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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 March 31, 2011
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 1-71
 
  MOMENTIVE SPECIALTY CHEMICALS INC.
(Exact name of registrant as specified in its charter)
 
New Jersey
 
13-0511250
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
180 East Broad St., Columbus, OH 43215
 
614-225-4000
(Address of principal executive offices including zip code)
 
(Registrant’s telephone number including area code)
 
(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  x   No  o
As a voluntary filer, the Company 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.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  o No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
o
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
x
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o No  x.
Number of shares of common stock, par value $0.01 per share, outstanding as of the close of business on May 1, 2011: 82,556,847

Table of Contents

MOMENTIVE SPECIALTY CHEMICALS INC.
INDEX
 
 
 
Page
PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
Momentive Specialty Chemicals Inc. Condensed Consolidated Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4T.
 
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.

2

Table of Contents

 
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
MOMENTIVE SPECIALTY CHEMICALS INC. (Unaudited)
 
 
Three Months Ended March 31,
(In millions)
2011
 
2010
Net sales
$
1,359
 
 
$
1,097
 
Cost of sales
1,146
 
 
958
 
Gross profit
213
 
 
139
 
Selling, general and administrative expense
88
 
 
76
 
Other operating expense, net
5
 
 
 
Operating income
120
 
 
63
 
Interest expense, net
64
 
 
63
 
Other non-operating (income) expense, net
(2
)
 
8
 
Income (loss) from continuing operations before income tax and earnings from unconsolidated entities
58
 
 
(8
)
Income tax expense
3
 
 
4
 
Income (loss) from continuing operations before earnings from unconsolidated entities
55
 
 
(12
)
Earnings from unconsolidated entities, net of taxes
3
 
 
2
 
Net income (loss) from continuing operations
58
 
 
(10
)
Net income from discontinued operations, net of taxes
5
 
 
3
 
Net income (loss)
$
63
 
 
$
(7
)
Comprehensive income (loss) attributable to Momentive Specialty Chemicals Inc.
$
93
 
 
$
(33
)
See Notes to Condensed Consolidated Financial Statements

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Table of Contents

CONDENSED CONSOLIDATED BALANCE SHEETS
MOMENTIVE SPECIALTY CHEMICALS INC. (Unaudited) 
(In millions, except share data)
March 31,
2011
 
December 31,
2010
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents (including restricted cash of $4 and $6, respectively)
$
106
 
 
$
186
 
Short-term investments
6
 
 
6
 
Accounts receivable (net of allowance for doubtful accounts of $27 and $25, respectively)
833
 
 
547
 
Inventories:
 
 
 
Finished and in-process goods
365
 
 
279
 
Raw materials and supplies
138
 
 
117
 
Other current assets
91
 
 
80
 
Discontinued operations
 
 
180
 
Total current assets
1,539
 
 
1,395
 
Other assets, net
166
 
 
153
 
Property and equipment
 
 
 
Land
84
 
 
80
 
Buildings
319
 
 
305
 
Machinery and equipment
2,345
 
 
2,268
 
 
2,748
 
 
2,653
 
Less accumulated depreciation
(1,434
)
 
(1,365
)
 
1,314
 
 
1,288
 
Goodwill
172
 
 
169
 
Other intangible assets, net
132
 
 
132
 
Total assets
$
3,323
 
 
$
3,137
 
Liabilities and Deficit
 
 
 
Current liabilities
 
 
 
Accounts and drafts payable
$
585
 
 
$
430
 
Debt payable within one year
81
 
 
82
 
Affiliated debt payable within one year
2
 
 
2
 
Interest payable
48
 
 
69
 
Income taxes payable
24
 
 
24
 
Accrued payroll and incentive compensation
100
 
 
66
 
Other current liabilities
143
 
 
152
 
Discontinued operations
 
 
40
 
Total current liabilities
983
 
 
865
 
Long-term liabilities
 
 
 
Long-term debt
3,464
 
 
3,488
 
Affiliated long-term debt
100
 
 
100
 
Long-term pension and post employment benefit obligations
213
 
 
208
 
Deferred income taxes
111
 
 
110
 
Other long-term liabilities
155
 
 
160
 
Advance from affiliates
225
 
 
225
 
Total liabilities
5,251
 
 
5,156
 
Commitments and contingencies (See Note 6)
 
 
 
Deficit
 
 
 
Common stock—$0.01 par value; 300,000,000 shares authorized, 170,605,906 issued and 82,556,847 outstanding at March 31, 2011 and December 31, 2010
1
 
 
1
 
Paid-in capital
324
 
 
324
 
Treasury stock, at cost—88,049,059 shares
(296
)
 
(296
)
Note receivable from parent
(24
)
 
(24
)
Accumulated other comprehensive income
118
 
 
88
 
Accumulated deficit
(2,052
)
 
(2,115
)
Total Momentive Specialty Chemicals Inc. shareholder’s deficit
(1,929
)
 
(2,022
)
Noncontrolling interest
1
 
 
3
 
Total deficit
(1,928
)
 
(2,019
)
Total liabilities and deficit
$
3,323
 
 
$
3,137
 
See Notes to Condensed Consolidated Financial Statements

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
MOMENTIVE SPECIALTY CHEMICALS INC. (Unaudited)
 
 
Three Months Ended March 31,
(In millions)
2011
 
2010
Cash flows used in operating activities
 
 
 
Net income (loss)
$
63
 
 
$
(7
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
Depreciation and amortization
42
 
 
43
 
Deferred tax benefit
(4
)
 
 
Write-off of deferred financing fees
 
 
7
 
Other non-cash adjustments
 
 
4
 
Net change in assets and liabilities:
 
 
 
Accounts receivable
(253
)
 
(171
)
Inventories
(108
)
 
(58
)
Accounts and drafts payable
151
 
 
91
 
Income taxes payable
5
 
 
(3
)
Other assets, current and non-current
46
 
 
(15
)
Other liabilities, current and long-term
(77
)
 
18
 
Net cash used in operating activities
(135
)
 
(91
)
Cash flows provided by (used in) investing activities
 
 
 
Capital expenditures
(27
)
 
(21
)
Capitalized interest
 
 
(1
)
Purchases of debt securities
 
 
(2
)
Change in restricted cash
2
 
 
3
 
Deconsolidation of variable interest entities
 
 
(4
)
Funds remitted to unconsolidated affiliates
(5
)
 
 
Proceeds from sale of business, net of cash transferred
124
 
 
8
 
Net cash provided by (used in) investing activities
94
 
 
(17
)
Cash flows (used in) provided by financing activities
 
 
 
Net short-term debt (repayments) borrowings
(4
)
 
3
 
Borrowings of long-term debt
226
 
 
1,151
 
Repayments of long-term debt
(260
)
 
(998
)
Long-term debt and credit facility financing fees
 
 
(32
)
Net cash (used in) provided by financing activities
(38
)
 
124
 
Effect of exchange rates on cash and cash equivalents
1
 
 
 
(Decrease) increase in cash and cash equivalents
(78
)
 
16
 
Cash and cash equivalents (unrestricted) at beginning of period
180
 
 
135
 
Cash and cash equivalents (unrestricted) at end of period
$
102
 
 
$
151
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid for:
 
 
 
Interest, net
$
83
 
 
$
42
 
Income taxes, net of cash refunds
2
 
 
8
 
See Notes to Condensed Consolidated Financial Statements

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Table of Contents

CONDENSED CONSOLIDATED STATEMENT OF DEFICIT AND COMPREHENSIVE INCOME
MOMENTIVE SPECIALTY CHEMICALS INC. (Unaudited)
 
(In millions)
Common
Stock
 
Paid-in
Capital
 
Treasury
Stock
 
Note
Receivable
From Parent
 
Accumulated
Other
Comprehensive
Income (a)
 
