a basic chemicals and polyvinyl chloride business which was taken public as Borden Chemicals and Plastics Operating Limited Partnership (“BCPOLP”) in 1987. BCI retained a 1% interest and the general partner interest, which were held by its subsidiary, BCP Management (“BCPM”). BCI also retained the liability for certain environmental matters after BCPOLP’s formation. Under a Settlement Agreement approved by the United States Bankruptcy Court for the District of Delaware among BCI, BCPOLP, BCPM, the United States Environmental Protection Agency and the Louisiana Department of Environmental Quality, BCI agreed to perform certain of BCPOLP’s obligations with respect to environmental conditions at BCPOLP’s Geismar, Louisiana site. These obligations are related to soil and groundwater contamination at the Geismar site. The Company bears the sole responsibility for these obligations, as there are no other potentially responsible parties (“PRPs”) or third parties from which the Company can seek reimbursement, and no additional insurance recoveries are expected.

 

A groundwater pump and treat system for the removal of contaminants is operational, and natural attenuation studies are proceeding. The Company has performed extensive soil and groundwater testing. Regulatory agencies are reviewing the current findings and remediation efforts. If closure procedures and remediation systems prove inadequate, or if additional contamination is discovered, this could result in the costs approaching the higher end of the range of possible outcomes discussed below.

 

The Company has recorded a liability of approximately $20 and $21 at September 30, 2005 and December 31, 2004, respectively, related to the BCP Geismar site. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with this site may fall within a range of $14 to $32, depending upon the factors discussed above. Due to the long-term nature of the project, the reliability of timing and the ability to estimate remediation payments, this liability was recorded at its net present value, assuming a 3% discount rate and a time period of thirty years and the range of possible outcomes is discounted similarly. The undiscounted liability is approximately $30 over thirty years.

 

Following are expected payments for each of the next five years, and a reconciliation of the expected aggregate payments to the liability reflected at September 30, 2005:

 

2005

   $ 1  

2006

     2  

2007

     2  

2008

     1  

2009

     1  

Remaining aggregate payments

     23  
    


Total undiscounted liability

     30  

Less: discount to net present value

     (10 )
    


Liability per Condensed Consolidated Balance Sheet

   $ 20  
    


 

Superfund Sites / Offsite Landfills—The Company is currently involved in environmental remediation activities at 29 sites (26 at December 31, 2004) in which it has been notified that it is, or may be, a PRP under the United States Comprehensive Environmental Response, Compensation and Liability Act or similar state “superfund” laws. The Company has recorded a liability of approximately $8 at September 30, 2005 and December 31, 2004 related to these sites. The Company anticipates approximately 60% of this liability will be paid within the next five years, with the remaining payments occurring over the next twenty-five years. The Company generally does not bear a significant level of responsibility for these sites, and therefore, has little control over the costs and timing of cash flows. At 17 of the 29 sites, the Company’s share is less than 1%. At the remaining 12 sites, the Company has a share of up to 8.8% of the total liability which accounts for $7 of the total amount reserved for superfund / offsite landfill sites at September 30, 2005 and December 31, 2004. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may be as low as $6 or as high as $19, in the aggregate. In estimating both its current reserves for environmental remediation at these sites and the possible range of additional costs, the Company has not assumed that it will bear the entire cost of remediation of every site to the exclusion of other known PRPs who may be jointly and severally liable. The Company has limited information to assess the viability of other PRPs and their probable contribution on a per site basis. The range of possible outcomes also takes into account the maturity of each project, which results in a more narrow range as the project progresses. The Company’s ultimate liability will depend on many factors including its volumetric share of waste, the financial viability of other PRPs, the remediation methods and technology used, the amount of time necessary to accomplish remediation, and the availability of insurance coverage. The Company’s insurance provides very limited, if any, coverage for these environmental matters.

 

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Sites Under Current Ownership—The Company is conducting environmental remediation at 15 locations currently owned by the Company, of which 2 sites are no longer operating. There are no other parties responsible for remediation at these sites. Much of the remediation is being performed by the Company on a voluntary basis; therefore, the Company has greater control over the costs to be incurred and the timing of cash flows. The Company has accrued approximately $7 and $8 at September 30, 2005 and December 31, 2004, respectively, for remediation and restoration liabilities at these locations. The Company anticipates approximately $4 of these liabilities will be paid within the next three years, with the remaining amounts being paid over the next ten years. Approximately $2 of these reserves is included in the Company’s business realignment reserve, as the environmental clean up is being handled in conjunction with planned closure of the location. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may fall within a range of $5 to $15, in the aggregate. The factors influencing the ultimate outcome include the methods of remediation to be elected, the conclusions and assessment of site studies remaining to be completed and the time period required to complete the work.

 

Other Sites—The Company is conducting environmental remediation at 10 locations (9 at December 31, 2004) formerly owned by BCI. The Company has accrued approximately $3 at September 30, 2005 and December 31, 2004 for remediation and restoration liabilities at these locations. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such sites may fall within a range of $2 to $14, in the aggregate. The primary drivers in determining the final costs to the Company on these matters are the method of remediation selected and the level of participation of third parties.

 

In addition, the Company is responsible for 13 sites (11 at December 31, 2004) that require monitoring where no additional remediation is expected and has also established accruals for other related costs, such as fines and penalties. The Company has accrued approximately $1 at September 30, 2005 and December 31, 2004, respectively, related to these sites. Payment of these liabilities is anticipated to occur over the next ten years. The ultimate cost to the Company will be influenced by any variations in projected monitoring periods or by findings that are better or worse than anticipated findings.

 

BCI formerly operated the Smith Douglass fertilizer business, which included a phosphate processing operation in Manatee County, Florida and an animal food processing operation in Hillsborough County, Florida. Both operations were sold in 1980. The EPA sent the Company and another former owner of the Manatee County facility a request for $0.1 relating to oversight costs incurred when the site was abandoned by its current owner. The Company is disputing the charge. The Company is aware that state and Federal environmental agencies have taken measures to prevent the off-site release of water from rainfall that accumulated in the drainage ditches and lagoons surrounding the gypsum piles located on this site. The Company is aware that the current owner of the Hillsborough County site ceased operations in March 2004 and is working with governmental agencies to effect closure of that site. At this time, the Company has received an information request from the EPA but has not received any demands from any governmental agencies or others regarding the closure and environmental cleanup at this site, which the Company believes is the responsibility of the current owner. While it is reasonably possible some costs could be incurred related to these sites, the Company has inadequate information to enable it to estimate a potential range of liability, if any.

 

As a result of the Bakelite Acquisition, the Company acquired a site in Duisburg, Germany with significant soil and groundwater contamination beneath a facility that is shared with Rütgers Chemicals AG (“Rütgers”). Rütgers is in discussions with the local authorities concerning a proposed remediation plan; however, the scope and extent of that plan and the costs of its possible implementation are not yet reasonably estimable. Rütgers has contractually agreed to provide indemnifications to the Company with respect to this matter until 2025, subject to certain exceptions and limitations. Management believes that it is unlikely that the Company will have to take extensive actions for remediation. While it is reasonably possible some costs could be incurred related to these sites, the Company has inadequate information to enable it to estimate a potential range of liability, if any.

