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2: EX-10.1 2018 Incentive Compensation Plan HTML 40K
3: EX-10.2 Deer Park Site Servces, Utilities, Materials and HTML 244K
Facilities Agreement
4: EX-10.3 Moerdijk Vad Site Services, Utilities, Materials HTML 258K
and Facilities Agreement
5: EX-10.4 Pernis Vad Site Services, Utilities, Materials and HTML 269K
Facilities Agreement
6: EX-10.5 Pernis Beri Site Services, Utilities, Materials HTML 271K
and Facilities Agreement
7: EX-10.6 Assignment and Assumption of Deer Park Ground HTML 35K
Lease and Extension
8: EX-10.7 Assignment and Extension of Amended and Restated HTML 37K
Agreement of Pernis Sublease
9: EX-10.8 First Amended and Restated Moerdijk Agreement of HTML 71K
Lease
10: EX-10.9 Extension of Amended and Restated Agreement of HTML 31K
Moerdijk Lease
11: EX-31.1(A) Section 302 CEO Certification HTML 29K
12: EX-31.1(B) Section 302 CFO Certification HTML 29K
13: EX-32.1 Section 906 CEO & CFO Certification HTML 25K
20: R1 Document and Entity Information Document HTML 41K
21: R2 Condensed Consolidated Balance Sheets HTML 146K
22: R3 Condensed Consolidated Balance Sheets HTML 42K
(Parentheticals)
23: R4 Condensed Consolidated Statements of Operations HTML 61K
24: R5 Condensed Consolidated Statements of Comprehensive HTML 34K
Income
25: R6 Condensed Consolidated Statements of Cash Flows HTML 110K
26: R7 Condensed Consolidated Statement of Equity HTML 35K
(Deficit)
27: R8 Background and Basis of Presentation HTML 28K
28: R9 Significant Accounting Policies HTML 124K
29: R10 Restructuring (Notes) HTML 51K
30: R11 Related Party Transactions HTML 77K
31: R12 Fair Value HTML 52K
32: R13 Debt Obligations HTML 78K
33: R14 Commitments and Contingencies HTML 72K
34: R15 Pension and Postretirement Expense HTML 59K
35: R16 Disposition (Notes) HTML 26K
36: R17 Segment Information HTML 91K
37: R18 Changes in Accumulated Other Comprehensive Income HTML 44K
Level 1 (Notes)
38: R19 Income Taxes (Notes) HTML 30K
39: R20 Guarantor Non-Guarantor Subsidiary Financial HTML 577K
Information
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41: R22 Significant Accounting Policies Level 3 (Tables) HTML 114K
42: R23 Restructuring (Tables) HTML 48K
43: R24 Related Party Transactions Level 3 (Tables) HTML 70K
44: R25 Fair Value Level 3 (Tables) HTML 45K
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47: R28 Pension and Postretirement Expense Level 3 HTML 59K
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49: R30 Changes in Accumulated Other Comprehensive Income HTML 44K
Level 3 (Tables)
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Information Level 3 (Tables)
51: R32 Background and Basis of Presentation Level 4 HTML 23K
(Details) - Number of Reportable Segments
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53: R34 Restructuring Restructuring and Cost Reduction HTML 44K
Programs (Details)
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related to contract termination costs and ARO
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55: R36 Related Party Transactions Level 4 (Details) HTML 69K
56: R37 Fair Value Level 4 (Details) - Fair Value of Debt HTML 35K
57: R38 Debt Obligations Level 4 (Details) HTML 77K
58: R39 Commitments and Contingencies Level 4 (Details) - HTML 68K
Environmental Liabilities
59: R40 Commitments and Contingencies Level 4 (Details) - HTML 27K
Non-Environmental Liabilities
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(Details) - Components of net pension and
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62: R43 Segment Information Level 4 (Details) - Revenues HTML 45K
by Segment
63: R44 Segment Information Level 4 (Details) - EBITDA by HTML 30K
Segment
64: R45 Segment Information Level 4 (Details) - HTML 58K
Reconciliation of Segment EBITDA to Net Income
65: R46 Changes in Accumulated Other Comprehensive Income HTML 42K
Level 4 (Details) - Summary of Changes in
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66: R47 Income Taxes (Details) HTML 28K
67: R48 Guarantor Non-Guarantor Subsidiary Financial HTML 34K
Information Level 4 (Details) - Additional
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68: R49 Guarantor Non-Guarantor Subsidiary Financial HTML 208K
Information Level 4 (Details) - Consolidating
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69: R50 Guarantor Non-Guarantor Subsidiary Financial HTML 97K
Information Level 4 (Details) - Consolidating
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(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
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 x 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”, and
“emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
o
Non-accelerated
filer
x
(Do not check if a smaller reporting company)
Smaller reporting company
o
Emerging
growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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, 2018: 82,556,847
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(In millions, except share data)
1. Background and Basis of Presentation
Based in Columbus, Ohio, Hexion Inc. (“Hexion” or the “Company”) serves global industrial markets through a broad range of thermoset technologies, specialty products and technical
support for customers in a diverse range of applications and industries. The Company’s business is organized based on the products offered and the markets served. At March 31, 2018, the Company had three reportable segments: Epoxy, Phenolic and Coating Resins; Forest Products Resins; and Corporate and Other.
The Company’s direct parent is Hexion LLC, a holding company and wholly owned subsidiary of Hexion Holdings LLC (“Hexion Holdings”), the ultimate parent entity of Hexion. Hexion Holdings is controlled by investment funds
managed by affiliates of Apollo Management Holdings, L.P. (together with Apollo Global Management, LLC and its subsidiaries, “Apollo”).
The unaudited Condensed Consolidated Financial Statements include the accounts of the Company and its majority-owned subsidiaries in which minority shareholders hold no substantive participating rights. Intercompany accounts and transactions are eliminated in consolidation. In the opinion of management, all adjustments consisting of normal, recurring adjustments considered necessary for a fair statement have been included. Results for the interim periods are not necessarily indicative of results for the entire year.
Year-end
condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”).
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 U.S. GAAP have been condensed or omitted. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated 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
Revenue Recognition—The Company follows the principles-based five step model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. Revenue, net of estimated allowances and returns, is recognized when the Company has completed its performance obligations under a contract and control of the product is transferred to the customer. Substantially all revenue is recognized at the time shipment is made or upon delivery as risk and title to the product transfer to the
customer. Sales, value add, and other taxes that are collected concurrently with revenue-producing activities are excluded from revenue. Contract terms for certain transactions, including sales made on a consignment basis, result in the transfer of control of the finished product to the customer prior to the point at which the Company has the right to invoice for the product. In these cases, timing of revenue recognition will differ from the timing of invoicing to customers and will result in the Company recording a contract asset. At March 31,
2018, a contract asset balance of $12 is recorded within “Other current assets” with an offsetting decrease of $10 recorded within “Finished and in-process goods” in the unaudited Condensed Consolidated Balance Sheet. Refer to Note 10 for additional discussion of the Company’s net sales by reportable segment disaggregated by geographic region.
Shipping and Handling—Freight costs that are billed to customers are included in “Net sales” in the unaudited Condensed Consolidated Statements of Operations. Shipping costs are incurred to move the
Company’s products from production and storage facilities to the customer. Handling costs are incurred from the point the product is removed from inventory until it is provided to the shipper and generally include costs to store, move and prepare the products for shipment. Revenue from shipping and handling services is recognized when control of the product is transferred to the customer. Shipping and handling costs are recorded in “Cost of sales” in the unaudited Condensed Consolidated Statements of Operations.
Use of Estimates—The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and also requires the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, it requires management to make estimates and assumptions that
affect 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, 2018 through the date of issuance of its unaudited Condensed Consolidated Financial Statements.
Cash and Cash Equivalents— The Company considers all highly liquid investments that are purchased with an original maturity of three months or less to be cash equivalents. The Company’s
restricted cash balances of $18 as of March 31, 2018 and December 31, 2017 represent deposits to secure certain bank guarantees issued to third parties to guarantee potential obligations of the Company primarily related to the completion of tax audits and environmental liabilities. These balances will remain restricted as long as the underlying exposures exist and are included in the Consolidated Balance Sheets as a component of “Cash and cash equivalents.” Following the adoption of ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, the Company
includes restricted cash in the cash and cash equivalents balance of the Condensed Consolidated Statements of Cash Flows.
The following table includes the restricted cash changes as a result of the adoption of ASU 2016-18 in the unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017, respectively:
Unaudited
Condensed Consolidated Statements of Cash Flows for the three months ended:
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Board Update No. 2014-09: Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the existing revenue recognition guidance and most industry-specific guidance applicable to revenue recognition. According to the new guidance, an entity will apply a principles-based five step model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. The effective date for ASU
2014-09 is for annual and interim periods beginning on or after December 15, 2017.
The Company adopted ASU 2014-09 as of January 1, 2018 utilizing a modified retrospective approach, which resulted in a cumulative adjustment to “Accumulated deficit” of $1 on the date of adoption. ASU 2014-09 was applied to all open contracts as of the date of adoption and resulted only in timing difference for recognition of certain revenue items. The cumulative effects of the changes made to the Company’s unaudited Condensed Consolidated
Balance Sheet on January 1, 2018 for the adoption of ASU 2014-09 were as follows:
In accordance with the new revenue standard requirements, the impact of adoption on the Company’s unaudited Condensed Consolidated Statements of Operations and unaudited Condensed Consolidated Balance Sheets
were as follows:
In August 2016,
the FASB issued Accounting Standards Board Update No. 2016-15: Statement of Cash Flows (Topic 230) (“ASU 2016-15”) as part of the FASB simplification initiative. ASU 2016-15 provides guidance on treatment in the statement of cash flows for eight specific cash flow topics, with the objective of reducing existing diversity in practice. Of the eight cash flow topics addressed in the new guidance, the topics expected to have an impact on the Company include debt prepayment or debt extinguishment costs, accounts receivable factoring, proceeds from the settlement of insurance claims and distributions received from equity method investees. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. The
Company adopted ASU 2016-15 as of January 1, 2018 and adoption of this standard had an immaterial impact on the Company’s financial statements.
In November 2016, the FASB issued Accounting Standards Board Update No. 2016-18: Statement of Cash Flows (Topic 230) Restricted Cash (“ASU 2016-18”) as part of the FASB simplification initiative. ASU 2016-18 requires that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of period total amounts shown on the statement of cash flows. ASU 2016-18 also requires supplemental disclosure regarding the nature of restrictions on a company’s cash and cash equivalents, such as
the purpose and terms of the restriction, expected duration of the restriction and the amount of cash subject to restriction. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. The Company adopted ASU 2016-18 as of January 1, 2018. As a result of adopting ASU 2016-18, the beginning and ending cash balances within the unaudited Condensed Consolidated Statements of Cash Flows now include restricted cash as of March 31, 2018 and 2017. The impact of the adoption of this standard on the
Company’s unaudited Condensed Consolidated Statements of Cash Flows is disclosed above in the cash and cash equivalents section of this footnote.
In January 2017, the FASB issued Accounting Standards Board Update No. 2017-01: Clarifying the Definition of a Business (Topic 805) (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. The
Company adopted ASU 2017-01 as of January 1, 2018 and the adoption of this standard had no impact on the Company’s financial statements.
In March 2017, the FASB issued Accounting Standards Board Update No. 2017-07: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”). ASU 2017-07 requires that an employer report the service cost component of its net periodic pension and postretirement benefit costs (“net benefit cost”) in the same line item or items as other compensation costs arising from services rendered by employees during the period. Additionally, ASU 2017-07 only allows the service cost component of net benefit cost to be eligible for capitalization into inventory.
All other components of net benefit cost, which primarily include interest cost, expected return on assets and the annual mark-to-market liability remeasurement, are required to be presented in the income statement separately from the service cost component and outside of income from operations. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. The Company adopted ASU 2017-07 as of January 1, 2018. The components of the net (benefit) cost are shown in Note 8.
The impact of these pension and OPEB accounting policy changes were applied through retrospective adoption of the new ASU 2017-07 to all periods presented. Accordingly, all relevant information for the
three months ended March 31, 2018 and all prior periods has been adjusted to reflect the application of the changes. The effects of the changes to the unaudited Condensed Consolidated Statements of Operations are as follows:
Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2017:
Previous
Accounting Method
Effect of Accounting Change
As Reported
Selling, general and administrative expense
77
2
79
Operating
income
55
(2
)
53
Other non-operating (income) expense, net
4
(2
)
2
Newly
Issued Accounting Standards
In February 2016, the FASB issued Accounting Standards Board Update No. 2016-02: Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 supersedes the existing lease guidance in Topic 840. According to the new guidance, all leases, with limited scope exceptions, will be recorded on the balance sheet in the form of a liability to make lease payments (lease liability) and a right-of-use asset representing the right to use the underlying asset for the lease term. The guidance is effective for annual and interim periods beginning on or after December 15, 2018, and early adoption is permitted. The Company is currently assessing the potential impact of this standard on its financial statements through a formalized implementation
project and is in process of implementing a software solution to facilitate the development of reporting and disclosure processes and controls around leases to meet the new accounting and disclosure requirements upon adoption in January 2019.
In February 2018, the FASB issued Accounting Standards Board Update No. 2018-02: Income Statement-Reporting Comprehensive Income (Topic 220) (“ASU 2018-02”). ASU 2018-02 was issued in response to the United States tax reform legislation, the Tax Cuts and Jobs Act (“Tax Reform”), enacted in December 2017. The amendments in ASU 2018-02 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the new tax legislation. The guidance is effective for annual and interim periods beginning on or after December 15,
2018, and early adoption is permitted. The Company is currently assessing the potential impact of ASU 2018-02 on its financial statements.
In November 2017, the
Company initiated new restructuring actions with the intent to optimize its cost structure. The total one-time cash costs expected to be incurred for these restructuring activities are estimated at $26, consisting primarily of workforce reduction costs.
The following table summarizes restructuring information by reporting segment:
Epoxy,
Phenolic and Coating Resins
Forest Products Resins
Corporate and Other
Total
Total restructuring costs expected to be incurred
$
16
$
6
$
4
$
26
Total
restructuring costs incurred through March 31, 2018
During
the first quarter of 2018, the Company indefinitely idled an oilfield manufacturing facility within its Epoxy, Phenolic and Coating Resins segment, and production was shifted to another facility within the oilfield manufacturing group. This represented a triggering event resulting in an impairment evaluation of the fixed and intangible assets within the U.S. oilfield asset group. As a result, an asset impairment of $20 was recorded during the three months ended March 31, 2018 related to the fixed assets at the idled manufacturing facility. In addition, the remaining U.S. oilfield asset group was evaluated for impairment utilizing a discounted cash flow approach, resulting in an additional impairment of $5
that was recorded during the three months ended March 31, 2018 related to an existing customer relationship intangible asset. Overall, the Company incurred $25 of total impairment related to these assets, which is included in “Asset impairments” in the unaudited Condensed Consolidated Statements of Operations.