Accumulated
Deficit
 
Noncontrolling
Interest
 
Total
Balance at December 31, 2010
$
1
 
 
$
324
 
 
$
(296
)
 
$
(24
)
 
$
88
 
 
$
(2,115
)
 
$
3
 
 
$
(2,019
)
Net income
 
 
 
 
 
 
 
 
 
 
63
 
 
 
 
63
 
Net losses on cash flow hedges reclassified to income
 
 
 
 
 
 
 
 
1
 
 
 
 
 
 
1
 
Loss recognized in comprehensive income from pension and postretirement benefits, net of tax
 
 
 
 
 
 
 
 
(1
)
 
 
 
 
 
(1
)
Translation adjustments
 
 
 
 
 
 
 
 
30
 
 
 
 
 
 
30
 
Comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
93
 
Stock-based compensation expense
 
 
1
 
 
 
 
 
 
 
 
 
 
 
 
1
 
Distribution declared to parent
 
 
(1
)
 
 
 
 
 
 
 
 
 
 
 
(1
)
Divestiture of IAR business
 
 
 
 
 
 
 
 
 
 
 
 
(2
)
 
(2
)
Balance at March 31, 2011
$
1
 
 
$
324
 
 
$
(296
)
 
$
(24
)
 
$
118
 
 
$
(2,052
)
 
$
1
 
 
$
(1,928
)
 
(a)
Accumulated other comprehensive income at March 31, 2011 represents $203 of net foreign currency translation gains, net of tax, $1 of net deferred losses on cash flow hedges and a $84 unrealized loss, net of tax, related to net actuarial losses and prior service costs for the Company’s defined benefit pension and postretirement plans. Accumulated other comprehensive income at December 31, 2010 represents $173 of net foreign currency translation gains, net of tax, $2 of net deferred losses on cash flow hedges and a $83 unrealized loss, net of tax, related to net actuarial losses and prior service costs for the Company’s defined benefit pension and postretirement benefit plans.
See Notes to Condensed Consolidated Financial Statements

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Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In millions, except share and common unit data)
 
1. Background and Basis of Presentation
Based in Columbus, Ohio, Momentive Specialty Chemicals Inc., (which may be referred to "MSC" or the "Company") serves global industrial markets through a broad range of thermoset technologies, specialty products and technical support for customers in a diverse range of applications and industries. The Company's business is organized based on the products offered and the markets served. At March 31, 2011, the Company had two reportable segments: Epoxy, Phenolic and Coating Resins and Forest Products Resins.
The Company's direct parent is Momentive Specialty Chemicals Holdings LLC, a holding company and wholly-owned subsidiary of Momentive Performance Materials Holdings LLC ("Momentive Holdings"), the ultimate parent entity of MSC. Momentive Holdings is controlled by investment funds (the “Apollo Funds”) managed by affiliates of Apollo Management Holdings, L.P. (together with Apollo Global Management, LLC and its subsidiaries, “Apollo”).
Basis of Presentation—The unaudited Condensed Consolidated Financial Statements include the accounts of the Company, its majority-owned subsidiaries in which minority shareholders hold no substantive participating rights and variable interest entities (“VIEs”) in which the Company has a controlling financial interest. Intercompany accounts and transactions are eliminated in consolidation. In the opinion of management, all adjustments consisting of normal, recurring adjustments, except for the adoption of new accounting standards discussed in Note 2 below, considered necessary for a fair statement, have been included. Results for the interim periods are not necessarily indicative of results for the entire year.
Year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.
Pursuant to the rules and regulations of the Securities and Exchange Commission, certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These unaudited financial statements should be read in conjunction with the audited financial statements and the accompanying notes included in the Company's most recent Annual Report on Form 10-K.
2. Summary of Significant Accounting Policies
Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. It also requires the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Subsequent Events—The Company has evaluated events and transactions subsequent to March 31, 2011 through the time that it files its unaudited Condensed Consolidated Financial Statements.
Reclassifications—Certain prior period balances have been reclassified to conform with current presentations.
Recently Issued Accounting Standards
There were no newly issued accounting standards in the first quarter of 2011 applicable to the Company's unaudited Condensed Consolidated Financial Statements.
3. Discontinued Operations
 
On January 31, 2011, the Company sold its Inks and Adhesive Resins (“IAR”) business to Harima Chemicals Inc (the "Buyer") for a purchase price of $120. The Buyer also paid $14 for cash and $8 for working capital transferred to the Buyer at the time of closing as part of the Purchase Agreement, less indebtedness and pension plan liability transferred to the Buyer of $4. In the first quarter of 2011, a subsequent adjustment to the purchase price of $2 was accrued based upon the final expected working capital settlement as defined by the Purchase Agreement.
In conjunction with the sale, as part of a Transitional Services Agreement, the Company is providing certain transitional services to the Buyer for a period of six months. The purpose of these services is to provide short-term assistance to the Buyer in assuming the operations of the IAR business. These services do not confer to the Company the ability to influence the operating or financial policies of the IAR business under its new ownership. The Company’s cash inflows and outflows from these services are expected to be insignificant during the transition period.
The IAR business is engaged in the production of naturally derived resins and related products primarily used for the manufacture of printing inks, adhesives, synthetic rubber, specialty coatings and aroma chemicals and includes 11 manufacturing facilities in the United States, Europe and the Asia-Pacific region. The IAR business had net sales for the three months ended March 31, 2010 of $31 and pre-tax income of $6. The IAR business is reported as a discontinued operation for all periods presented. In addition, the Company incurred approximately $4 in transaction and other costs for the year ended December 31, 2010.
 
The Company recorded a loss on sale of the IAR business of $1 in the fourth quarter of 2010.