 

For environmental conditions that existed at RPP related sites prior to November 2000, the Royal Dutch/Shell Group of Companies (“Shell”) generally will indemnify the Company for environmental damages associated with environmental conditions that occurred or existed before the recapitalization in November 2000, subject to certain limitations. There have been no claims against RPP since November 2000 relating to RPP environmental matters; therefore, the Company has no accruals at September 30, 2005 and December 31, 2004 relating to RPP environmental matters.

 

According to the terms of the RSM Transaction, Eastman retained the liability and indemnified RSM for certain matters that occurred or existed before the acquisition in August 2004 subject to certain limitations.

 

Non-Environmental Legal Matters

 

The Company has reserved approximately $13 and $21 at September 30, 2005 and December 31, 2004, respectively, relating to all non-environmental legal matters for legal defense and settlement costs that it believes are probable and estimable at this time.

 

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Following is a discussion of non-environmental legal proceedings that are not in the ordinary course of business:

 

Brazil Tax Claim—In 1992, the State of Sao Paulo Administrative Tax Bureau issued an assessment against BCI’s primary Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes, characterized by the Tax Bureau as intercompany sales. Since that time, management and the Tax Bureau have held discussions and the subsidiary has filed an administrative appeal seeking cancellation of the assessment. The Administrative Court upheld the assessment in December 2001. In 2002, the subsidiary filed a second appeal with the highest-level Administrative Court, again seeking cancellation of the assessment. Argument was made to the court in September 2004; the Company is awaiting its ruling. At September 30, 2005, the amount of the assessment, including tax, penalties, monetary correction and interest, is 72 million Brazilian Reais, or approximately $32. The Company believes it has a strong defense against the assessment and will pursue the appeal vigorously, including appealing to the judicial level; however, there is no assurance that the assessment will not be upheld. At this time, the Company does not believe a loss is probable; therefore, only related legal fees have been accrued.

 

HAI Grand Jury Investigation—HAI received a grand jury subpoena dated November 5, 2003 from the U.S. Department of Justice Antitrust Division relating to a foundry resins Grand Jury investigation. HAI has provided documentation in response to the subpoena. As is frequently the case when such investigations are in progress, various antitrust lawsuits have been brought against the Company alleging that BCI and HAI, along with various other entities, engaged in a price fixing conspiracy. At this time, the Company does not believe a loss is probable; therefore, only related legal fees have been accrued. The Company does not have sufficient information to determine a range of possible outcomes for this matter at this time.

 

CTA Acoustics—From the third quarter 2003 to the first quarter 2004, six lawsuits were filed against BCI in the 27th Judicial District, Laurel County Circuit Court, in Kentucky, arising from an explosion at a customer’s plant where seven plant workers were killed and other workers were injured. The lawsuits primarily seek recovery for wrongful death, emotional and personal injury, loss of consortium, property damage and indemnity. The litigation also includes claims by the Company’s customer against its insurer and the Company for property damage. On October 20, 2005, a settlement was reached with representatives of the seven deceased plant workers and twelve seriously injured workers. The Company’s proposed share of the settlement amount is covered by insurance. In the unlikely event that the co-defendants do not pay their $21 proposed share of the settlement, the Company could be held liable for this amount. The Company believes any additional liability would be covered by insurance. The property damage claim and suits by workers for emotional distress and minor injuries remain to be resolved. The Company previously accrued $5, the amount of its insurance deductible, relating to these actions and has insurance coverage expected to address any additional payments and legal fees.

 

Other Legal Matters— The Company is involved in various product liability, commercial and employment litigation, personal injury, property damage and other legal proceedings which are considered to be in the ordinary course of business. There has been increased publicity about asbestos liabilities faced by manufacturing companies. In large part, as a result of the bankruptcies of many asbestos producers, plaintiffs’ attorneys are increasing their focus on peripheral defendants, including the Company, and asserting that even products that contained a small amount of asbestos caused injury. Plaintiffs are also focusing on alleged harm caused by other products the Company has made or used, including those containing silica and vinyl chloride monomer. The Company does not believe that it has a material exposure relating to these claims and believes it has adequate reserves and insurance to cover currently pending and foreseeable future claims.

 

The Company is named in two lawsuits filed in Hillsborough County, Florida Circuit Court, relating to an animal feed supplement processing site formerly operated by BCI and sold in 1980. The lawsuits are filed on behalf of multiple residents of Hillsborough County living near the site and allege various injuries related to exposure to toxic chemicals. At this time, the Company has inadequate information from which to estimate a potential range of liability, if any.

 

Other Commitments and Contingencies

 

The Company entered into contractual agreements with Shell and other third parties for the supply of site services, utilities, materials and facilities and for operation and maintenance services necessary to operate certain RPP facilities on a stand-alone basis. The duration of the contracts range from less than one year to 20 years, depending on the nature of services. Such contracts may be terminated by either party under certain conditions as provided for in the respective agreements; generally, 90 days notice is required for short-term contracts and three years notice is required for longer-term contracts (generally those contracts in excess of five years). Contractual pricing generally includes a fixed and variable component.

 

In addition, the Company entered into contractual agreements with Shell and other third parties for the purchase of feedstocks. The terms of the agreements vary from three to ten years, extendable at the Company’s request and cancelable by either party as provided for in the respective agreements. Feedstock prices are based on market prices less negotiated volume discounts or cost input formulas.

 

On October 15, 2004, in order to secure the long-term supply of a key raw material, the Company entered into a ten-year contract with a supplier to purchase a specified quantity of product at a specified price whether or not it takes delivery. Prices are adjusted annually according to a formula that is based on an agreed upon raw material benchmark index. The initial volume is adjusted annually based on the prior year’s sales of the related finished good manufactured with the raw material. In addition, the Company is party to a non-cancelable agreement to purchase certain gas supplies at a fixed monthly rate through June 30, 2012. The Company is required to make minimum annual payments under these contracts as follows:

 

2005

   $ 2  

2006

     3  

2007

     3  

2008

     3  

2009

     3  

2010 and beyond

     14  
    


Total minimum payments

     28  

Less: Amount represents interest

     (8 )
    


Present value of minimum payments

   $ 20  
    


 

The Company had purchases of $1 and $2 during the three and nine months ended September 30, 2005 under the contracts.