4. Related Party Transactions
Administrative Service, Management and Consulting Arrangement
The Company is subject to
a Management Consulting Agreement with Apollo (the “Management Consulting Agreement”) that renews on an annual basis, unless notice to the contrary is given by either party. Under the Management Consulting Agreement, 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 waive charges of any portion of the annual management fee due in excess of $3
for the calendar year 2018 and 2017.
During the three months ended March 31, 2018 and 2017, the Company recognized expense under the Management Consulting Agreement of $1. This amount is included in “Other operating expense (income), net” in the unaudited Condensed Consolidated Statements of Operations.
Transactions with MPM
Shared Services Agreement
On October
1, 2010, the Company entered into a shared services agreement with Momentive Performance Materials Inc. (“MPM”) (which, from October 1, 2010 through October 24, 2014, was a subsidiary of Hexion Holdings), as amended in October 2014 (the “Shared Services Agreement”). Under this agreement, the Company provides to MPM, and MPM provides to the Company, certain services, including, but not limited to, executive and senior management, administrative support, human resources, information technology support, accounting, finance, legal and procurement services. The Shared Services Agreement establishes certain criteria
upon which the costs of such services are allocated between the Company and MPM. The Shared Services Agreement was renewed for one year starting October 2017 and is subject to termination by either the Company or MPM, without cause, on not less than 30 days’ written notice, and expires in October 2018 (subject to one-year renewals every year thereafter; absent contrary notice from either party). The Company periodically reviews the scope of services provided under this agreement.
(1) Included in the net costs incurred during
the three months ended March 31, 2018 and 2017, were net billings from Hexion to MPM of $3 and $9, respectively, to bring the percentage of total net incurred costs for shared services under the Shared Services Agreement to the applicable agreed upon allocation percentage.
Sales and Purchases of Products with MPM
The Company also sells products to, and purchases products from, MPM and earned revenue from MPM as compensation for acting as distributor
of their products. Refer to the below table for the summary of the sales and purchases of products with MPM:
Purchases
and Sales of Products and Services with Apollo Affiliates Other than MPM
The Company sells products to various Apollo affiliates other than MPM. Refer to the below table for the summary of the sales of products with Apollo Affiliates Other than MPM:
The
Company sells products and provides services to, and purchases products from, its joint ventures which are recorded under the equity method of accounting. Refer to the below table for a summary of the sales and purchases with the Company and its joint ventures which are recorded under the equity method of accounting:
In addition to the accounts receivable from joint ventures disclosed above, the Company had a loan receivable of $7 and $6 as of March 31, 2018 and December 31, 2017, respectively, from its unconsolidated forest products joint venture in Russia.
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. 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 that are supported by little or no market activity and are developed based on the best information available in the circumstances. For example, inputs derived
through extrapolation or interpolation that cannot be corroborated by observable market data.
Recurring Fair Value Measurements
As of March 31, 2018, the Company had derivative liabilities related to electricity, natural gas and foreign exchange contracts of less than $1, which were measured using level 2 inputs, and consisted of derivative instruments transacted primarily in over-the-counter markets. There were no transfers between Level 1, Level 2 or Level 3 measurements during the three months ended March 31,
2018 or 2017.
The Company calculates the fair value of its Level 2 derivative liabilities using 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 both March 31, 2018 and December 31, 2017, no adjustment was made by the Company to reduce its derivative
position for nonperformance risk.
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.
Non-derivative Financial Instruments
The following table summarizes the carrying amount and fair value of the Company’s non-derivative financial instruments:
Debt
carrying amounts exclude unamortized deferred debt issuance costs of $39 and $41 at March 31, 2018 and December 31, 2017, respectively.
Fair values of debt classified as Level 2 are determined 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. Level 3 amounts represent capital leases whose fair value is determined through the use of present value and specific contract
terms. The carrying amount and fair value of the Company’s debt is exclusive of unamortized deferred financing fees. The carrying amounts of cash and cash equivalents, short term investments, accounts receivable, accounts payable and other accrued liabilities are considered reasonable estimates of their fair values due to the short-term maturity of these financial instruments.
6.625% First-Priority Senior Secured Notes due 2020 (includes $2 of unamortized debt premium)
1,552
—
1,552
—
10.00%
First-Priority Senior Secured Notes due 2020
315
—
315
—
10.375% First-Priority
Senior Secured Notes due 2022
560
—
560
—
13.75% Senior Secured Notes due
2022
225
—
225
—
9.00% Second-Priority Senior Secured Notes due 2020
574
—
574
—
Debentures:
9.2%
debentures due 2021
74
—
74
—
7.875% debentures due 2023
189
—
189
—
Other
Borrowings:
Australia Facility due 2021 (1)
36
4
—
50
Brazilian
bank loans
12
35
9
34
Lease obligations
42
6
44
5
Other
3
21
2
36
Unamortized
debt issuance costs
(39
)
—
(41
)
—
Total
$
3,703
$
66
$
3,584
$
125
(1)
In February 2018, the Company extended its Australian Term Loan Facility through January 2021.
The Company has $1.9 billion of First Priority Senior Secured Notes maturing in April 2020 and $0.6 billion of Second Priority Notes maturing in November 2020. Additionally, if 91 days prior to the scheduled maturity of these notes, more than $50 aggregate principal amount of the maturing notes is outstanding, the ABL Facility, which matures in December 2021, will accelerate and become immediately due and payable.
The
Company regularly reviews its portfolio and is currently exploring potential divestitures. While there is no guarantee of a transaction, it could include a specific business unit or combination of several businesses. The Company expects that the proceeds from a transaction or transactions upon completion would be used to help reduce the absolute amount of the Company’s debt.
Further, depending upon market, pricing and other conditions, including the current state of the high yield bond market, as well as cash balances and available liquidity, the Company or its affiliates, may seek to acquire notes or other indebtedness of the
Company through open market purchases, privately negotiated transactions, tender offers, redemption or otherwise, upon such terms and at such prices as the Company or its affiliates may determine (or as may be provided for in the indentures governing the notes), for cash or other consideration.
7. 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.
Environmental Institution of Paraná IAP—On August 10, 2005, the Environmental Institute of Paraná (IAP), an environmental agency in the State of Paraná, provided Hexion Quimica Industria, the
Company’s Brazilian subsidiary, with notice of an environmental assessment in the amount of 12 Brazilian reals. The assessment related to alleged environmental damages to the Paranagua Bay caused in November 2004 from an explosion on a shipping vessel carrying methanol purchased by the Company. The investigations performed by the public authorities have not identified any actions of the Company that contributed to or caused the accident. In September 2017, after a series of legal proceedings, the State of Paraná Court of Appeals decided that IAP did not prove that the Company was negligent and granted the Company’s request to annul the environmental
assessment. IAP filed a motion for clarification regarding the Court of Appeals’ analysis of the case and the Company filed a motion for clarification regarding attorney fees. After the pending motions are resolved, IAP will have 15 business days to file an appeal with the Superior Court of Justice. The Company believes the potential loss related to this matter is now remote.
The following table summarizes all probable environmental remediation, indemnification and restoration liabilities,
including related legal expenses, at March 31, 2018 and December 31, 2017:
Superfund
and offsite landfills – allocated share:
Less than 1%
2
2
1
4
Equal
to or greater than 1%
6
6
5
14
Currently-owned
4
4
3
9
Formerly-owned:
Remediation
24
26
21
39
Monitoring
only
—
—
—
1
Total
$
49
$
52
$
39
$
89
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, 2018 and December 31, 2017, $8 and $11,
respectively, have 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, 2018:
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 tasks related to 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 21 years. The range of possible outcomes is discounted in a similar manner. The undiscounted liability, which is expected to be paid over the next 21 years, is approximately $18.
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 ten 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 factors influencing the ultimate outcome include the methods of remediation elected, the conclusions and assessment of site studies remaining to be completed, and the time period required to complete the work. No other parties are responsible for remediation at these sites.
Formerly-Owned Sites—The Company is conducting, or has been identified as a PRP in connection with, environmental remediation at a number of locations that it formerly owned and/or operated.
Remediation costs at these former sites, such as those associated with our former phosphate mining and processing operations, could be material. The Company has accrued those costs for formerly-owned sites which are currently probable and reasonably estimable. One such site is the Coronet Industries, Inc. Superfund Alternative Site in Plant City, Florida. The current owner of the site alleged that it incurred environmental costs at the site for which it has a contribution claim against the Company, and that additional future costs are likely to be incurred. The Company signed a settlement agreement with the current owner and past owner of the site, which provides the
Company will pay $10 over three annual installments in fulfillment of the contribution claim against the Company for past remediation costs. The Company timely paid all three annual installments. Additionally, the Company accepted a 40% allocable share of specified future remediation costs at this site. The Company estimates its allocable share of future remediation costs to be approximately $15. The final costs to the Company will depend on the method of remediation
chosen, the amount of time necessary to accomplish remediation and the ongoing financial viability of the other PRPs. Currently, the Company has insufficient information to estimate the range of reasonably possible costs related to this site.
Monitoring Only Sites—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 or more 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 had reserves of $2 and $3 at March 31, 2018 and December 31, 2017, respectively, for all non-environmental legal defense costs incurred and settlement costs that it believes are probable and estimable. At March 31, 2018
and December 31, 2017, $2 has been included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets, with the remaining amount included in “Other long-term liabilities.”
Other Legal Matters—The Company is also involved in various product liability, commercial and employment litigation, personal injury, property damage and other legal proceedings, including actions that allege harm caused by products the Company has allegedly made or used, containing silica, vinyl chloride monomer and asbestos. The
Company believes it has adequate reserves and that it is not reasonably possible that a loss exceeding amounts already reserved would be material. Furthermore, the Company has insurance to cover claims of these types.
8. Pension and Postretirement Benefit Plans
As a result of the adoption of ASU 2017-07, the Company’s service cost component of net benefit cost is included in “Operating income” and all other components of net benefit cost are included in “Other non-operating (income) expense, net” within the Company’s unaudited
Condensed Consolidated Statements of Operations. Following are the components of net benefit cost recognized by the Company for the three months ended March 31, 2018 and 2017:
On January 8, 2018, the Company completed the sale of its Additives Technology Group business (“ATG”) to MÜNZING CHEMIE GmbH, a privately-owned specialty additive company headquartered in Abstatt, Germany. ATG was previously included within the Company’s Forest Products Resins segment and includes manufacturing sites located in Somersby, Australia and Sungai Petani, Malaysia. The ATG business produces a range of specialty chemical materials for the engineered wood, paper impregnation and laminating industries, including catalysts, release agents and wetting agents.
The
Company received gross cash consideration for the ATG business in the amount of $49, which was used for general corporate purposes. The Company recorded a gain on this disposition of $44 which is included in “Gain on disposition” in the unaudited Condensed Consolidated Statements of Operations.
The
Company’s business segments are based on the products that the Company offers and the markets that it serves. In the fourth quarter of 2017, the Company added Corporate and Other as a reportable segment. At March 31, 2018, the Company had three reportable segments: Epoxy, Phenolic and Coating Resins; Forest Products Resins; and Corporate and Other. A summary of the major products of the Company’s reportable segments follows:
•
Epoxy,
Phenolic and Coating Resins: epoxy specialty resins, phenolic encapsulated substrates, versatic acids and derivatives, basic epoxy resins and intermediates and phenolic specialty resins and molding compounds
•
Forest Products Resins: forest products resins and formaldehyde applications
•
Corporate and Other: primarily corporate general and administrative
expenses that are not allocated to the other segments, such as shared service and administrative functions, foreign exchange gains and losses and legacy company costs.
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 for certain non-cash items and other income and 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.
Net Sales (1):
Following is revenue by reportable segment. Product sales within each reportable segment share economically similar risks. These risks include general economic and industrial conditions, competitive pricing pressures and the Company’s ability to pass on fluctuations in raw material prices to its customers. A substantial number of the Company’s
raw material inputs are petroleum-based and their prices fluctuate with the price of oil. Due to differing regional industrial and economic conditions, the geographic distribution of revenue may impact the amount, timing and uncertainty of revenue and cash flows from contracts with customers.
Following is net sales by reportable segment disaggregated by geographic region:
Realized and unrealized foreign currency losses (gains)
7
(1
)
Loss on extinguishment of debt
—
3
Other
13
9
Total
adjustments
10
18
Segment EBITDA
$
118
$
95
Segment
EBITDA:
Epoxy, Phenolic and Coating Resins
$
70
$
52
Forest
Products Resins
67
61
Corporate and Other
(19
)
(18
)
Total
$
118
$
95
Items
Not Included in Segment EBITDA
Not included in Segment EBITDA are certain non-cash items and other income and expenses. For the three months ended March 31, 2018 and 2017, these items primarily include expenses from retention programs and certain professional fees related to strategic projects. Business realignment costs for the three months ended March 31, 2018 and 2017 primarily include costs related to certain in-process facility rationalizations and cost reduction programs.
11. Changes in
Accumulated Other Comprehensive Income (Loss)
Following is a summary of changes in “Accumulated other comprehensive income (loss)” for the three months ended March 31, 2018 and 2017:
On December 22, 2017, the United States enacted tax reform legislation (“Tax Reform”) that included a broad range of business tax provisions, including but not limited to a reduction in the U.S. federal tax rate from 35% to 21% as well as provisions that limit or eliminate various deductions or credits. The legislation also causes U.S. expenses, such as interest and general administrative expenses, to be taxed and imposes a new tax on U.S. cross-border payments.
The 2017 provision for income taxes included a provisional one-time charge of $65 for the transition tax on accumulated foreign earnings and profits, which resulted in an associated one-time reduction of an estimated $185 in the Company’s net operating loss carryforward. The 2017 provisional amounts for transition tax and related reduction to the Company’s net operating loss carryforward remain unchanged as of March 31, 2018.
In response to the enactment of U.S. tax reform, the SEC issued guidance (referred to as “SAB 118”) to address the complexity in accounting
for this new legislation. When the initial accounting for items under the new legislation is incomplete, the guidance allows companies to recognize provisional amounts when reasonable estimates can be made or to continue to apply the prior tax law if a reasonable estimate of the impact cannot be made. The SEC has provided up to a one-year window for companies to finalize the accounting for the impacts of this new legislation and the Company anticipates finalizing its accounting during 2018.