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Table of Contents

4. Related Party Transactions
Administrative Service, Management and Consulting Arrangements
The Company is subject to a seven-year Amended and Restated Management Consulting Agreement with Apollo (the “Management Consulting Agreement”) that terminates on May 31, 2012 under which the Company receives certain structuring and advisory services from Apollo and its affiliates. The Management Consulting Agreement provides indemnification to Apollo, its affiliates and their directors, officers and representatives for potential losses arising from these services. Apollo is entitled to an annual fee equal to the greater of $3 or 2% of the Company's Adjusted EBITDA. Apollo elected to defer payment of any portion of the annual fee due in excess of $3 for the years ended December 31, 2010, 2008 and 2007. Due to the economic downturn, Apollo elected to waive payment of the 2009 fee in its entirety. Apollo has elected to waive its right to receive any portion of the annual fee in excess of $3 for the year ended December 31, 2011.
During the three months ended March 31, 2011 and 2010 the Company recognized expense under the Management Consulting Agreement of $1. This amount is included in Other operating expense, net in the Company’s unaudited Condensed Consolidated Statements of Operations.
Shared Services Agreement
On October 1, 2010, the Company entered into a shared services agreement, as amended on March 17, 2011, with Momentive Performance Materials Inc. ("MPM"). Pursuant to the shared services agreement, the Company will provide to MPM, and MPM will provide to the Company, certain services, including, but not limited to, executive and senior management, administrative support, human resources, information technology support, accounting, finance, technology development, legal and procurement services. The shared services agreement establishes certain criteria upon which the costs of such services will be allocated between the Company and MPM. Allocation of service costs not demonstrably attributable to either the Company or MPM will initially be 51% to the Company and 49% to MPM, except to the extent that 100% of any cost was demonstrably attributable to or for the benefit of either MPM or the Company, in which case the total cost was allocated 100% to such party. The Shared Services Agreement remains in effect until terminated according to its terms. MPM or the Company may terminate the agreement for convenience, without cause, by giving written notice not less than thirty (30) days prior to the effective date of termination. It is also anticipated that the Company and MPM will cooperate to achieve favorable pricing with respect to purchases of raw materials and logistics services.
Pursuant to this agreement, during the three months ended March 31, 2011, the Company incurred approximately $44 of costs for shared services and MPM incurred approximately $41 of costs for shared services (excluding, in each case, costs allocated 100% to one party). During the three months ended March 31, 2011, the Company realized approximately $4 in cost savings as a result of the Shared Services Agreement. MSC billed MPM approximately $1 which represents a true-up payment to bring the percentage of total net incurred costs for shared services under the Shared Services Agreement to 51% for the Company and 49% for MPM. The true-up amount is included in Other operating expense, net, in the unaudited Condensed Consolidated Statement of Operations. The Company has accounts receivable from MPM of approximately $1 at March 31, 2011.
Financing Agreements
In connection with the terminated Huntsman merger and related litigation settlement agreement and release among the Company, Huntsman and other parties entered into on December 14, 2008, the Company paid Huntsman $225. The settlement payment was funded to the Company by an advance from Apollo, while reserving all rights with respect to reallocation of the payments to other affiliates of Apollo. Under the provisions of the settlement agreement and release, the Company is only contractually obligated to reimburse Apollo for any insurance recoveries on the $225 settlement payment, net of expense incurred in obtaining such recoveries. Apollo has agreed that the payment of any such insurance recoveries will satisfy the Company’s obligation to repay amounts received under the $225 advance. The Company has recorded the $225 settlement payment advance as a long-term liability at March 31, 2011. As of March 31, 2011, the Company has not recovered any insurance proceeds related to the $225 settlement payment.
In addition, certain affiliates of Apollo have agreed to make a $200 investment in Momentive Holdings. Certain affiliates of Apollo have entered into a commitment letter with the Company and MSC Holdings pursuant to which they committed to purchase $200 in preferred units and warrants of Momentive Holdings by December 31, 2011. Momentive Holdings has agreed to contribute any proceeds from the issuance of preferred or common units under this agreement as a capital contribution to MSC Holdings, and MSC Holdings has agreed to contribute such amounts as a capital contribution to the Company.
Prior to the purchase of all the preferred shares and warrants, certain affiliates of Apollo have committed to provide liquidity facilities to the Company on an interim basis. The aggregate liquidity facilities outstanding, together with the purchase price for any purchased preferred shares and warrants, will at no time exceed $200. In connection therewith, the Company has $100 in term loans outstanding with affiliates of Apollo which will mature on December 31, 2011, with interested at adjusted LIBOR plus 2.25%. The Company also has $2 outstanding with an affiliate of Apollo, which is due upon demand. The weighted average interest rate of affiliated borrowings at March 31, 2011 was 2.58%.

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Purchase of MSC Holdings debt
In 2009, the Company purchased $180 in face value of the outstanding MSC Holdings LLC PIK Debt Facility for $24, including accrued interest. The loan receivable from MSC Holdings has been recorded at its acquisition value of $24 as a reduction in the unaudited Condensed Consolidated Statement of Deficit and Comprehensive Income as MSC Holdings is the Company’s parent. In addition, at March 31, 2011 the Company has not recorded accretion of the purchase discount or interest income as ultimate receipt of these cash flows is under the control of MSC Holdings. The Company will continue to assess the collectibility of these cash flows to determine future amounts to record, if any.
Purchases and Sales of Products and Services with Apollo Affiliates
The Company sells products to certain Apollo affiliates and members of Momentive Holdings. These sales were $1 and less than $1 for the three months ended March 31, 2011 and 2010, respectively. Accounts receivable from these affiliates were less than $1 at March 31, 2011 and December 31, 2010. The Company also purchases raw materials and services from certain Apollo affiliates. These purchases were $6 and $2 for the three months ended March 31, 2011 and 2010, respectively. The Company had accounts payable to Apollo affiliates of $1 at March 31, 2011 and December 31, 2010, respectively.
Other Transactions and Arrangements
The Company sells finished goods to and purchases raw materials from its foundry joint venture between the Company and Delta-HA, Inc. ("HAI"). The Company also provides toll-manufacturing and other services to HAI. The Company’s investment in HAI is recorded under the equity method of accounting and the related sales and purchases are not eliminated from the Company’s unaudited Condensed Consolidated Financial Statements. However, any profit on these transactions is eliminated in the Company’s unaudited Condensed Consolidated Financial Statements to the extent of the Company’s 50% interest in HAI. Sales and services provided to HAI were $29 and $21 for the three months ended March 31, 2011 and 2010, respectively. Accounts receivable from HAI were $20 and $13 at March 31, 2011 and December 31, 2010, respectively. Purchases from HAI were $14 and $10 for the three months ended March 31, 2011and 2010, respectively. The Company had accounts payable to HAI of $7 and $2 at March 31, 2011 and December 31, 2010, respectively.
The Company’s purchase contracts with HAI represent a significant portion of HAI’s total revenue. In addition, the Company has pledged its member interest in HAI as collateral on HAI’s revolving line of credit. These factors result in the Company absorbing the majority of the risk to potential losses or gains from a majority of the expected returns. However, the Company does not have the power to direct the activities that most significantly impact HAI, and therefore, does not have a controlling financial interest. The carrying value of HAI’s assets were $54 and $44 at March 31, 2011 and December 31, 2010, respectively. The carrying value of HAI’s liabilities were $26 and $22 at March 31, 2011 and December 31, 2010, respectively.
The Company has a loan receivable from its unconsolidated forest products joint venture in Russia of $4 as of March 31, 2011 and December 31, 2010.
5. Fair Value and Financial Instruments
Fair Value
Fair value measurement provisions establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This guidance describes three levels of inputs that may be used to measure fair value:
 
Level 1: Inputs are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reported date.
Level 3: Unobservable inputs, for example, inputs derived through extrapolation or interpolation that cannot be corroborated by observable market data.
Recurring Fair Value Measurements
Following is a summary of assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010:
 
Fair Value Measurements Using
 
Total
 
Quoted Prices in Active Markets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Unobservable Inputs (Level 3)
 
March 31, 2011
 
 
 
 
 
 
 
Derivative liabilities
$
 
 
$
(7
)
 
$
 
 
$
(7
)
December 31, 2010
 
 
 
 
 
 
 
Derivative liabilities
 
 
(10
)
 
 
 
(10
)
Level 1 primarily consists of financial instruments traded on exchange or futures markets. Level 2 includes those derivative instruments transacted primarily in over the counter markets.

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The Company calculates the fair value of its derivative liabilities using quoted market prices whenever available. When quoted market prices are not available, the Company uses standard pricing models with market-based inputs, adjusted for nonperformance risk. When its financial instruments are in a liability position, the Company evaluates its credit risk as a component of fair value. At March 31, 2011 and December 31, 2010, no adjustment was made by the Company to reduce its derivative liabilities for nonperformance risk. As a significant portion of the Company’s derivative liabilities are cash flow hedges, $0 was recognized in Accumulated other comprehensive income at March 31, 2011 and December 31, 2010.
When its financial instruments are in an asset position, the Company is exposed to credit loss in the event of nonperformance by other parties to these contracts and evaluates their credit risk as a component of fair value.
 