 

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Table of Contents

9. Redeemable Preferred Stock

 

In May 2005, Hexion Escrow Corp., a subsidiary of Hexion which merged into Hexion coincidental with the Combinations, offered 14 million shares of Redeemable Series A Floating Rate Preferred Stock, par value $0.01 per share, and a liquidation preference of $25 per share (the “Preferred Stock”). The Preferred Stock will accumulate cumulative preferential dividends from the issue date at an initial rate of LIBOR plus 8.0%, compounded semi-annually. The dividend rate increases 75 basis points every six months beginning November 15, 2005 until May 15, 2007, at which time the rate is LIBOR plus 11.0%. Dividends will be paid by issuing additional shares of Preferred Stock through May 15, 2010. Thereafter, dividends will be required to be paid in cash. Prior to November 15, 2005, the Company has the option to redeem all or a portion of the Preferred Stock at 100% of the aggregate liquidation value plus accrued and unpaid dividends. After November 15, 2005, the Company has the option to redeem all or a portion of the Preferred Stock at between 101% and 103% of the aggregate liquidation value plus accrued and unpaid dividends. On or after May 15, 2007, the Company may convert the Preferred Stock from a floating rate security to a fixed rate security, with dividends payable at an annual rate equal to 14.0%. On October 15, 2014, or upon a change in control of the Company, the Preferred Stock shareholders have the option to require the Company to repurchase all or a portion of the Preferred Stock. Because of this mandatory redemption clause, the Preferred Stock is considered a mezzanine financing and is recorded outside of Common Stock and Other Shareholders’ Deficit.

 

The Company expects to use a portion of the proceeds it receives from its proposed IPO (See Note 1) to redeem the Preferred Stock. The net proceeds from the Preferred Stock issuance were $334, after deducting underwriting expenses and expenses of the offering of $16, and were used along with term loan debt borrowed under the Hexion Credit Facility to pay a dividend to its parent on May 31, 2005 (See Note 11). For presentation purposes, the issuance costs of $16 offset the carrying amount of the Preferred Stock. These costs are amortized using the effective interest method from the issue date through October 15, 2014. For accounting purposes, the Preferred Stock is considered increasing rate preferred stock issued at an implied premium. As such, the implied premium is being accreted using the effective interest method from the issue date through May 15, 2007, which is the commencement of the perpetual dividend. For the three and nine months ended September 30, 2005, the Company has recognized accreted dividends, including accretion of the implied premium, of $13 and $18, respectively.

 

10. Pension and Postretirement Expense

 

Following are the components of net pension and postretirement expense recognized by the Company for the periods ended September 30, 2005 and 2004:

 

     Pension

    Postretirement

 
     Three months ended September 30,

    Three months ended September 30,

 
     2005

    2004

    2005

    2004

 

Service cost

   $ 5     $ 2     $ —       $ —    

Interest cost

     6       3       —         —    

Expected return on plan assets

     (7 )     (4 )     —         —    

Amortization of prior service cost

     —         —         (2 )     (1 )

Recognized net actuarial loss (gain)

     2       —         (1 )     (1 )
    


 


 


 


     $ 6     $ 1     $ (3 )   $ (2 )
     Pension

    Postretirement

 
     Nine months ended September 30,

    Nine months ended September 30,

 
     2005

    2004

    2005

    2004

 

Service cost

   $ 11     $ 5     $ —       $ —    

Interest cost

     17       6       1       —    

Expected return on plan assets

     (20 )     (8 )     —         —    

Amortization of prior service cost

     —         —         (8 )     (1 )

Recognized net actuarial loss (gain)

     6       —         (2 )     (1 )
    


 


 


 


     $ 14     $ 3     $ (9 )   $ (2 )
    


 


 


 


 

The amortization of prior service cost included in the postretirement benefit relates to plan amendments made in 2004 and 2003.

 

        As part of the Bakelite Acquisition, the Company acquired various defined benefit and defined contribution pension plans covering Bakelite’s employees worldwide. In Germany, Bakelite provides a defined benefit pension plan with a total projected benefit obligation of $78, while in certain other countries, defined contribution pension plans are provided. In addition, Bakelite’s Italian and Korean subsidiaries have statutory requirements to provide severance indemnity benefits to employees. All of the Bakelite benefit plans are unfunded. The Company anticipates making contributions of $1 to pay current obligations related to the Bakelite benefit plans in 2005.

 

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11. Common Stock and Other Shareholders’ Deficit

 

On September 19, 2005, the Board of Directors approved a 0.85268157-to-1 reverse stock split. The reverse stock split was effective September 19, 2005 and the par value of the common stock remained at $0.01 per share. All share and per share amounts have been retroactively adjusted for all periods presented to reflect the 0.85268157-to-1 reverse stock split.

 

As a result of the Combinations and subsequent reverse stock split, the Company’s capital structure consists of 82,629,906 shares outstanding. The Company’s capital structure has been retroactively consolidated for all periods presented. No new shares were issued as a result of the legal merger of RPP, RSM and BCI.

 

In conjunction with the Combinations, Hexion declared a dividend to its parent of $550 and paid $517 on May 31, 2005. Approximately $6 of the unpaid amount was distributed in the third quarter of 2005, and the remainder is expected to be paid in the second quarter of 2007, and is classified in Other long-term liabilities. The dividend was funded through the proceeds from the issuance of preferred stock and from amounts borrowed under the Company’s credit facility.

 

At December 31, 2004, BCI held a note receivable in an aggregate principal amount of $405 and accrued interest of $156 from BHI Acquisition, which was accounted for as a reduction of equity. The note accrued interest at 12% per year, payable quarterly, and BCI accrued interest quarterly in paid-in capital. The notes were previously due from Borden Holdings, Inc., BCI’s parent prior to August 12, 2004. Historically, Borden Holdings, Inc. funded the payment of the interest on the note through common dividends received from BCI. BCI had not received a payment on the accrued interest, nor had BCI paid an associated dividend, since October 15, 2001. In connection with the Combinations, the note (including $176 of accrued interest to the date of the Combinations) was reclassified to Paid-in capital.

 

12. Stock Based Compensation

 

Prior to the Combinations, RPP, RSM and BHI Acquisition maintained three stock option plans: the RPP 2000 Stock Option Plan (the “RPP plan”), the RSM 2004 Stock Option Plan (the “RSM plan”) and the BHI Acquisition 2004 Stock Incentive Plan (the “2004 Incentive Plan”). In addition to these option plans, the Company’s parent maintains a stock-based deferred compensation plan. Upon the Combinations, the stock options under the RPP plan and RSM plan were exchanged for equivalent stock options under the 2004 Incentive Plan based upon relative fair value.

 

On September 20, 2005, a 0.464637297-to-1 reverse stock split of Hexion LLC common units was made effective. All common unit amounts relating to options issued by Hexion LLC to the Company’s employees and directors have been retroactively adjusted for all periods presented to reflect the 0.464637297-to-1 reverse stock split. At September 30, 2005, on an as converted basis, there were approximately 4,136,000 options outstanding under the 2004 Incentive Plan and approximately 1,008,000 deferred common stock units under the deferred compensation plan. All outstanding awards at September 30, 2005 are denominated in Hexion LLC units.

