UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2019
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 1-71
_______________________________________
HEXION INC.
(Exact name of registrant as specified in its charter)
________________________________________
New Jersey | 13-0511250 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
180 East Broad St., Columbus, OH 43215 | 614-225-4000 | |
(Address of principal executive offices including zip code) | (Registrant’s telephone number including area code) |
(Former name, former address and former fiscal year, if changed since last report) |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
None | None |
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 o No x
Explanatory Note: While the registrant is not subject to the filing requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, it has filed all reports required to be filed by such filing requirements during the preceding 12 months.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit 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, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | o | Accelerated filer | o | |||
Non-accelerated filer | x | 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.
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes x No o
Number of shares of common stock, par value $0.01 per share, outstanding as of the close of business on November 1, 2019: 100
HEXION INC.
INDEX
Page | ||
PART I – FINANCIAL INFORMATION | ||
Item 1. | Hexion Inc. Condensed Consolidated Financial Statements (Unaudited) | |
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II – OTHER INFORMATION | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. |
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
HEXION INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
Successor | Predecessor | |||||||
(In millions, except share data) | September 30, 2019 | December 31, 2018 | ||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents (including restricted cash of $15) | $ | 108 | $ | 128 | ||||
Accounts receivable (net of allowance for doubtful accounts of $1 and $16, respectively) | 471 | 412 | ||||||
Inventories: | ||||||||
Finished and in-process goods | 241 | 240 | ||||||
Raw materials and supplies | 101 | 94 | ||||||
Other current assets | 62 | 57 | ||||||
Total current assets | 983 | 931 | ||||||
Investment in unconsolidated entities | 18 | 19 | ||||||
Deferred tax assets | 5 | — | ||||||
Other long-term assets | 49 | 34 | ||||||
Property and equipment: | ||||||||
Land | 110 | 89 | ||||||
Buildings | 165 | 285 | ||||||
Machinery and equipment | 1,315 | 2,293 | ||||||
1,590 | 2,667 | |||||||
Less accumulated depreciation | (40 | ) | (1,826 | ) | ||||
1,550 | 841 | |||||||
Operating lease assets (see Note 10) | 125 | — | ||||||
Goodwill | 178 | 109 | ||||||
Other intangible assets, net | 1,193 | 27 | ||||||
Total assets | $ | 4,101 | $ | 1,961 | ||||
Liabilities and Deficit | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 276 | $ | 384 | ||||
Debt payable within one year | 87 | 3,716 | ||||||
Interest payable | 26 | 82 | ||||||
Income taxes payable | 17 | 5 | ||||||
Accrued payroll and incentive compensation | 50 | 52 | ||||||
Current portion of operating lease liabilities (see Note 10) | 23 | — | ||||||
Other current liabilities | 99 | 106 | ||||||
Total current liabilities | 578 | 4,345 | ||||||
Long-term liabilities: | ||||||||
Long-term debt | 1,702 | 99 | ||||||
Long-term pension and post employment benefit obligations | 248 | 221 | ||||||
Deferred income taxes | 162 | 15 | ||||||
Operating lease liabilities (see Note 10) | 88 | — | ||||||
Other long-term liabilities | 221 | 195 | ||||||
Total liabilities | 2,999 | 4,875 | ||||||
Commitments and contingencies (see Note 11) | ||||||||
Equity (Deficit) | ||||||||
Common stock (Successor)—$0.01 par value; 100 shares authorized, issued and outstanding September 30, 2019 | — | — | ||||||
Paid-in capital (Successor) | 1,162 | — | ||||||
Common stock (Predecessor)—$0.01 par value; 300,000,000 shares authorized, 170,605,906 issued and 82,556,847 outstanding December 31, 2018 | — | 1 | ||||||
Paid-in capital (Predecessor) | — | 526 | ||||||
Treasury stock (Predecessor), at cost—88,049,059 shares at December 31, 2018 | — | (296 | ) | |||||
Accumulated other comprehensive loss | (16 | ) | (18 | ) | ||||
Accumulated deficit | (43 | ) | (3,125 | ) | ||||
Total Hexion Inc. equity (deficit) | 1,103 | (2,912 | ) | |||||
Noncontrolling interest | (1 | ) | (2 | ) | ||||
Total equity (deficit) | 1,102 | (2,914 | ) | |||||
Total liabilities and equity (deficit) | $ | 4,101 | $ | 1,961 |
See Notes to Condensed Consolidated Financial Statements
3
HEXION INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||
(In millions) | July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, 2018 | July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | |||||||||||||||||||
Net sales | $ | 836 | $ | — | $ | 952 | $ | 836 | $ | 1,778 | $ | 2,893 | |||||||||||||
Cost of sales (exclusive of depreciation and amortization shown below, see Note 2) | 710 | — | 773 | 710 | 1,462 | 2,343 | |||||||||||||||||||
Selling, general and administrative expense (see Note 2) | 69 | — | 68 | 69 | 145 | 217 | |||||||||||||||||||
Depreciation and amortization (see Note 2) | 55 | — | 27 | 55 | 52 | 85 | |||||||||||||||||||
Gain on disposition | — | — | — | — | — | (44 | ) | ||||||||||||||||||
Asset impairments | — | — | 3 | — | — | 28 | |||||||||||||||||||
Business realignment costs | 13 | — | 5 | 13 | 15 | 19 | |||||||||||||||||||
Other operating expense, net | 5 | — | 6 | 5 | 16 | 26 | |||||||||||||||||||
Operating (loss) income | (16 | ) | — | 70 | (16 | ) | 88 | 219 | |||||||||||||||||
Interest expense, net | 28 | — | 83 | 28 | 89 | 250 | |||||||||||||||||||
Other non-operating expense (income), net | 4 | — | (1 | ) | 4 | (11 | ) | 6 | |||||||||||||||||
Reorganization items, net (see Note 5) | — | (3,261 | ) | — | — | (3,105 | ) | — | |||||||||||||||||
(Loss) income before income tax and earnings from unconsolidated entities | (48 | ) | 3,261 | (12 | ) | (48 | ) | 3,115 | (37 | ) | |||||||||||||||
Income tax (benefit) expense | (4 | ) | 207 | 6 | (4 | ) | 222 | 17 | |||||||||||||||||
(Loss) income before earnings from unconsolidated entities | (44 | ) | 3,054 | (18 | ) | (44 | ) | 2,893 | (54 | ) | |||||||||||||||
Earnings from unconsolidated entities, net of taxes | 1 | — | — | 1 | 2 | 2 | |||||||||||||||||||
Net (loss) income | (43 | ) | 3,054 | (18 | ) | (43 | ) | 2,895 | (52 | ) | |||||||||||||||
Net income attributable to noncontrolling interest | — | — | — | — | (1 | ) | (1 | ) | |||||||||||||||||
Net (loss) income attributable to Hexion Inc. | $ | (43 | ) | $ | 3,054 | $ | (18 | ) | $ | (43 | ) | $ | 2,894 | $ | (53 | ) |
See Notes to Condensed Consolidated Financial Statements
4
HEXION INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (Unaudited)
Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||
(In millions) | July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, 2018 | July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | |||||||||||||||||||
Net (loss) income | $ | (43 | ) | $ | 3,054 | $ | (18 | ) | $ | (43 | ) | $ | 2,895 | $ | (52 | ) | |||||||||
Other comprehensive loss, net of tax: | |||||||||||||||||||||||||
Foreign currency translation adjustments | (16 | ) | — | (6 | ) | (16 | ) | (8 | ) | (8 | ) | ||||||||||||||
Other comprehensive loss | (16 | ) | — | (6 | ) | (16 | ) | (8 | ) | (8 | ) | ||||||||||||||
Comprehensive (loss) income | (59 | ) | 3,054 | (24 | ) | (59 | ) | 2,887 | (60 | ) | |||||||||||||||
Comprehensive income attributable to noncontrolling interest | — | — | — | — | (1 | ) | (1 | ) | |||||||||||||||||
Comprehensive (loss) income attributable to Hexion Inc. | $ | (59 | ) | $ | 3,054 | $ | (24 | ) | $ | (59 | ) | $ | 2,886 | $ | (61 | ) |
See Notes to Condensed Consolidated Financial Statements
5
HEXION INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Successor | Predecessor | |||||||||||
(In millions) | July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | |||||||||
Cash flows provided by (used in) operating activities | ||||||||||||
Net (loss) income | $ | (43 | ) | $ | 2,895 | $ | (52 | ) | ||||
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: | ||||||||||||
Depreciation and amortization | 55 | 52 | 85 | |||||||||
Non-cash asset impairments | — | — | 30 | |||||||||
Non-cash reorganization items, net | — | (3,293 | ) | — | ||||||||
Deferred tax (benefit) expense | (8 | ) | 156 | — | ||||||||
Loss on sale of assets | — | 3 | 3 | |||||||||
Gain on disposition | — | — | (44 | ) | ||||||||
Amortization of deferred financing fees | — | — | 13 | |||||||||
Unrealized foreign currency losses (gains) | 6 | (7 | ) | 12 | ||||||||
Financing fees included in net loss | — | 136 | — | |||||||||
Other non-cash adjustments | 3 | (2 | ) | — | ||||||||
Net change in assets and liabilities: | ||||||||||||
Accounts receivable | 22 | (88 | ) | (25 | ) | |||||||
Inventories | 29 | (19 | ) | (91 | ) | |||||||
Accounts payable | (67 | ) | (28 | ) | 10 | |||||||
Income taxes payable | — | 18 | 4 | |||||||||
Other assets, current and non-current | 10 | (7 | ) | (20 | ) | |||||||
Other liabilities, current and long-term | 18 | 11 | 26 | |||||||||
Net cash provided by (used in) operating activities | 25 | (173 | ) | (49 | ) | |||||||
Cash flows used in investing activities | ||||||||||||
Capital expenditures | (22 | ) | (43 | ) | (62 | ) | ||||||
Proceeds from disposition, net | — | — | 49 | |||||||||
Proceeds from sale of assets, net | — | 1 | 1 | |||||||||
Net cash used in investing activities | (22 | ) | (42 | ) | (12 | ) | ||||||
Cash flows (used in) provided by financing activities | ||||||||||||
Net short-term debt (repayments) borrowings | (6 | ) | (4 | ) | 6 | |||||||
Borrowings of long-term debt | 91 | 2,313 | 425 | |||||||||
Repayments of long-term debt | (100 | ) | (2,261 | ) | (343 | ) | ||||||
Proceeds from rights offering | — | 300 | — | |||||||||
Financing fees paid | (2 | ) | (136 | ) | (1 | ) | ||||||
Net cash (used in) provided by financing activities | (17 | ) | 212 | 87 | ||||||||
Effect of exchange rates on cash and cash equivalents, including restricted cash | (3 | ) | — | (4 | ) | |||||||
Change in cash and cash equivalents, including restricted cash | (17 | ) | (3 | ) | 22 | |||||||
Cash, cash equivalents and restricted cash at beginning of period | 125 | 128 | 115 | |||||||||
Cash, cash equivalents and restricted cash at end of period | $ | 108 | $ | 125 | $ | 137 | ||||||
Supplemental disclosures of cash flow information | ||||||||||||
Cash paid for: | ||||||||||||
Interest, net | $ | 3 | $ | 71 | $ | 219 | ||||||
Income taxes, net | 4 | 10 | 12 | |||||||||
Reorganization items, net | — | 188 | — |
See Notes to Condensed Consolidated Financial Statements
6
HEXION INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER’S EQUITY (DEFICIT) (Unaudited)
(In millions) | Common Stock | Paid-in Capital | Treasury Stock | Accumulated Other Comprehensive Loss | Accumulated (Deficit) Equity | Total Hexion Inc. (Deficit) Equity | Noncontrolling Interest | Total Shareholder’s (Deficit) Equity | |||||||||||||||||||||||
Predecessor | |||||||||||||||||||||||||||||||
Balance at December 31, 2017 | $ | 1 | $ | 526 | $ | (296 | ) | $ | (8 | ) | $ | (2,964 | ) | $ | (2,741 | ) | $ | (1 | ) | $ | (2,742 | ) | |||||||||
Net (loss) income | — | — | — | — | (53 | ) | (53 | ) | 1 | (52 | ) | ||||||||||||||||||||
Other comprehensive loss | — | — | — | (8 | ) | — | (8 | ) | — | (8 | ) | ||||||||||||||||||||
Impact of change in accounting policy | — | — | — | — | 1 | 1 | — | 1 | |||||||||||||||||||||||
Balance at September 30, 2018 | $ | 1 | $ | 526 | $ | (296 | ) | $ | (16 | ) | $ | (3,016 | ) | $ | (2,801 | ) | $ | — | $ | (2,801 | ) | ||||||||||
Balance at June 30, 2018 | $ | 1 | $ | 526 | $ | (296 | ) | $ | (10 | ) | $ | (2,998 | ) | $ | (2,777 | ) | $ | — | $ | (2,777 | ) | ||||||||||
Net (loss) income | — | — | — | — | (18 | ) | (18 | ) | — | (18 | ) | ||||||||||||||||||||
Other comprehensive loss | — | — | — | (6 | ) | — | (6 | ) | — | (6 | ) | ||||||||||||||||||||
Balance at September 30, 2018 | $ | 1 | $ | 526 | $ | (296 | ) | $ | (16 | ) | $ | (3,016 | ) | $ | (2,801 | ) | $ | — | $ | (2,801 | ) | ||||||||||
Balance at December 31, 2018 | $ | 1 | $ | 526 | $ | (296 | ) | $ | (18 | ) | $ | (3,125 | ) | $ | (2,912 | ) | $ | (2 | ) | $ | (2,914 | ) | |||||||||
Net (loss) income | — | — | — | — | (160 | ) | (160 | ) | 1 | (159 | ) | ||||||||||||||||||||
Other comprehensive loss | — | — | — | (8 | ) | — | (8 | ) | — | (8 | ) | ||||||||||||||||||||
Balance at June 30, 2019 | $ | 1 | $ | 526 | $ | (296 | ) | $ | (26 | ) | $ | (3,285 | ) | $ | (3,080 | ) | $ | (1 | ) | $ | (3,081 | ) | |||||||||
Elimination of Predecessor equity | (1 | ) | (526 | ) | 296 | — | 231 | — | — | — | |||||||||||||||||||||
Elimination of Predecessor accumulated other comprehensive loss | — | — | — | 26 | — | 26 | — | 26 | |||||||||||||||||||||||
Net income | — | — | — | — | 3,054 | 3,054 | — | 3,054 | |||||||||||||||||||||||
Balance at July 1, 2019 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | (1 | ) | $ | (1 | ) | |||||||||||||
Issuance of Successor Company common stock | — | 1,157 | — | — | — | 1,157 | — | 1,157 | |||||||||||||||||||||||
Successor | |||||||||||||||||||||||||||||||
Balance at July 2, 2019 | $ | — | $ | 1,157 | $ | — | $ | — | $ | — | $ | 1,157 | $ | (1 | ) | $ | 1,156 | ||||||||||||||
Net loss | — | — | — | — | (43 | ) | (43 | ) | — | (43 | ) | ||||||||||||||||||||
Stock-based compensation expense | — | 5 | — | — | — | 5 | — | 5 | |||||||||||||||||||||||
Other comprehensive loss | — | — | — | (16 | ) | — | (16 | ) | — | (16 | ) | ||||||||||||||||||||
Balance at September 30, 2019 | $ | — | $ | 1,162 | $ | — | $ | (16 | ) | $ | (43 | ) | $ | 1,103 | $ | (1 | ) | $ | 1,102 |
See Notes to Condensed Consolidated Financial Statements
7
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 adhesive, coatings, composites and 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 September 30, 2019, the Company had three reportable segments: Epoxy, Phenolic and Coating Resins; Forest Products Resins; and Corporate and Other.