Derivative Financial Instruments
The Company is exposed to certain risks related to its ongoing business operations. The primary risks managed by using derivative instruments are foreign currency exchange risk, interest rate risk and commodity price risk. The Company does not hold or issue derivative financial instruments for trading purposes.
Foreign Exchange Rate Swaps
International operations account for a significant portion of the Company’s revenue and operating income. The Company’s policy is to reduce foreign currency cash flow exposure from exchange rate fluctuations by hedging anticipated and firmly committed transactions when it is economically feasible. The Company periodically enters into forward contracts to buy and sell foreign currencies to reduce foreign exchange exposure and protect the U.S. dollar value of certain transactions to the extent of the amount under contract. The counter-parties to our forward contracts are financial institutions with investment grade ratings. The Company does not apply hedge accounting to these derivative instruments.
Interest Rate Swaps
The Company periodically uses interest rate swaps to alter interest rate exposures between fixed and floating rates on certain long-term debt. Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts calculated using an agreed-upon notional principal amount. The counter-parties to the interest rate swap agreements are financial institutions with investment grade ratings.
In January 2007, the Company entered into an interest rate swap agreement. This swap is designed to offset the cash flow variability that results from interest rate fluctuations on the Company’s variable rate debt and matured in the first quarter of 2011. The Company previously accounted for the swap as a qualifying cash flow hedge.
In February 2007, the Company entered into interest rate swap agreements to offset the cash flow variability that results from interest rate fluctuations on the Company’s Australian variable rate debt. The Company has not applied hedge accounting to this derivative instrument.
In July 2010, the Company entered into a two-year interest rate swap agreement . This swap is designed to offset the cash flow variability that results from interest rate fluctuations on the Company’s variable rate debt. This swap became effective on January 4, 2011 upon the expiration of the January 2007 interest rate swap. The initial notional amount of the swap is $350, and will subsequently be amortized down to $325. The Company pays a fixed rate of 1.032% and will receive a variable one month LIBOR rate. The Company accounts for the swap as a qualifying cash flow hedge.
Commodity Contracts
The Company hedges a portion of its electricity purchases for certain North American plants. The Company enters into forward contracts with fixed prices to hedge electricity pricing at these plants. Any unused electricity is net settled for cash each month based on the market electricity price versus the contract price. The Company also hedges a portion of its natural gas purchases for certain North American plants. The Company uses futures contracts to hedge natural gas pricing at these plants. The natural gas contracts are settled for cash each month based on the closing market price on the last day the contract trades on the New York Mercantile Exchange. The Company does not apply hedge accounting to these electricity or natural gas future contracts.
 

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The following tables summarize the Company’s derivative financial instruments:
 
 
 
March 31, 2011
 
December 31, 2010
Liability Derivatives
Balance Sheet Location
 
Notional
Amount
 
Fair Value
Liability
 
Notional
Amount
 
Fair Value
Liability
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
Interest Rate Swaps
 
 
 
 
 
 
 
 
 
Interest swap – 2007
Other current liabilities
 
$
 
 
$
 
 
$
375
 
 
$
(5
)
Interest swap – 2010
Other current liabilities
 
350
 
 
(2
)
 
350
 
 
(2
)
Total derivatives designated as hedging instruments
 
 
 
 
$
(2
)
 
 
 
$
(7
)
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
Foreign Exchange and Interest Rate Swaps
 
 
 
 
 
 
 
 
 
Cross-Currency and Interest Rate Swap
Other current liabilities
 
$
25
 
 
$
(5
)
 
$
25
 
 
$
(3
)
Interest Rate Swap
 
 
 
 
 
 
 
 
 
Interest swap – Australia Multi-Currency Term
Other current liabilities
 
22
 
 
 
 
22
 
 
 
Commodity Contracts
 
 
 
 
 
 
 
 
 
Electricity contracts
Other current liabilities
 
3
 
 
 
 
4
 
 
 
Natural gas futures
Other current liabilities
 
2
 
 
 
 
2
 
 
 
Total derivatives not designated as hedging instruments
 
 
 
 
$
(5
)
 
 
 
$
(3
)
Derivatives in Cash Flow
Hedging Relationship
Amount of Loss
Recognized in OCI on Derivative
for the three months ended:
 
Location of Loss
Reclassified from
Accumulated OCI into Income
 
Amount of Loss Reclassified
from Accumulated OCI into
Income for the three months ended:
March 31, 2011
 
March 31, 2010
March 31, 2011
 
March 31, 2010
Interest Rate Swaps
 
 
 
 
 
 
 
 
 
Interest swap – 2007
$
 
 
$
(1
)
 
Interest expense, net
 
$
 
 
$
(7
)
Interest swap – 2010
 
 
 
 
Interest expense, net
 
(1
)
 
 
Total
$
 
 
$
(1
)
 
 
 
$
(1
)
 
$
(7
)
 
Derivatives Not Designated as Hedging Instruments
Amount of (Loss) Gain Recognized in Income on Derivative for  the three months ended:
 
Location of (Loss) Gain Recognized in Income on Derivative
March 31, 2011
 
March 31, 2010
 
Foreign Exchange and Interest Rate Swaps
 
 
 
 
 
Cross-Currency and Interest Rate Swap
$
(2
)
 
$
2
 
 
Other non-operating expense, net
Natural gas futures
 
 
(1
)
 
Cost of sales
Total
$
(2
)
 
$
1
 
 
 
Non-derivative Financial Instruments
The following table summarizes the carrying amount and fair value of the Company’s non-derivative financial instruments:
 
March 31, 2011
 
December 31, 2010
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Debt
$
3,647
 
 
$
3,666
 
 
$
3,672
 
 
$
3,708
 
Fair values of debt are determined from quoted, observable market prices, where available, based on other similar financial instruments, or based upon interest rates that are currently available to the Company for the issuance of debt with similar terms and maturities. The carrying amounts of cash and cash equivalents, accounts receivable, accounts and drafts payable and other accrued liabilities are considered reasonable estimates of their fair values due to the short-term maturity of these financial instruments.
6. Commitments and Contingencies
Environmental Matters
The Company’s operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials. The Company is subject to extensive environmental regulation at the federal, state and local levels as well as foreign laws and regulations, and is therefore exposed to the risk of claims for environmental remediation or restoration. In addition, violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

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The following table summarizes all probable environmental remediation, indemnification and restoration liabilities, including related legal expenses, at March 31, 2011 and December 31, 2010:
 
Number of Sites
 
Liability
 
Range of Reasonably Possible Costs
Site Description
March 31, 2011
 
December 31, 2010
 
March 31, 2011
 
December 31, 2010
 
Low
 
High
Geismar, LA
1
 
 
1
 
 
$
17
 
 
$
17
 
 
$
10
 
 
$
25
 
Superfund and offsite landfills – allocated share:
 
 
 
 
 
 
 
 
 
 
 
Less than 1%
28
 
 
29
 
 
1
 
 
1
 
 
1
 
 
2
 
Equal to or greater than 1%
12
 
 
12
 
 
7
 
 
7
 
 
5
 
 
12
 
Currently-owned
18
 
 
21
 
 
10
 
 
9
 
 
7
 
 
17
 
Formerly-owned:
 
 
 
 
 
 
 
 
 
 
 
Remediation
10
 
 
10
 
 
1
 
 
1
 
 
1
 
 
10
 
Monitoring only
6
 
 
7
 
 
1
 
 
1
 
 
 