 

In connection with the filing of a registration statement, which is not yet effective, with the SEC for a proposed IPO of its common stock, the Company became subject to the measurement requirements as a public company and consequently remeasured liability designated awards. In addition, modifications to the awards under the 2004 Incentive Plan and the stock-based deferred compensation plan were made to allow for the value of the options to be determined by fair market value instead of by formula. Also, certain directors’ options granted under the RPP plan and RSM plan, which would have been forfeited upon the Combinations, were modified to allow for immediate vesting. These equity modifications were treated in accordance with the provisions of SFAS No. 123(R). As a result of this remeasurement and modifications associated with the Combinations to the RPP plan, the RSM plan, the 2004 Incentive Plan and the deferred compensation plan, the Company recognized a compensation charge of $2 and $10 for the three and nine months ended September 30, 2005, respectively, which is included in Selling, general & administrative expense. The Company expects to realize additional compensation expense of $20, which will be recognized over the vesting period of the underlying stock based awards. These awards are expected to vest over the next seven years.

 

The Company’s compensation expense was calculated using the Black-Scholes pricing model with risk-free weighted average interest rates ranging from 2.83% to 4.23%, expected lives of 0.75 to 8.22 years, a dividend rate of zero and expected volatility of 30%. In calculating the compensation expense recognized in connection with the modification of the options, the fair value of the Company’s common stock was calculated using a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) approach, which is a valuation technique commonly used by the investment banking community. Under this technique, estimated enterprise values are the result of an EBITDA multiple derived from comparison to comparable company multiples applied to an appropriate EBITDA amount. The equity value is then calculated by subtracting the amount of the company’s net debt from the calculated enterprise value. This calculation yielded a fair value per share of $17.52 at the combination date.

 

On May 11, 2005, BHI Acquisition issued options to purchase 84,424 membership units to the Company’s non-management directors. These options have a ten-year life with immediate vesting and exercise upon an IPO. Upon the consummation of an IPO, the Company will recognize expense of $1, which represents the fair value of the options at the date of grant as determined by the Black-Sholes pricing model.

 

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13. Income Taxes

 

Effective with the Combinations, Hexion and its eligible subsidiaries file consolidated income tax returns. Prior to the Combinations, RPP, RSM and BCI each filed separate returns. The Company uses the asset and liability method required by SFAS No. 109 to provide income taxes on all transactions recorded in its Financial Statements. This requires that income taxes reflect the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. Accordingly, a deferred tax asset or liability for each temporary difference is determined based on the tax rates that the Company expects to be in effect when the underlying items of income and expense are to be realized. The Company’s expense for income taxes includes the current and deferred portions of that expense.

 

A valuation allowance is provided when it is more likely than not that some portion of the Federal tax asset will not be realized. At the date of their acquisition by Apollo, BCI and RSM had valuation allowances on a portion of their deferred tax assets. Those assets consisted primarily of net operating and capital loss carryforwards. At that time, RPP had a net deferred tax liability. As a result of the Combinations, the total valuation allowance was reduced by $50 based on RPP’s net deferred tax liability position. In management’s opinion, the results of future operations will not generate sufficient taxable income to realize these deferred tax assets. Consequently, a full valuation allowance has been provided against these attributes.

 

Income tax expense for the nine-month period ending September 30, 2005 primarily reflects the impact of taxes on income in non-U.S. jurisdictions, the impact of a cumulative translation adjustment on the settlement of an intercompany loan that had been previously treated as permanently invested and the adjustment of an income tax reserve in the Netherlands. The Company has increased its valuation allowances in various tax jurisdictions, including the U.S., related primarily to net operating losses that may not be realized.

 

Each quarter, taxes for the full year are estimated and year-to-date tax accrual adjustments are made. Revisions of the full year estimate of accrued taxes occur periodically due to changes in the tax rates, audit resolution with taxing authorities, and newly enacted statutory, judicial and regulatory guidance. These changes, when they occur, affect accrued taxes and can result in a change in the quarterly tax provision. Although the final resolution of any proposed adjustments is uncertain and may involve unsettled areas, based on currently available information, the Company has provided the best estimate of the probable tax liability for such matters.

 

14. Segment Data

 

At September 30, 2005, the Company’s management had not made a final determination regarding the financial reporting structure of the internal organization and the composition of its reportable segments. Subsequent to the Combinations, the Company’s management has continued to make operating decisions and assess performance based upon the reportable segments in place prior to the Combinations.

 

The Company’s reportable segments were determined in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, based on the way that management organized the business operations for decision-making purposes. This organization of the business operations has resulted in a historical presentation of nine segments, including Bakelite, which is deemed to be a reportable segment of BCI. Prior to the Combinations, the legacy RPP business organized and managed its operations on the basis of geographic regions. These geographic regions resulted in three reportable segments: (i) Americas, (ii) Europe and Africa, and (iii) Asia Pacific and Middle East. RSM operated its business by product line, and had two reportable segments: (i) Specialty Resins and Monomers (“SRM”) and (ii) Inks. BCI had four reportable business segments: (i) Forest Products, (ii) Performance Resins, (iii) International and (iv) Bakelite, which was acquired by BCI in April 2005. Consolidated results for RSM and BCI also include Corporate & Other, which includes general and administrative expenses.

 

The following tables include the stand-alone disclosures for each of the nine historical segments in accordance with SFAS No. 131. In addition, the Company has voluntarily included the RSM and BCI information using the same segments utilized by RPP because management deems the additional segment data to be beneficial for an enhanced understanding of the combined entity.

 

Net sales to external customers:

 

     Three months ended September 30, 2005

     RPP

   RSM

   BCI (1)

   Elim. (2)

    Total

Americas

   $ 128    $ 137    $ 394    $ —       $ 659

Europe and Africa

     163      87      215      (29 )     436

Asia Pacific and Middle East

     —        2      37      —         39
    

  

  

  


 

Total

   $ 291    $ 226    $ 646    $ (29 )   $ 1,134
    

  

  

  


 

 

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     Three months ended September 30, 2004

     RPP

   RSM (3)

   BCI (4)

   Elim. (2)

    Total

Americas

   $ 109    $ 76    $ 212    $ —       $ 397

Europe and Africa

     136      48      23      —         207

Asia Pacific and Middle East

     —        2      12      —         14
    

  

  

  


 

Total

   $ 245    $ 126    $ 247    $ —       $ 618
    

  

  

  


 

     Nine months ended September 30, 2005

     RPP

   RSM

   BCI (1)

   Elim. (2)

    Total

Americas

   $ 405    $ 393    $ 1,245    $ (12 )   $ 2,031

Europe and Africa

     530      276      398      (30 )     1,174

Asia Pacific and Middle East

     1      9      102      —         112
    

  

  

  


 

Total

   $ 936    $ 678    $ 1,745    $ (42 )   $ 3,317
    

  

  

  


 

     Nine months ended September 30, 2004

     RPP

   RSM (3)

   BCI (4)

   Elim. (2)

    Total

Americas

   $ 315    $ 76    $ 212    $ —       $ 603

Europe and Africa

     391      48      23      —         462

Asia Pacific and Middle East

     2      2      12      —         16
    

  

  

  


 

Total

   $ 708    $ 126    $ 247    $ —       $ 1,081
    

  

  

  


 


(1) Includes Bakelite results from the date of the Bakelite Acquisition.
(2) Entries to eliminate intersegment transactions between RPP, RSM and BCI.
(3) Includes results from August 2, 2004.
(4) Includes results from August 12, 2004.