The Company's accounting for the above items is based upon reasonable estimates of the tax effects of Tax Reform; however, its estimates may change upon the finalization of its implementation and additional interpretive guidance from regulatory authorities. We continue the
process of gathering and analyzing additional information with respect to our earnings and profits to more precisely compute the amount of the one-time transition tax. The Company will complete its accounting for the above tax effects of Tax Reform during 2018 as provided in SAB 118 and will reflect any adjustments to its provisional amounts as an adjustment to the provision for taxes in the reporting period in which the amounts are finally determined.
Additionally, certain provisions of Tax Reform are not effective until 2018. The Company continues to evaluate the impact of these provisions and has recorded a net zero impact in the financial statements due to U.S.’ valuation allowance. The
Company has not made any accounting policy elections with respect to these items.
The effective tax rate was (133)% and (23)% for the three months ended March 31, 2018 and 2017, respectively. The change in the effective tax rate was primarily attributable to the amount and distribution of income and losses among the various jurisdictions in which we operate. The effective tax rates were also impacted by operating gains and losses generated in jurisdictions where no tax expense or benefit was recognized due to the maintenance of a full valuation allowance.
For
the three months ended March 31, 2018 and 2017, income tax expense relates primarily to income from certain foreign operations. In 2018, losses in the United States and certain foreign jurisdictions had no impact on income tax expense as no tax benefit was recognized due to the maintenance of a full valuation allowance.
13. Guarantor/Non-Guarantor Subsidiary Financial Information
The
Company’s 6.625% First-Priority Senior Secured Notes due 2020, 10.00% First-Priority Senior Secured Notes due 2020, 10.375% First Priority Senior Secured Notes due 2022, 13.75% Senior Secured Notes due 2022 and 9.00% Second-Priority Senior Secured Notes due 2020 are guaranteed by certain of its U.S. subsidiaries.
The following information contains the condensed consolidating financial information for Hexion Inc. (the parent), the combined subsidiary guarantors (Hexion Investments Inc.; Lawter International, Inc.; HSC Capital Corporation (dissolved in April 2017); Hexion International Inc.; Hexion CI Holding Company (China) LLC; NL COOP Holdings LLC and Oilfield Technology Group, Inc. (dissolved in September 2017)) and the combined non-guarantor subsidiaries,
which includes all of the Company’s foreign subsidiaries.
All of the subsidiary guarantors are 100% owned by Hexion Inc. 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.
These financial statements are prepared on the same basis as the consolidated financial statements of the Company except that investments in subsidiaries are accounted for using the equity method for purposes of the consolidating presentation. The principal elimination entries relate to investments in subsidiaries
and intercompany balances and transactions.
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.
Return
of capital from subsidiary from sales of accounts receivable
73
(a)
—
—
(73
)
—
89
—
9
(73
)
25
Cash
flows (used in) provided by financing activities
Net short-term debt borrowings
(3
)
—
(12
)
—
(15
)
Borrowings
of long-term debt
50
—
116
—
166
Repayments
of long-term debt
(58
)
—
(38
)
—
(96
)
Net
intercompany loan (repayments) borrowings
(23
)
—
23
—
—
Long-term
debt and credit facility financing fees paid
—
—
(1
)
—
(1
)
Return
of capital to parent from sales of accounts receivable
—
—
(73
)
(a)
73
—
(34
)
—
15
73
54
Effect
of exchange rates on cash and cash equivalents
—
—
2
—
2
Change
in cash and cash equivalents
6
—
(8
)
—
(2
)
Cash
and cash equivalents at beginning of period
13
—
102
—
115
Cash
and cash equivalents at end of period
$
19
$
—
$
94
$
—
$
113
(a)
During
the three months ended March 31, 2018, Hexion Inc. contributed receivables of $73 to a non-guarantor subsidiary as capital contributions, resulting in a non-cash transaction. During the three months ended March 31, 2018, the non-guarantor subsidiary sold the contributed receivables to certain banks under various supplier financing agreements. The cash proceeds were returned to Hexion Inc. by the non-guarantor subsidiary as a return of capital. The sale of receivables has been included within cash flows from operating activities on the Combined non-guarantor subsidiaries. The return of the cash proceeds from the sale of receivables has been
included as a financing outflow and an investing inflow on the Combined Non-Guarantor Subsidiaries and Hexion Inc., respectively.
Cash
flows provided by (used in) investing activities
Capital expenditures
(13
)
—
(17
)
—
(30
)
Proceeds
from sale of assets, net
4
—
—
—
4
Return
of capital from subsidiary from sales of accounts receivable
33
(a)
—
—
(33
)
—
24
—
(17
)
(33
)
(26
)
Cash
flows provided by (used in) financing activities
Net short-term debt (repayments) borrowings
(3
)
—
14
—
11
Borrowings
of long-term debt
770
—
101
—
871
Repayments
of long-term debt
(742
)
—
(49
)
—
(791
)
Net
intercompany loan borrowings (repayments)
46
—
(46
)
—
—
Long-term
debt and credit facility financing fees
(18
)
—
(4
)
—
(22
)
Return
of capital to parent from sales of accounts receivable
—
—
(33
)
(a)
33
—
53
—
(17
)
33
69
Effect
of exchange rates on cash and cash equivalents
—
—
2
—
2
Change
in cash and cash equivalents
(16
)
—
(57
)
—
(73
)
Cash
and cash equivalents at beginning of period
28
—
168
—
196
Cash
and cash equivalents at end of period
$
12
$
—
$
111
$
—
$
123
(a)
During
the three months ended March 31, 2017, Hexion Inc. contributed receivables of $33 to a non-guarantor subsidiary as capital contributions, resulting in a non-cash transaction. During the three months ended March 31, 2017, the non-guarantor subsidiary sold the contributed receivables to certain banks under various supplier financing agreements. The cash proceeds were returned to Hexion Inc. by the non-guarantor subsidiary as a return of capital. The sale of receivables has been included within cash flows from operating activities on the Combined non-guarantor subsidiaries. The return of the cash proceeds from the sale of receivables has been
included as a financing outflow and an investing inflow on the Combined Non-Guarantor Subsidiaries and Hexion Inc., respectively.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollar amounts in millions)
The
following commentary should be read in conjunction with the audited Consolidated Financial Statements and the accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s most recent Annual Report on Form 10-K.
Within the following discussion, unless otherwise stated, “the first quarter of 2018” refers to the three months ended March 31, 2018 and “the first quarter of 2017” refers to the three months ended March 31,
2017.
Forward-Looking and Cautionary Statements
Certain statements in this report, including without limitation, certain statements made under the caption “Overview and Outlook,” are forward-looking statements within the meaning of and made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, our management may from time to time make oral forward-looking statements. All statements, other than statements of historical facts, are forward-looking statements. Forward-looking statements may be identified by the words “believe,”“expect,”“anticipate,”“project,”“plan,”“estimate,”“may,”“will,”“could,”“should,”“seek” or “intend” and similar expressions. Forward-looking statements reflect our current expectations and assumptions regarding our business, the economy and other future events and conditions and are based on currently available financial, economic and competitive data and our current business plans. Actual results could vary materially depending on risks and uncertainties that may affect our operations, markets, services, prices and other factors as discussed in the Risk Factors section of this report and our other filings with the Securities and Exchange Commission (the “SEC”). While we believe our assumptions are reasonable, we caution you against relying on any forward-looking statements as it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from those in
the forward-looking statements include, but are not limited to, a weakening of global economic and financial conditions, interruptions in the supply of or increased cost of raw materials, the loss of, or difficulties with the further realization of, cost savings in connection with our strategic initiatives, including transactions with our affiliate, Momentive Performance Materials Inc., the impact of our substantial indebtedness, our failure to comply with financial covenants under our credit facilities or other debt, pricing actions by our competitors that could affect our operating margins, changes in governmental regulations and related compliance and litigation costs and the other factors listed in the Risk Factors section of this report and in our other SEC filings. For a more detailed discussion of these and other risk factors, see the Risk Factors section of this report and our most recent filings made with the SEC. All forward-looking statements are expressly
qualified in their entirety by this cautionary notice. The forward-looking statements made by us speak only as of the date on which they are made. Factors or events that could cause our actual results to differ may emerge from time to time. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.
Overview and Outlook
Business Overview
We are a large participant in the specialty chemicals industry, and a leading producer of adhesive and structural resins and coatings. Thermosets are a critical ingredient for virtually all paints, coatings, glues and other adhesives produced for consumer or industrial uses. We provide a broad array of thermosets
and associated technologies and have significant market positions in all of the key markets that we serve.
Our products are used in thousands of applications and are sold into diverse markets, such as forest products, architectural and industrial paints, packaging, consumer products and automotive coatings, as well as higher growth markets, such as wind energy and electrical composites. Major industry sectors that we serve include industrial/marine, construction, consumer/durable goods, automotive, wind energy, aviation, electronics, architectural, civil engineering, repair/remodeling and oil and gas drilling. Key drivers for our business include general economic and industrial conditions, including housing starts, auto build rates and active oil and gas drilling rigs. In addition, due to the nature of our products and the markets we serve, competitor capacity constraints and the availability of similar products in the market
may impact our results. As is true for many industries, our financial results are impacted by the effect on our customers of economic upturns or downturns, as well as by the impact on our own costs to produce, sell and deliver our products. Our customers use most of our products in their production processes. As a result, factors that impact their industries can and have significantly affected our results.
Through our worldwide network of strategically located production facilities we serve more than 3,300 customers in approximately 90 countries. Our global customers include large companies in their respective industries, such as 3M, Akzo Nobel, BASF, Bayer, Dow, Louisiana Pacific, Monsanto, Owens Corning, PPG Industries, Valspar and Weyerhaeuser.
Our business segments are based on the products that we offer and the markets that we serve. At March 31, 2018, we had three reportable segments: Epoxy, Phenolic and Coating Resins; Forest Products Resins; and Corporate and Other. A summary of the major products of our reportable segments follows:
•
Epoxy, Phenolic and Coating Resins: epoxy specialty resins, phenolic encapsulated substrates, versatic acids and derivatives, basic epoxy resins and intermediates,
phenolic specialty resins and molding compounds
•
Forest Products Resins: forest products resins and formaldehyde applications
•
Corporate and Other: primarily corporate general and administrative expenses that are not allocated to the other segments, such as shared service and administrative functions, foreign exchange gains and losses and legacy company costs.
2018
Overview
Following are highlights from our results of operations for the three months ended March 31, 2018 and 2017:
2018
2017
$
Change
% Change
Statements of Operations:
Net sales
$
946
$
870
$
76
9
%
Gross
profit
157
133
24
18
%
Operating income
76
53
23
43
%
Loss
before income tax
(6
)
(35
)
29
83
%
Net loss
(13
)
(42
)
29
69
%
Segment
EBITDA:
Epoxy, Phenolic and Coating Resins
$
70
$
52
$
18
35
%
Forest
Products Resins
67
61
6
10
%
Corporate and Other
(19
)
(18
)
(1
)
(6
)%
Total
$
118
$
95
$
23
24
%
•
Net
Sales—Net sales in the first quarter of 2018 were $946, an increase of 9% compared with the first quarter of 2017. This increase was driven by pricing, which positively impacted sales by $62 due largely to improved market conditions in our base epoxy resins business and raw material price increases contractually passed through to customers across many of our businesses. The impact of foreign exchange translation positively impacted net sales by $46 due to the strengthening of various currencies against the U.S. dollar in the first three
months of 2018 compared to the first three months of 2017. Overall, volumes negatively impacted net sales by $28 primarily due to volume decreases in our epoxy specialty business driven by delays in the production of wind turbines in China.
•
Net Loss—Net loss in the first quarter of 2018 was $13, an improvement of 69% as compared with a net
loss of $42 in the first quarter of 2017. This improvement was primarily driven by an increase in gross profit due to margin improvements discussed above and a gain on the sale of our ATG business of $44, partially offset by asset impairments of $25 in our oilfield business.
•
Segment EBITDA—For the first quarter of 2018, Segment EBITDA was $118, an increase of 24% compared with $95 in the first quarter of 2017.
This increase was driven by increased margins in our base epoxy resins business and productivity in our North American formaldehyde and forest products resins businesses, in addition to the impact of our ongoing cost reduction initiatives. These improvements were partially offset by the volume decreases discussed above in our epoxy specialty business.
•
Restructuring and Cost Reduction Programs—In November 2017, we initiated new cost reduction programs that will be completed in the first half of 2018. We expect these programs to generate $43 of incremental annual savings once fully implemented. During the first quarter of 2018, we have achieved $13
in cost savings related to our new and ongoing productivity and cost reduction programs. With the addition of the new programs discussed above, we have a total of $39 of in-process cost savings. We have taken the majority of the actions and the impact will be realized by the end of 2018.
•
Sale of ATG Business—In January 2018, we completed the sale of our ATG business for a purchase price of $49 and recorded a gain on this disposition of $44.
•
Growth
Initiatives—We recently introduced our new Voyager mobile resin coating service within our oilfield business, a new technology offering customers efficient manufacturing of resin coated proppants in close proximity to the wellsite. Further, we continue to invest in new coatings technologies and capacity in response to recent volatile organic compounds regulation in China. We also continue to focus on new product development and have taken steps to improve our analytical and product development services for our global grid, such as the recently completed expansion of our technology center in Edmonton.
In 2018, we expect strong market demand to continue to drive volume increases in our North American formaldehyde business. Additionally, we continue to expect improved demand in our North American forest products resins business due to ongoing growth in U.S. housing starts and remodeling. We also anticipate modest overall improvement in our Latin American forest products resins business due to recovery in the Brazilian economy.
We expect results in our base epoxy business to continue to improve throughout 2018 due to improved market conditions. We expect our epoxy specialty business to benefit from significant improvements in market demand for waterborne coatings over the next few years, primarily in China. Overall, we expect demand in our epoxy specialty business to remain below historical levels, although demand is expected
to stabilize during the year due to government supported investment in the China wind energy market. Lastly, we expect our phenolic resins business to benefit from cost reductions associated with our recently completed grid optimization efforts in Europe.
We also anticipate year over year improvements across all of our businesses due to savings associated with our ongoing restructuring and cost reduction initiatives. Finally, we expect raw material prices to stabilize in 2018, following large increases in 2017.
Portfolio Optimization Initiatives
In January 2018, we completed the sale of our ATG business. We received $49 million in proceeds from the transaction, or approximately twelve times ATG’s Segment EBITDA over the last twelve months. In addition, we have initiated a process for the potential sale of a portion of our Epoxy, Phenolic
and Coatings Resins segment. Should a sale occur, we expect that proceeds will be used to reduce our debt.