 
2
 
 
75
 
 
80
 
 
$
37
 
 
$
36
 
 
$
24
 
 
$
68
 
These amounts include estimates for unasserted claims that the Company believes are probable of loss and reasonably estimable. The estimate of the range of reasonably possible costs is less certain than the estimates upon which the liabilities are based. To establish the upper end of a range, assumptions less favorable to the Company among the range of reasonably possible outcomes were used. As with any estimate, if facts or circumstances change, the final outcome could differ materially from these estimates. At March 31, 2011 and December 31, 2010, $11 and $10, respectively, has been included in Other current liabilities in the unaudited Condensed Consolidated Balance Sheets with the remaining amount included in Other long-term liabilities.
Following is a discussion of the Company’s environmental liabilities and the related assumptions at March 31, 2011:
Geismar, LA Site—The Company formerly owned a basic chemicals and polyvinyl chloride business that was taken public as Borden Chemicals and Plastics Operating Limited Partnership (“BCPOLP”) in 1987. The Company retained a 1% interest, the general partner interest and the liability for certain environmental matters after BCPOLP’s formation. Under a Settlement Agreement approved by the United States Bankruptcy Court for the District of Delaware among the Company, BCPOLP, the United States Environmental Protection Agency and the Louisiana Department of Environmental Quality, the Company agreed to perform certain of BCPOLP’s obligations for soil and groundwater contamination at BCPOLP’s Geismar, Louisiana site. The Company bears the sole responsibility for these obligations because there are no other potentially responsible parties (“PRP”) or third parties from whom the Company could seek reimbursement.
A groundwater pump and treat system to remove contaminants is operational, and natural attenuation studies are proceeding. If closure procedures and remediation systems prove to be inadequate, or if additional contamination is discovered, costs that would approach the higher end of the range of possible outcomes could result.
Due to the long-term nature of the project, the reliability of timing and the ability to estimate remediation payments, a portion of this liability was recorded at its net present value, assuming a 3% discount rate and a time period of 28 years. The range of possible outcomes is discounted in a similar manner. The undiscounted liability, which is expected to be paid over the next 28 years, is approximately $24. Over the next five years, the Company expects to make ratable payments totaling $6.
 Superfund Sites and Offsite Landfills—The Company is currently involved in environmental remediation activities at a number of sites for which it has been notified that it is, or may be, a PRP under the United States Comprehensive Environmental Response, Compensation and Liability Act or similar state “superfund” laws. The Company anticipates approximately 50% of the estimated liability for these sites will be paid within the next five years, with the remainder over the next twenty-five years. The Company generally does not bear a significant level of responsibility for these sites, and as a result, has little control over the costs and timing of cash flows.
The Company’s ultimate liability will depend on many factors including its share of waste volume, the financial viability of other PRPs, the remediation methods and technology used, the amount of time necessary to accomplish remediation and the availability of insurance coverage. The range of possible outcomes takes into account the maturity of each project, resulting in a more narrow range as the project progresses. To estimate both its current reserves for environmental remediation at these sites and the possible range of additional costs, the Company has not assumed that it will bear the entire cost of remediation of every site to the exclusion of other known PRPs who may be jointly and severally liable. The Company has limited information to assess the viability of other PRPs and their probable contribution on a per site basis. The Company’s insurance provides very limited, if any, coverage for these environmental matters.
Sites Under Current Ownership—The Company is conducting environmental remediation at a number of locations that it currently owns, of which eight sites are no longer in operation. As the Company is performing a portion of the remediation on a voluntary basis, it has some control over the costs to be incurred and the timing of cash flows. The Company expects to pay approximately $8 of these liabilities within the next five years, with the remainder over the next ten years. The factors influencing the ultimate outcome include the methods of remediation elected, the conclusions and assessment of site studies remaining to be completed, and the time period required to complete the work. No other parties are responsible for remediation at these sites.

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Formerly-Owned Sites—The Company is conducting environmental remediation at a number of locations that it formerly owned. The final costs to the Company will depend on the method of remediation chosen and the level of participation of third parties.
In addition, the Company is responsible for a number of sites that require monitoring where no additional remediation is expected. The Company has established reserves for costs related to these sites. Payment of these liabilities is anticipated to occur over the next ten years. The ultimate cost to the Company will be influenced by fluctuations in projected monitoring periods or by findings that are different than anticipated.
Indemnifications —In connection with the acquisition of certain of the Company’s operating businesses, the Company has been indemnified by the sellers against certain liabilities of the acquired businesses, including liabilities relating to both known and unknown environmental contamination arising prior to the date of the purchase. The indemnifications may be subject to certain exceptions and limitations, deductibles and indemnity caps. While it is reasonably possible that some costs could be incurred, except for those sites identified above, the Company has inadequate information to allow it to estimate a potential range of liability, if any.
Non-Environmental Legal Matters
The Company is involved in various legal proceedings in the ordinary course of business and has reserves of $10 and $11 at March 31, 2011 and December 31, 2010, respectively, for all non-environmental legal defense costs incurred and settlement costs that it believes are probable and estimable. At March 31, 2011 and December 31, 2010, $4 and $5, respectively, has been included in Other current liabilities in the unaudited Condensed Consolidated Balance Sheets with the remaining amount included in Other long-term liabilities.
Following is a discussion of significant non-environmental legal proceedings:
Brazil Tax Claim— In 1992, the State of Sao Paulo Administrative Tax Bureau issued an assessment against the Company’s Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes. These loans were characterized by the Tax Bureau as intercompany sales. Since that time, management and the Tax Bureau have held discussions and the subsidiary filed an administrative appeal seeking cancellation of the assessment. The Administrative Court upheld the assessment in December 2001. In 2002, the subsidiary filed a second appeal with the highest-level Administrative Court, again seeking cancellation of the assessment. In February 2007, the highest-level Administrative Court upheld the assessment. The Company requested a review of this decision. On April 23, 2008, the Brazilian Administrative Tax Tribunal issued its final decision upholding the assessment against the subsidiary. The Company filed an Annulment action in the Brazilian Judicial Courts in May 2008 along with a request for an injunction to suspend the tax collection. The injunction was denied but the Annulment action is being pursued. The Company has pledged certain properties and assets in Brazil during the pendency of the Annulment action in lieu of paying the assessment. In September 2010, in the Company's favor, the Court adopted its appointed expert's report finding that the transactions in question were intercompany loans. Sao Paulo has mandatory appeal rights but the Court's decision based on the facts is likely to be upheld and therefore, the Company does not believe a loss is probable. At March 31, 2011, the amount of the assessment, including tax, penalties, monetary correction and interest, is 66 Brazilian reais, or approximately $41.
Formosa Plant—Several lawsuits were filed in Sangamon County, Illinois in May 2006 against the Company on behalf of individuals injured or killed in an explosion at a Formosa Plastics Corporation (“Formosa”) plant in Illiopolis, Illinois that occurred on April 23, 2004. The Company sold the facility in 1987. The facility was operated by BCPOLP until it was sold to Formosa out of BCPOLP’s bankrupt estate in 2002. In March 2007, an independent federal agency found that operator errors caused the explosion, but that current and former owners could have implemented systems to minimize the impacts from these errors. In March 2008, the Company filed a motion for summary judgment, which is still pending. At this time there is inadequate information from which to estimate a potential range of liability, if any.
Hillsborough County—The Company is named in a lawsuit filed on July 12, 2004 in Hillsborough County, Florida Circuit Court, for an animal feed supplement processing site formerly operated by the Company and sold in 1980. The lawsuit is filed on behalf of multiple residents of Hillsborough County living near the site and it alleges various injuries from exposure to toxic chemicals. The Company does not have adequate information from which to estimate a potential range of liability, if any. The court dismissed a similar lawsuit brought on behalf of a class of plaintiffs in November 2005.
Environmental Institution of Paraná IAP—On August 10, 2005, Governo Do Paraná and the Environmental Institution of Paraná IAP, an environmental agency of the Brazilian government, provided Hexion Quimica Industria, our Brazilian subsidiary, with notice of a potential fine of up to $12 in connection with alleged environmental damages to the Port of Paranagua caused in November 2004 by an oil spill from a shipping vessel carrying methanol purchased by the Company. The investigation as to the cause of the accident has not been finalized. In early October 2009, the Company was granted an injunction precluding the imposition of any fines or penalties by the Paraná IAP. Should the injunction be vacated, the Company believes it has a strong defense and does not believe a loss is probable. At March 31, 2011, the amount of the assessment, including tax, penalties, monetary correction and interest, is 26 Brazilian reais, or approximately $16.
Other Legal Matters—The Company is involved in various other product liability, commercial and employment litigation, personal injury, property damage and other legal proceedings in addition to those described above, including actions that allege harm caused by products the Company has allegedly made or used, containing silica, vinyl chloride monomer and asbestos. The Company does not believe that it has a material exposure for these claims and believes it has adequate reserves and insurance to cover pending and foreseeable future claims.
 