 

Operating income (loss):

 

     Three months ended September 30, 2005

     RPP

   RSM

    BCI (1)

   Elim. (2)

    Total

Americas

   $ 3    $ (1 )   $ 27    $ 1     $ 30

Europe and Africa

     15      9       1      (2 )     23

Asia Pacific and Middle East

     —        —         2      —         2
    

  


 

  


 

Total

   $ 18    $ 8     $ 30    $ (1 )   $ 55
    

  


 

  


 

 

     Three months ended September 30, 2004

 
     RPP

    RSM (3)

    BCI (4)

    Elim. (2)

   Total

 

Americas

   $ (1 )   $ (14 )   $ (30 )   $ —      $ (45 )

Europe and Africa

     5       4       —         —        9  

Asia Pacific and Middle East

     —         —         1       —        1  
    


 


 


 

  


Total

   $ 4     $ (10 )   $ (29 )   $ —      $ (35 )
    


 


 


 

  


 

24


Table of Contents
     Nine months ended September 30, 2005

 
     RPP

    RSM

    BCI (1)

    Elim. (2)

    Total

 

Americas

   $ (18 )   $ (21 )   $ 76     $ (1 )   $ 36  

Europe and Africa

     79       44       7       (2 )     128  

Asia Pacific and Middle East

     (2 )     1       3       —         2  
    


 


 


 


 


Total

   $ 59     $ 24     $ 86     $ (3 )   $ 166  
    


 


 


 


 


     Nine months ended September 30, 2004

 
     RPP

    RSM (3)

    BCI (4)

    Elim. (2)

    Total

 

Americas

   $ 1     $ (14 )   $ (30 )   $ —       $ (43 )

Europe and Africa

     6       4       —         —         10  

Asia Pacific and Middle East

     —         —         1       —         1  
    


 


 


 


 


Total

   $ 7     $ (10 )   $ (29 )   $ —       $ (32 )
    


 


 


 


 



(1) Includes Bakelite results from the date of the Bakelite Acquisition.
(2) Entries to eliminate transactions between RPP, RSM and BCI.
(3) Includes results from August 2, 2004.
(4) Includes results from August 12, 2004.

 

Total assets

 

     September 30, 2005

     RPP

   RSM

   BCI

   Elim. (1)

    Total

Americas

   $ 687    $ 173    $ 871    $ (18 )   $ 1,713

Europe and Africa

     562      217      614      (36 )     1,357

Asia Pacific and Middle East

     1      15      111      —         127
    

  

  

  


 

Total

   $ 1,250    $ 405    $ 1,596    $ (54 )   $ 3,197
    

  

  

  


 

     December 31, 2004

     RPP

   RSM

   BCI

   Elim. (1)

    Total

Americas

   $ 644      194    $ 840    $ (4 )   $ 1,674

Europe and Africa

     611      193      131      —         935

Asia Pacific and Middle East

     1      13      73      —         87
    

  

  

  


 

Total

   $ 1,256    $ 400    $ 1,044    $ (4 )   $ 2,696
    

  

  

  


 


(1) Entries to eliminate transactions between RPP, RSM and BCI and to record deferred taxes.

 

Reconciliation of operating income to loss from continuing operations before income tax and minority interest:

 

    

Three months ended

September 30, 2005


   

Three months ended

September 30, 2004 (1)


 

Operating income (loss)

   $ 55     $ (35 )

Interest expense

     (56 )     (34 )

Other non-operating income, net

     4       —    
    


 


Income (loss) from continuing operations before income tax and minority interest

   $ 3     $ (69 )
    


 


                  
    

Nine months ended

September 30, 2005


   

Nine months Ended

September 30, 2004 (1)


 

Operating income (loss)

     166       (32 )

Interest expense

     (152 )     (73 )

Write-off of deferred financing fees

     (17 )     —    

Other non-operating expense, net

     (14 )     —    
    


 


Loss from continuing operations before income tax and minority interest

   $ (17 )   $ (105 )
    


 



(1) Includes RSM results from August 2, 2004 and BCI results from August 12, 2004.

 

25


Table of Contents

Set forth below is the segment reporting for RSM and BCI.

 

Segment reporting for RSM for the three and nine months ended September 30, 2005 and 2004:

 

     Three months ended
September 30, 2005


   

Three months ended

September 30, 2004 (1)


 

Net sales to external customers

                

SRM

   $ 181     $ 98  

Inks

     45       28  
    


 


Total

   $ 226     $ 126  
    


 


Operating income (loss)

                

SRM

   $ 12     $ (1 )

Inks

     1       (2 )

Corporate and Other

     (5 )     (7 )
    


 


Total

   $ 8     $ (10 )
    


 


     Nine months ended
September 30, 2005


   

Nine months ended

September 30, 2004 (1)


 

Net sales to external customers

                

SRM

   $ 545     $ 98  

Inks

     133       28  
    


 


Total

   $ 678     $ 126  
    


 


Operating income (loss)

                

SRM

   $ 47     $ (1 )

Inks

     5       (2 )

Corporate and Other

     (28 )     (7 )
    


 


Total

   $ 24     $ (10 )
     September 30, 2005

    December 31, 2004

 

Total Assets

                

SRM

   $ 304     $ 288  

Inks

     101       108  

Corporate and Other

     —         4  
    


 


Total

   $ 405     $ 400  
    


 



(1) Includes results from August 2, 2004.

 

Segment reporting for BCI for the three and nine months ended September 30, 2005 and 2004:

 

     Three months ended
September 30, 2005


   

Three months ended

September 30, 2004 (1)


 

Net sales to external customers

                

Forest Products

   $ 243     $ 132  

Performance Resins

     123       62  

Bakelite(2)

     176       —    

International

     104       53  
    


 


Total

   $ 646     $ 247  
    


 


Segment EBITDA

                

Forest Products

   $ 28     $ 15  

Performance Resins

     22       7  

Bakelite(2)

     8       —    

International

     9       3  

Corporate and Other

     (10 )     (2 )
    


 


Total

   $ 57     $ 23  
    


 


     Nine months ended
September 30, 2005 (2)


   

Nine months ended

September 30, 2004 (1)


 

Net sales to external customers

                

Forest Products

   $ 766     $ 132  

 

26


Table of Contents

Performance Resins

     369       62  

Bakelite(2)

     297       —    

International

     313       53  
    


 


Total

   $ 1,745     $ 247  
    


 


Segment EBITDA

                

Forest Products

   $ 90     $ 15  

Performance Resins

     55       7  

Bakelite(2)

     14       —    

International

     30       3  

Corporate and Other

     (32 )     (2 )
    


 


Total

   $ 157     $ 23  
     September 30, 2005

    December 31, 2004

 

Total Assets

                

Forest Products

   $ 373     $ 403  

Performance Resins

     213       213  

Bakelite

     534       —    

International

     288       291  

Corporate and Other

     188       137  
    


 


Total

   $ 1,596     $ 1,044  
    


 



(1) Includes results from August 12, 2004.
(2) Includes Bakelite results from the date of the Bakelite Acquisition.