Tax Reform Implications
The 2017 U.S. tax reform reduced the U.S corporate tax rate and included beneficial depreciation provisions, while other provisions could have an adverse effect on our results. Specifically, new provisions that cause U.S. expenses, such as interest and general administrative expenses, to be taxed and also imposes a tax on U.S cross-border payments that could adversely impact our effective tax rate. We continue to evaluate the impacts as additional guidance becomes available. See Note 12 in Item 1 of this Quarterly Report on Form 10-Q for more information.
Matters Impacting Comparability of Results
Raw Material Prices
Raw
materials comprise approximately 75% of our cost of sales. The three largest raw materials used in our production processes are phenol, methanol and urea. These materials represent about half of our total raw material costs. Fluctuations in energy costs, such as volatility in the price of crude oil and related petrochemical products, as well as the cost of natural gas have historically caused volatility in our raw material and utility costs. In the first three months of 2018 compared to the first three months of 2017 the average price of methanol and urea increased by approximately 10%, and 3%, respectively, and the average price of phenol decreased by approximately 3%. The impact of passing through raw material price changes to customers
can result in significant variances in sales comparisons from year to year.
Other Comprehensive Income
Our other comprehensive income is significantly impacted by foreign currency translation, and to a lesser degree by defined benefit pension and postretirement benefit adjustments. The impact of foreign currency translation is driven by the translation of assets and liabilities of our foreign subsidiaries which are denominated in functional currencies other than the U.S. dollar. The primary assets and liabilities driving the adjustments are cash and cash equivalents; accounts receivable; inventory; property, plant and equipment; accounts payable; pension and other postretirement benefit obligations and certain intercompany loans payable and receivable. The primary currencies in which these assets
and liabilities are denominated are the euro, Brazilian real, Chinese yuan, Canadian dollar and Australian dollar. The impact of defined benefit pension and postretirement benefit adjustments is primarily driven by unrecognized prior service cost related to our defined benefit and other non-pension postretirement benefit plans (“OPEB”), as well as the subsequent amortization of these amounts from accumulated other comprehensive income in periods following the initial recording of such amounts.
In the first quarter of 2018, net sales increased by $76, or 9%, compared to the first quarter of 2017. Pricing positively impacted sales by $62 due primarily to improved market conditions
in our base epoxy resins business and raw material price increases contractually passed through to customers across many of our businesses. Foreign currency translation positively impacted net sales by $46 due to an overall strengthening of various foreign currencies against the U.S. dollar in the first quarter of 2018 compared to the first quarter of 2017. Volume decreases had a negative impact on net sales of $28, which was primarily due to volume decreases in our epoxy specialty business largely driven by delays in the production of wind turbines in China.
Gross Profit
In
the first quarter of 2018, gross profit increased by $24 compared to the first quarter of 2017. Gross profit as a percentage of net sales increased by 2% due to margin expansion driven by the market conditions in our base epoxy resins business and raw material price increases discussed above, as well as our ongoing restructuring initiatives.
Operating Income
In the first quarter of 2018, operating income increased
by $23 compared to the first quarter of 2017, driven primarily by a gain on the disposition of our ATG business of $44 and the increase in gross profit of $24 discussed above. These increases were partially offset by asset impairments in our oilfield business of $25, as well an increase in other operating expense of $15, increased selling, general and administrative expense of $3 and increased business realignment costs of $2. The increase in other operating expense was driven by an increase in realized
and unrealized foreign currency losses and a reduction in gains on the sale of assets. The increase in selling, general and administrative expense was due primarily to fees related to ongoing strategic projects, partially offset by our ongoing cost savings and productivity actions. Lastly, the increase in business realignment costs is related to the idling of a manufacturing facility in our oilfield business during the first quarter of 2018.
Non-Operating Expense
In the first quarter of 2018, total non-operating expense decreased by $6 compared to the first quarter of 2017 due to losses on debt extinguishment in 2017 that did not recur in 2018
and an increase in realized and unrealized foreign currency gains.
The effective tax rate was (133)% and (23)% for the first quarter of 2018 and 2017, respectively. The change in the effective tax rate was primarily attributable to the amount and distribution of income and losses among the various jurisdictions
in which we operate. The effective tax rates were also impacted by operating gains and losses generated in jurisdictions where no tax expense or benefit was recognized due to the maintenance of a full valuation allowance.
For the first quarter of 2018 and 2017, income tax expense relates primarily to income from certain foreign operations. In 2018, losses in the United States and certain foreign jurisdictions had no impact on income tax expense as no tax benefit was recognized due to the maintenance of a full valuation allowance.
Other Comprehensive Income
For the first
quarter of 2018, foreign currency translation positively impacted other comprehensive income by $14, primarily due to an overall strengthening of various foreign currencies against the U.S. dollar in the first quarter of 2018.
For the first quarter of 2017, foreign currency translation positively impacted other comprehensive income by $6, primarily due to the strengthening of the Brazilian real against the U.S. dollar in the first quarter of 2017.
Results of Operations by Segment
Following are net sales and
Segment EBITDA (earnings before interest, income taxes, depreciation and amortization) by reportable segment. Segment EBITDA is defined as EBITDA adjusted for certain non-cash items and other income and expenses. Segment EBITDA is the primary performance measure used by our senior management, the chief operating decision-maker and the board of directors to evaluate operating results and allocate capital resources among segments. Segment EBITDA is also the profitability measure used to set management and executive incentive compensation goals. Segment EBITDA should not be considered a substitute for net loss or other results reported in accordance with U.S. GAAP. Segment EBITDA may not be comparable to similarly titled measures reported by other companies.
Following is an analysis of the percentage change in net sales by segment from the three months ended March 31, 2017 to the three months ended March 31, 2018:
Volume
Price/Mix
Currency
Translation
Impact
of Dispositions
Total
Epoxy, Phenolic and Coating Resins
(5
)%
7
%
8
%
—
%
10
%
Forest
Products Resins
(1
)%
7
%
2
%
(1
)%
7
%
Epoxy,
Phenolic and Coating Resins
Net sales in the first quarter of 2018 increased by $48, or 10%, when compared to the first quarter of 2017. Pricing positively impacted net sales by $36 due primarily to improved market conditions in our base epoxy resins business and raw material price increases contractually passed through to customers across many of our businesses. The impact of foreign exchange translation positively impacted net sales by $37, due primarily to the strengthening of the euro and Chinese yuan against the U.S. dollar in the first quarter
of 2018 compared to the first quarter of 2017. Lastly, volume negatively impacted net sales by $25, primarily due to volume decreases in our epoxy specialty business largely driven by delays in the production of wind turbines in China.
Segment EBITDA in the first quarter of 2018 increased by $18 to $70
compared to the first quarter of 2017. The increase was driven by increased margins in our base epoxy resins business, as well as increased operating efficiencies and the impact of our ongoing cost reduction initiatives, most notably in our phenolic resins business. This increase was partially offset by margin compression and the volume decrease discussed above in our epoxy specialty business.
Forest Products Resins
Net sales in the first quarter of 2018 increased by $28, or 7%, when compared to the first quarter of 2017.
Pricing positively impacted net sales by $26, which was primarily due to raw material price increases contractually passed through to customers across many of our businesses. Foreign exchange translation positively impacted net sales by $9 due to an overall strengthening of various foreign currencies against the U.S. dollar in the first quarter of 2018 compared to the first quarter of 2017. Volumes negatively impacted net sales by $3, and were primarily driven by decreases in our North American formaldehyde and forest products resins businesses due to unfavorable weather conditions in the U.S. Gulf Coast, partially offset by increased volumes
in our Latin American forest products resins business driven by ongoing recovery in the Brazilian economy. Lastly, the disposition of our ATG business in the first quarter of 2018 negatively impacted sales by $4.
Segment EBITDA in the first quarter of 2018 increased by $6, to $67, compared to the first quarter of 2017. This increase was primarily driven by productivity and ongoing cost reduction initiatives in our North American formaldehyde and forest products resins businesses.
Corporate
and Other
Corporate and Other is primarily corporate, general and administrative expenses that are not allocated to the segments, such as shared service and administrative functions, unallocated foreign exchange gains and losses and legacy company costs not allocated to the other segments. Corporate and Other charges in the first quarter of 2018 increased by $1 compared to the first quarter of 2017 due primarily to higher compensation costs and the negative impact of foreign exchange translation, largely offset by our ongoing cost savings efforts.
Realized and unrealized foreign currency losses (gains)
7
(1
)
Loss on extinguishment of debt
—
3
Other
13
9
Total
adjustments
10
18
Segment EBITDA
$
118
$
95
Segment
EBITDA:
Epoxy, Phenolic and Coating Resins
$
70
$
52
Forest Products Resins
67
61
Corporate
and Other
(19
)
(18
)
Total
$
118
$
95
Items
Not Included in Segment EBITDA
Not included in Segment EBITDA are certain non-cash items and other income and expenses. For the three months ended March 31, 2018 and 2017, these items primarily include expenses from retention programs and certain professional fees related to strategic projects. Business realignment costs for the three months ended March 31, 2018 and 2017 primarily include costs related to certain in-process facility rationalizations and cost reduction programs.
We are a highly leveraged company. Our primary sources of liquidity are cash flows generated from operations and availability under the ABL Facility. Our primary liquidity requirements are interest, working capital and capital expenditures.
At March 31, 2018, we had $3,769 of outstanding debt and $282
in liquidity consisting of the following:
•
$95 of unrestricted cash and cash equivalents (of which $76 is maintained in foreign jurisdictions);
•
$145 of borrowings available under our ABL Facility ($350 borrowing base less $160 of outstanding borrowings and $45 of outstanding letters of credit); and
•
$42
of time drafts and borrowings available under credit facilities at certain international subsidiaries
Our net working capital (defined as accounts receivable and inventories less accounts payable) at March 31, 2018 and December 31, 2017 was $482 and $373, respectively. A summary of the components of our net working capital as of March 31, 2018 and December 31, 2017
is as follows:
The
components of net working capital at December 31, 2017 exclude $6 of net working capital related to the ATG business. The assets and liabilities are classified as held for sale in the December 31, 2017 Consolidated Balance Sheet.
The increase in net working capital of $109 from December 31, 2017 was driven by increases in accounts receivable of $42 and inventory of $37 and a decrease
in accounts payable of $30. The increases were primarily the result of increased volumes in the first quarter of 2018 compared to the fourth quarter of 2017 due to market conditions and seasonality, as well as raw material price inflation and inventory build for turnarounds. The decrease in accounts payable was largely related to the timing of vendor payments. To minimize the impact of seasonal changes in net working capital on cash flows, we continue to review inventory safety stock levels, focus on accelerating receivable collections by offering incentives to customers to encourage early payment or through the sale of receivables at a discount and negotiate with vendors or enter into inventory financing arrangements to extend payment terms.
We periodically borrow from the ABL Facility to support our short-term liquidity requirements, particularly when net working capital requirements
increase in response to the seasonality of our volumes. As of March 31, 2018, there were $160 of outstanding borrowings under the ABL Facility.
Short-Term Outlook
The following factors will impact cash flows for the remainder of 2018:
•
Interest and Income Taxes: We expect cash outflows in 2018 related to interest payments on our debt of approximately $315, with
the largest components being paid in the second and fourth quarters, and income tax payments between $15 and $25.
•
Capital Spending: Capital spending in 2018 is expected to be between $80 and $90.
•
Working Capital: In the first quarter of 2018, our net working capital increased by $109 due primarily to sequential volume increases,
seasonality, inventory build for turnarounds and a weaker U.S. dollar. We expect net working capital to stabilize in the second quarter and decrease in the second half of the year, consistent with historical trends. For the year we anticipate a slight increase in working capital in 2018, as compared to 2017.
•
Restructuring Activities: We expect that the 2018 cost savings associated with our recently announced cost reduction programs, as well as our other ongoing and recently completed restructuring and cost reduction activities, will exceed the one-time cash costs in 2018 associated with these programs and have a net positive
impact on our liquidity and cash flows.
•
Sales of Assets: We regularly review our portfolio and are currently exploring potential divestitures. While there is no guarantee of a transaction, it could include a specific business unit or combination of several businesses. As mentioned above, we completed the sale of our ATG business in January 2018 for cash proceeds of $49. Also, we continue to evaluate additional sales of miscellaneous or idle assets, which would further increase our liquidity.
We plan to fund these outflows with available cash and cash equivalents, cash from operations and, if necessary, through available borrowings under our ABL Facility. We
continue to expect significant improvement in our overall 2018 operating cash flows compared to 2017, driven by anticipated improvement in business performance, the impact of our cost reduction programs and lower restructuring spend. Based on our liquidity position as of March 31, 2018 and projections of operating cash flows, we expect to have sufficient liquidity to fund our operations for the next twelve months.
We have $1.9 billion of First Priority Senior Secured Notes maturing in April 2020 and $0.6 billion of Second Priority Notes maturing in November
2020. Additionally, if 91 days prior to the scheduled maturity of these notes, more than $50 aggregate principal amount of maturing notes is outstanding, our ABL Facility, which matures in December 2021, will accelerate and become immediately due and payable.
We regularly review our portfolio and are currently exploring potential divestitures. While there is no guarantee of a transaction, it could include a specific business unit or combination of several businesses. We expect that the proceeds from a transaction or transactions upon completion would be used to help reduce the absolute amount of our debt.
Further, depending upon market, pricing and other conditions, including the current state of the high yield bond market, as well as cash balances and available liquidity, we or our affiliates, may seek to acquire notes or other indebtedness of the
Company through open market purchases, privately negotiated transactions, tender offers, redemption or otherwise, upon such terms and at such prices as we or our affiliates may determine (or as may be provided for in the indentures governing the notes), for cash or other consideration.
Sources and Uses of Cash
Following are highlights from our unaudited Condensed Consolidated Statements of Cash Flows:
In the first quarter of 2018, operations used $83 of cash. Net loss of $13 included $18 of net
non-cash expense items, consisting of depreciation and amortization of $30, non-cash asset impairments of $25, amortization of deferred financing fees of $4, unrealized foreign currency losses of $3 and deferred tax expense of $1, partially offset by a gain on disposition of $44. Net working capital used $94, which was largely driven by increases in accounts receivable and inventories due primarily to raw material price increases. Changes in other assets and liabilities and income taxes payable provided $6 due to the timing of when items were expensed versus paid.