As a result of the Company’s reorganization and emergence from Chapter 11 (as defined in Note 3) on the morning of July 1, 2019 (the “Effective Date”), the Company’s direct parent is Hexion Intermediate Holding 2, Inc. (“Hexion Intermediate”), a holding company and wholly owned subsidiary of Hexion Intermediate Holding 1, Inc., a holding company and wholly owned subsidiary of Hexion Holdings Corporation, the ultimate parent of Hexion (“Hexion Holdings”). Prior to its reorganization, the Company’s parent was Hexion LLC, a holding company and wholly owned subsidiary of Hexion Holdings LLC (now known as Hexion TopCo, LLC or “TopCo”), the previous ultimate parent entity of Hexion, which was controlled by investment funds managed by affiliates of Apollo Management Holdings, L.P. (together with Apollo Global Management, Inc. and its subsidiaries, “Apollo”). On the Effective Date, the Company’s existing common stock were cancelled and 100 new shares of common stock were issued at a par value of $0.01 to the Company’s new direct parent Hexion Intermediate in accordance with the Plan (as defined in Note 3). See Note 3 for more information.
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 (“SEC”), 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.
Going Concern
The Company filed for Chapter 11 bankruptcy protection on April 1, 2019 (the “Petition Date”) and as the Company previously disclosed, based on its financial condition and its projected operating results, the defaults under its debt agreements, and the risks and uncertainties surrounding its Chapter 11 proceedings (see Note 3), that there was substantial doubt as to the Company’s ability to continue as a going concern as of the issuance of the Company’s 2018 Annual Report on Form 10-K. After the Company’s emergence from Chapter 11 on July 1, 2019, based on its new capital structure, liquidity position and projected operating results, the Company expects to continue as a going concern for the next twelve months. See Note 3 for more information.
Financial Reporting in Reorganization
Effective on the Petition Date, the Company applied Accounting Standard Codification, No. 852, “Reorganizations,” (“ASC 852”) which is applicable to companies under Chapter 11 bankruptcy protection. It requires the financial statements for periods subsequent to the Chapter 11 filing to distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Expenses, realized gains and losses, and provisions for losses that are directly associated with reorganization proceedings must be reported separately as “Reorganization items, net” in the Condensed Consolidated Statements of Operations. In addition, the balance sheet must distinguish debtor pre-petition liabilities subject to compromise (“LSTC”) from liabilities of non-filing entities, pre-petition liabilities that are not subject to compromise and post-petition liabilities in the accompanying Condensed Consolidated Balance Sheet. LSTC are pre-petition obligations that are not fully secured and have at least a possibility of not being repaid at the full claim amount. LSTC related to debt, its related interest payable and certain affiliate payables were settled in accordance with the Plan, as applicable, on or shortly after the Company emerged from Chapter 11 bankruptcy on July 1, 2019. As of July 1, 2019, all remaining liabilities subject to compromise were not impaired and remain on the Company’s Condensed Consolidated Balance Sheets.
The Company’s Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018 included in this Quarterly Report on Form 10-Q were prepared under the basis of accounting assuming that the Company will continue as a going concern, which contemplated continuity of operations, realization of assets and satisfaction of liabilities and commitments in the normal course of business.
8
Fresh Start Accounting
On the Effective Date, in accordance with ASC 852, the Company applied fresh start accounting to its financial statements as (i) the holders of existing voting shares of the Company prior to its emergence received less than 50% of the voting shares of the Company outstanding following its emergence from bankruptcy and (ii) the reorganization value of the Company’s assets immediately prior to confirmation of the plan of reorganization was less than the post-petition liabilities and allowed claims. Fresh start accounting was applied to the Company’s consolidated financial statements as of July 1, 2019, the date it emerged from bankruptcy, which resulted in a new basis of accounting and the Company became a new entity for financial reporting purposes. As a result, the Company allocated the reorganization value of the Company to its individual assets based on their estimated fair values. Reorganization value represents the fair value of the Company’s assets before considering liabilities. The excess reorganization value over the fair value of identified tangible and intangible assets was reported as goodwill.
As a result of the application of fresh start accounting and the effects of the implementation of the Plan, the Condensed Consolidated Financial Statements after the Effective Date are not comparable with the Condensed Consolidated Financial Statements prior to that date. References to “Successor” or “Successor Company” relate to the financial position and results of operations of the Company after the Effective Date. References to “Predecessor” or “Predecessor Company” refer to the financial position and results of operations of the Company on or before the Effective Date. Refer to Note 4 for more information.
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. A contract asset balance of $10 and $11 is recorded within “Other current assets” at September 30, 2019 and December 31, 2018, respectively, in the unaudited Condensed Consolidated Balance Sheet. Refer to Note 15 for additional discussion of the Company’s net sales by reportable segment disaggregated by geographic region.
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.
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 balance of $15 as of both September 30, 2019 and December 31, 2018 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.”
Income Statement Presentation— As a result of the application of fresh start accounting upon the Company’s emergence from Chapter 11, the Company elected to change its income statement presentation of depreciation and amortization expense beginning in the Successor period July 2, 2019 through September 30, 2019 and all periods thereafter. As a result, “Depreciation and amortization” has been added as a line item in the unaudited Condensed Consolidated Statements of Operations and “Cost of sales” and “Selling, general and administrative expense” will now exclude all depreciation and amortization expense. In addition, the Company will no longer present “Gross profit” as a subtotal caption. For comparability purposes, this presentation change will be applied to all comparable periods presented in this Quarterly Report on Form 10-Q and all future filings.
The effects of the income statement presentation change on the Predecessor Company’s previously reported unaudited Condensed Consolidated Statements of Operations are presented below. As noted above, a component of this presentation change is removal of the “Gross profit” subtotal.
Unaudited Condensed Consolidated Statements of Operations for the period from January 1, 2019 to July 1, 2019: | ||||||||
Previous Presentation Method | Effect of Presentation Change | As Reported | ||||||
Cost of sales | 1,507 | (45 | ) | 1,462 | ||||
Selling, general and administrative expense | 152 | (7 | ) | 145 | ||||
Depreciation and amortization | — | 52 | 52 |
9
Unaudited Condensed Consolidated Statements of Operations for the three months ended September 30, 2018: | ||||||||
As Previously Reported | Effect of Presentation Change | As Reported | ||||||
Cost of sales | 796 | (23 | ) | 773 | ||||
Selling, general and administrative expense | 72 | (4 | ) | 68 | ||||
Depreciation and amortization | — | 27 | 27 |
Unaudited Condensed Consolidated Statements of Operations for the nine months ended September 30, 2018: | ||||||||
As Previously Reported | Effect of Presentation Change | As Reported | ||||||
Cost of sales | 2,414 | (71 | ) | 2,343 | ||||
Selling, general and administrative expense | 231 | (14 | ) | 217 | ||||
Depreciation and amortization | — | 85 | 85 |
Goodwill—Upon the application of fresh start accounting, the excess of reorganization value over the fair value of identified tangible and intangible assets of $178 is carried as “Goodwill” in the Consolidated Balance Sheets, and the Company does not amortize goodwill. As of September 30, 2019, the Company has goodwill of $141 and $37 for its Forest Products Resins and Epoxy, Phenolic and Coating Resins segments, respectively. The Company reviews goodwill for impairment annually during the fourth quarter by comparing the estimated fair value to the book value of each reporting unit utilizing either a qualitative or quantitative approach. Goodwill impairment is also tested as needed upon the occurrence of an impairment triggering event.
Intangible assets - Separately identifiable intangible assets that are used in operations of the business are recorded at cost (fair value at the time of acquisition) and reported as “Other intangible assets, net” in the Condensed Consolidated Balance Sheets. Costs to renew or extend the term of identifiable intangible assets are expensed as incurred. Intangible assets with determinable lives are amortized on a straight-line basis over the shorter of the legal or useful life of the assets, which range from 15 to 25 years.
As part of fresh start accounting, on the Effective Date, the Company established new intangible assets at fair value and the Predecessor Company’s intangible asset accumulated amortization was eliminated. As of September 30, 2019, the Company’s intangible assets with identifiable useful lives consisted of the following:
Customer relationships | $ | 968 | |
Trademarks | 110 | ||
Technology | 141 | ||
Accumulated amortization (1) | (26 | ) | |
Other intangible assets, net | $ | 1,193 |
(1) | The impact of foreign currency translation on intangible assets is included in accumulated amortization. |
Derivative Financial Instruments and Hedging Activities—Periodically, the Company is a party to forward exchange contracts, foreign exchange rate swaps, interest rate swaps, natural gas futures and electricity forward contracts to reduce its cash flow exposure to changes in interest rates and natural gas and electricity prices. The Company does not hold or issue derivative financial instruments for trading purposes. All derivatives, whether designated as hedging relationships or not, are recorded on our balance sheet at fair value. For fair value and cash flow hedges qualifying for hedge accounting, the Company formally documents at inception the relationship between hedging instruments and hedged items, the risk management objective, strategy and the evaluation of effectiveness for the hedge transaction. If the derivative is designated as a cash flow hedge, changes in the fair value of the derivative are recorded in accumulated other comprehensive income, to the extent effective, and will be recognized in the Consolidated Statement of Operations when the hedged item affects earnings. The effectiveness of a cash flow hedging relationship is established at the inception of the hedge, and after inception the Company performs effectiveness assessments at least every three months. For a derivative that does not qualify or has not been designated as a hedge, changes in fair value are recognized in earnings.
Turnaround Costs—The Company periodically performs procedures at its major production facilities to extend the useful life, increase output and efficiency and ensure the long-term reliability and safety of plant machinery (“turnaround” or “turnaround costs”). As a result of the application of fresh start accounting upon the Company’s emergence from Chapter 11, the Successor Company adopted an accounting policy to capitalize certain turnaround costs and amortize on a straight-line basis over the estimated period until the next turnaround. Costs for routine repairs and maintenance are expensed as incurred. Capitalized turnaround costs were less than $1 at September 30, 2019 and are included in “Other long-term assets”.
Subsequent Events—The Company has evaluated events and transactions subsequent to September 30, 2019 through the date of issuance of its unaudited Condensed Consolidated Financial Statements.
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Recently Issued Accounting Standards
Newly Adopted 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 was effective for annual and interim periods beginning on or after December 15, 2018.
The Company adopted ASU 2016-02 using a modified retrospective adoption method at January 1, 2019. Under this method of adoption, there is no impact to the comparative Condensed Consolidated Statement of Operations and the Condensed Consolidated Balance Sheets. The Company also determined that there was no cumulative-effect adjustment to beginning retained earnings on the Condensed Consolidated Balance Sheet. The Company will continue to report periods prior to January 1, 2019 in its financial statements under prior guidance as outlined in Accounting Standards Codification Topic 840, “Leases”. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which allowed the Company to carry forward its historical lease classification. The Company also elected the hindsight practical expedient to determine the lease term for existing leases. Adoption of the new standard resulted in the recording of right of use assets and offsetting lease liabilities of $105 as of January 1, 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 adopted ASU 2018-02 as of January 1, 2019 and it did not have a material impact on the financial statements.