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7. Pension and Postretirement Expense
Following are the components of net pension and postretirement expense (benefit) recognized by the Company for the three months ended March 31, 2011 and 2010:
 
Pension Benefits
 
Non-Pension Postretirement Benefits
 
Three Months Ended March 31,
 
Three Months Ended March 31,
 
2011
 
2010
 
2011
 
2010
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
Service cost
$
1
 
 
$
2
 
 
$
1
 
 
$
2
 
 
$
 
 
$
 
 
$
 
 
$
 
Interest cost on projected benefit obligation
3
 
 
4
 
 
4
 
 
4
 
 
 
 
 
 
 
 
 
Expected return on assets
(4
)
 
(3
)
 
(4
)
 
(3
)
 
 
 
 
 
 
 
 
Amortization of prior service cost
 
 
 
 
 
 
 
 
(3
)
 
 
 
(3
)
 
 
Recognized actuarial loss
2
 
 
 
 
2
 
 
 
 
 
 
 
 
 
 
 
Net expense (benefit)
$
2
 
 
$
3
 
 
$
3
 
 
$
3
 
 
$
(3
)
 
$
 
 
$
(3
)
 
$
 
 
8. Segment Information
In the first quarter of 2011, the Company completed the sale of the IAR business and made certain changes to its internal reporting structure, which caused the Company to re-evaluate its reportable segments. As a result of these changes, effective in the first quarter of 2011, the results of the Company's coatings reporting unit are included within the Epoxy, Phenolic and Coating Resins segment. Previously the results of this reporting unit were reported in the Coatings segment. The prior periods have been recasted for comparability purposes. In addition, the Company has renamed its Formaldehyde and Forest Products Resins segment to Forest Products Resins. No changes were made to the product lines that comprise this segment.
The Company's business segments are based on the products that the Company offers and the markets that it serves. At March 31, 2011, the Company had two reportable segments: Epoxy, Phenolic and Coating Resins and Forest Products Resins. A summary of the major products of the Company's reportable segments follows:
 
Epoxy, Phenolic and Coating Resins: epoxy specialty resins, oil field products, versatic acids and derivatives, basic epoxy resins and intermediates, phenolic specialty resins and molding compounds, polyester resins, alkyds resins, acrylic resins and vinylic resins
 
Forest Products Resins: forest products resins and formaldehyde applications
 
Reportable Segments
Following are net sales and Segment EBITDA (earnings before interest, income taxes, depreciation and amortization) by reportable segment. Segment EBITDA is defined as EBITDA adjusted to exclude certain non-cash and certain non-recurring expenses. Segment EBITDA is the primary performance measure used by the Company's senior management, the chief operating decision-maker and the board of directors to evaluate operating results and allocate capital resources among segments. Segment EBITDA is also the profitability measure used to set management and executive incentive compensation goals. Corporate and Other is primarily corporate general and administrative expenses that are not allocated to the segments, such as shared service and administrative functions, foreign exchange gains and losses and legacy company costs not allocated to continuing segments.
Total assets by segment has been disclosed below due to the change in the Company's reportable segments in the first quarter of 2011.
 
Net Sales to Unaffiliated Customers for the three months ended March 31(1)(2):
 
2011
 
2010
Epoxy, Phenolic and Coating Resins
$
911
 
 
$
711
 
Forest Products Resins
448
 
 
386
 
 
$
1,359
 
 
$
1,097
 
 
Segment EBITDA for the three months ended March 31(2):
 
2011
 
2010
Epoxy, Phenolic and Coating Resins
$
152
 
 
$
85
 
Forest Products Resins
45
 
 
42
 
Corporate and Other
(17
)
 
(11
)
 

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Table of Contents

Total Assets(2):
 
As of March 31, 2011
 
As of December 31, 2010
Epoxy, Phenolic and Coating Resins
$
2,143
 
 
$
1,875
 
Forest Products Resins
891
 
 
849
 
Corporate and Other
289
 
 
233
 
Discontinued Operations
 
 
180
 
 
$
3,323
 
 
$
3,137
 
(1)
Intersegment sales are not significant and, as such, are eliminated within the selling segment.
(2)
The Company changed its reportable segments in the first quarter of 2011. Prior period balances have been recasted to conform to the Company's current reportable segments.
Reconciliation of Segment EBITDA to Net Income (Loss):
 
Three Months Ended March 31,
 
2011
 
2010
Segment EBITDA:
 
 
 
Epoxy, Phenolic and Coating Resins
$
152
 
 
$
85
 
Forest Products Resins
45
 
 
42
 
Corporate and Other
(17
)
 
(11
)
 
 
 
 
Reconciliation:
 
 
 
Items not included in Segment EBITDA
 
 
 
Non-cash charges
 
 
(11
)
Unusual items:
 
 
 
Loss on divestiture of assets
(1
)
 
(1
)
Net income from discontinued operations
5
 
 
3
 
Other
(12
)
 
(5
)
Total unusual items
(8
)
 
(3
)
Total adjustments
(8
)
 
(14
)
Interest expense, net
(64
)
 
(63
)
Income tax expense
(3
)
 
(4
)
Depreciation and amortization
(42
)
 
(42
)
Net income (loss)
$
63
 
 
$
(7
)
 Items not included in Segment EBITDA
Non-cash charges primarily represent stock-based compensation expense and unrealized derivative and foreign exchange gains and losses. For the three months ended March 31, 2010, non-cash charges also include the write-off of unamortized deferred financing fees associated with debt refinancings in January of 2010.
Not included in Segment EBITDA are certain non-cash and certain non-recurring income or expenses that are deemed by management to be unusual in nature. For the three months ended March 31, 2011, these items consisted of business realignment costs primarily related to expenses from the Company's productivity program, business optimization expenses and realized foreign exchange gains and losses. For the three months ended March 31, 2010, these items consisted of business realignment costs primarily related to expenses from the Company's productivity program, realized foreign exchange gains and losses, retention program costs and financing fees incurred as part of refinancing transaction in the first quarter of 2010, partially offset by insurance settlements related to previous litigation matters.
 

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9. Stock Option Plans and Stock-Based Compensation
On February 23, 2011, the Compensation Committee of the Board of Managers of Momentive Holdings approved the Momentive Performance Materials Holdings LLC 2011 Equity Incentive Plan (the “2011 Equity Plan”). Under the 2011 Equity Plan, Momentive Holdings can award unit options, unit awards, restricted units, restricted deferred units, and other unit-based awards. The restricted deferred units are non-voting units of measurement which are deemed to be equivalent to one common unit of Momentive Holdings. The unit options are options to purchase common units of Momentive Holdings. The awards contain restrictions on transferability and other typical terms and conditions.
The following is a summary of key terms of the stock-based awards granted to MSC employees under the 2011 Equity Plan on February 23, 2011:
Tranche
 
Units Granted
 
Vesting Terms
 
Option/Unit Term
Unit Options:
 
 
 
 
 
10 years
Tranche A Options
 
2,755,594
 
 
Time-vest ratably over 4 years; Accelerated vesting six months after a change of control event as defined by the 2011 Equity Plan
 
 
Tranche B Options
 
1,377,787
 
 
Performance-based: Vest upon the earlier of 1) two years from the achievement of the targeted common unit value and a realization event or 2) six months from a change of control event and the achievement of the targeted common unit value as defined by the 2011 Equity Plan
 
 
Tranche C Options
 
1,377,787
 
 
Performance-based: Vest upon the earlier of 1) one year from the achievement of the targeted common unit value and a realization event or 2) six months from a change in control event and the achievement of the targeted common unit value as defined by the 2011 Equity Plan
 