In the first quarter of 2017,
operations used $118 of cash. Net loss of $42 included $35 of net non-cash income items, consisting of depreciation and amortization of $28, amortization of deferred financing fees of $4, loss on debt extinguishment of $3 and unrealized foreign currency losses of $4, partially offset by gains on sale of assets of $3. Net working capital used $116, which was largely driven by increases in accounts receivable and inventories due primarily to volume increases related to market conditions and the seasonality of our businesses, as well as raw material price inflation. Changes in other assets and liabilities and income taxes payable provided $5 due to the timing of when items were expensed versus paid, which primarily included interest expense, employee retention programs, restructuring reserves, incentive compensation, pension plan contributions and taxes.
Investing Activities
In the
first quarter of 2018, investing activities provided $25 of cash, primarily related to net proceeds from the ATG disposition of $49 and proceeds from sale of assets of $1, partially offset by capital expenditures of $25 (including capitalized interest).
In the first quarter of 2017, investing activities used $26 of cash, primarily driven by capital expenditures of $30, partially offset by net proceeds from the sale of assets of $4.
Financing Activities
In the first quarter of 2018, financing activities provided
$54 of cash. Net short-term debt repayments were $15 and net long-term debt borrowings were $70. Our long-term debt borrowings primarily consisted of $160 in ABL borrowings.
In the first quarter of 2017, financing activities provided $69 of cash. Net short-term debt borrowings were $11 and net long-term debt borrowings were $80. Our long-term debt borrowings primarily consisted of $81 in ABL borrowings, and the refinancing our 8.875% Senior Secured Notes due 2018 in February 2017.
There are certain restrictions on the ability of certain of our subsidiaries
to transfer funds to Hexion Inc. in the form of cash dividends, loans or otherwise, which primarily arise as a result of certain foreign government regulations or as a result of restrictions within certain subsidiaries’ financing agreements limiting such transfers to the amounts of available earnings and profits or otherwise limit the amount of dividends that can be distributed. In either case, we have alternative methods to obtain cash from these subsidiaries in the form of intercompany loans and/or returns of capital in such instances where payment of dividends is limited to the extent of earnings and profits.
The instruments that govern our indebtedness contain, among other provisions, restrictive covenants (and incurrence tests in certain cases) regarding indebtedness, dividends and distributions, mergers and acquisitions, asset sales, affiliate transactions, capital expenditures and, in the case of our ABL Facility, the maintenance of a financial ratio (depending on certain conditions). Payment of borrowings under the ABL Facility and our notes may be accelerated if there is an event of default as determined under the governing debt instrument. Events of default under the credit agreement governing our ABL Facility includes the failure to pay principal and interest when due, a material breach of representations or warranties, most covenant defaults, events of bankruptcy and a change of control. Events of default under the indentures
governing our notes include the failure to pay principal and interest, a failure to comply with covenants, subject to a 30-day grace period in certain instances, and certain events of bankruptcy.
The indentures that govern our 6.625% First-Priority Senior Secured Notes, 10.00% First Lien Notes, 10.375% First Priority Senior Secured Notes, 13.75% Senior Secured Notes and 9.00% Second-Priority Senior Secured Notes (the “Secured Indentures”) contain an Adjusted EBITDA to Fixed Charges ratio incurrence test which may restrict our ability to take certain actions such as incurring additional debt or making acquisitions if we are unable to meet this ratio (measured on a last twelve months, or LTM, basis) of at least 2.0:1. The Adjusted EBITDA to Fixed
Charges Ratio under the Secured Indentures is generally defined as the ratio of (a) Adjusted EBITDA to (b) net interest expense excluding the amortization or write-off of deferred financing costs, each measured on an LTM basis. See below for our Adjusted EBITDA to Fixed Charges Ratio calculation.
Our ABL Facility, which is subject to a borrowing base, does not have any financial maintenance covenant other than a minimum fixed charge coverage ratio of 1.0 to 1.0 that would only apply if our availability under the ABL Facility at any time is less than the greater of (a) $35 and (b) 12.5% of the lesser of the borrowing base and the total ABL Facility commitments at such time. The fixed charge coverage ratio under the credit agreement governing the ABL Facility is generally defined as the ratio of (a) Adjusted EBITDA minus non-financed capital
expenditures and cash taxes to (b) debt service plus cash interest expense plus certain restricted payments, each measured on an LTM basis. At March 31, 2018, our availability under the ABL Facility exceeded such levels; therefore, the minimum fixed charge ratio covenant did not apply. As of March 31, 2018, we were in compliance with all covenants that govern the ABL Facility. We do not believe that a covenant default under the ABL Facility is reasonably likely to occur in the foreseeable future.
Reconciliation of Last Twelve Months Net Loss to Adjusted EBITDA
Adjusted EBITDA is defined as EBITDA adjusted for certain non-cash and certain non-recurring items and other adjustments calculated
on a pro-forma basis, including the expected future cost savings from business optimization programs or other programs and the expected future impact of acquisitions, in each case as determined under the governing debt instrument. As we are highly leveraged, we believe that including the supplemental adjustments that are made to calculate Adjusted EBITDA provides additional information to investors about our ability to comply with our financial covenants and to obtain additional debt in the future. Adjusted EBITDA and Fixed Charges are not defined terms under U.S. GAAP. Adjusted EBITDA is not a measure of financial condition, liquidity or profitability, and should not be considered as an alternative to net income (loss) determined in accordance with U.S. GAAP or operating cash flows determined in accordance with U.S. GAAP. Additionally, EBITDA is not intended to be a measure of free cash flow for management’s discretionary use, as it does not take into account certain
items such as interest and principal payments on our indebtedness, depreciation and amortization expense (because we use capital assets, depreciation and amortization expense is a necessary element of our costs and ability to generate revenue), working capital needs, tax payments (because the payment of taxes is part of our operations, it is a necessary element of our costs and ability to operate), non-recurring expenses and capital expenditures. Fixed Charges under the Secured Indentures should not be considered an alternative to interest expense.
The following table
reconciles net loss to EBITDA and Adjusted EBITDA, and calculates the ratio of Adjusted EBITDA to Fixed Charges as calculated under our Secured Indentures for the period presented:
Unrealized
gains on pension and postretirement benefits (2)
(4
)
Other (3)
67
Cost reduction programs savings (4)
39
Adjustment for ATG disposition(5)
(4
)
Adjusted
EBITDA
$
430
Pro forma fixed charges (6)
$
314
Ratio of Adjusted EBITDA to Fixed Charges (7)
1.37
(1)
Primarily
represents cost related to headcount reduction expenses and plant rationalization costs related to in-process and recently completed cost reduction programs, termination costs and other costs associated with business realignments.
(2)
Represents non-cash losses resulting from pension and postretirement benefit plan liability remeasurements.
(3)
Primarily includes certain professional fees related to strategic projects, retention program costs, business
optimization expenses, management fees and expenses related to legacy liabilities.
(4)
Represents pro forma impact of in-process cost reduction programs savings. Cost reduction program savings represent the unrealized headcount reduction savings and plant rationalization savings related to cost reduction programs and other unrealized savings associated with the Company’s business realignments activities, and represent our estimate of the unrealized savings from such initiatives that would have been realized had the related actions been completed at the beginning of the period presented. The savings are calculated based on actual costs of exiting headcount and
elimination or reduction of site costs.
(5)
Represents pro forma LTM Adjusted EBITDA impact of the ATG disposition, which occurred during the first quarter of 2018.
(6)
Reflects pro forma interest expense based on interest rates at March 31, 2018.
(7)
The
Company’s ability to incur additional indebtedness, among other actions, is restricted under the Secured Indentures, unless the Company has an Adjusted EBITDA to Fixed Charges ratio of at least 2.0 to 1.0. As of March 31, 2018, we did not satisfy this test. As a result, we are subject to restrictions on our ability to incur additional indebtedness and to make investments; however, there are exceptions to these restrictions, including exceptions that permit indebtedness under our ABL Facility (available borrowings of which were $145 at March 31, 2018).
Recently
Issued Accounting Standards
See Note 2 in Item 1 of Part I of this Quarterly Report on Form 10-Q for a detailed description of recently issued accounting pronouncements.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
There have been no material developments during the first three months of 2018 on the matters we have previously disclosed about quantitative and qualitative market risk in our Annual Report on Form 10-K
for the year ended December 31, 2017.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, including the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, performed an evaluation of the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2018. Based upon that
evaluation, the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer concluded that our disclosure controls and procedures were effective at March 31, 2018.
Changes in Internal Control Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely
to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
The Company agreed to pay the Louisville Air Pollution Control District (the “District”) a $0.2 million penalty to resolve alleged violations in 2016, 2017 and 2018 of the District’s
air pollution laws and the Company’s air permit. The District approved an Order documenting this resolution on April 18, 2018.
Item 1A. Risk Factors
Following are our principal risks. These factors may or may not occur, and we cannot express a view on the likelihood that any of
these may occur. Other factors may exist that we do not consider significant based on information that is currently available or that we are not
currently able to anticipate. Any of the following risks could materially adversely affect our business, financial condition
or results of operations and prospects.
Risks Related to Our Business
If global economic conditions are weak or deteriorate, it will negatively impact our business operations, results of operations and financial condition.
Changes in global economic and financial market conditions could impact our business operations in a number of ways including, but not limited to, the following:
•
reduced demand in key customer segments, such as oil and gas, automotive, building, construction and electronics, compared to prior years;
•
weak
economic conditions in our primary regions of operations: U.S., Europe, and Asia;
•
payment delays by customers and reduced demand for our products caused by customer insolvencies and/or the inability of customers to obtain adequate financing to maintain operations;
•
insolvency of suppliers or the failure of suppliers to meet their commitments resulting in product delays;
•
more
onerous credit and commercial terms from our suppliers such as shortening the required payment period for outstanding accounts receivable or reducing or eliminating the amount of trade credit available to us; and
•
potential delays in accessing our senior secured asset based revolving credit facility (the “ABL Facility”) or obtaining new credit facilities on terms we deem commercially reasonable or at all, and the potential inability of one or more of the financial institutions included in our syndicated ABL Facility to fulfill their funding obligations. Should a bank in our syndicated ABL Facility be unable to fund a future draw request, we could find it difficult to replace that bank in the facility.
Due
to worldwide economic volatility and uncertainty, the short-term outlook for our business is difficult to predict.
Fluctuations in direct or indirect raw material costs could have an adverse impact on our business.
Raw materials costs made up approximately 75% of our cost of sales in the first quarter of 2018. The prices of our direct and indirect raw materials have been, and we expect them to continue to be, volatile. If the cost of direct or indirect raw materials increases significantly and we are unable to offset the increased costs with higher selling prices, our profitability will decline. Increases in prices for our products could also hurt our ability to remain both competitive and profitable in the markets in which we compete.
Although some of our materials contracts
include competitive price clauses that allow us to buy outside the contract if market pricing falls below contract pricing, and certain contracts have minimum-maximum monthly volume commitments that allow us to take advantage of spot pricing, we may be unable to purchase raw materials at market prices. In addition, some of our customer contracts have fixed prices for a certain term, and as a result, we may not be able to pass on raw material price increases to our customers immediately, if at all. Due to differences in timing of the pricing trigger points between our sales and purchase contracts,
there is often a “lead-lag” impact. In many cases this “lead-lag” impact can negatively impact our margins in the short term in periods of rising raw material prices and positively impact them in the short term in periods of falling raw material prices. Future raw material prices may be impacted by new laws or regulations, suppliers’ allocations to other purchasers, changes in our supplier manufacturing processes as some of our products are byproducts of these processes, interruptions in production by suppliers, natural disasters, volatility in the price of crude oil and related petrochemical products and changes in exchange rates.
An inadequate
supply of direct or indirect raw materials and intermediate products could have a material adverse effect on our business.
Our manufacturing operations require adequate supplies of raw materials and intermediate products on a timely basis. The loss of a key source or a delay in shipments could have a material adverse effect on our business. Raw material availability may be subject to curtailment or change due to, among other things:
•
new or existing laws or regulations;
•
suppliers’ allocations
to other purchasers;
•
interruptions in production by suppliers; and
•
natural disasters.
Many of our raw materials and intermediate products are available in the quantities we require from a limited number of suppliers. Should any of our key suppliers fail to deliver these raw materials or intermediate products to us or no longer supply us, we may be unable to purchase these materials in necessary quantities, which could adversely affect our volumes,
or may not be able to purchase them at prices that would allow us to remain competitive. During the past several years, certain of our suppliers have experienced force majeure events rendering them unable to deliver all, or a portion of, the contracted-for raw materials. On these occasions, we have been forced to limit production or were forced to purchase replacement raw materials in the open market at significantly higher costs or place our customers on an allocation of our products. In the past, some of our customers have chosen to discontinue or decrease the use of our products as a result of these measures. We have experienced force majeure events by certain of our suppliers which have had significant negative impacts on our business. For example, in 2014, Shell notified us of a supply interruption event at its Moerdijk, Netherlands facility, which provides key raw materials to us, and this event resulted in us allocating certain products to our customers through
mid-2015, at which point the disruption was resolved. In addition, we cannot predict whether new regulations or restrictions may be imposed in the future which may result in reduced supply or further increases in prices. We cannot assure investors that we will be able to renew our current materials contracts or enter into replacement contracts on commercially acceptable terms, or at all. Fluctuations in the price of these or other raw materials or intermediate products, the loss of a key source of supply or any delay in the supply could result in a material adverse effect on our business.
Our production facilities are subject to significant operating hazards which could cause environmental contamination, personal injury and loss of life, and severe
damage to, or destruction of, property and equipment.
Our production facilities are subject to hazards associated with the manufacturing, handling, storage and transportation of chemical materials and products, including human exposure to hazardous substances, pipeline and equipment leaks and ruptures, explosions, fires, inclement weather and natural disasters, mechanical failures, unscheduled downtime, transportation interruptions, remedial complications, chemical spills, discharges or releases of toxic or hazardous substances or gases, storage tank leaks and other environmental risks. Additionally, a number of our operations are adjacent to operations of independent entities that engage in hazardous and potentially dangerous activities. Our operations or adjacent operations could result in personal injury or loss of life, severe damage to or destruction of property or equipment, environmental damage, or a loss of the use
of all or a portion of one of our key manufacturing facilities. Such events at our facilities, or adjacent third-party facilities, could have a material adverse effect on us.
We may incur losses beyond the limits or coverage of our insurance policies for liabilities that are associated with these hazards. In addition, various kinds of insurance for companies in the chemical industry have not been available on commercially acceptable terms, or, in some cases, have been unavailable altogether. In the future, we may not be able to obtain coverage at current levels, and our premiums may increase significantly on coverage that we maintain.
Environmental obligations and liabilities could have a substantial negative impact on our financial condition, cash flows and profitability.