In August 2017, the FASB issued Accounting Standards Board Update No. 2017-12: Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). The amendments in this ASU 2017-12 better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships as well as the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements to increase the understandability of the results of an entity’s intended hedging strategies. The amendments in ASU 2017-12 also include certain targeted improvements to ease the application of current guidance related to the assessment of hedge effectiveness. The amendments in ASU 2017-12 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company adopted ASU 2017-12 as of January 1, 2019, and the initial adoption had no impact on the Company’s financial statements.
In October 2018, the FASB issued ASU 2018-16: Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes (“ASU 2018-16”). ASU 2018-16 permits the use of the Overnight Index Swap (“OIS”) based on the Secured Overnight Financing Rate (“SOFR”) as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the interest rates on direct Treasury obligations of the U.S. government (“UST”), the London Interbank Offered Rate (“LIBOR”) swap rate, the OIS rate based on the Fed Funds Effective Rate, and the Securities Industry and Financial Markets Association (“SIFMA”) Municipal Swap Rate. The amendments in this ASU 2018-16 update permit the OIS rate based on SOFR as a U.S. benchmark interest rate. Including the OIS rate based on SOFR as an eligible benchmark interest rate during the early stages of the marketplace transition will facilitate the LIBOR to SOFR transition and provide sufficient lead time for entities to prepare for changes to interest rate risk hedging strategies for both risk management and hedge accounting purposes. For entities that have not already adopted Update 2017-12, the amendments in this Update are required to be adopted concurrently with the amendments in ASU 2017-12. The Company has adopted ASU 2018-16 as of January 1, 2019 and it did not have a material impact on the financial statements.
Recently Issued Accounting Standards
In June 2016, the FASB issued ASU 2016-13: Financial Instruments - Credit Losses (Topic 820): Measurement of Credit Losses on Financial Instruments, (“ASU 2016-13”). The amendments in this update replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. New disclosures are also required with this standard. The standard is effective for annual and interim periods beginning after December 15, 2019. The Company is currently assessing the potential impact of adopting this standard.
In August 2018, the FASB issued ASU 2018-15: Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract (“ASU 2018-15”). ASU 2018-15 align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The standard is effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted and an entity can elect to apply the new guidance on a prospective or retrospective basis. The Company is currently assessing the potential impact of adopting this standard.
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3. Emergence from Chapter 11 Bankruptcy
Bankruptcy Petitions and Emergence from Chapter 11
On the Petition Date, the Company, Hexion Holdings LLC, Hexion LLC and certain of the Company’s subsidiaries (collectively, the “Debtors”) filed voluntary petitions (the “Bankruptcy Petitions”) for reorganization under Chapter 11 (“Chapter 11”) of the U.S. Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware, (the “Bankruptcy Court”). The Chapter 11 proceedings were jointly administered under the caption In re Hexion TopCo, LLC, No. 19-10684 (the “Chapter 11 Cases”). The Debtors continued to operate their businesses as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court.
On June 25, 2019, the Court entered an order (the “Confirmation Order”) confirming the Second Amended Joint Chapter 11 Plan of Reorganization of Hexion Holdings LLC and its Debtor Affiliates under Chapter 11 (the “Plan”). On the morning of July 1, 2019, in accordance with the terms of the Plan and the Confirmation Order, the Plan became effective and the Debtors emerged from bankruptcy (the “Emergence”).
Debtor-in-Possession Financing
DIP Term Loan Facility
In connection with the filing of the Bankruptcy Petitions, on April 3, 2019, the Company entered into a New York law-governed senior secured term loan agreement (the “DIP Term Loan Facility”), among Hexion LLC (“Holdings”), the Company, Hexion International Holdings B.V. (the “Dutch Borrower”), which was amended on April 17, 2019, the lenders party thereto and JPMorgan Chase Bank, N.A. (“JPMorgan”), as administrative agent and collateral agent (the “Term Loan Agent”). The proceeds of the DIP Term Loan Facility were loaned by the Dutch Borrower to the Company pursuant to an intercompany loan agreement (the “Intercompany Loan Agreement”) and were used in part to repay in full the outstanding obligations under the Company’s existing asset-based revolving credit agreement ABL Facility (the “ABL Facility”). As of June 30, 2019, the Company had $350 borrowings outstanding under DIP Term Loan Facility. The Company’s remaining obligations under the DIP Term Loan Facility were repaid in full and the DIP Term Loan Facility was terminated upon consummation of the Plan by the Company on July 1, 2019.
DIP ABL Facility
In connection with the filing of the Bankruptcy Petitions, on April 3, 2019, Holdings, the Company and certain of its subsidiaries (collectively, the “Borrowers”), the lenders party thereto, JPMorgan, as administrative agent, and JPMorgan, as collateral agent (the “DIP ABL Collateral Agent” and together with the DIP Term Loan Facility, the “Credit Facilities”), entered into an amended and restated senior secured debtor-in-possession asset-based revolving credit agreement, which was further amended on May 10, 2019 (the “DIP ABL Facility”), which amended and restated the Company’s ABL Facility among Holdings, the Company, the Borrowers, the lenders party thereto, JPMorgan, as administrative agent, and JPMorgan, as collateral agent. As of June 30, 2019, the Company had no outstanding borrowings under the DIP ABL Facility and the DIP ABL Facility was terminated upon consummation of the Plan by the Company on July 1, 2019.
Restructuring Support Agreement
On April 1, 2019, the Debtors entered into a Restructuring Support Agreement (the “Support Agreement”) with equityholders that beneficially owned more than a majority of the Company’s outstanding equity (the “Consenting Sponsors”) and creditors that held more than a majority of the aggregate outstanding principal amount of each of the Company’s 6.625% Notes and 10.00% Notes, (the “1L Notes”), 13.750% 1.5 lien notes due 2022 (the “1.5L Notes”), 9.00% second lien notes due 2020 (the “2L Notes”), 9.20% Debentures due 2021 and/or 7.875% Debentures due 2023 issued by Borden, Inc. (the “Unsecured Notes”) (the “Consenting Creditors” and, together with the Consenting Sponsors, the “Consenting Parties”). The Support Agreement incorporated the economic terms regarding a restructuring of the Debtors agreed to by the parties reflected in the Support Agreement. The restructuring transactions were effectuated through the Plan.
Equity Backstop Agreement and Rights Offering
On April 25, 2019, the Debtors entered into the Equity Backstop Commitment Agreement, as subsequently amended (the “Equity Backstop”), among the Debtors and the equity backstop parties party thereto (the “Equity Backstop Parties”). The Equity Backstop provides that upon the satisfaction of certain terms and conditions, including the confirmation of the Plan, the Company will have the option to require the Equity Backstop Parties to backstop the common stock of the reorganized Company (the “New Common Stock”) that is not otherwise purchased in connection with the $300 rights offerings for New Common Stock of Hexion Holdings (the “Rights Offering”) to be made in connection with the Plan (the “Unsubscribed Shares”) on a several, and not joint and several, basis. In consideration for their commitment to purchase the Unsubscribed Shares, the Equity Backstop Parties will be paid a Premium of 8% of the Rights Offering Amount (the “Equity Backstop Premium”), which premium was earned in full upon entry of the Equity Backstop Approval Order and which is payable either in Cash or in New Common Equity at the option of each Equity Backstop Party. Pursuant to the terms of the Equity Backstop, the Equity Backstop Premium was deemed earned, nonrefundable and non-avoidable upon entry of the approval order by the Court. The Company incurred $24 for the Equity Backstop Premium, which is included in “Reorganization items, net” in the unaudited Condensed Consolidated Statements of Operations. The Company paid the Equity Backstop Premium on the Effective Date in accordance with the Plan.
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Debt Backstop Agreement
On April 25, 2019, the Debtors entered into the Debt Backstop Commitment Agreement, as subsequently amended (the “Debt Backstop”), among the Debtors and the debt backstop parties party thereto (the “Debt Backstop Parties”). The Debt Backstop provides that upon satisfaction of certain terms and conditions, including the confirmation of the Plan, the Debt Backstop Parties will backstop the New Long-Term Debt on a several, and not joint and several, basis of an amount equal to such Debt Backstop Party’s commitment percentage, in exchange for (a) the Debt Backstop Premium of 3.375% of the backstop commitments thereunder payable either in Cash or in New Common Equity at the option of each Debt Backstop Party and (b) for certain Debt Backstop Parties, the Additional Debt Backstop Premium of 1.5% of the backstop commitments thereunder payable in Cash, both of which premiums (described in (a) and (b)) were earned in full upon entry of the Debt Backstop Approval Order. Pursuant to the terms of the Debt Backstop, the Backstop Commitment Premium was deemed earned, nonrefundable and non-avoidable upon entry of the approval order by the Court. The Company incurred $80 for the Backstop Commitment Premium, which is included in “Reorganization items, net” in the unaudited Condensed Consolidated Statements of Operations. The Company paid the Debt Backstop Premium on the Effective Date in accordance with the Plan.
Pre-Petition Claims
On June 7, 2019, the Debtors filed schedules of assets and liabilities and statements of financial affairs with the Court, which were amended on June 14, 2019. Prior to the Company’s emergence from Chapter 11 bankruptcy on the Effective Date, all pre-petition amounts were classified as “Liabilities subject to compromise” in the unaudited Condensed Consolidated Balance Sheets as of June 30, 2019 and have either been settled or reinstated pursuant to the terms of the Plan. See Note 4 for more information.
The Debt Instruments provide that as a result of the Bankruptcy Petitions the principal and interest due thereunder shall be immediately
due and payable. Any efforts to enforce such payment obligations under the Debt Instruments are automatically stayed as a result of the Bankruptcy Petitions and the creditors’ rights of enforcement in respect of the Debt Instruments are subject to the applicable provisions of the Bankruptcy Code. Upon Emergence on July 1, 2019, these automatic stay provisions are no longer in effect.
Emergence from Chapter 11 Bankruptcy
On July 1, 2019, the Plan became effective and the Debtors emerged from the Chapter 11 proceedings.
On or following the Effective Date, and pursuant to the terms of the Plan, the following occurred:
• | The restructuring of the Debtors’ pre-petition funded debt obligations with the proceeds of $1,658 in new long-term debt (“New Long-term Debt”) (see Note 9); |
• | A $300 Rights Offering for new common equity of Hexion Holdings; |
• | A percentage of the Rights Offering was issued in the form of warrants (“New Warrants”), these warrants represented 15% of the Rights Offering which are exercisable for shares of Common Stock, issued by Hexion Holdings under the Plan, and referred to as New Warrants under the Plan (together with New Common Stock, “Registrable Securities”); |
• | Certain of the Debtors entered into the $350 ABL Facility (see Note 9) ; |
• | General unsecured claims being paid in full or otherwise continuing unimpaired; |
• | Holders of claims with respect to the 1L Notes received their pro rata share of (a) cash in the amount of $1.450 billion (less the sum of adequate protection payments paid on account of the 1L Notes during the Chapter 11 cases), (b) 72.5% of new common equity of Hexion Holdings (“New Common Equity”) (subject to the Agreed Dilution), and (c) 72.5% of the rights to purchase additional New Common Equity pursuant to the Rights Offering. The dilution of the New Common Equity (“the Agreed Dilution”) resulted from the Rights Offering, the Management Incentive Plan (as defined in the Plan, 10% of the fully-diluted equity of Hexion Holdings is to be reserved for grant to key members of management and independent, non-employee members of the Board of Directors, (see Note 14 for further details on the Management Incentive Plan ); |
• | Holders of claims with respect to the 1.5L Notes, 2L Notes, and Unsecured Notes received their pro rata share of (a) 27.5% of the New Common Equity (subject to the Agreed Dilution) and (b) 27.5% of the rights to purchase additional New Common Equity pursuant to the Rights Offering; |
• | Holders of equity interests (i.e., any class of equity securities) in TopCo received no distributions and all such Equity Interests being cancelled; |
• | Reorganized Hexion issuing a $2.5 settlement note to the Consenting Sponsors; and |
• | Appointment of a new board of directors. |
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Cancellation of Prior Common Stock
In accordance with the Plan, each share of the Predecessor Company’s common stock outstanding prior to the Effective Date, including treasury stock, were canceled. Furthermore, all of the Company’s equity award agreements under prior incentive plans, and the awards granted pursuant thereto, were extinguished, canceled and discharged and have no further force or effect after the Effective Date. On the Effective Date, 100 new shares of common stock were issued at a par value of $0.01 to the Company’s new direct parent Hexion Intermediate in accordance with the Plan.
Issuance of New Common Stock
On the Effective Date, all previously issued and outstanding equity interests in TopCo were cancelled. Upon effectiveness of the Plan, Hexion Holdings issued 58,410,731 shares of a new class of common stock, par value $0.01 per share (“New Common Stock”), pursuant to the Rights Offering. The shares of New Common Stock were exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Section 1145 of the Bankruptcy Code, which generally exempts from such registration requirements the issuance of securities under a plan of reorganization.