 

27


Table of Contents

Reconciliation of Segment EBITDA to net loss:

 

    

Three months ended

September 30, 2005


   

Three months ended

September 30, 2004 (1)


 

Segment EBITDA—BCI:

                

Forest Products

   $ 28     $ 15  

Performance Resins

     22       7  

Bakelite

     8       —    

International

     9       3  

Corporate & Other

     (10 )     (2 )

Operating expense not included in BCI Segment EDITDA

     (9 )     (45 )

Depreciation and amortization-BCI

     (18 )     (7 )

Operating income-RPP

     18       4  

Operating income (loss) -RSM

     8       (10 )

Transaction costs and elimination of intercompany profits

     (1 )     —    
    


 


Total operating income – consolidated

     55       (35 )

Interest expense— consolidated

     (56 )     (34 )

Other non-operating income — consolidated

     4       —    

Income tax expense— consolidated

     (8 )     (14 )

Minority interest in net (income) loss of consolidated subsidiaries

     (1 )     4  
    


 


Net loss— consolidated

   $ (6 )   $ (79 )

(1) Includes RSM results from August 2, 2004 and BCI results from August 12, 2004.

 

    

Nine months ended

September 30, 2005


   

Nine months ended

September 30, 2004 (1)


 

Segment EBITDA—BCI:

                

Forest Products

   $ 90     $ 15  

Performance Resins

     55       7  

Bakelite

     14       —    

International

     30       3  

Corporate & Other

     (32 )     (2 )

Operating expense not included in BCI Segment EDITDA

     (24 )     (45 )

Depreciation and amortization-BCI

     (47 )     (7 )

Operating income-RPP

     59       7  

Operating income (loss)-RSM

     24       (10 )

Transaction costs and elimination of intercompany profits

     (3 )     —    
    


 


Total operating income (loss) – consolidated

     166       (32 )

Interest expense— consolidated

     (152 )     (73 )

Write-off of deferred financing fees

     (17 )     —    

Other non-operating expense — consolidated

     (14 )     —    

Income tax (expense) benefit — consolidated

     (43 )     4  

Minority interest in net (income) loss of consolidated subsidiaries

     (3 )     7  

Loss from discontinued operations

     (10 )     —    
    


 


Net loss— consolidated

   $ (73 )   $ (94 )

(1) Includes RSM results from August 2, 2004 and BCI results from August 12, 2004.

 

Segment EBITDA is equal to net income before depreciation and amortization, interest expense, other non-operating expenses or income, income taxes and other adjustments. Segment EBITDA is presented by reportable segment and for Corporate & Other of BCI for the three and nine months ended September 30, 2005 and 2004. Segment EBITDA information is presented with BCI’s segment disclosures because it is the measure used by BCI’s management in the evaluation of operating results and in determining allocations of capital resources among the business segments. It is also the metric used by BCI to set management and executive incentive compensation.

 

28


Table of Contents

15. Guarantor/Non-Guarantor Subsidiary Financial Information

 

In conjunction with the Apollo acquisition of BCI, BCI formed two wholly owned finance subsidiaries to borrow $475 through a private debt offering. The Company and certain of its U.S. subsidiaries (the “combined subsidiary guarantors”) guarantee this debt. In addition, following the Combinations, the Company, the combined subsidiary guarantors and Hexion U.S. Finance Corporation (formerly known as Borden U.S. Finance) also guarantee the senior secured debt previously issued by RPP (“the RPP guaranteed debt”).

 

The following information contains the condensed consolidating financial information for the parent, Hexion, the subsidiary issuers (Hexion U.S. Finance Corporation, formerly known as Borden U.S. Finance Corporation, Hexion Nova Scotia Finance, ULC (formerly known as Borden Nova Scotia, ULC) (“Nova Scotia, ULC”) and HSC Capital Corporation (formerly known as RPP Capital Corporation) (“HSC Capital”)), the combined subsidiary guarantors (BDS Two, Inc., Borden Chemical Investments, Inc., Borden Chemical Foundry, Inc., Lawter International, Inc., Borden Chemical International, Inc., Bakelite North America Holding Company, Bakelite Epoxy Polymers Corporation, Oilfield Technology Group, Inc. and Borden Services Company) and the combined non-guarantor subsidiaries, which includes all of the Company’s foreign subsidiaries and HAI. All of the subsidiary issuers and subsidiary guarantors are owned 100% by Hexion. All guarantees are full and unconditional and are joint and several. There are no significant restrictions on the ability of the Company to obtain funds from its domestic subsidiaries by dividend or loan. While the Company’s Australian subsidiary and HAI are restricted in the payment of dividends and intercompany loans due to the terms of their credit facilities, there are no material restrictions on the Company’s ability to obtain cash from the remaining U.S. non-guarantor subsidiaries.

 

This information includes allocations of corporate overhead to the combined non-guarantor subsidiaries based on net sales. Income tax expense has been provided on the combined non-guarantor subsidiaries based on actual effective tax rates. All other tax expense is reflected in the parent.

 

29


Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

THREE MONTHS ENDED SEPTEMBER 30, 2005

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)

 

     Hexion
Specialty
Chemicals,
Inc.


    Subsidiary
Issuers (1)


    Combined
Subsidiary
Guarantors


    Combined
Non-
Guarantor
Subsidiaries


   Eliminations

    Consolidated

 

Net sales

   $ 525     $ —       $ 26     $ 663    $ (80 )   $ 1,134  

Cost of sales

     457       —         25       561      (79 )     964  
    


 


 


 

  


 


Gross profit

     68       —         1       102      (1 )     170  
    


 


 


 

  


 


Selling, general & administrative expense

     44       —         2       58      —         104  

Transaction related costs

     4       —         —         1      —         5  

Other operating expense

     3       —         —         3      —         6  
    


 


 


 

  


 


Operating income (loss)

     17       —         (1 )     40      (1 )     55  
    


 


 


 

  


 


Interest expense

     34       15       —         7      —         56  

Intercompany royalty expense (income)

     7       —         (7 )     —        —         —    

Intercompany interest expense (income)

     76       (17 )     (70 )     11      —         —    

Equity in earnings of subsidiaries, net

     (86 )     —         (2 )     —        88       —    

Other non-operating (income) expense

     (10 )     —         —         6      —         (4 )
    


 


 


 

  


 


Income (loss) before income tax and minority interest

     (4 )     2       78       16      (89 )     3  

Income tax expense (benefit)

     1       —         —         7      —         8  
    


 


 


 

  


 


(Loss) income before minority interest

     (5 )     2       78       9      (89 )     (5 )

Minority interest in net income of consolidated subsidiaries

     1       —         —         —        —         1  
    


 


 


 

  


 


Net (loss) income

   $ (6 )   $ 2     $ 78     $ 9    $ (89 )   $ (6 )
    


 


 


 

  


 



(1) Subsidiary issuers include Hexion U.S. Finance Corporation, HSC Capital and Nova Scotia, ULC. Hexion U.S. Finance Corporation is also a guarantor of the RPP guaranteed debt. HSC Capital is also a subsidiary guarantor of the debt issued by Hexion U.S. Finance Corporation and Nova Scotia, ULC. The primary asset of the Hexion U.S. Finance Corporation is an intercompany receivable from Hexion (the parent) for $197, which is essentially offset by the debt payable. HSC Capital has no significant assets.