 
Restricted Deferred Units ("RDUs"):
 
 
 
 
 
N/A
Tranche A RDUs
 
918,535
 
 
Time-vest ratably over 4 years; Accelerated vesting six months from a change in control event as defined by the 2011 Equity Plan
 
 
Tranche B RDUs
 
459,258
 
 
Performance-based: Vest upon the earlier of 1) two years from the achievement of the targeted common unit value and a realization event or 2) six months from a change of control event and the achievement of the targeted common unit value as defined by the 2011 Equity Plan
 
 
Tranche C RDUs
 
459,258
 
 
Performance-based: Vest upon the earlier of 1) one year from the achievement of the targeted common unit value and a realization event or 2) six months from a change in control event and the achievement of the targeted common unit value as defined by the 2011 Equity Plan
 
 
Unit Options
The Tranche A Options were granted with a grant date fair value of approximately $6. The fair value of each option was estimated at the grant date using a Black-Scholes option pricing model. The assumptions used to estimate the fair value were a 2.21% risk-free interest rate, a 6.25 year expected life, a 37.4% expected volatility rate and a 0% dividend rate. Compensation cost of $1 related to these awards was recognized during the three months ended March 31, 2011.
The Tranche B and Tranche C Options were granted with performance and market conditions with a grant date fair value of approximately $3 and $3, respectively. The fair value was estimated at the grant date using a Monte Carlo valuation method, which is a commonly accepted valuation model for awards with market and performance conditions. The Monte Carlo valuation method requires the use of a range of assumptions. The range of risk-free interest rates were 0.16% to 3.49%, expected volatility rates ranged from 34.5% to 41.5% and a 0% dividend rate. The expected life assumption is not used in the Monte Carlo valuation method, but the output of the model indicated a weighted-average expected life of 9.2 years. Compensation cost has not been recognized for the Tranche B and Tranche C Options during the three months ended March 31, 2011 because as of March 31, 2011, it is not probable the related options will vest. Compensation cost will be recognized over the service period once the satisfaction of the performance condition is probable.
Restricted Deferred Units
The Tranche A RDUs were granted with a grant date fair value of approximately $4. Compensation cost of less than $1 related to these awards was recognized during the three months ended March 31, 2011.
The Tranche B RDUs and Tranche C RDUs were granted with a grant date fair value of approximately $2 and $2, respectively. The fair value was estimated at the grant date using the same Monte Carlo valuation method and assumptions. The RDU's have an indefinite life, thus the term used in the valuation model was 30 years, which resulted in a weighted-average expected life of 21.4 years. Compensation cost has not been recognized for the Tranche B RDUs and Tranche C RDUs during the three months ended March 31, 2011 because as of March 31, 2011, it is not probable the related restricted deferred units will vest. Compensation cost will be recognized over the service period once the satisfaction of the performance condition is probable.
Although the 2011 Equity Plan is issued by Momentive Holdings, the underlying compensation cost represents compensation costs paid for by Momentive Holdings on MSC's behalf, as a result of the employees' service to MSC. All compensation cost is recorded over the requisite service period on a graded-vesting basis and is included in Selling, general and administrative expense in the unaudited Condensed Consolidated Statements of Operations.
 

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10. Guarantor/Non-Guarantor Subsidiary Financial Information
The Company and certain of its U.S. subsidiaries guarantee debt issued by its wholly owned subsidiaries Hexion Nova Scotia, ULC and Hexion U.S. Finance Corporation (together, the “Subsidiary Issuers”), which includes the 8.875% first priority senior secured notes due 2018, the floating rate second-priority senior secured notes due 2014 and the 9% second-priority notes due 2020.
The following information contains the condensed consolidating financial information for MSC (the parent), the Subsidiary Issuers, the combined subsidiary guarantors (Momentive Specialty Chemical Investments Inc.; Borden Chemical Foundry; LLC, Lawter International, Inc.; HSC Capital Corporation; Momentive International, Inc.; Momentive CI Holding Company; NL COOP Holdings LLC and Oilfield Technology Group, Inc.) and the combined non-guarantor subsidiaries, which includes all of the Company’s foreign subsidiaries and HAI (prior to the deconsolidation of this entity).
All of the subsidiary issuers and subsidiary guarantors are 100% owned by MSC. 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, New Zealand and Brazilian subsidiaries are restricted in the payment of dividends and intercompany loans due to the terms of their credit facilities, there are no material restrictions on the Company’s ability to obtain cash from the remaining non-guarantor subsidiaries.
This information includes allocations of corporate overhead to the combined non-guarantor subsidiaries based on net sales. Income tax expense has been provided on the combined non-guarantor subsidiaries based on actual effective tax rates.

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MOMENTIVE SPECIALTY CHEMICALS INC.
THREE MONTHS ENDED MARCH 31, 2011
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net sales
$
627
 
 
$
 
 
$
 
 
$
814
 
 
$
(82
)
 
$
1,359
 
Cost of sales
528
 
 
 
 
 
 
700
 
 
(82
)
 
1,146
 
Gross profit
99
 
 
 
 
 
 
114
 
 
 
 
213
 
Selling, general and administrative expense
32
 
 
 
 
 
 
56
 
 
 
 
88
 
Other operating expense, net
(16
)
 
 
 
 
 
21
 
 
 
 
5
 
Operating income
83
 
 
 
 
 
 
37
 
 
 
 
120
 
Interest expense, net
17
 
 
38
 
 
 
 
9
 
 
 
 
64
 
Intercompany interest expense (income)
30
 
 
(43
)
 
 
 
13
 
 
 
 
 
Other non-operating (income) expense, net
(27
)
 
 
 
 
 
25
 
 
 
 
(2
)
Income (loss) from continuing operations before income tax, earnings from unconsolidated entities
63
 
 
5
 
 
 
 
(10
)
 
 
 
58
 
Income tax (benefit) expense
(8
)
 
 
 
 
 
11
 
 
 
 
3
 
Income (loss) from continuing operations before earnings from unconsolidated entities
71
 
 
5
 
 
 
 
(21
)
 
 
 
55
 
Earnings from unconsolidated entities, net of taxes
10
 
 
 
 
19
 
 
 
 
(26
)
 
3
 
Net income (loss) from continuing operations
81
 
 
5
 
 
19
 
 
(21
)
 
(26
)
 
58
 
Net (loss) gain from discontinued operations, net of tax
(18
)
 
 
 
 
 
23
 
 
 
 
5
 
Net income (loss)
$
63
 
 
$
5
 
 
$
19
 
 
$
2
 
 
$
(26
)
 
$
63
 
 

18

Table of Contents

 
MOMENTIVE SPECIALTY CHEMICALS INC.
THREE MONTHS ENDED MARCH 31, 2010
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net sales
$
509
 
 
$
 
 
$
 
 
$
690
 
 
$
(102
)
 
$
1,097
 
Cost of sales
448
 
 
 
 
 
 
612
 
 
(102
)
 
958
 
Gross profit
61
 
 
 
 
 
 
78
 
 
 
 
139
 
Selling, general and administrative expense
28
 
 
 
 
 
 
48
 
 
 
 
76
 
Other operating (income) expense, net
(5
)
 
 
 
 
 
5
 
 
 
 
 
Operating income
38
 
 
 
 
 
 
25
 
 
 
 
63
 
Interest expense, net
25
 
 
30
 
 
 
 
8
 
 
 
 
63
 
Intercompany interest expense (income)
29
 
 
(37
)
 
 
 
8
 
 
 
 
 
Other non-operating expense (income), net
6
 
 
3
 
 
 
 
(1
)
 
 
 
8
 
(Loss) income from continuing operations before income tax, earnings from unconsolidated entities
(22
)
 