New Warrant Agreement
In addition, Hexion Holdings entered into a warrant agreement (the “Warrant Agreement”) and upon effectiveness of the Plan, Hexion Holdings issued 10,307,778 New Warrants as a part of the Rights Offering on the Effective Date. The New Warrants represented 15% of the Rights Offering which are exercisable to purchase shares of New Common Stock. These New Warrants may be exercised, at any time on or after the initial exercise date for exercise price per share of the New Common Stock of $0.01. The Warrant Agreement contains customary anti-dilution adjustments in the event of any stock split, reverse stock split, reclassification, stock dividend or other distributions.
The holder or group of holders (the “Attribution Parties”) of New Warrants shall be permitted to exercise these New Warrants, at any time, in part or in whole, in amounts sufficient for the holder and Attribution Parties to maintain in the aggregate no less than the beneficial ownership limitation of 9.9% of the fully diluted shares outstanding. Fully diluted shares outstanding is calculated as (x) the aggregate number of shares of New Common Stock issued and outstanding plus (y) the aggregate number of shares of common stock issuable upon the conversion of any other issued and outstanding securities or rights convertible into, or exchangeable for (in each case, directly or indirectly), common stock (excluding, for the avoidance of doubt, any unexercised warrants or options to purchase common stock).
The New Warrants do not entitle the holder or group of holders of the New Warrants to any voting rights, dividends or other rights as a stockholder of the Company prior to exercise of the held New Warrants. If any shares of common stock are listed on a trading market, Hexion Holdings shall use its reasonable best efforts to cause the New Warrants shares issued upon exercise of these New Warrants to also be listed on such trading market, in accordance with the Warrant Agreement.
Registration Rights Agreement
On the Effective Date, Hexion Holdings entered into a registration rights agreement with certain of its stockholders (the “Registration Rights Agreement”).
Under the Registration Rights Agreement, upon delivery of a written notice by one or more stockholders holding, individually or in the aggregate, at least a majority of the outstanding Registrable Securities and New Warrants, voting together (as if such New Warrants had been exercised), Hexion Holdings is required to file a registration statement and effect an initial public offering and listing of its common stock, so long as the total offering size is at least $100 (a “Qualified IPO”).
Hexion Holdings is also required to file a registration statement at any time following 180 days after the closing of a Qualified IPO upon the delivery of a written notice by one or more stockholders proposing to sell, individually or in the aggregate, at least $50 of Registrable Securities. In addition, under the Registration Rights Agreement, Hexion Holdings is required to file a shelf registration statement as soon as practicable following the closing of a Qualified IPO to register the resale, on a delayed or continuous basis, of all Registrable Securities that have been timely designated for inclusion by the holders (specified in the Registration Rights Agreement). Any individual holder or holders of our outstanding common stock party thereto can demand up to four “shelf takedowns” in any 12-month period which may be conducted in underwritten offerings so long as the total offering size is at least $50. Furthermore, each stockholder party to the Registration Rights Agreement has unlimited piggyback registration rights with respect to underwritten offerings, subject to certain exceptions and limitations.
The foregoing registration rights are subject to certain cutback provisions and customary suspension/blackout provisions. Hexion Holdings has agreed to pay all registration expenses under the Registration Rights Agreement.
Generally, “Registrable Securities” under the Registration Rights Agreement includes New Common Equity issued under the Plan, except that “Registrable Securities” does not include securities that have been sold under an effective registration statement or Rule 144 under the Securities Act.
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4. Fresh Start Accounting
Upon emergence from bankruptcy, the Company applied fresh start accounting, in accordance with ASC 852, to its financial statements because (i) the holders of existing voting shares of the Predecessor Company prior to its emergence received less than 50% of the voting shares of the Successor Company outstanding following its emergence from bankruptcy and (ii) the reorganization value of the Company’s assets immediately prior to confirmation of the plan of reorganization was less than the post-petition liabilities and allowed claims. Fresh start accounting was applied to the Company’s consolidated financial statements as of the Emergence.
Under the principles of fresh start accounting, a new reporting entity was created, and, as a result, the Company allocated the reorganization value of the Company to its individual assets based on their estimated fair values in conformity with ASC 805, “Business Combinations”. Reorganization value represents the fair value of the Successor Company’s assets before considering liabilities. The excess reorganization value over the fair value of identified tangible and intangible assets was reported as goodwill. As a result of the application of fresh start accounting and the effects of the implementation of the Plan of Reorganization, the consolidated financial statements after the Effective Date are not comparable with the consolidated financial statements as of or prior to that date.
Reorganization Value
As set forth in the Plan of Reorganization and the Disclosure Statement, the enterprise value of the Successor Company was estimated to be between $2,900 and $3,300 as of the Effective Date. Based on the estimates and assumptions discussed below, the Company estimated the enterprise value to be $3,100 for financial reporting purposes, which is the mid-point of the range of enterprise value per the Plan of Reorganization.
The Company estimated the enterprise value of the Successor Company utilizing three valuation methods: a comparable public company analysis, a selected precedent transactions analysis, and a discounted cash flow (“DCF”) method. The comparable public company analysis is based on the enterprise values of selected publicly traded diversified chemical companies with operating and financial characteristics comparable to the Company. Under this methodology, certain financial multiples that measure financial performance and value are calculated for each selected company and then applied to imply an estimated enterprise value of the Company.
The selected precedent transaction analysis is based on the implied enterprise values of companies and assets involved in publicly disclosed merger and acquisition transactions which the targets had operating and financial characteristics comparable to certain respects of the Company. Under this methodology, a multiple is derived using the enterprise value of each such target, calculated as the consideration paid and the net debt assumed in the merger or acquisition transaction relative to a financial metric, in this case, EBITDA (earnings before interest, income taxes, depreciation and amortization) for the Company, for the last twelve month period which financial results have been publicly announced. Utilizing these multiples a reference range was created to imply an estimated enterprise value range.
The DCF analysis is a forward-looking enterprise valuation methodology that estimates fair value by calculating the present value of expected future cash flows to be generated plus a present value of the estimated terminal value. The Company established a five year estimate of future cash flows based on the financial projections and assumptions utilized in the Company’s disclosure statement, which were derived from earnings forecasts and assumptions regarding growth and margin projections. A terminal value was included, and was calculated using the constant growth method based on the projected cash flows of the final year of the forecast period. While the Company considers such estimates and assumptions reasonable, they are inherently subject to significant business, economic and competitive uncertainties, many of which are beyond the Company’s control and, therefore, may not be realized. Changes in these estimates and assumptions may have a significant effect on the determination of the Company’s enterprise value. The assumptions used in the calculations for the DCF analysis included projected revenue, cost and cash flows representing the Company’s best estimates at the time the analysis was prepared. The DCF analysis has various complex considerations and judgments, including the discount rate and all of the other projections, etc. Due to the unobservable inputs to the valuation, the fair value would be considered Level 3 in the fair value hierarchy.
The estimated enterprise value is not necessarily indicative of the actual value and the financial results; changes in the economy or the financial markets could result in a different enterprise value. The calculated enterprise value relies on all three of the methodologies listed above collectively. The actual value of the business is subject to certain uncertainties and contingencies that are difficult to predict and will fluctuate with changes in various factors affecting the financial conditions and prospects of such a business.
The discount rate for each reporting unit was estimated based on an after-tax weighted average cost of capital (“WACC”) reflecting the rate of return that would be expected by a market participant and ranged between approximately 11% and 19%. The WACC also takes into consideration a company-specific risk premium, reflecting the risk associated with the overall uncertainty of the financial projections used to estimate future cash flows.
The fair value of debt obligations represents $97 of debt payable within one year and $1,733 of long-term debt. The fair value of long-term debt was determined based on a market approach utilizing current market yields and was estimated to be approximately 100% of par value.
The fair value of pension liabilities of $239 was determined based upon assumptions related to discount rates and expected return on assets, as well as certain other assumptions related to various demographic factors.
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The following table reconciles the enterprise value to the estimated reorganization value as of the Effective Date:
Enterprise value | $ | 3,100 | |
Plus: Total cash | 125 | ||
Plus: Fair value of non-debt and non-pension liabilities | |||
Current liabilities | 540 | ||
Long-term liabilities | 527 | ||
Total non-debt and non-pension liabilities | 1,067 | ||
Reorganization value of Successor assets | $ | 4,292 |
The fair value of non-debt and non-pension liabilities represents the total liabilities, less debt payable within one year, long-term debt and pension obligations, of the Successor Company as of the Effective Date.
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Condensed Consolidated Statement of Financial Position
The following balance sheet illustrates the impacts of the implementation of the Plan and the application of fresh start accounting, which results in the opening balance sheet of the Successor Company.
As of July 1, 2019 (in millions, except share data) | Predecessor Company | Reorganization Adjustments(a) | Fresh Start Adjustments(q) | Successor Company | |||||||||||
Assets | |||||||||||||||
Current assets: | |||||||||||||||
Cash and cash equivalents (including restricted cash of $15) | $ | 96 | $ | 29 | (b) | $ | — | $ | 125 | ||||||
Accounts receivable (net of allowance for doubtful accounts of $16 and $0, respectively) | 499 | — | 6 | (r) | 505 | ||||||||||
Inventories: | |||||||||||||||
Finished and in-process goods | 242 | — | 29 | (s) | 271 | ||||||||||
Raw materials and supplies | 109 | — | — | 109 | |||||||||||
Other current assets | 69 | 2 | (c) | — | 71 | ||||||||||
Total current assets | 1,015 | 31 | 35 | 1,081 | |||||||||||
Investment in unconsolidated entities | 20 | — | (3 | ) | (t) | 17 | |||||||||
Deferred tax assets | — | 12 | (d) | (4 | ) | (u) | 8 | ||||||||
Other long-term assets | 42 | 4 | (e) | 2 | (v) | 48 | |||||||||
Property and equipment: | |||||||||||||||
Land | 90 | — | 23 | (w) | 113 | ||||||||||
Buildings | 287 | — | (119 | ) | (w) | 168 | |||||||||
Machinery and equipment | 2,320 | — | (994 | ) | (w) | 1,326 | |||||||||
2,697 | — | (1,090 | ) | 1,607 | |||||||||||
Less accumulated depreciation | (1,870 | ) | — | 1,870 | (w) | — | |||||||||
827 | — | 780 | 1,607 | ||||||||||||
Operating lease assets | 95 | — | 39 | (x) | 134 | ||||||||||
Goodwill | 108 | — | 70 | (y) | 178 | ||||||||||
Other intangible assets, net | 24 | — | 1,195 | (z) | 1,219 | ||||||||||
Total assets | $ | 2,131 | $ | 47 | $ | 2,114 | $ | 4,292 | |||||||
Liabilities and Deficit | |||||||||||||||
Current liabilities: | |||||||||||||||
Accounts payable | $ | 293 | $ | 56 | (a) | $ | — | $ | 349 | ||||||
Debt payable within one year | 438 | (343 | ) | (f) | 2 | (aa) | 97 | ||||||||
Interest payable | 7 | (5 | ) | (g) | — | 2 | |||||||||
Income taxes payable | 6 | 11 | (h) | — | 17 | ||||||||||
Accrued payroll and incentive compensation | 38 | — | — | 38 | |||||||||||
Current portion of operating lease liabilities | 21 | — | 7 | (x) | 28 | ||||||||||
Financing fees payable | 104 | (104 | ) | (i) | — | — | |||||||||
Other current liabilities | 106 | 5 | (j) | — | 111 | ||||||||||
Total current liabilities | 1,013 | (380 | ) | 9 | 642 | ||||||||||
Long-term liabilities: | |||||||||||||||
Liabilities subject to compromise | 3,672 | (3,672 | ) | (k) | — | — | |||||||||
Long-term debt | 90 | 1,622 | (l) | 21 | (aa) | 1,733 | |||||||||
Long-term pension and post employment benefit obligations | 184 | 33 | (a) | 44 | (ab) | 261 | |||||||||
Deferred income taxes | 15 | 1 | (m) | 163 | (ac) | 179 | |||||||||
Operating lease liabilities | 74 | — | 17 | (x) | 91 | ||||||||||
Other long-term liabilities | 164 | 72 | (n) | (6 | ) | (r) | 230 | ||||||||
Total liabilities | 5,212 | (2,324 | ) | 248 | 3,136 | ||||||||||
Equity (Deficit) | |||||||||||||||
Common stock (Successor) | — | — | (o) | — | — | ||||||||||
Paid-in capital (Successor) | — | 1,157 | (o) | — | 1,157 | ||||||||||
Common stock (Predecessor) | 1 | (1 | ) | (p) | — | — | |||||||||
Paid-in capital (Predecessor) | 526 | (526 | ) | (p) | — | — | |||||||||
Treasury stock (Predecessor), at cost—88,049,059 shares at December 31, 2018 | (296 | ) | 296 | (p) | — | — | |||||||||
Accumulated other comprehensive loss | (26 | ) | — | 26 | (ad) | — | |||||||||
Accumulated deficit | (3,285 | ) | 1,445 | (p) | 1,840 | (ad) | — | ||||||||
Total Hexion Inc. equity (deficit) | (3,080 | ) | 2,371 | 1,866 | 1,157 | ||||||||||
Noncontrolling interest | (1 | ) | — | — | (1 | ) | |||||||||
Total equity (deficit) | (3,081 | ) | 2,371 | (o) | 1,866 | 1,156 | |||||||||
Total liabilities and equity (deficit) | $ | 2,131 | $ | 47 | $ | 2,114 | $ | 4,292 |
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Reorganization Adjustments
(a) | The reorganization adjustments column reflects adjustments related to the consummation of the Plan, including the settlement of liabilities subject to compromise and related payments, other distributions of cash, issuance of new shares of common stock and the cancellation of the common equity of the Predecessor Company, as discussed in Note 3. |
The following is a calculation of the total pre-tax gain on the settlement of the liabilities subject to compromise:
Liabilities subject to compromise (“LSTC”) (see (k) below) | $ | 3,672 | |
Repayment of 1st Lien Notes | (1,383 | ) | |
Liabilities reinstated at emergence: | |||
Accounts payable | (56 | ) | |
Pension and other post employment benefit obligations | (33 | ) | |
Other current liabilities | (19 | ) | |
Other long-term liabilities | (32 | ) | |
Total liabilities reinstated at emergence | (140 | ) | |
Fair value of equity issued in exchange for debt: | |||
Fair value of equity | (1,156 | ) | |
Less: Proceeds from Rights Offering | 300 | ||
Total fair value of equity issued in exchange for debt | (856 | ) | |
Gain on settlement of LSTC | $ | 1,293 |
(b) Reflects the net cash received as of the Effective Date from implementation of the Plan:
Sources: | |||
Proceeds from the Rights Offerings | $ | 300 | |
Proceeds from the Senior Notes | 450 | ||
Proceeds from the Senior Secured Term Loan | 1,196 | ||
Release of utility deposit | 1 | ||
Total sources | 1,947 | ||
Uses: | |||
Repayment of 1st Lien Notes | (1,383 | ) | |
Repayment of DIP Term Loan Facility | (350 | ) | |
Repayment of DIP Term Loan interest | (5 | ) | |
Debt and Equity Backstop premiums | (104 | ) | |
Financing fees | (19 | ) | |
Success fees at emergence | (31 | ) | |
Other professional fees | (26 | ) | |
Total uses | (1,918 | ) | |
Net cash received | $ | 29 |
(c) | Represents $3 of excess professional fees due to the Company offset by $1 for the settlement of certain amounts owed during reorganization. |
(d) | Reflects the adjustment to release the valuation allowance on deferred tax assets for certain non-U.S. subsidiaries which management believes more likely than not will be realized as a result of reorganization. |
(e) Reflects the adjustments to capitalize the ABL Facility financing fees incurred upon emergence.