Our operations involve the use, handling, processing, storage,
transportation and disposal of hazardous materials and are subject to extensive and complex U.S. federal, state, local and non-U.S. supranational, national, provincial, and local environmental, health and safety laws and regulations. These environmental laws and regulations include those that govern the discharge of pollutants into the air and water, the generation, use, storage, transportation, treatment and disposal of hazardous materials and wastes, the cleanup of contaminated sites, occupational health and safety and those requiring permits, licenses, or other government approvals for specified operations or activities. Our products are also subject to a variety of international, national, regional, state, and provincial requirements and restrictions applicable to the manufacture, import, export or subsequent use of such products. In addition, we are required to maintain, and may be required to obtain in the future, environmental, health and safety permits, licenses,
or government approvals to continue current operations at most of our manufacturing and research facilities throughout the world.
Compliance with environmental, health and safety laws and regulations, and maintenance of permits, can be costly and complex, and we have incurred and will continue to incur costs, including capital expenditures and costs associated with the issuance and maintenance of letters of credit, to comply with these requirements. In 2017, we incurred capital expenditures of $25 to comply with environmental, health and safety laws and regulations and to make other environmental improvements. If we are unable to comply with environmental, health and safety laws and regulations, or maintain our permits, we could incur substantial costs, including fines and civil or criminal sanctions, third party property damage or personal injury claims or costs associated with upgrades to our facilities or changes in our
manufacturing processes in order to achieve and maintain compliance, and may also be required to halt permitted activities or operations until any necessary permits can be obtained or complied with, or decide to close the impacted facility. In addition, future developments or increasingly stringent regulations could require us to make additional unforeseen environmental expenditures, which could have a material adverse effect on our business.
Environmental, health and safety requirements change frequently and have tended to become more stringent over time. We cannot predict what environmental, health and safety laws and regulations or permit requirements
will be enacted or amended in the future, how existing or future laws or regulations will be interpreted or enforced or the impact of such laws, regulations or permits on future production expenditures, supply chain or sales. Our costs of compliance with current and future environmental, health and safety requirements could be material. Such future requirements include legislation designed to reduce emissions of carbon dioxide and other substances associated with climate change (“greenhouse gases”). The European Union has enacted greenhouse gas emissions legislation and continues to expand the scope of such legislation. The U.S. Environmental Protection Agency (the “USEPA”) has promulgated regulations applicable to projects involving greenhouse gas emissions above a certain threshold, and the United States and certain states within the United States have enacted, or are considering, limitations on greenhouse gas emissions. These requirements to limit greenhouse
gas emissions could significantly increase our energy costs, and may also require us to incur material capital costs to modify our manufacturing facilities.
In addition, we are subject to liability associated with hazardous substances in soil, groundwater and elsewhere at a number of sites. These include sites that we formerly owned or operated and sites where hazardous wastes and other substances from our current and former facilities and operations have been sent, treated, stored, or recycled or disposed of, as well as sites that we currently own or operate. Depending upon the circumstances, our liability may be strict, joint and several, meaning that we may be held responsible for more than our proportionate share, or even all, of the liability involved regardless of our fault or whether we are aware of the conditions giving rise to the liability. Even where liability has been allocated among parties, we may be subject
to material changes in such allocation in the future for a number of reasons, including the discovery of new contamination, the insolvency of a responsible party, or a heightened nexus to the remediation site. Environmental conditions at these sites can lead to environmental cleanup liability and claims against us for personal injury or wrongful death, property damages and natural resource damages, as well as to claims and obligations for the investigation and cleanup of environmental conditions. The extent of any of these liabilities is difficult to predict, but in the aggregate such liabilities could be material.
We have been notified that we are or may be responsible for environmental remediation at a number of sites in North America, Europe and South America. We are also performing a number of voluntary cleanups. The most significant sites at which we are performing or participating in environmental remediation are sites
formerly owned by us in Geismar, Louisiana and Plant City, Florida. As the result of former, current or future operations, there may be additional environmental remediation or restoration liabilities or claims of personal injury by employees or members of the public due to exposure or alleged exposure to hazardous materials in connection with our operations, properties or products. Sites sold by us in past years may have significant site closure or remediation costs and our share, if any, may be unknown to us at this time. These environmental liabilities or obligations, or any that may arise or become known to us in the future, could have a material adverse effect on our financial condition, cash flows and profitability.
Future chemical regulatory actions may decrease our profitability.
Several governmental agencies have enacted, are considering or may consider in the future, regulations
that may impact our ability to sell certain chemical products in certain geographic areas. The European Registration, Evaluation and Authorization of Chemicals (“REACH”) regulation requires manufacturers, importers and consumers of certain chemicals manufactured in, or imported into, the European Union to register such chemicals and evaluate their potential impacts on human health and the environment. REACH may result in certain chemicals being further regulated, restricted or banned from use in the European Union. In addition, the Frank R. Lautenberg Chemical Safety for the 21st Century Act (“LCSA”) was signed into law on June 22, 2016, and updates and revises the Toxic Substances Control Act. LCSA requires the implementing agency to conduct risk evaluations on high priority chemicals, which could include chemical products we manufacture. Other countries have implemented, or are considering implementation
of, similar chemical regulatory programs. When fully implemented, REACH, LCSA and other similar regulatory programs may result in significant adverse market impacts on the affected chemical products. If we fail to comply with REACH, LCSA or other similar laws and regulations, we may be subject to penalties or other enforcement actions, including fines, injunctions, recalls or seizures, which would have a material adverse effect on our financial condition, cash flows and profitability. Additionally, studies conducted in association with these regulatory programs, or otherwise conducted through trade associations, may result in new information regarding the health effects and environmental impact of our products and raw materials. Such studies could result in future regulations restricting the manufacture or use of our products, liability for adverse environmental or health effects linked to our products, and/or de-selection of our products for specific applications.
These restrictions, liability, and product de-selection could have a material adverse effect on our business, our financial condition and/or liquidity.
Because of certain government public health agencies’ concerns regarding the potential for adverse human health effects, formaldehyde is a regulated chemical and public health agencies continue to evaluate its safety. A division of the World Health Organization, the International Agency for Research on Cancer, or IARC, and the National Toxicology Program, or NTP, within the U.S. Department of Health and Human Services, have classified formaldehyde as being carcinogenic to humans. The USEPA, under its Integrated Risk Information System, or IRIS, released a draft of its toxicological review of formaldehyde in 2010, stating that formaldehyde meets the criteria to be described as “carcinogenic to humans.” The National Academy of Sciences peer reviewed the draft IRIS toxicological
review and issued a report in April 2011 that criticized the draft IRIS toxicological review and stated that the methodologies and the underlying science used in the draft IRIS review did not clearly support a conclusion of a causal link between formaldehyde exposure and leukemia. USEPA may issue a revised draft IRIS toxicological review to reflect the NAS findings, including the conclusions regarding a causal link between formaldehyde exposure and leukemia. Effective January 1, 2016, ECHA classified formaldehyde as a Category 2 Mutagen, but rejected reclassification as a Category 1A Carcinogen. It is possible that new regulatory requirements could be promulgated to limit human exposure to formaldehyde, that we could incur substantial additional costs to meet any such regulatory requirements, and that there could be a reduction in demand for our formaldehyde-based products. These additional costs and reduced demand could
have a material adverse effect on our operations and profitability.
BPA, which is manufactured and used as an intermediate at our Deer Park, Texas and Pernis, Netherlands manufacturing facilities, and is also sold directly to third parties, is currently considered under certain state and international regulatory programs as a reproductive toxicant and an “endocrine disrupter,” meaning BPA could disrupt normal biological processes. BPA continues to be subject to scientific, regulatory and legislative review and negative media attention. In Europe, the EU Committee for Risk Assessment adopted an opinion to change the existing harmonized classification
and labeling of BPA from a category 2 reproductive Toxicant to a category 1B reproductive Toxicant. This classification change will become effective March 1, 2018. The EU Member State Committee agreed to add BPA to the Substance of Very High Concern (“SVHC”) candidate list based upon its classification as a reproductive toxicant, as well as for its endocrine disrupting properties to both human health and the environment. The REACH Risk Management Option Analysis (RMOA) was released July 6, 2017, in which BPA is identified as an endocrine disruptor for the environment with no safe threshold, and REACH restrictions are identified as the preferred risk management measure. The California Environmental Protection Agency’s Office of Environmental Health Hazard Assessment (“OEHHA”) listed BPA under Proposition 65 as a developmental and reproductive toxicant, requiring
warning labels unless BPA exposures are shown to be less than a risk-based level (the maximum allowable dose level (“MADL”)). As of May 11, 2016, products containing BPA sold into California must comply with Proposition 65’s requirements. Despite these hazard designations and listings, the US Food and Drug Administration (“FDA”) is also actively engaged in the scientific and regulatory review of BPA and, in a letter submitted to OEHHA dated April 6, 2015, reaffirmed that BPA is safe as currently permitted in FDA-regulated food contact uses and concluded that FDA’s National Center for Toxicological Research study did not support the listing of BPA as a reproductive toxicant. In December 2012, France enacted a law that bans direct contact of packaging containing BPA with food and consumer products. In January 2015, the European Food Safety Authority (“EFSA”)
concluded that BPA poses no health risk to consumers of any age group (including unborn children, infants and adolescents) at currently permitted exposure levels. EFSA confirmed this conclusion in October 2016. Regulatory and legislative initiatives such as these, or product de-selection resulting from such regulatory actions, may result in a reduction in demand for BPA and our products containing BPA and could also result in additional liabilities as well as an increase in operating costs to meet more stringent regulations. Such increases in operating costs and/or reduction in demand could have a material adverse effect on our operations and profitability.
Scientists periodically conduct studies on the potential human health and environmental impacts of chemicals, including products we manufacture and sell. Also, nongovernmental advocacy organizations and individuals periodically issue public statements alleging human health
and environmental impacts of chemicals, including products we manufacture and sell. Based upon such studies or public statements, our customers may elect to discontinue the purchase and use of our products, even in the absence of any government regulation. Such actions could significantly decrease the demand for our products and, accordingly, have a material adverse effect on our business, financial condition, cash flows and profitability.
We are subject to certain risks related to litigation filed by or against us, and adverse results may harm our business.
We cannot predict with certainty the cost of defense, of prosecution or of the ultimate outcome of litigation and other proceedings filed by or against us, including penalties or other civil or criminal sanctions, or remedies or damage awards, and adverse results in any litigation and other proceedings may materially harm our
business. Litigation and other proceedings may include, but are not limited to, actions relating to intellectual property, international trade, commercial arrangements, product liability, environmental, health and safety, joint venture agreements, labor and employment or other harms resulting from the actions of individuals or entities outside of our control. In the case of intellectual property litigation and proceedings, adverse outcomes could include the cancellation, invalidation or other loss of material intellectual property rights used in our business and injunctions prohibiting our use of business processes or technology that are subject to third-party patents or other third-party intellectual property rights. Litigation based on environmental matters or exposure to hazardous substances in the workplace or based upon the use of our products could result in significant liability for us, which could have a material adverse effect on our business, financial condition
and/or profitability.
Because we manufacture and use materials that are known to be hazardous, we are subject to, or affected by, certain product and manufacturing regulations, for which compliance can be costly and time consuming. In addition, we may be subject to personal injury or product liability claims as a result of human exposure to such hazardous materials.
We produce hazardous chemicals that require care in handling and use that are subject to regulation by many U.S. and non-U.S. national, supra-national, state and local governmental authorities. In some circumstances, these authorities must review and, in some cases approve, our products and/or manufacturing processes and facilities before we may manufacture and sell some of these chemicals. To be able to manufacture and sell certain new chemical products, we may be required, among other things, to demonstrate to the
relevant authority that the product does not pose an unreasonable risk during its intended uses and/or that we are capable of manufacturing the product in compliance with current regulations. The process of seeking any necessary approvals can be costly, time consuming and subject to unanticipated and significant delays. Approvals may not be granted to us on a timely basis, or at all. Any delay in obtaining, or any failure to obtain or maintain, these approvals would adversely affect our ability to introduce new products and to generate revenue from those products. New laws and regulations may be introduced in the future that could result in additional compliance costs, bans on product sales or use, seizures, confiscation, recall or monetary fines, any of which could prevent or inhibit the development, distribution or sale of our products and could increase our customers’ efforts to find less hazardous substitutes for our products. We are subject to ongoing reviews of
our products and manufacturing processes.
As discussed above, we manufacture and sell products containing formaldehyde, and certain governmental bodies have stated that there is a causal link between formaldehyde exposure and certain types of cancer, including myeloid leukemia and NPC. These conclusions could adversely impact our business and also become the basis of product liability litigation.
Other products we have made or used have been and could be the focus of legal claims based upon allegations of harm to human health. While we cannot predict the outcome of pending suits and claims, we believe that
we maintain adequate reserves, in accordance with our policy, to address currently pending litigation and are adequately insured to cover currently pending and foreseeable future claims. However, an unfavorable outcome in these litigation matters could have a material adverse effect on our business, financial condition and/or profitability and cause our reputation to decline.
We are subject to claims from our customers and their employees, environmental action groups and neighbors living near our production facilities.
We produce and use hazardous chemicals that require appropriate procedures and care to be used in handling them or in using them to manufacture other products. As a result of the hazardous nature of some of the products we produce and use, we may face claims relating to incidents that involve our customers’ improper handling, storage and use of our products. We have
historically faced lawsuits, including class action lawsuits that claim liability for death, injury or property damage caused by products that we manufacture or that contain our components. Additionally, we may face lawsuits alleging personal injury or property damage by neighbors living near our production facilities. These lawsuits, and any future lawsuits, could result in substantial damage awards against us, which in turn could encourage additional lawsuits and could cause us to incur significant legal fees to defend such lawsuits, either of which could have a material adverse effect on our business, financial condition and/or profitability. In addition, the activities of environmental action groups could result in litigation or damage to our reputation.
Our manufacturing facilities are subject to disruption due to operating hazards
The
storage, handling, manufacturing and transportation of chemicals at our facilities and adjacent facilities could result in leaks, spills, fires or explosions, which could result in production downtime, production delays, raw material supply delays, interruptions and environmental hazards. We have experienced incidents at our own facilities and a raw material supplier located adjacent to our facility that have resulted mostly in short term, but some long term, production delays. Production interruption may also result from severe weather, particularly with respect to our southern U.S. operations near the Gulf Coast. Production lapses caused by any such delays can often be absorbed by our other manufacturing facilities, and we maintain insurance to cover such potential events. However, such events could negatively affect our operations.
As a global business, we are subject to numerous risks associated with our international
operations that could have a material adverse effect on our business.