4
 
 
 
 
10
 
 
 
 
(8
)
Income tax expense
2
 
 
 
 
 
 
2
 
 
 
 
4
 
(Loss) income from continuing operations before earnings from unconsolidated entities
(24
)
 
4
 
 
 
 
8
 
 
 
 
(12
)
Earnings from unconsolidated entities, net of taxes
16
 
 
 
 
2
 
 
 
 
(16
)
 
2
 
Net (loss) income from continuing operations
(8
)
 
4
 
 
2
 
 
8
 
 
(16
)
 
(10
)
Net income from discontinued operations, net of tax
1
 
 
 
 
 
 
2
 
 
 
 
3
 
Net (loss) income
$
(7
)
 
$
4
 
 
$
2
 
 
$
10
 
 
$
(16
)
 
$
(7
)
 
 
 
 

19

Table of Contents

MOMENTIVE SPECIALTY CHEMICALS INC.
MARCH 31, 2011
CONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
 
 
Current assets
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (including restricted cash of $0 and $4, respectively)
$
11
 
 
$
 
 
$
 
 
$
95
 
 
$
 
 
$
106
 
Short-term investments
 
 
 
 
 
 
6
 
 
 
 
6
 
Accounts receivable, net
269
 
 
 
 
 
 
564
 
 
 
 
833
 
Inventories:
 
 
 
 
 
 
 
 
 
 
 
Finished and in-process goods
171
 
 
 
 
 
 
194
 
 
 
 
365
 
Raw materials and supplies
51
 
 
 
 
 
 
87
 
 
 
 
138
 
Other current assets
24
 
 
 
 
 
 
67
 
 
 
 
91
 
Total current assets
526
 
 
 
 
 
 
1,013
 
 
 
 
1,539
 
Other assets
 
 
 
 
 
 
 
 
 
 
 
Investment in subsidiaries
23
 
 
 
 
28
 
 
 
 
(51
)
 
 
Other assets
21
 
 
40
 
 
20
 
 
85
 
 
 
 
166
 
 
44
 
 
40
 
 
48
 
 
85
 
 
(51
)
 
166
 
Property and equipment, net
520
 
 
 
 
 
 
794
 
 
 
 
1,314
 
Goodwill
93
 
 
 
 
 
 
79
 
 
 
 
172
 
Other intangible assets, net
61
 
 
 
 
 
 
71
 
 
 
 
132
 
Total assets
$
1,244
 
 
$
40
 
 
$
48
 
 
$
2,042
 
 
$
(51
)
 
$
3,323
 
Liabilities and (Deficit) Equity
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
 
 
 
 
 
 
 
 
 
 
 
Accounts and drafts payable
$
219
 
 
$
 
 
$
 
 
$
366
 
 
$
 
 
$
585
 
Intercompany accounts (receivable) payable
(192
)
 
(34
)
 
 
 
226
 
 
 
 
 
Debt payable within one year
21
 
 
 
 
 
 
60
 
 
 
 
81
 
Intercompany loans (receivable) payable
(11
)
 
 
 
 
 
11
 
 
 
 
 
Loans payable to affiliates
2
 
 
 
 
 
 
 
 
 
 
2
 
Interest payable
11
 
 
36
 
 
 
 
1
 
 
 
 
48
 
Income taxes payable
2
 
 
 
 
 
 
22
 
 
 
 
24
 
Accrued payroll and incentive compensation
58
 
 
 
 
 
 
42
 
 
 
 
100
 
Other current liabilities
77
 
 
 
 
 
 
66
 
 
 
 
143
 
Total current liabilities
187
 
 
2
 
 
 
 
794
 
 
 
 
983
 
Long-term debt
1,147
 
 
1,687
 
 
 
 
630
 
 
 
 
3,464
 
Affiliated long-term debt
80
 
 
 
 
 
 
20
 
 
 
 
100
 
Intercompany loans payable (receivable)
1,300
 
 
(1,896
)
 
(15
)
 
611
 
 
 
 
 
Long-term pension and post employment benefit obligations
80
 
 
 
 
 
 
133
 
 
 
 
213
 
Deferred income taxes
37
 
 
2
 
 
 
 
72
 
 
 
 
111
 
Other long-term liabilities
117
 
 
6
 
 
 
 
32
 
 
 
 
155
 
Advance from affiliates
225
 
 
 
 
 
 
 
 
 
 
225
 
Total liabilities
3,173
 
 
(199
)
 
(15
)
 
2,292
 
 
 
 
5,251
 
Total Momentive Specialty Chemicals Inc. shareholders (deficit) equity
(1,929
)
 
239
 
 
63
 
 
(251
)
 
(51
)
 
(1,929
)
Noncontrolling interest
 
 
 
 
 
 
1
 
 
 
 
1
 
Total (deficit) equity
(1,929
)
 
239
 
 
63
 
 
(250
)
 
(51
)
 
(1,928
)
Total liabilities and (deficit) equity
$
1,244
 
 
$
40
 
 
$
48
 
 
$
2,042
 
 
$
(51
)
 
$
3,323
 
 

20

Table of Contents

 
MOMENTIVE SPECIALTY CHEMICALS INC.
DECEMBER 31, 2010
CONDENSED CONSOLIDATING BALANCE SHEET
  
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
 
 
Current assets
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (including restricted cash of $0 and $6, respectively)
$
56
 
 
$
 
 
$
 
 
$
130
 
 
$
 
 
$
186
 
Short-term investments
 
 
 
 
 
 
6
 
 
 
 
6
 
Accounts receivable, net
135
 
 
 
 
 
 
412
 
 
 
 
547
 
Inventories:
 
 
 
 
 
 
 
 
 
 
 
Finished and in-process goods
135
 
 
 
 
 
 
144
 
 
 
 
279
 
Raw materials and supplies
43
 
 
 
 
 
 
74
 
 
 
 
117
 
Other current assets
32
 
 
 
 
 
 
48
 
 
 
 
80
 
Discontinued operations
39
 
 
 
 
 
 
141
 
 
 
 
180
 
Total current assets
440
 
 
 
 
 
 
955
 
 
 
 
1,395
 
Other assets
 
 
 
 
 
 
 
 
 
 
 
Other assets
6
 
 
41
 
 
30
 
 
73
 
 
3
 
 
153
 
Property and equipment, net
518
 
 
 
 
 
 
770
 
 
 
 
1,288
 
Goodwill
93
 
 
 
 
 
 
76
 
 
 
 
169
 
Other intangible assets, net
62
 
 
 
 
 
 
70
 
 
 
 
132
 
Total assets
$
1,119
 
 
$
41
 
 
$
30
 
 
$
1,944
 
 
$
3
 
 
$
3,137
 
Liabilities and (Deficit) Equity
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
 
 
 
 
 
 
 
 
 
 
 
Accounts and drafts payable
$
153
 
 
$
 
 
$
 
 
$
277
 
 
$
 
 
$
430
 
Intercompany accounts (receivable) payable
(140
)
 
(46
)
 
 
 
186
 
 
 
 
 
Debt payable within one year
25
 
 
 
 
 
 
57
 
 
 
 
82
 
Intercompany loans (receivable) payable
(97
)
 
 
 
 
 
97
 
 
 
 
 
Loans payable to affiliates
2
 
 
 
 
 
 
 
 
 
 
2
 
Interest payable
21
 
 
46
 
 
 
 
2
 
 
 
 
69
 
Income taxes payable
7
 
 
 
 
 
 
17
 
 
 
 
24
 
Accrued payroll and incentive compensation
29
 
 
 
 
 
 
37
 
 
 
 
66
 
Other current liabilities
92
 
 
 
 
 
 
60
 
 
 
 
152
 
Discontinued operations
18
 
 
 
 
 
 
22