(f) | Reflects the adjustments made on the Effective Date to repay $350 in outstanding DIP Term Loans and to incur $7 for the current portion of the new Senior Secured Term Loan (see Note 9). |
(g) | On the Effective Date, the Company repaid $5 of accrued unpaid interest on the DIP Term Loan Facility. |
(h) | Reflects the adjustment to record income taxes payable as a result of reorganization. |
(i) | On the Effective Date, the Company paid $24 of Equity Backstop premiums to the parties participating in the Rights Offering and $80 of Debt Backstop premiums. See Note 3 for more information. |
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(j) | Represents $19 of other current liabilities that were reclassified from “Liabilities subject to compromise” and $12 of other current liabilities incurred as a result of emergence offset by $26 of professional fees paid at emergence. |
(k) | Liabilities subject to compromise represent unsecured liabilities incurred prior to the Petition Date. As a result of the Bankruptcy Petitions, actions to enforce or otherwise effect payment of pre-petition liabilities were generally stayed. These liabilities represent the amounts which have been allowed on known claims which were resolved through the Chapter 11 process, and have been approved by the Court as a result of the Confirmation Order. |
The following table summarizes pre-petition liabilities that are classified as “Liabilities subject to compromise” in the unaudited Condensed Consolidated Balance Sheets:
June 30, 2019 | |||
Debt | $ | 3,420 | |
Interest payable | 99 | ||
Accounts payable | 56 | ||
Environmental reserve | 43 | ||
Pension and other post employment benefit obligations | 33 | ||
Dividends payable to parent | 13 | ||
Other | 8 | ||
Total | $ | 3,672 |
(l) | Represents the issuance of the new Senior Term Loan due 2026 of $1,208 and the new Senior Secured Notes due 2027 of $450 offset by $12 of debt discounts and $17 of debt issuance costs of which $7 is classified as “Debt due within one year” on the Condensed Consolidated Balance Sheets. The term loan and notes were recorded at estimated fair value, which was determined based on a market approach utilizing current yield. |
(m) | Represents deferred tax activity associated with emergence. |
(n) | Reflects the adjustments made to reclassify $32 of other long-term liabilities from “Liabilities subject to compromise” and to record $40 of tax liability as a result of emergence. |
(o) The following table reconciles the enterprise value to the estimated fair value of the Successor equity as of the Emergence Date:
Enterprise value | $ | 3,100 | |
Plus: Total cash | 125 | ||
Less: Fair value of new debt | (1,646 | ) | |
Less: Fair value of remaining debt obligations | (184 | ) | |
Less: Pension obligations | (239 | ) | |
Fair value of equity | 1,156 | ||
Plus: Fair value of noncontrolling interest | 1 | ||
Fair value of Successor paid-in capital | $ | 1,157 |
At the Effective Date, 100 shares of Common Stock of Hexion Inc. held by new direct parent Hexion Intermediate were issued and outstanding at a par value of $0.01 per share.
(p) Reflects the cumulative impact of the reorganization adjustments discussed above:
Gain on settlement of LSTC | $ | 1,293 | |
Success and other fees recognized at emergence | (39 | ) | |
Net gain on reorganization adjustments(1) | 1,254 | ||
Tax impact on reorganization adjustments | (40 | ) | |
Cancellation of Predecessor common stock | 1 | ||
Cancellation of Predecessor additional paid-in capital | 526 | ||
Cancellation of Predecessor treasury stock | (296 | ) | |
Net impact to Accumulated Deficit | $ | 1,445 |
(1) The net gain on reorganization adjustments has been included in “Reorganization items, net” in the Condensed Consolidated Statements of Operations.
Fresh Start Adjustments
(q) | The Fresh Start Adjustments column reflects adjustments required to record the assets and liabilities of the Company at fair value, including the elimination of the accumulated deficit and accumulated other comprehensive (loss) of the Predecessor Company. |
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(r) | Reflects the adjustments made to Predecessor deferred revenue in situations where it has been determined the Successor Company has no remaining legal performance obligation related to the arrangement that give rise to the deferred revenue for the Predecessor Company. |
(s) | Reflects the adjustment made to record finished goods inventory at its estimated fair value, which was determined based on the current acquisition cost, including disposal and holding period costs and a reasonable profit margin less costs to sell. |
(t) | Reflects the adjustments made to record the Predecessor Company’s investments in unconsolidated subsidiaries at fair value utilizing a cost approach method. |
(u) | Reflects the deferred tax asset impact of the fresh start adjustments, resulting primarily from the book adjustment made to foreign property, plant, and equipment and intangibles that increased the future taxable temporary differences recorded. |
(v) | Reflects the adjustments required to record the Predecessor Company’s long-term assets at fair value. |
(w) | Reflects the adjustments made to record property, plant and equipment at its estimated fair value and eliminate Predecessor depreciation. Depreciable lives were also revised to reflect the remaining estimated useful lives of the related property, plant and equipment, which range from 1 to 39 years. Fair value was determined as follows: |
• | The market, sales comparison or trended cost approach was utilized to estimate fair value for land and buildings. This approach relies upon recent sales, offerings of similar assets or a specific inflationary adjustment to original purchase price to arrive at a probable selling price. |
• | The cost approach was utilized to estimate fair value for machinery and equipment. This approach considers the amount required to construct or purchase a new asset of equal utility at current market prices, with adjustments in value for physical deterioration and functional and economic obsolescence. Physical deterioration is an adjustment made in the cost approach to reflect the real operating age of an asset with regard to wear and tear, decay and deterioration that is not prevented by maintenance. Functional obsolescence is an adjustment made to reflect the loss in value or usefulness of an asset caused by inefficiencies or inadequacies of the asset, as compared to a more efficient or less costly replacement asset with newer technology. Economic obsolescence is an adjustment made to reflect the loss in value or usefulness of an asset due to factors external to the asset, such as the economics of the industry, reduced demand, increased competition or similar factors. |
Depreciable lives were revised to reflect the remaining estimated useful lives as follows (in years):
Buildings | 9 to 39 years |
Machinery and equipment | 1 to 20 years |
(x) | Reflects $25 of adjustments made to bring the right-of-use operating leased assets and their associated liabilities to fair value utilizing an average discount rate of approximately 6% and to record favorable leasehold interests of $14, which were valued using a rental analysis approach based on (i) fair market rent was determined based on rates for facilities comparable to the Company’s properties, (ii) discount rates ranging from 8.0% to 12.0%, which were based on the after-tax WACC; and (iii) market rental growth rates ranging from 0.0% to 5.0%. |
(y) | Reflects the adjustments made to record the elimination of the Predecessor goodwill balance of $108 and to record the Successor goodwill of $178, which represents the reorganization value of assets in excess of amounts allocated to identified tangible and intangible assets. |
(z) | Reflects the adjustments made to eliminate the Predecessor Company’s other intangible assets of $24 and to record $1,219 in estimated fair value of Successor other intangible assets. Fair value was comprised of the following: |
• | Customer related intangible assets of $968 were valued using the multi-period excess earnings income approach based on the following significant assumptions; |
i. | Forecasted net sales and profit margins attributable to the current customer base through the applicable economic useful life; |
ii. | Attrition rates ranging from 0.5% to 5.0%; |
iii. | Discount rates ranging from 13.0% to 17.5%, which were based on the after-tax WACC; and |
iv. | Economic lives of 20 to 25 years. |
• | Trademarks of $141 were valued using the relief from royalty income approach based on the following significant assumptions: |
i. | Forecasted net sales attributable to the trademarks through the applicable economic useful life; |
ii. | Royalty rates ranging from 0.2% to 2.0% of expected net sales determined with regard to comparable market transactions and profitability analysis; |
iii. | Discount rates ranging from 11.0% to 16.5%, which were based on the after-tax weighted average cost of capital (“WACC”); and |
iv. | Economic lives ranging from 15 to 20 years. |
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• | Technology based intangible assets of $110 were valued used the relief from royalty income approach based on the following significant assumptions: |
i. | Forecasted net sales attributable to the respective technologies through the applicable economic useful life; |
ii. | Royalty rates ranging from 0.5% to 2.25% of expected net sales determined with regard to expected cash flows of respective technologies and the overall importance of respective technologies to product offering |
iii. | Discount rates ranging from 11.0% to 16.5%, which were based on the after-tax WACC; and |
iv. | Economic lives of 15 years. |
(aa) | Reflects the adjustments made to bring various sale-leaseback financing arrangements to fair value and to revalue debt obligations. |
(ab) | Reflects the remeasurement of the Predecessor Company’s pension liabilities. The increase in pension liabilities was driven by reductions in discount rates and changes in other actuarial assumptions as of the Effective Date, primarily impacting our unfunded German pension plans. |
(ac) | Represents the deferred tax liability impact of the fresh start adjustments, resulting primarily from the book adjustment made to foreign property, plant, and equipment and intangibles that increased the future taxable temporary differences recorded. |
(ad) Reflects the cumulative impact of the fresh start accounting adjustments discussed above and the elimination of the Predecessor Company’s accumulated other comprehensive income:
Establishment of Successor goodwill | $ | 178 | |
Elimination of Predecessor goodwill | (108 | ) | |
Establishment of Successor other intangible assets | 1,219 | ||
Elimination of Predecessor other intangible assets | (24 | ) | |
Inventory fair value adjustments | 29 | ||
Property, plant and equipment fair value adjustment | 780 | ||
Pension liability fair value adjustment | (44 | ) | |
Other assets and liabilities fair value adjustment | 3 | ||
Elimination of Predecessor Company accumulated other comprehensive income | (26 | ) | |
Net gain on fresh start adjustments(1) | 2,007 | ||
Tax impact on fresh start adjustments | (167 | ) | |
Net impact on accumulated deficit | $ | 1,840 |
(1) The net gain on fresh start adjustments has been included in “Reorganization items, net” in the Condensed Statements of Operations.
5. Reorganization Items, Net
Incremental costs incurred directly as a result of the Bankruptcy Petitions, gains on the settlement of liabilities under the Plan and the net impact of fresh start accounting adjustments are classified as “Reorganization items, net” in the unaudited Condensed Consolidated Statements of Operations. The following table summarizes reorganization items:
Successor | Predecessor | Successor | Predecessor | ||||||||||||||
July 2, 2019 through September 30, 2019 | July 1, 2019 | July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | ||||||||||||||
Net gain on reorganization adjustments (see Note 4) | $ | — | $ | (1,254 | ) | $ | — | $ | (1,254 | ) | |||||||
Net gain on fresh start adjustments (see Note 4) | — | (2,007 | ) | — | (2,007 | ) | |||||||||||
Financing fees | — | — | — | 104 | |||||||||||||
Professional fees | — | — | — | 39 | |||||||||||||
DIP ABL Facility fees | — | — | — | 13 | |||||||||||||
Total | $ | — | $ | (3,261 | ) | $ | — | $ | (3,105 | ) |
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6. Restructuring & Business Realignment
Restructuring Activities
In November 2017, the Company initiated new restructuring actions with the intent to optimize its cost structure. As of September 30, 2019, $26 of one-time cash costs have been incurred for these restructuring activities, consisting primarily of workforce reduction costs, and no additional costs are expected to be incurred related to the 2017 programs. All costs for these restructuring activities were incurred in the predecessor period.