We have significant manufacturing and other operations outside the United States. Some of these operations are in jurisdictions with unstable political or economic conditions. There are numerous inherent risks in international operations, including, but not limited to:
•
exchange controls and currency restrictions;
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currency fluctuations and devaluations;
•
tariffs
and trade barriers imposed by the current U.S. administration or foreign governments;
•
renegotiation of trade agreements by the current U.S. administration;
•
export duties and quotas;
•
changes in local economic conditions;
•
changes
in laws and regulations;
•
exposure to possible expropriation or other government actions;
•
acts by national or regional banks, including the European Central Bank, to increase or restrict the availability of credit;
•
hostility from local populations;
•
diminished
ability to legally enforce our contractual rights in non-U.S. countries;
•
restrictions on our ability to repatriate dividends from our subsidiaries; and
•
unsettled political conditions and possible terrorist attacks against U.S. interests.
Our international operations expose us to different local political and business risks and challenges. For example, we may face
potential difficulties in staffing and managing local operations, and we may have to design local solutions to manage credit risks of local customers and distributors. In addition, some of our operations are located in regions that may be politically unstable, having particular exposure to riots, civil commotion or civil unrests, acts of war (declared or undeclared) or armed hostilities or other national or international calamity. In some of these regions, our status as a U.S. company also exposes us to increased risk of sabotage, terrorist attacks, interference by civil or military authorities or to greater impact from the national and global military, diplomatic and financial response to any future attacks or other threats.
In addition, intellectual property rights may be more difficult to enforce in non-U.S. or non-Western European countries.
If global economic and market conditions,
or economic conditions in Europe, China, Brazil, Australia, the United States or other key markets remain uncertain or deteriorate further, the value of associated foreign currencies and the global credit markets may weaken. Additionally, general financial instability in countries where we do not transact a significant amount of business could have a contagion effect and contribute to the general instability and uncertainty within a particular region or globally. If this were to occur, it could adversely affect our customers and suppliers and in turn have a materially adverse effect on our international business and results of operations.
Our overall
success as a global business depends, in part, upon our ability to succeed under different economic, social and political conditions. We may fail to develop and implement policies and strategies that are effective in each location where we do business, and failure to do so could have a material adverse effect on our business, financial condition and results of operations.
Our business is subject to foreign currency risk.
In 2017, approximately 60% of our net sales originated outside the United States. In our consolidated financial statements, we translate our local currency financial results into U.S. dollars based on average exchange rates prevailing during a reporting period or the exchange rate at the end of that period. During times of a strengthening U.S. dollar, at a constant level of business, our reported international revenues and earnings would be reduced because the local
currency would translate into fewer U.S. dollars.
In addition to currency translation risks, we incur a currency transaction risk whenever we enter into a purchase or a sales transaction or indebtedness transaction using a different currency from the currency in which we record revenues. Given the recent volatility of exchange rates, we may not manage our currency transaction and/or translation risks effectively, and volatility in currency exchange rates may materially adversely affect our financial condition or results of operations, including our tax obligations. Since the vast majority of our indebtedness is denominated in U.S. dollars, a strengthening of the U.S. dollar could make it more difficult for us to repay our indebtedness.
We have entered and expect to continue to enter into various hedging and other programs in an effort to protect against adverse changes in the non-U.S.
exchange markets and attempt to minimize potential material adverse effects. These hedging and other programs may be unsuccessful in protecting against these risks. Our results of operations could be materially adversely affected if the U.S. dollar strengthens against non-U.S. currencies and our protective strategies are not successful. Likewise, a strengthening U.S. dollar provides opportunities to source raw materials more cheaply from foreign countries.
Fluctuations in energy costs could have an adverse impact on our profitability and negatively affect our financial condition.
Oil and natural gas prices have fluctuated greatly over the past several years and we anticipate that they will continue to do so. Natural gas and electricity are essential to our manufacturing processes, which are energy-intensive. Our energy costs represented approximately 4% of our total cost of sales
for the year ended December 31, 2017.
Our operating expenses will increase if our energy prices increase. Increased energy prices may also result in greater raw materials costs. If we cannot pass these costs through to our customers, our profitability may decline. Increased energy costs may also negatively affect our customers and the demand for our products. In addition, as oil and natural gas prices fall, while having a positive effect on our overall costs, such falling prices can have a negative impact on our oilfield business, as the number of oil and natural gas wells drilled declines in response to market condition.
If energy prices decrease, we expect benefits in the short-run with decreased operating expenses and increased operating income, but may face increased pricing pressure from competitors that are similarly impacted
by energy prices. As a result, profitability may decrease over an extended period of time of lower energy prices. Moreover, any future increases in energy prices after a period of lower energy prices may have an adverse impact on our profitability for the reasons described above.
We face increased competition from other companies and from substitute products, which could force us to lower our prices, which would adversely affect our profitability and financial condition.
Several of the markets that we operate in are highly competitive, and this competition could harm our results of operations, cash flows and financial condition. Our competitors include major international producers as well as smaller regional competitors. We believe that the most significant competitive factor that impacts demand for certain of our products is selling price. We may be forced to lower our selling
price based on our competitors’ pricing decisions, which would reduce our profitability. Certain markets that we serve have become commoditized in recent years and have given rise to several industry participants, resulting in strong price competition in these markets. In addition, we face competition from a number of products that are potential substitutes for our products. Growth in substitute products could adversely affect our market share, net sales and profit margins.
Additional trends include current and anticipated consolidation among our competitors and customers which may cause us to lose market share as well as put downward pressure on pricing. There is also a trend in our industries toward relocating manufacturing facilities to lower cost regions, such as Asia, which may permit some of our competitors to lower their costs and improve their competitive position. Furthermore, there has been an increase in new competitors
based in these regions.
Some of our competitors are larger, have greater financial resources, have a lower cost structure, and/or have less debt than we do. As a result, those competitors may be better able to withstand a change in conditions within our industry and in the economy as a whole. If we do not compete successfully, our operating margins, financial condition, cash flows and profitability could be adversely affected. Furthermore, if we do not have adequate capital to invest in technology, including expenditures for research and development, our technology could be rendered uneconomical or obsolete, negatively affecting our ability to remain competitive.
We
expect substantial cost savings from our ongoing strategic initiatives, and if we are unable to achieve these cost savings, or sustain our current cost structure, it could have a material adverse effect on our business operations, results of operations and financial condition.
We have not yet realized all of the cost savings and synergies we expect to achieve from our ongoing strategic initiatives. A variety of risks could cause us not to realize the expected cost savings and synergies, including but not limited to, higher than expected severance costs related to staff reductions; higher than expected retention costs for employees that will be retained; higher than expected stand-alone overhead expenses; delays in the anticipated timing of activities related to our cost-savings plans; and other unexpected costs associated with operating our business. In November 2017, we initiated new cost reduction programs that we expect
to generate approximately $43 of annual savings once fully implemented. As of March 31, 2018, we had $39 of total in-process cost savings related to new and existing programs.
If we are unable to achieve these cost savings or synergies it could adversely affect our profitability and financial condition. In addition, while we have been successful in reducing costs and generating savings, factors may arise that may not allow us to sustain our current cost structure. As market and economic conditions change, we may also make changes to our operating cost structure.
Our success depends in part on our ability to protect our intellectual property rights, and our inability to enforce these rights could have a material adverse effect on our competitive
position.
We rely on the patent, trademark, copyright and trade-secret laws of the United States and the countries where we do business to protect our intellectual property rights. We may be unable to prevent third parties from using our intellectual property without our authorization. The unauthorized use of our intellectual property could reduce any competitive advantage we have developed, reduce our market share or otherwise harm our business. In the event of unauthorized use of our intellectual property, litigation to protect or enforce our rights could be costly, and we may not prevail.
Many of our technologies are not covered by any patent or patent application, and our issued and pending U.S. and non-U.S. patents may not provide us with any competitive advantage and could be challenged by third parties. Our inability to secure issuance of our pending patent applications
may limit our ability to protect the intellectual property rights these pending patent applications were intended to cover. Our competitors may attempt to design around our patents to avoid liability for infringement and, if successful, our competitors could adversely affect our market share. Furthermore, the expiration of our patents may lead to increased competition.
Our pending trademark applications may not be approved by the responsible governmental authorities and, even if these trademark applications are granted, third parties may seek to oppose or otherwise challenge these trademark applications. A failure to obtain trademark registrations in the United States and in other countries could limit our ability to protect our products and their associated trademarks and impede our marketing efforts in those jurisdictions.
In addition, effective patent, trademark, copyright and
trade secret protection may be unavailable or limited in some foreign countries. In some countries we do not apply for patent, trademark or copyright protection. We also rely on unpatented proprietary manufacturing expertise, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we generally enter into confidentiality agreements with our employees and third parties to protect our intellectual property, these confidentiality agreements are limited in duration and could be breached, and may not provide meaningful protection of our trade secrets or proprietary manufacturing expertise. Adequate remedies may not be available if there is an unauthorized use or disclosure of our trade secrets and manufacturing expertise. In addition, others may obtain knowledge about our trade secrets through independent development or by legal means. The failure to protect our processes, apparatuses, technology, trade secrets and
proprietary manufacturing expertise, methods and compounds could have a material adverse effect on our business by jeopardizing critical intellectual property.
Where a product formulation or process is kept as a trade secret, third parties may independently develop or invent and patent products or processes identical to our trade-secret products or processes. This could have an adverse impact on our ability to make and sell products or use such processes and could potentially result in costly litigation in which we might not prevail.
We could face intellectual property infringement claims that could result in significant legal costs and damages and impede our ability to produce key products, which could have a material adverse effect on our business, financial condition and results of operations.
Our production processes and products
are specialized; however, we could face intellectual property infringement claims from our competitors or others alleging that our processes or products infringe on their proprietary technology. If we were subject to an infringement suit, we may be required to change our processes or products, or stop using certain technologies or producing the infringing product entirely. Even if we ultimately prevail in an infringement suit, the existence of the suit could cause our customers to seek other products that are not subject to infringement suits. Any infringement suit could result in significant legal costs and damages and impede our ability to produce key products, which could have a material adverse effect on our business, financial condition and results of operations.
We depend on certain of our key executives and our ability to attract and retain qualified employees.
Our ability to operate our business and implement our strategies depends, in part, on the skills, experience and efforts of key members of our leadership team. We do not maintain any key-man insurance on any of these individuals. In addition, our success will depend on, among other factors, our ability to attract and retain other managerial, scientific and technical qualified personnel, particularly research scientists, technical sales professionals, and engineers who have specialized skills required by our business and focused on the industries in which we compete. Competition for qualified employees in the chemicals industry is intense and the loss of the services of any of our key employees or the failure to attract or retain other qualified
personnel could have a material adverse effect on our business or business prospects. Further, if any of these executives or employees joins a competitor, we could lose customers and suppliers and incur additional expenses to recruit and train personnel, who require time to become productive and to learn our business.
Our majority shareholder’s interest may conflict with or differ from our interests.
Apollo controls our ultimate parent company, Hexion Holdings LLC, or Hexion Holdings, which indirectly owns 100% of our common equity. In addition, Apollo has significant representation on Hexion Holdings’ Board of Managers. As a result, Apollo can significantly influence our ability to enter into significant corporate transactions such as mergers, tender offers and the sale of all or substantially all of our assets. The interests of Apollo and its affiliates could conflict with or
differ from our interests. For example, the concentration of ownership held by Apollo could delay, defer or prevent a change of control of our company or impede a merger, takeover or other business combination which may otherwise be favorable for us.
Additionally, Apollo is in the business of making investments in companies and may, from time to time, acquire and hold interests in businesses that compete, directly or indirectly with us. Apollo may also pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. Additionally, even if Apollo invests in competing businesses through Hexion Holdings, such investments may be made through a newly-formed subsidiary of Hexion Holdings. Any such investment may increase the potential for the conflicts of interest
discussed in this risk factor.
So long as Apollo continues to indirectly own a significant amount of the equity of Hexion Holdings, even if such amount is less than 50%, they will continue to be able to substantially influence or effectively control our ability to enter into any corporate transactions.
Because our equity securities are not and will not be registered under the securities laws of the United States or in any other jurisdiction and are not listed on any U.S. securities exchange, we are not subject to certain of the corporate governance requirements of U.S. securities authorities or to any corporate governance requirements of any U.S. securities exchanges.
If we fail to extend or renegotiate our collective bargaining agreements with our works councils and labor unions as they expire from time to time, if disputes with our
works councils or unions arise, or if our unionized or represented employees were to engage in a strike or other work stoppage, our business and operating results could be materially adversely affected.
As of December 31, 2017, approximately 37% of our employees were unionized or represented by works councils that were covered by collective bargaining agreements. In addition, some of our employees reside in countries in which employment laws provide greater bargaining or other employee rights than the laws of the United States. These rights may require us to expend more time and money altering or amending employees’ terms of employment or making staff reductions. For example, most of our employees in Europe are represented by works councils, which generally must approve changes in conditions of employment, including restructuring initiatives and changes in salaries and benefits.
A significant dispute could divert our management’s attention and otherwise hinder our ability to conduct our business or to achieve planned cost savings.
We may be unable to timely extend or renegotiate our collective bargaining agreements as they expire. We have collective bargaining agreements which will expire during the next two years. We also may be subject to strikes or work stoppages by, or disputes with, our labor unions. If we fail to extend or renegotiate our collective bargaining agreements, if disputes with our works councils or unions arise or if our unionized or represented workers engage in a strike or other work stoppage, we could incur higher labor costs or experience a significant disruption of operations, which could have a material adverse effect on our business, financial position and results of operations.
Our pension plans are unfunded or under-funded and
our required cash contributions could be higher than we expect, each of which could have a material adverse effect on our financial condition and liquidity.
We sponsor various pension and similar benefit plans worldwide.
Our U.S. and non-U.S. defined benefit pension plans were under-funded in the aggregate by $25 and $224, respectively, as of December 31, 2017. We are legally required to make contributions to our pension plans in the future, and those contributions could be material.
In 2018, we do not expect to make any contributions to our U.S. defined benefit pension plan and we expect to contribute approximately $23 to our non-U.S. defined benefit pension plans, which we believe is sufficient to meet the minimum funding requirements as set forth in employee benefit and tax laws.
Our
future funding obligations for our employee benefit plans depend upon the levels of benefits provided for by the plans, the future performance of assets set aside for these plans, the rates of interest used to determine funding levels, the impact of potential business dispositions, actuarial data and experience, and any changes in government laws and regulations. In addition, certain of our funded employee benefit plans hold a significant amount of equity securities. If the market values of these securities decline, our pension expense and funding requirements would increase and, as a result, could have a material adverse effect on our business.