 

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Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

THREE MONTHS ENDED SEPTEMBER 30, 2004

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)

 

     Hexion
Specialty
Chemicals,
Inc.


    Subsidiary
Issuers(1)


    Combined
Subsidiary
Guarantors(1)


   

Combined

Non-

Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 325     $ —       $ 13     $ 313     $ (33 )   $ 618  

Cost of sales

     300       —         14       271       (33 )     552  
    


 


 


 


 


 


Gross profit (loss)

     25       —         (1 )     42       —         66  
    


 


 


 


 


 


Selling, general & administrative expense

     18       —         1       34       —         53  

Transaction related costs

     32       —         —         15       —         47  

Other operating expense (income)

     (5 )     —         (1 )     7       —         1  
    


 


 


 


 


 


Operating loss

     (20 )     —         (1 )     (14 )     —         (35 )
    


 


 


 


 


 


Interest expense

     27       6       —         1       —         34  

Intercompany interest expense (income)

     19       (6 )     (18 )     5       —         —    

Equity in earnings (loss) of subsidiaries, net

     6       —         (1 )     —         (5 )     —    

Other non-operating (income) expense

     (1 )     —         —         1       —         —    
    


 


 


 


 


 


(Loss) income before income tax and minority interest

     (71 )     —         18       (21 )     5       (69 )

Income tax expense

     12       —         —         2       —         14  
    


 


 


 


 


 


(Loss) income before minority interest

     (83 )     —         18       (23 )     5       (83 )

Minority interest in net loss of consolidated subsidiaries

     (4 )     —         —         —         —         (4 )
    


 


 


 


 


 


Net (loss) income

   $ (79 )   $ —       $ 18     $ (23 )   $ 5     $ (79 )
    


 


 


 


 


 



(1) The three and nine month data for 2004 reflects RPP results for the full year, RSM results from August 2, 2004 and BCI results from August 12, 2004.

 

31


Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

NINE MONTHS ENDED SEPTEMBER 30, 2005

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)

 

     Hexion
Specialty
Chemicals,
Inc.


    Subsidiary
Issuers (1)


    Combined
Subsidiary
Guarantors


    Combined
Non-
Guarantor
Subsidiaries


   Eliminations

    Consolidated

 

Net sales

   $ 1,625     $ —       $ 67     $ 1,835    $ (210 )   $ 3,317  

Cost of sales

     1,428       —         66       1,544      (207 )     2,831  
    


 


 


 

  


 


Gross profit

     197       —         1       291      (3 )     486  
    


 


 


 

  


 


Selling, general & administrative expense

     135       —         4       151      —         290  

Transaction related costs

     25       —         —         9      —         34  

Other operating (income) expense

     (5 )     —         (2 )     3      —         (4 )
    


 


 


 

  


 


Operating income (loss)

     42       —         (1 )     128      (3 )     166  
    


 


 


 

  


 


Interest expense

     101       40       —         11      —         152  

Write-off of deferred financing fees

     9       6       —         2      —         17  

Intercompany royalty expense (income)

     17       —         (19 )     2      —         —    

Intercompany interest expense (income)

     197       (42 )     (185 )     30      —         —    

Equity in earnings of subsidiaries, net

     (212 )     —         (6 )     —        218       —    

Other non-operating expense (income)

     (5 )     1       —         18      —         14  
    


 


 


 

  


 


(Loss) income from continuing operations before income tax and minority interest

     (65 )     (5 )     209       65      (221 )     (17 )

Income tax expense

     2       —         1       40      —         43  
    


 


 


 

  


 


(Loss) income from continuing operations before minority interest

     (67 )     (5 )     208       25      (221 )     (60 )

Minority interest in net income of consolidated subsidiaries

     3       —         —         —        —         3  
    


 


 


 

  


 


(Loss) income from continuing operations

     (70 )     (5 )     208       25      (221 )     (63 )

Loss from discontinued operations

     3       —         —         7      —         10  
    


 


 


 

  


 


Net (loss) income

   $ (73 )   $ (5 )   $ 208     $ 18    $ (221 )   $ (73 )
    


 


 


 

  


 



(1) Subsidiary issuers include Hexion U.S. Finance Corporation, HSC Capital and Nova Scotia, ULC. Hexion U.S. Finance Corporation is also a guarantor of the RPP guaranteed debt. HSC Capital is also a subsidiary guarantor of the debt issued by Hexion U.S. Finance Corporation and Nova Scotia, ULC. The primary asset of the Hexion U.S. Finance Corporation is an intercompany receivable from Hexion (the parent) for $197, which is essentially offset by the debt payable. HSC Capital has no significant assets.

 

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Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

NINE MONTHS ENDED SEPTEMBER 30, 2004

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)

 

     Hexion
Specialty
Chemicals,
Inc.


   

Subsidiary

Issuers(1)


    Combined
Subsidiary
Guarantors(1)


    Combined
Non-
Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

Net sales

   $ 541     $ —       $ 13     $ 580     $ (53 )   $ 1,081  

Cost of sales

     497       —         14       510       (53 )     968  
    


 


 


 


 


 


Gross profit (loss)

     44       —         (1 )     70       —         113  
    


 


 


 


 


 


Selling, general & administrative expense

     40       —         1       57       —         98  

Transaction related costs

     26       —         —         21       —         47  

Other operating (income) expense

     (5 )     —         (1 )     6       —         —    
    


 


 


 


 


 


Operating loss

     (17 )     —         (1 )     (14 )     —         (32 )
    


 


 


 


 


 


Interest expense

     66       6       —         1       —         73  

Intercompany interest expense (income)

     16       (6 )     (18 )     8       —         —    

Equity in earnings (loss) of subsidiaries, net

     5       —         (1 )     —         (4 )     —    

Other non-operating (income) expense

     (1 )     —         —         1       —         —    
    


 


 


 


 


 


(Loss) income before income tax and minority interest

     (103 )     —         18       (24 )     4       (105 )

Income tax benefit

     (2 )     —         —         (2 )     —         (4 )
    


 


 


 


 


 


(Loss) income before minority interest

     (101 )     —         18       (22 )     4       (101 )

Minority interest in net loss of consolidated subsidiaries

     (7 )     —         —         —         —         (7 )
    


 


 


 


 


 


Net (loss) income

   $ (94 )   $ —       $ 18     $ (22 )   $ 4     $ (94 )
    


 


 


 


 


 



(1) The three and nine month data for 2004 reflects RPP results for the full year, RSM results from August 2, 2004 and BCI results from August 12, 2004.