The following table summarizes restructuring information by reporting segment:
Epoxy, Phenolic and Coating Resins | Forest Products Resins | Corporate and Other | Total | ||||||||||||
Total restructuring costs incurred through September 30, 2019 | 14 | 8 | 4 | 26 | |||||||||||
Predecessor | |||||||||||||||
Accrued liability at December 31, 2018 | $ | 2 | $ | 2 | $ | 2 | $ | 6 | |||||||
Restructuring charges | 1 | — | — | 1 | |||||||||||
Payments | (2 | ) | (1 | ) | (1 | ) | (4 | ) | |||||||
Accrued liability at July 1, 2019 | $ | 1 | $ | 1 | $ | 1 | $ | 3 | |||||||
Successor | |||||||||||||||
Accrued liability at July 2, 2019 | $ | 1 | $ | 1 | $ | 1 | $ | 3 | |||||||
Restructuring charges | — | — | — | — | |||||||||||
Payments | — | — | (1 | ) | (1 | ) | |||||||||
Accrued liability at September 30, 2019 | $ | 1 | $ | 1 | $ | — | $ | 2 |
Oilfield
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 in the first quarter of 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 first quarter of 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 for the nine months ended September 30, 2018.
7. Related Party Transactions
Transactions with Apollo
As of the Company’s emergence from bankruptcy on July 1, 2019, Apollo is no longer a related party to the Company. The below disclosures are through July 1, 2019 and only reflect the time period when Apollo was a related party.
Management Consulting Agreement
The Company was party to a Management Consulting Agreement with Apollo (the “Management Consulting Agreement”) pursuant to which the Company received certain structuring and advisory services from Apollo and its affiliates. Apollo was 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.
During the three and nine months ended September 30, 2018, the Company recognized expense under the Management Consulting Agreement of $1 and $2, respectively. This amount is included in “Other operating expense, net” in the unaudited Condensed Consolidated Statements of Operations. In conjunction with the Company’s Chapter 11 proceedings and the Support Agreement filed on April 1, 2019, Apollo agreed to waive its annual management fee for 2019. In connection with the Company’s emergence from Chapter 11, the Management Consulting Agreement was terminated pursuant to the Confirmation Order, as of the Effective Date.
Support Agreement
Pursuant to the Support Agreement, Apollo will receive a $2.5 senior unsecured note maturing on March 31, 2020, payable upon the earlier of the maturity date or an initial public offering or listing on NYSE or NASDAQ.
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Purchases and Sales of Products and Services with Apollo Affiliates
The Company sells products to various Apollo affiliates. These sales were $1 for both the Predecessor period January 1, 2019 through July 1, 2019 and three months ended September 30, 2018 and $2 for the nine months ended September 30, 2018. Accounts receivable from these affiliates were less than $1 at December 31, 2018.
Transactions with MPM
As of May 15, 2019, MPM is no longer under the common control of Apollo and no longer a related party to the Company.
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 provided to MPM, and MPM provided 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 established certain criteria upon which the costs of such services are allocated between the Company and MPM.
On February 11, 2019, MPM provided notice of its intention to terminate the Shared Services Agreement, effective March 14, 2019. The termination triggers a period of up to 14 months during which time the parties will work together to facilitate an orderly transition of services provided under the Shared Services Agreement.
Pursuant to the Shared Services Agreement, during the nine months ended September 30, 2018 the Company incurred approximately $23 of net costs for shared services and MPM incurred approximately $17 of net costs for shared services. Included in the net costs incurred during the nine months ended September 30, 2018 were net billings from Hexion to MPM of $11 to bring the percentage of total net incurred costs for shared services under the Shared Services Agreement to the applicable agreed upon allocation percentage. The Company had accounts receivable from MPM of $2 at December 31, 2018.
Sales and Purchases of Products with MPM
The Company also sells products to, and purchases products from, MPM. There were no products sold during the Predecessor period January 1, 2019 through July 1, 2019 or the three months ended September 30, 2018 and during the nine months ended September 30, 2018 the Company sold less than $1 of products to MPM. During the nine months ended September 30, 2019 and 2018, the Company earned less than $1 from MPM as compensation for acting as distributor of products. The Company had $3 of accounts payable to MPM as of December 31, 2018. Refer to the below table for the summary of the purchases of products with MPM:
Predecessor | ||||||||||||
Three Months Ended September 30, 2018 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | ||||||||||
Purchases from MPM (1) | $ | 9 | $ | 10 | $ | 25 |
(1) Purchases from MPM are through May 15, 2019 and only reflect the time period when MPM was a related party
Other Transactions and Arrangements
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:
Successor | Predecessor | |||||||||||||||
July 2, 2019 through September 30, 2019 | Three Months Ended September 30, 2018 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | |||||||||||||
Sales to joint ventures(1) | $ | — | $ | 1 | $ | 2 | $ | 7 | ||||||||
Purchases from joint ventures(1) | 1 | <1 | 2 | 5 |
(1) There were no sales to joint ventures or purchases from joint ventures for the Predecessor period July 1, 2019.
Successor | Predecessor | |||||||
September 30, 2019 | December 31, 2018 | |||||||
Accounts receivable from joint ventures | $ | — | $ | 2 | ||||
Accounts payable to joint ventures | 1 | <1 |
In addition to the accounts receivable from joint ventures disclosed above, the Company had a loan receivable of $8 and $7 as of September 30, 2019 and December 31, 2018, respectively, from its unconsolidated forest products joint venture in Russia.
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8. Fair Value
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 September 30, 2019, the Company had derivative assets related to foreign exchange, electricity and natural gas contracts of $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 Successor period July 2, 2019 through September 30, 2019, the Predecessor period January 1, 2019 through July 1, 2019 and for the nine months ended September 30, 2018.
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 September 30, 2019 and December 31, 2018, 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.
Forward Contract
On June 26, 2019, the Predecessor Company entered into a foreign exchange forward contract (the “FX Contract”) to manage the foreign currency risk associated with the Euro denominated tranche of the new Term Loan Facility in an aggregate notional amount of €425M, in connection with the completion of the Plan on July 1, 2019 (see Note 9). The FX Contract committed the counterparty to exchange Euro denominated currency for U.S. dollar currency on July 1, 2019, the funding date of the Term Loan Facility. At the funding date, the FX Contract realized a mark-to-market loss of $1 within the Company’s Condensed Consolidated Statement of Operations, which was measured using Level 2 inputs.
Non-derivative Financial Instruments
The following table summarizes the carrying amount and fair value of the Company’s non-derivative financial instruments:
Carrying Amount | Fair Value | |||||||||||||||||||
Successor | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||
September 30, 2019 | ||||||||||||||||||||
Debt | $ | 1,789 | $ | — | $ | 1,721 | $ | 63 | $ | 1,784 | ||||||||||
Predecessor | ||||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||
Debt | $ | 3,815 | $ | — | $ | 2,679 | $ | 66 | $ | 2,745 |
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 finance leases and sale leaseback financing arrangements 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, accounts receivable, accounts payable and other accrued liabilities are classified as Level 1 and are considered reasonable estimates of their fair values due to the short-term maturity of these financial instruments.
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9. Debt Obligations
Debt outstanding at September 30, 2019 and December 31, 2018 is as follows:
Successor | Predecessor | ||||||||||||||||
September 30, 2019 | December 31, 2018 | ||||||||||||||||
Long-Term | Due Within One Year | Long-Term | Due Within One Year | ||||||||||||||
Senior Secured Credit Facilities: | |||||||||||||||||
ABL Facility (Predecessor) | $ | — | $ | — | $ | — | $ | 137 | |||||||||
ABL Facility (Successor) | — | — | — | — | |||||||||||||
Senior Secured Term Loan - USD due 2026 (includes $7 of unamortized debt discount) | 709 | 7 | — | — | |||||||||||||
Senior Secured Term Loan - EUR due 2026 (includes $5 of unamortized debt discount) | 459 | — | — | — | |||||||||||||
Senior Notes: | |||||||||||||||||
7.875% Senior Notes due 2027 | 450 | — | — | — | |||||||||||||
Senior Secured Notes: | |||||||||||||||||
6.625% First-Priority Senior Secured Notes due 2020 | — | — | — | 1,550 | |||||||||||||
10.00% First-Priority Senior Secured Notes due 2020 | — | — | — | 315 | |||||||||||||
10.375% First-Priority Senior Secured Notes due 2022 | — | — | — | 560 | |||||||||||||
13.75% Senior Secured Notes due 2022 | — | — | — | 225 | |||||||||||||
9.00% Second-Priority Senior Secured Notes due 2020 | — | — | — | 574 | |||||||||||||
Debentures: | |||||||||||||||||
9.2% debentures due 2021 | — | — | — | 74 | |||||||||||||
7.875% debentures due 2023 | — | — | — | 189 | |||||||||||||
Other Borrowings: | |||||||||||||||||
Australia Facility due 2021 | 27 | 3 | 30 | 4 | |||||||||||||
Brazilian bank loans | 8 | 33 | 12 | 41 | |||||||||||||
Lease obligations (1) | 49 | 14 | 56 | 10 | |||||||||||||
Other | — | 30 | 1 | 37 | |||||||||||||
Total | $ | 1,702 | $ | 87 | $ | 99 | $ | 3,716 |
(1) | Lease obligations include finance leases and sale leaseback financing arrangements. Amounts reflected for December 31, 2018 represent capital lease obligations and sale leaseback financing arrangements as recorded under ASC 840. |
As discussed in Note 1, there was substantial doubt as to the Company’s ability to continue as a going concern as of December 31, 2018. The Bankruptcy Petitions constituted an event of default that accelerated the Company’s obligations under its ABL Facility and 1L Notes, the 1.5L Notes, the 2L Notes, and the Unsecured Notes. As such, all outstanding debt as of December 31, 2018 related to these debt instruments were classified as “Debt payable within one year” in the audited Consolidated Balance Sheets and related footnote disclosures.
New Credit Facilities and Senior Notes
ABL Facility
On July 1, 2019, in connection with the Emergence, the Company, Hexion Canada Inc., a Canadian corporation (the “Canadian ABL Borrower”), Hexion B.V., a company organized under the laws of The Netherlands (the “Dutch ABL Borrower”), Hexion GmbH, a company organized under the laws of Germany (the “German ABL Borrower”), Hexion UK Limited, a corporation organized under the laws of England and Wales ( the “U.K. ABL Borrower” and, together with the Company, the Canadian ABL Borrower, the Dutch ABL Borrower and the German ABL Borrower, the “ABL Borrowers”) entered into a senior secured ABL Facility with the lenders and other parties thereto and JPMorgan Chase Bank, N.A., as administrative agent and collateral agent, in an aggregate principal amount of $350, under which the ABL Borrowers may borrow funds from time to time and up to $150 amount of which is available through a subfacility in the form of letters of credit, in each case subject to a borrowing base, as further described below. In addition, the Company may request one or more incremental facilities in an aggregate amount equal to the greater of (i) $100 and (ii) the excess of the borrowing base over $350.
The ABL Facility will mature and the commitments thereunder will terminate on July 1, 2024 and bears interest based on an adjusted LIBOR rate, EURIBOR or an alternate base rate (depending on the currency of the borrowing), in each case plus an applicable initial margin of 1.50% or, in the case of the alternate base rate, 0.50%, which margin may increase or decrease depending on the average availability under the ABL Facility.
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The borrowing base is, at any time of determination, an amount (net of reserves) equal to the sum of:
• | in the case of the borrowing base for the Company’s U.S., U.K., Dutch and Canadian subsidiaries, 85% of the amount of eligible receivables (or 90% of the amount of “investment grade” eligible receivables) (including trade receivables), plus |
• | in the case of the borrowing base for the Company’s U.S., U.K., Dutch and Canadian subsidiaries, the lesser of (i) 70% of the amount of eligible inventory and (ii) 85% of the net orderly liquidation value of eligible inventory, plus |
• | in the case of the borrowing base for the Company’s U.K., Dutch, Canadian and German subsidiaries, the lesser of (i) the sum of (a) 80% of the amount of eligible machinery and equipment appraised on a net orderly liquidation basis and (b) 75% of the appraised fair market value of eligible real property of the loan parties in Canada, England and Wales, the Netherlands and Germany and (ii) the lesser of (x) 20% of the total commitments and (y) 20% of the borrowing base of the borrowers without giving effect to the additional borrowing base from the eligible machinery and equipment and eligible real property, plus |
• | in the case of the borrowing base for the Company’s U.S. and Canadian subsidiaries, 100% of unrestricted cash, in each case held in an account subject to the springing control of the agent; provided, that the cash component of the borrowing base shall not constitute more than the lesser of (x) 15.0% of the total commitments and (y) 15.0% of the borrowing base of the borrowers (calculated prior to giving effect to such limitation). |
The borrowing base of the U.K., Dutch and German subsidiaries may not exceed the greater of 50% of the total commitments and 50% of the borrowing base of the ABL Borrowers. On the closing date of the ABL Facility, as adjusted for the consummation of the Plan and related transactions, the borrowing base reflecting various required reserves was determined to be approximately $350.