Any
decrease in interest rates and asset returns, if and to the extent not offset by contributions, could increase our obligations under these plans. If the performance of assets in the funded plans does not meet our expectations, our cash contributions for these plans could be higher than we expect, which could have a material adverse effect on our financial condition and liquidity.
Natural or other disasters have, and could in the future, disrupt our business and result in loss of revenue or higher expenses.
Any serious disruption at any of our facilities or our suppliers’ facilities due to hurricane, fire, earthquake, flood, terrorist attack or any other natural or man-made disaster could impair our ability to use our facilities and have a material adverse impact on our revenues and increase our costs and expenses. If there is a natural disaster or other serious disruption at any
of our facilities or our suppliers’ facilities, it could impair our ability to adequately supply our customers and negatively impact our operating results. For example, our manufacturing facilities in the U.S. Gulf Coast region were impacted by Hurricane Harvey in 2017. In addition, many of our current and potential customers are concentrated in specific geographic areas. A disaster in one of these regions could have a material adverse impact on our operations, operating results and financial condition. Our business interruption insurance may not be sufficient to cover all of our losses from a disaster, in which case our unreimbursed losses could be substantial. Some of our operations are located in regions with particular exposure to natural disasters such as storms, floods, fires and earthquakes. It would be difficult or impossible for us to relocate these operations and, as a result, any of the aforementioned occurrences could materially adversely affect our business.
Cyber
security attacks and other disruptions to our information systems could interfere with our operations, and could compromise our information and the information of our customers and suppliers, which would adversely affect our relationships with business partners and harm our brands, reputation and financial results.
In the ordinary course of business, we rely upon information systems, some of which are managed by third parties, to process, transmit and store digital information, and to manage or support a variety of business processes and activities, including supply chain, manufacturing, distribution, invoicing, and collection of payments from customers. We use information systems to record, process and summarize financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting, legal and tax requirements. Additionally,
we collect and store sensitive data, including intellectual property, proprietary business information, the proprietary business information of our customers, suppliers and Momentive Performance Materials Inc. (“MPM”) under the Shared Services Agreement, as well as personally identifiable information of our customers, suppliers and employees and MPM. The secure operation of our systems, and the processing and maintenance of this information is critical to our business operations and strategy. Despite actions to mitigate or eliminate risk, our information systems may be vulnerable to damage, disruptions or shutdowns due to the activity of hackers, employee error or malfeasance, or other disruptions including, power outages, telecommunication or utility failures, natural disasters or other catastrophic events. The occurrence of any of these events could compromise our systems and the information stored there could be accessed, publicly disclosed, lost or stolen.
Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability or regulatory penalties under laws protecting the privacy of personal information, disrupt operations, and damage our reputation which could adversely affect our business, financial condition and results of operations.
Divestitures that we pursue may present unforeseen obstacles and costs and alter the synergies we expect to continue to achieve from our ongoing cost reduction programs. Acquisitions and joint ventures that we pursue may present unforeseen integration obstacles and costs, increase our leverage and negatively impact our performance.
We have selectively made, and may in the future, pursue divestitures of certain of our businesses as one element of our portfolio optimization strategy. Divestitures may require us to separate integrated assets and personnel
from our retained businesses and devote our resources to transitioning assets and services to purchasers, resulting in disruptions to our ongoing business and distraction of management. Divestitures may alter synergies we expect to continue to achieve from our ongoing cost reduction programs. In the event of a large divestiture, we could use a significant amount of net operating losses which could result in our U.S. Company incurring future cash taxes. In addition, divestitures may result in the retention of certain current and future liabilities as well as obligations to indemnify or reimburse a buyer for certain liabilities of a divested business. These potential obligations could have an adverse effect on our results of operations and financial condition if triggered.
In addition, we have made acquisitions of related businesses, and entered into joint ventures in the past and could selectively pursue acquisitions of, and
joint ventures with, related businesses as one element of our growth strategy. If such acquisitions are consummated, the risk factors we describe above and below, and for our business generally, may be intensified.
We could face additional income tax obligations based on tax reform.
On December 22, 2017, the United States enacted tax reform legislation that included a broad range of business tax provisions, including but not limited to a reduction in the U.S. federal tax rate from 35% to 21% as well as provisions that limit or eliminate various deductions or credits. The legislation also causes U.S. expenses, such as interest and general administrative expenses, to be taxed and imposes a new tax on U.S. cross-border payments. Furthermore, the legislation includes a one-time transition
tax on accumulated foreign earnings and profits.
Many aspects of the Tax Reform remain unclear, and although further clarifying guidance is expected to be issued in the future (by the Internal Revenue Service (“IRS”), the U.S. Treasury Department or via a technical correction law change), it may not be clarified for some time. In addition, many U.S. states have not updated their laws to take into account the new federal legislation. Aspects of U.S. tax reform may lead foreign jurisdictions to respond by enacting additional tax legislation that is unfavorable to us. As a result, we have not yet been able to determine the full impact of the new laws on our results of operations and financial condition. It is possible that U.S. tax reform, or interpretations under it, could change and could have an adverse effect on us, and such effect could be material.
If we fail to establish and maintain an effective internal control environment, our ability to both timely and accurately report our financial results could be adversely affected.
Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to conduct a comprehensive evaluation of their internal control over financial reporting. To comply with this statute, each year we are required to document and test our internal control over financial reporting, our management is required to assess and issue a report concerning our internal control over financial reporting.
The existence of one or
more material weaknesses has resulted in, and could continue to result in, errors in our financial statements, and substantial costs and resources may be required to rectify these errors or other internal control deficiencies and may cause us to incur other costs, including potential legal expenses. If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information, and we may be unable to obtain additional financing to operate and expand our business and our business and financial condition could be harmed.
We have an established process to remediate identified control deficiencies timely and we continue to take appropriate actions to strengthen our internal control over financial reporting, but we cannot assure you that the measures we have taken to date, or any measures we may take in the future, will be sufficient to avoid potential future material weaknesses.
Risks
Related to Our Indebtedness
We may be unable to generate sufficient cash flows from operations to meet our consolidated debt service payments.
During the first quarter of 2017, we issued $485 aggregate principal amount of 10.375% First Priority Senior Secured Notes due 2022 (the “New First Lien Notes”) and $225 aggregate principal amount of 13.75% Senior Secured Notes due 2022 (the “New Senior Secured Notes”). During the second quarter of 2017, we issued $75 aggregate principal amount of New First Lien Notes. These notes mature in February 2022 and have substantially the same terms as the New First Lien Notes issued in February 2017. In connection with the issuance of the new notes in February 2017, certain lenders under our ABL Facility provided extended revolving facility commitments in an aggregate principal amount
of $350 with a maturity date of December 5, 2021 (subject to early maturity triggers), the existing commitments were terminated and the size of the ABL facility was reduced from $400 to $350.
We have substantial consolidated indebtedness. As of March 31, 2018, we had approximately $3.8 billion of consolidated outstanding indebtedness, including payments due within the next twelve months and short-term borrowings. In addition, we had a $145 undrawn revolver under our ABL Facility, subject to a borrowing base, after giving effect to $45 of outstanding letters of credit. In 2018, our annualized cash interest expense is projected to be approximately $313 based on consolidated indebtedness
and interest rates at March 31, 2018, of which $307 represents cash interest expense on fixed-rate obligations.
As of March 31, 2018, approximately $170, or 5%, of our borrowings were at variable interest rates and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same. Assuming our consolidated variable interest rate indebtedness outstanding as of March 31, 2018 remains the same, an increase of 1% in the interest rates payable on our variable rate indebtedness would increase our annual estimated debt service requirements by approximately $2.
Our ability to generate sufficient cash flows from operations
to make scheduled debt service payments depends on a range of economic, competitive and business factors, many of which are outside of our control. We maintain normal commercial terms with our major vendors and customers. If certain of our commercial counterparties request changes to our terms, it could put additional pressure on our liquidity position and our business may generate insufficient cash flows from operations to meet our debt service and other obligations, and currently anticipated cost savings, working capital reductions and operating improvements may not be realized on schedule, or at all. If we are unable to meet our expenses and debt service obligations, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or issue additional equity securities. We may be unable to refinance any of our indebtedness, sell assets or issue equity securities on commercially reasonable terms, or at all, which could cause us to default
on our obligations and result in the acceleration of our debt obligations. Our inability to generate sufficient cash flows to satisfy our outstanding debt obligations, or to refinance our obligations on commercially reasonable terms, would have a material adverse effect on our business, financial condition and results of operations.
Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations and limit our ability to react to changes in the economy or our industry.
Our substantial consolidated indebtedness could have other important consequences, including
but not limited to the following:
•
it may limit our flexibility in planning for, or reacting to, changes in our operations or business;
•
we are more highly leveraged than many of our competitors, which may place us at a competitive disadvantage;
•
it may make us more vulnerable to downturns in our business
or in the economy;
•
a substantial portion of our cash flows from operations will be dedicated to the repayment of our indebtedness and will not be available for other purposes;
•
it may restrict us from making strategic acquisitions, introducing new technologies or exploiting business opportunities;
•
it
may make it more difficult for us to satisfy our obligations with respect to our existing indebtedness;
•
it may adversely affect terms under which suppliers provide material and services to us;
•
it may limit our ability to borrow additional funds or dispose of assets; and
•
it may limit
our ability to fully achieve possible cost savings from the Shared Services Agreement with MPM.
There would be a material adverse effect on our business and financial condition if we were unable to service our indebtedness or obtain additional financing, as needed.
Despite our substantial indebtedness, we may still be able to incur additional indebtedness. This could intensify the risks described above and below.
We may be able to incur additional indebtedness in the future. Although the terms governing our indebtedness contain restrictions on our ability to incur additional indebtedness, these restrictions are subject to numerous qualifications and exceptions, and the indebtedness we may incur in compliance with these restrictions could be substantial. Increasing our indebtedness could intensify the risks described
above and below.
The terms governing our outstanding debt, including restrictive covenants, may adversely affect our operations.
The terms governing our outstanding debt contain, and any future indebtedness we incur would likely contain, numerous restrictive covenants that impose significant operating and financial restrictions on our ability to, among other things:
•
incur or guarantee additional debt;
•
pay dividends and make other distributions
to our shareholders;
•
create or incur certain liens;
•
make certain loans, acquisitions, capital expenditures or investments;
•
engage in sales of assets and subsidiary stock;
•
enter
into sale/leaseback transactions;
•
enter into transactions with affiliates; and
•
transfer all or substantially all of our assets or enter into merger or consolidation transactions.
In addition, the credit agreement governing our ABL Facility requires us to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 at any time when the availability is less than the greater of (x) $35 and (y) 12.5% of the lesser of the borrowing base and the total
ABL Facility commitments at such time. The fixed charge coverage ratio under the credit agreement governing the ABL Facility is generally defined as the ratio of (a) Adjusted EBITDA minus non-financed capital expenditures and cash taxes to (b) debt service plus cash interest expense plus certain restricted payments, each measured for the four most recent quarters for which financial statements have been delivered. We may not be able to satisfy such ratio in future periods. If we anticipate we will be unable to meet such ratio, we expect not to allow our availability under the ABL Facility to fall below such levels.
A breach of our fixed charge coverage ratio covenant, if in effect, would result in an event of default under our ABL Facility. Pursuant to the terms of our ABL Facility, our direct parent company will have the right, but not the obligation, to cure such default through the purchase of additional equity in up to
two of any four consecutive quarters and seven total during the term of the ABL Facility. If a breach of a fixed charge coverage ratio covenant is not cured or waived, or if any other event of default under the ABL Facility occurs, the lenders under such credit facility:
•
would not be required to lend any additional amounts to us;
•
could elect to declare all borrowings outstanding under the ABL Facility, together with accrued and unpaid interest and fees, due and payable and could demand cash collateral for all letters of credit
issued thereunder;
•
could apply all of our available cash that is subject to the cash sweep mechanism of the ABL Facility to repay these borrowings; and/or
•
could prevent us from making payments on our notes;
any or all of which could result in an event of default under our notes.
The ABL Facility provides for “springing control” over the cash in our deposit accounts constituting collateral for the ABL Facility, and such cash management arrangements includes a cash sweep at any time that availability under the ABL Facility is less than the greater of (x) $35 and (y) 12.5% of the lesser of the borrowing base and the total ABL Facility commitments at such time. Such cash sweep, if in effect, will cause all our available cash to be applied to outstanding borrowings under our ABL Facility. If we satisfy the conditions to borrowings under the ABL Facility while any such cash sweep is in effect, we may be able to make additional borrowings under the ABL Facility to satisfy our working capital and other operational needs. If we do not satisfy the conditions to borrowing, we will not be permitted to make additional borrowings under our ABL Facility, and we will not
have sufficient cash to satisfy our working capital and other operational needs.
In addition, the terms governing our indebtedness limit our ability to sell assets and also restrict the use of proceeds from that sale. We may be unable to sell assets quickly enough or for sufficient amounts to enable us to meet our obligations. Furthermore, a substantial portion of our assets is, and may continue to be, intangible assets. Therefore, it may be difficult for us to pay our consolidated debt obligations in the event of an acceleration of any of our consolidated indebtedness.
Repayment of our debt, including required principal and interest payments, depends on cash flows generated by our subsidiaries, which may be subject to limitations beyond our control.
Our
subsidiaries own a significant portion of our consolidated assets and conduct a significant portion of our consolidated operations. Repayment of our indebtedness depends, to a significant extent, on the generation of cash flows and the ability of our subsidiaries to make cash available to us by dividend, debt repayment or otherwise. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments on our indebtedness. Each subsidiary is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from subsidiaries.
While there are limitations on the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make intercompany payments, these limitations are subject to certain qualifications and exceptions. In the event that we are unable to receive distributions from our subsidiaries, we may be unable to make required principal and interest payments on our indebtedness.
A downgrade in our debt ratings could restrict our access to, and negatively impact the terms of, current or future financings or trade credit.
Standard & Poor’s Ratings Services (“S&P”) and Moody’s Investors Service (“Moody’s”) maintain credit ratings on us and certain of our debt. Each
of these ratings is currently below investment grade. Any decision by these or other ratings agencies to downgrade such ratings in the future could restrict our access to, and negatively impact the terms of, current or future financings and trade credit extended by our suppliers of raw materials or other vendors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
* Attached as Exhibit 101 to this report are documents formatted in XBRL (Extensible Business Reporting Language). The financial information in the XBRL-related documents is “unaudited”
or “unreviewed.”
† Represents a management contract or compensatory plan or arrangement.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