 

33


Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

SEPTEMBER 30, 2005

CONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)

 

     Hexion
Specialty
Chemicals,
Inc.


    Subsidiary
Issuers (1)


    Combined
Subsidiary
Guarantors


   Combined
Non-
Guarantor
Subsidiaries


    Eliminations

    Consolidated

 

ASSETS

                                               

Current Assets

                                               

Cash and equivalents

   $ 12     $ —       $ 1    $ 151     $ —       $ 164  

Accounts receivable, net

     177       —         16      414       —         607  

Accounts receivable from (payable to) affiliates

     (2 )     2       1      (1 )     —         —    

Inventories:

                                               

Finished and in-process goods

     127       —         8      161       —         296  

Raw materials and supplies

     60       —         5      91       —         156  

Other current assets

     118       —         1      29       —         148  
    


 


 

  


 


 


       492       2       32      845       —         1,371  
    


 


 

  


 


 


Other Assets

                                               

Investment in subsidiaries

     6,815       —         14      —         (6,829 )     —    

Intercompany loans receivable

     —         652       6,349      73       (7,074 )     —    

Other assets

     54       20       2      23       —         99  
    


 


 

  


 


 


       6,869       672       6,365      96       (13,903 )     99  
    


 


 

  


 


 


Property and Equipment, net

     661       —         7      743       —         1,411  

Goodwill

     59       —         —        87       —         146  

Other Intangible Assets, net

     97       —         —        73       —         170  
    


 


 

  


 


 


Total Assets

   $ 8,178     $ 674     $ 6,404    $ 1,844     $ (13,903 )   $ 3,197  
    


 


 

  


 


 


LIABILITIES, REDEEMABLE PREFERRED STOCK, COMMON STOCK AND OTHER SHAREHOLDERS’ (DEFICIT) EQUITY

                                               

Current Liabilities

                                               

Accounts and drafts payable

   $ 185     $ —       $ 11    $ 244     $ —       $ 440  

Debt payable within one year

     17       —         —        44       —         61  

Loans payable to affiliates

     2       —         3      (5 )     —         —    

Interest payable

     38       12       —        —         —         50  

Income taxes payable

     38       —         —        27       —         65  

Other current liabilities

     136       —         1      83       —         220  
    


 


 

  


 


 


       416       12       15      393       —         836  
    


 


 

  


 


 


Other Liabilities

                                               

Long-term debt

     1,368       625       —        313       —         2,306  

Intercompany loans payable

     6,601       (12 )     —        485       (7,074 )     —    

Non-pension postemployment benefit obligations

     114       —         —        23       —         137  

Deferred income taxes

     14       —         —        141       —         155  

Other long-term liabilities

     172       —         —        95       —         267  
    


 


 

  


 


 


       8,269       613       —        1,057       (7,074 )     2,865  
    


 


 

  


 


 


Minority interest in consolidated subsidiaries

     8       —         —        3       —         11  

Redeemable preferred stock

     352       —         —        —         —         352  

Common Stock and Other Shareholders’ (Deficit) Equity

     (867 )     49       6,389      391       (6,829 )     (867 )
    


 


 

  


 


 


Total Liabilities, Redeemable Preferred Stock, Common Stock and Other Shareholders’ (Deficit) Equity

   $ 8,178     $ 674     $ 6,404    $ 1,844     $ (13,903 )   $ 3,197  
    


 


 

  


 


 



(1) Subsidiary issuers include Hexion U.S. Finance Corporation, HSC Capital and Nova Scotia, ULC. Hexion U.S. Finance Corporation is also a guarantor of the RPP guaranteed debt. HSC Capital is also a subsidiary guarantor of the debt issued by Hexion U.S. Finance Corporation and Nova Scotia, ULC. The primary asset of the Hexion U.S. Finance Corporation is an intercompany receivable from Hexion (the parent) for $197, which is essentially offset by the debt payable. HSC Capital has no significant assets.

 

34


Table of Contents

HEXION SPECIALTY CHEMICALS, INC.

DECEMBER 31, 2004

CONDENSED CONSOLIDATING BALANCE SHEET

 

    

Hexion
Specialty

Chemicals,
Inc.


    Subsidiary
Issuers (1)


    Combined
Subsidiary
Guarantors


  

Combined

Non-

Guarantor
Subsidiaries


   Eliminations

    Consolidated

 

ASSETS

                                              

Current Assets

                                              

Cash and equivalents

   $ 63     $ —       $ 9    $ 80    $ —       $ 152  

Accounts receivable, net

     198       —         15      305      —         518  

Accounts receivable from affiliates

     10       —         —        —        (10 )     —    

Inventories:

                                              

Finished and in-process goods

     152       —         8      130      —         290  

Raw materials and supplies

     52       —         6      57      —         115  

Other current assets

     43       —         1      10      10       64  
    


 


 

  

  


 


       518       —         39      582      —         1,139  
    


 


 

  

  


 


Other Assets

                                              

Investment in subsidiaries

     6,648       —         16      —        (6,664 )     —    

Intercompany loans receivable

     189       482       6,152      —        (6,823 )     —    

Other assets

     29       19       —        47      —         95  
    


 


 

  

  


 


       6,866       501       6,168      47      (13,487 )     95  
    


 


 

  

  


 


Property and Equipment, net

     636       —         8      679      —         1,323  

Goodwill

     35       —         —        16      —         51  

Other Intangible Assets, net

     82       —         —        6      —         88  
    


 


 

  

  


 


Total Assets

   $ 8,137     $ 501     $ 6,215    $ 1,330    $ (13,487 )   $ 2,696  
    


 


 

  

  


 


LIABILITIES AND SHAREHOLDERS’ (DEFICIT) EQUITY

                                              

Current Liabilities

                                              

Accounts and drafts payable

   $ 228     $ —       $ 9    $ 251    $ —       $ 488  

Accounts payable to affiliates

     2       (14 )     15      —        (3 )     —    

Debt payable within one year

     8       —         —        8      —         16  

Interest payable

     22       14       —        —        —         36  

Income taxes payable

     33       —         —        —        —         33  

Other current liabilities

     85       —         1      44      3       133  
    


 


 

  

  


 


       378       —         25      303      —         706  
    


 


 

  

  


 


Other Liabilities

                                              

Long-term debt

     1,348       475       —        11      —         1,834  

Intercompany loans payable

     6,390       —         —        433      (6,823 )     —    

Non-pension postemployment benefit obligations

     120       —         —        22      —         142  

Deferred income taxes

     34       —         —