In addition to paying interest on outstanding principal under the ABL Facility, the Company is required to pay a commitment fee to the lenders in respect of the unutilized commitments thereunder at a rate equal to 0.50% or 0.375% per annum depending on the average utilization of the commitments. The Company also pays a customary letter of credit fee, including a fronting fee of 0.125% per annum of the daily average stated amount of each outstanding letter of credit, and customary agency fees.
Outstanding loans under the ABL Facility may be voluntarily repaid at any time without premium or penalty, other than customary “breakage” costs with respect to eurocurrency loans.
The obligations of the Company under the ABL Facility are unconditionally guaranteed by the Company’s direct parent, Hexion Intermediate, and each of the Company’s existing and future wholly-owned material U.S. subsidiaries, which the Company refers to as the “U.S. ABL Guarantors.” In addition, all obligations of the foreign subsidiary borrowers under the ABL Facility are guaranteed by the U.S. ABL Guarantors and certain other direct and indirect wholly-owned foreign subsidiaries, which the Company refers to collectively as the “Foreign ABL Guarantors” and, together with the U.S. ABL Guarantors, the “ABL Guarantors.”
In addition, the ABL Facility requires the Company to maintain a minimum fixed charge coverage ratio at any time when the excess availability is less than the greater of (x) $30 and (y) 10.0% of the lesser of (i) the borrowing base at such time and (ii) the aggregate amount of ABL Facility commitments at such time. In that event, the Company must satisfy a minimum fixed charge coverage ratio of 1.0 to 1.0. The Company was in compliance with all ABL Facility provisions as of September 30, 2019.
New Senior Secured Term Loan Facility
Additionally, in connection with the completion of the Plan, on July 1, 2019, the Company and Hexion International Cooperatief U.A., a company organized under the laws of the Netherlands (the “Dutch Term Loan Borrower” and, together with the Company, the “Term Loan Borrowers”), entered into a senior secured term loan facility with the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent and collateral agent (the “Term Loan Facility”), which consists of (i) a USD denominated tranche in an aggregate principal amount of $725 (“Senior Secured Term Loan - USD”) borrowed by the Company and (ii) a EUR denominated tranche in an aggregate principal amount of €425 (“Senior Secured Term Loan - EUR”) borrowed by the Dutch Term Loan Borrower. In addition, the Company may request one or more incremental facilities in an aggregate amount up to the sum of $425 and amounts that may be incurred pursuant to certain leverage and coverage ratios.
The Term Loan Facility will mature on July 1, 2026 and bears interest based on (i) in the case of the USD tranche, at the Company’s option, an adjusted LIBOR rate or an alternate base rate, in each case plus an applicable margin equal to 3.50% or, in the case of the alternate base rate, 2.50% and (ii) in the case of the EUR tranche, EURIBOR plus an applicable margin equal to 4.00%. As of September 30, 2019, the effective interest for the Company’s Term Loan Facility on the USD tranche and EUR tranche was 5.82% and 4.00%, respectively.
The obligations of the Company under the Term Loan Facility are unconditionally guaranteed by Hexion Intermediate and each of the Company’s existing and future wholly owned material U.S. subsidiaries, which subsidiaries the Company refers to collectively as “U.S. Term Guarantors”. In addition, all obligations of the Dutch Term Loan Borrower under the Term Loan Facility are guaranteed by Hexion Intermediate, the Company, the U.S. Term Guarantors and certain other direct and indirect wholly-owned foreign subsidiaries, which foreign subsidiaries the Company collectively refers to as the “Foreign Term Guarantors” (together with the U.S. Term Guarantors, the “Subsidiary Term Guarantors” and, together with Hexion Intermediate, the “Term Guarantors”).
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The Credit Facilities contain among other provisions, restrictive covenants regarding indebtedness, payments and distributions, mergers and acquisitions, asset sales, affiliate transactions, capital expenditures and the maintenance of certain financial ratios. Events of default include the failure to pay principal and interest when due, a material breach of representation or warranty, covenant defaults, events of bankruptcy and a change of control. The Credit Facilities also contain certain other customary affirmative covenants and events of default. If the Company fails to perform its obligations under these and other covenants, the Credit Facilities could be terminated and any outstanding borrowings, together with accrued interest, under the Credit Facilities could be declared immediately due and payable. There were no covenant violations or events of default as of September 30, 2019.
Indenture and 7.875% Senior Notes due 2027
The Company entered into an indenture, dated as of July 1, 2019 (the “Indenture”), among the Company, the subsidiary guarantors party thereto and Wilmington Trust, National Association, as trustee, and issued $450 aggregate principal amount of 7.875% Senior Notes due 2027 (the “Senior Notes”) thereunder. The Senior Notes are guaranteed on a senior basis by the Company’s existing domestic subsidiaries that guarantee its obligations under its Credit Facilities (as defined below) (the “Guarantors”) on a full and unconditional basis. The following is a brief description of the material provisions of the Indenture and the Senior Notes.
The Senior Notes will mature on July 15, 2027. Interest on the Senior Notes will accrue at the rate of 7.875% per annum and will be payable semiannually in arrears on January 15 and July 15, commencing on January 15, 2020.
Optional Redemption. At any time prior to July 15, 2022, the Company may redeem the Senior Notes, in whole or in part, at a price equal to 100% of the principal amount of the Senior Notes redeemed, plus an applicable “make-whole” premium and accrued and unpaid interest, if any, to the redemption date.
In addition, at any time prior to July 15, 2022, the Company may redeem up to 40% of the aggregate principal amount of the Senior Notes at a redemption price of 107.875% of the principal amount thereof, plus accrued and unpaid interest, if any, to the redemption date, with the net cash proceeds of certain equity offerings; provided that at least 50% of the aggregate principal amount of the Senior Notes originally issued under the Indenture remains outstanding immediately after the occurrence of such redemption (excluding Notes held by the Company and its subsidiaries); and provided, further, that such redemption occurs within 90 days of the date of the closing of such equity offering.
On and after July 15, 2022, the Company may redeem all or a part of the Senior Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest, if any, thereon, to the applicable redemption date, if redeemed during the twelve-month period beginning on July 15 of the years indicated below:
Year | Percentage | |
2022 | 103.94 | % |
2023 | 101.97 | % |
2024 and thereafter | 100.00 | % |
Change of Control. If a change of control (as defined in the Indenture) occurs, holders of the Senior Notes will have the right to require the Company to repurchase all or any part of their Senior Notes at a purchase price equal to 101% of the aggregate principal amount of the Senior Notes repurchased, plus accrued and unpaid interest, if any, to the repurchase date.
Certain Covenants. The Indenture governing the Senior Notes contains, among other provisions, restrictive covenants regarding indebtedness, payments and distributions, mergers and acquisitions, asset sales, affiliate transactions, capital expenditures and the maintenance of certain financial ratios. At such time as (1) the Senior Notes have an investment grade rating from both of Moody’s Investors Service, Inc. and Standard and Poor’s Ratings Services and (2) no default has occurred and is continuing under the Indenture, certain of these and other covenants will be suspended and cease to be in effect.
Events of Default. The Indenture also provides for certain customary events of default, including, among others, nonpayment of principal or interest, failure to pay final judgments in excess of a specified threshold, failure of a guarantee to remain in effect, bankruptcy and insolvency events, and cross acceleration, which would permit the principal, premium, if any, interest and other monetary obligations on all the then outstanding Senior Notes to be declared due and payable immediately.
Intercreditor Agreement
On July 1, 2019, in connection with the Emergence, JPMorgan Chase Bank, N.A., as collateral agent under each of the Credit Facilities, and the Company and certain of its subsidiaries entered into an ABL Intercreditor Agreement that, among other things, sets forth the relative lien priorities of the secured parties under the Credit Facilities on the collateral shared by the ABL Facility and the Term Loan Facility.
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Subsequent events
Interest Rate Swap
On October 10, 2019, the Company executed an interest rate swap syndication agreement with Credit Suisse International where Hexion receives a variable 3-month LIBOR, and pays fixed interest rate swaps, effective January 1, 2020 and expiring January 1, 2025 (the “Hedge”) for a total notional amount of $300. The purpose of this arrangement is to hedge the variability caused by quarterly changes in cash flow due to associated changes in LIBOR for $300 of the total $725 of the Company’s variable rate Senior Secured Term Loan denominated in USD. The Company has evaluated this transaction and designated this derivative instrument as a cash flow hedge for hedge accounting under Accounting Standard Codification, No. 815, “Derivatives and hedging,” (“ASC 815”). Hedge accounting under ASC 815 required the Company to formally document at inception the relationship between the hedging instrument and the hedged item, the risk management objective, strategy and the evaluation of effectiveness of the hedged transaction. For the Hedge, the Company will record changes in the fair value of the derivative in other comprehensive income (“OCI”) and will subsequently reclassify gains and losses from these changes in fair value from OCI to Consolidated Statement of Operations in the same period that the hedged transaction affects net income and in the same Consolidated Statement of Operations category as the hedged item, “Interest expense, net”.
Interest Rate Cap
On October 22, 2019, the Company executed an interest rate cap derivative instrument for a premium amount of less than $1. The objective of this instrument is to partially eliminate the variability of cash flows in future interest payments for a notional amount of $375 of its variable rate Senior Secured Term Loan when 3-month LIBOR is above 2.50%. This transaction becomes effective January 1, 2020 and expires January 1, 2023. This instrument is a derivative under ASC 815 that does not qualify for hedge accounting and as a result, changes in fair value will be recognized within earnings in the Consolidated Statement of Operations throughout the term of the instrument.
10. Leases
The Company leases certain buildings, warehouses, rail cars, land and operating equipment under both operating and finance leases expiring on various dates through 2044. Leases with an initial term of 12 months or less are not recorded on the balance sheet and the Company recognizes lease expense for these leases on a straight-line basis over the lease term. For lease agreements entered into or reassessed after the adoption of Topic 842, the Company combines lease and non-lease components.
The Company determines if a contract is a lease at the inception of the arrangement. The Company reviews all options to extend, terminate, or purchase its right of use assets at the inception of the lease and accounts for these options when they are reasonably certain of being exercised. Nearly all of the Company’s lease contracts do not provide a readily determinable implicit rate. For these contracts, the Company estimates the incremental borrowing rate to discount the lease payments based on information available at lease commencement.
Lease Costs
The table below summarizes the lease costs for the for the Successor period July 2, 2019 through September 30, 2019 and the Predecessor periods July 1, 2019 and January 1, 2019 through July 1, 2019:
Classification | Successor | Predecessor(1) | ||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | |||||||||
Operating lease expense | Operating (loss) income | $ | 9 | $ | 18 | |||||
Short-term lease expense | Operating (loss) income | 1 | 5 | |||||||
Amortization expense | Operating (loss) income | <1 | 1 | |||||||
Interest expense from financing leases | Interest expense, net | <1 | <1 | |||||||
Variable lease expense | Operating (loss) income | 1 | 2 |
(1) | For the Predecessor period July 1, 2019 the Company recorded expense of less than $1 for operating leases, short-term leases, variable leases, amortization or interest from finance leases. |
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Balance Sheet Classification
The table below presents the lease-related assets and liabilities recorded on the unaudited Condensed Consolidated Balance Sheet:
Successor | ||||||
Classification | September 30, 2019(1) | |||||
Assets: | ||||||
Operating(1) | Operating lease assets | $ | 125 | |||
Finance(2) | Machinery and Equipment | 10 | ||||
Total leased assets | $ | 135 | ||||
Liabilities: | ||||||
Current | ||||||
Operating | Current portion of operating lease liabilities | $ | 23 | |||
Finance | Debt payable within one year | 4 | ||||
Noncurrent | ||||||
Operating | Operating lease liabilities | 88 | ||||
Finance | Long-term debt | 4 | ||||
Total leased liabilities | $ | 119 |
(1) Operating lease assets include $14 of favorable leasehold interests as of September 30, 2019.
(2) Finance lease assets are recorded net of accumulated amortization for the Successor Period of less than $1 as of September 30, 2019.
Other Lease Information
Cash paid for operating leases approximated operating lease expense and non-cash right-of-use asset amortization for the Successor period July 2, 2019 through September 30, 2019 and the Predecessor period January 1, 2019 through July 1, 2019. The table below presents other cash consideration detail for the Successor period July 2, 2019 through September 30, 2019 and the Predecessor period January 1, 2019 through July 1, 2019:
Successor | Predecessor(1) | |||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | |||||||
Cash paid for finance leases | $ | 1 | $ | 2 | ||||
Right-of-use assets obtained in exchange for operating lease | 1 | 1 | ||||||
Right-of-use assets obtained in exchange for finance lease obligations | — | 3 |
(1) | For the Predecessor period July 1, 2019 there was no cash paid for finance or operating leases and no right-of-use assets were obtained in exchange for operating lease obligations. |
The tables below present supplemental information related to leases as of September 30, 2019:
Successor | September 30, 2019 | ||
Weighted-average remaining lease term (years) | |||
Operating leases | 10.2 | ||
Finance leases | 2.0 | ||
Weighted-average discount rate | |||
Operating leases | 5.81 | % | |
Finance leases | 10.00 | % |
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The table below reconciles the undiscounted cash flows for each of the first five years and the total of the remaining years to the finance lease liabilities and operating lease liabilities recorded on the Successor Company’s unaudited Condensed Consolidated Balance Sheet as of September 30, 2019:
Year | Minimum Rentals Under Operating Leases | Minimum Payments Under Finance Leases(1) | ||||||
Remaining three months of 2019 | $ | 9 | $ | 1 | ||||
2020 | 27 | 5 | ||||||
2021 | 21 | 2 | ||||||
2022 | 14 | — | ||||||
2023 | 10 | — | ||||||
2024 and thereafter | 67 | 1 | ||||||
Total lease payments | $ | 148 | $ | 9 | ||||
Less: Amount representing interest | 37 | 1 | ||||||
Present value of lease liabilities | $ | 111 | $ | 8 |
(1) | Amounts exclude sale leaseback financing arrangements which are not considered leases under Topic 842. |
Disclosures related to periods prior to adoption of ASU 2016-02
The Company adopted ASU 2016-02 using a retrospective adoption method at January 1, 2019. See Note 2 for more information. The following is the minimum lease commitments under the previous lease guidance (ASC 840) as of December 31, 2018, as disclosed in the Predecessor Company’s most recent Annual Report on Form 10-K.
Predecessor | ||||||||
Year | Minimum Rentals Under Operating Leases | Minimum Payments Under Capital Leases | ||||||
2019 | $ | 33 | $ | 15 | ||||
2020 | 24 | 20 | ||||||
2021 | 20 | 13 | ||||||
2022 | 13 | 26 | ||||||
2023 | 10 | 9 | ||||||
2024 and thereafter | 61 | 1 | ||||||
Total minimum payments | $ | 161 | 84 | |||||
Less: Amount representing interest | (18 | ) | ||||||
Present value of minimum payments | $ | 66 |
11. Commitments and Contingencies
Environmental Matters
The Company’s operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials. The Company is subject to extensive environmental regulation at the federal, state and local levels as well as foreign laws and regulations, and is therefore exposed to the risk of claims for environmental remediation or restoration. In addition, violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.
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The following table summarizes all probable environmental remediation, indemnification and restoration liabilities, including related legal expenses, at September 30, 2019 and December 31, 2018:
Liability | Range of Reasonably Possible Costs at September 30, 2019 | ||||||||||||||
Successor | Predecessor | Successor | |||||||||||||
Site Description | September 30, 2019 | December 31, 2018 | Low | High | |||||||||||
Geismar, LA | $ | 12 | $ | 13 | $ | 9 | $ | 22 | |||||||
Superfund and offsite landfills – allocated share: | |||||||||||||||
Less than 1% | 3 | 3 | 2 | 6 | |||||||||||
Equal to or greater than 1% | 5 | 5 | 5 | 14 | |||||||||||
Currently-owned | 6 | 6 | 4 | 10 | |||||||||||
Formerly-owned: | |||||||||||||||
Remediation | 23 | 22 | 19 | 39 | |||||||||||
Monitoring only | 1 | 1 | 1 | 4 | |||||||||||
Total | $ | 50 | $ | 50 | $ | 40 | $ | 95 |
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 September 30, 2019, $18 has been included in “Other current liabilities” with the remaining amount included in “Other long-term liabilities” within the Successor Company’s unaudited Condensed Consolidated Balance Sheets. At December 31, 2018, $11 has been included in “Other current liabilities” in the Predecessor Company’s 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 September 30, 2019:
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 20 years. The range of possible outcomes is discounted in a similar manner. The undiscounted liability, which is expected to be paid over the next 20 years, is approximately $16. Over the next five years, the Company expects to make ratable payments totaling $5.
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.
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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 the Company’s 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 in 2016 with the current site owner and a past site owner, pursuant to which the Company paid $10 for past remediation costs and 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 $13. The final costs to the Company will depend on natural variations in remediation costs, including unforeseen circumstances, agency requests, new contaminants of concern and the ongoing financial viability of the other PRPs.
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 $4 and $2, respectively, at September 30, 2019 and December 31, 2018 for all non-environmental legal defense costs incurred and settlement costs that it believes are probable and estimable. At September 30, 2019 and December 31, 2018, $3 and $2, 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.”
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.
12. Pension and Postretirement Benefit Plans
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 July 2, 2019 through September 30, 2019, July 1, 2019, three months ended September 30, 2018, July 2, 2019 through September 30, 2019, January 1, 2019 through July 1, 2019 and for the nine months ended September 30, 2018 :
Pension Benefits | ||||||||||||||||||||||||
Successor | Predecessor | |||||||||||||||||||||||
July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, 2018 | ||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | |||||||||||||||||||
Service cost | $ | 1 | $ | 3 | $ | — | $ | — | $ | 1 | $ | 4 | ||||||||||||
Interest cost on projected benefit obligation | 1 | 1 | — | — | 1 | 3 | ||||||||||||||||||
Expected return on assets | (3 | ) | (2 | ) | — | — | (3 | ) | (4 | ) | ||||||||||||||
Net expense (benefit) | $ | (1 | ) | $ | 2 | $ | — | $ | — | $ | (1 | ) | $ | 3 | ||||||||||
Pension Benefits | ||||||||||||||||||||||||
Successor | Predecessor | |||||||||||||||||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | ||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | |||||||||||||||||||
Service cost | $ | 1 | $ | 3 | $ | 2 | $ | 7 | $ | 2 | $ | 13 | ||||||||||||
Interest cost on projected benefit obligation | 1 | 1 | 4 | 4 | 5 | 8 | ||||||||||||||||||
Expected return on assets | (3 | ) | (2 | ) | (6 | ) | (6 | ) | (10 | ) | (10 | ) | ||||||||||||
Net expense (benefit) | $ | (1 | ) | $ | 2 | $ | — | $ | 5 | $ | (3 | ) | $ | 11 |
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Non-Pension Postretirement Benefits | ||||||||||||||||||||||||
Successor | Predecessor | |||||||||||||||||||||||
July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, 2018 | ||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | |||||||||||||||||||
Service cost | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Interest cost on projected benefit obligation | — | — | — | — | — | 1 | ||||||||||||||||||
Expected return on assets | — | — | — | — | — | — | ||||||||||||||||||
Net expense (benefit) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 1 | ||||||||||||
Non-Pension Postretirement Benefits | ||||||||||||||||||||||||
Successor | Predecessor | |||||||||||||||||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | ||||||||||||||||||||||
U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | U.S. Plans | Non-U.S. Plans | |||||||||||||||||||
Service cost | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Interest cost on projected benefit obligation | — | — | — | — | — | 1 | ||||||||||||||||||
Expected return on assets | — | — | — | — | — | — | ||||||||||||||||||
Net expense (benefit) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 1 |
13. Dispositions
ATG
On January 8, 2018, the Company completed the sale of its Additives Technology Group business (“ATG”). ATG was previously included within the Company’s Forest Products Resins segment and included manufacturing sites located in Somersby, Australia and Sungai Petani, Malaysia. The ATG business produced 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 Predecessor Company’s unaudited Condensed Consolidated Statements of Operations for the nine months ended September 30, 2018.
14. Stock Based Compensation
Cancellation and Expiration of Outstanding Equity Awards
As of the Effective Date, in conjunction with the Company’s emergence from Chapter 11, all outstanding unvested unit options and restricted deferred units of the Predecessor Company’s parent company, TopCo, were canceled, effective immediately (See Note 3 for more information). There was no financial statement impact as a result of these cancellations.
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Successor Company Stock Based Awards
The following is a summary of the new stock based compensation plans issued on Emergence and their related outstanding shares as of September 30, 2019:
Plan Name | Shares Outstanding | Plan Expiration | Vesting Terms/Status | Option Term | Number of Shares Authorized | ||||||
Hexion Holdings Corporation 2019 Omnibus Incentive Plan | August 2029 | 10 years | 7,635,389 | ||||||||
Restricted Stock Units (“RSUs”) and Performance Stock Units (“PSUs”): | |||||||||||
2019 Grant | |||||||||||
RSUs | 1,034,100 | Time-vest ratably over 3 years, but must be employed on July 1, 2022 in order to receive shares; Accelerated vesting upon change in control. | |||||||||
PSUs | 2,412,894 | Performance based: Step vest over 4 years based on a 20 consecutive trading-day volume weighted average price per share from $20 to $30 per share. PSUs that vest by June 30, 2022 will be settled in July 2022 and remaining PSUs that vest by June 30, 2023 will be settled in July 2023. |
Summary of Plans
On August 8, 2019, the Board of Directors of Hexion Holdings approved the Hexion Holdings Corporation 2019 Omnibus Incentive Plan (the “2019 Incentive Plan”), whereby Hexion Holdings is reserving shares of Class B Common Stock, par value $0.01 per share, representing 10% of Hexion Holding’s fully diluted equity as of the date of approval of the 2019 Incentive Plan, for issuance to employees, directors, and other key service providers in connection with stock options, restricted stock units, performance-based stock units and other equity-based awards (such as performance stock units) to be awarded from time to time as the Board determines. The restricted and performance stock units are deemed to be equivalent to one share of common stock of Hexion Holdings. The awards contain restrictions on transferability and other typical terms and conditions.
Restricted Share Units
In September 2019, Hexion Holdings granted RSUs that time vest over three years with an aggregate grant date fair value of approximately $16. Compensation cost is recognized equally over the 3 year service period. For certain retirement eligible associates, the stock-based compensation cost is accelerated according to the plan documents.
Performance Share Units
In September 2019, Hexion Holdings granted PSUs with market conditions with an aggregate grant date fair value of approximately $29. The fair value was estimated at the grant date using a Monte Carlo valuation method. The Monte Carlo valuation method requires the use of a range of assumptions that include the risk-free interest rates of 1.49% to 1.87% and expected volatility rates ranged from 39% to 60%. The expected life assumption is not used in the Monte Carlo valuation method, but the output of the model indicated a weighted-average expected life of 3.8 years. The PSUs step vest over four years upon the achievement of the pre-established goals by the end of the fourth year of the term. As of September 30, 2019, the market conditions have not been met and no PSUs have vested. Compensation cost will be recognized over 3.8 years and adjusted accordingly as vesting conditions are met. For certain retirement eligible associates, the stock-based compensation cost is accelerated according to the plan documents.
Financial Statement Impact
Although the 2019 Incentive Plan was issued by Hexion Holdings, the underlying share-based compensation cost represents compensation costs paid for by Hexion Holdings on Hexion’s behalf, as a result of the employees’ service to Hexion. The compensation costs for RSUs and PSUs are recorded over the requisite service period on a graded-vesting basis and over the derived service period, respectively.
Share-based compensation costs are recognized, net of actual forfeitures, over the requisite service period on a graded-vesting basis for RSUs. Stock-based compensation cost is recognized, net of forfeitures, over the requisite service period on a graded-vesting basis over the derived service period for PSUs. The Company adjusts compensation expense periodically for forfeitures. Stock based compensation costs are included in “Other non-cash adjustments” on the Condensed Consolidated Statements of Cash Flows.
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The Company recognized $5 share-based compensation costs for the period from July 2, 2019 through September 30, 2019 and there were no share-based compensation costs for the period from January 1, 2019 through July 1, 2019, three months ended September 30, 2018 and nine months ended September 30, 2018, respectively. The amounts are included in “Selling, general and administrative expense” in the Condensed Consolidated Statements of Operations.
As of September 30, 2019 the Company has 1,034,100 shares of nonvested RSUs with a weighted average grant date fair value of $15.37 per share and 2,412,894 shares of nonvested PSUs with a weighted average grant date fair value of $11.97 per share. As of September 30, 2019 there were no restricted or performance share units forfeited.
15. Segment Information
The Company’s business segments are based on the products that the Company offers and the markets that it serves. At September 30, 2019, the Company had three reportable segments: Forest Products Resins; Epoxy, Phenolic and Coating Resins; and Corporate and Other. A summary of the major products of the Company’s reportable segments follows:
• | Forest Products Resins: forest products resins and formaldehyde applications |
• | 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 |
• | Corporate and Other: primarily corporate general and administrative expenses that are not allocated to the other segments, such as shared service and administrative functions and foreign exchange gains and losses. |
Reportable Segments
Following are net sales and Segment EBITDA 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 other segments, such as shared service and administrative functions and foreign exchange gains and losses 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.
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Following is net sales by reportable segment disaggregated by geographic region:
Successor | Predecessor | |||||||||||||||||||||||||||||||||||
July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, 2018 | ||||||||||||||||||||||||||||||||||
Forest Products Resins | Epoxy, Phenolic and Coating Resins | Total | Forest Products Resins | Epoxy, Phenolic and Coating Resins | Total | Forest Products Resins | Epoxy, Phenolic and Coating Resins | Total | ||||||||||||||||||||||||||||
North America | $ | 248 | $ | 206 | $ | 454 | $ | — | $ | — | $ | — | $ | 294 | $ | 225 | $ | 519 | ||||||||||||||||||
Europe | 42 | 184 | 226 | — | — | — | 49 | 215 | 264 | |||||||||||||||||||||||||||
Asia Pacific | 30 | 79 | 109 | — | — | — | 35 | 80 | 115 | |||||||||||||||||||||||||||
Latin America | 47 | — | 47 | — | — | — | 53 | 1 | 54 | |||||||||||||||||||||||||||
Total | $ | 367 | $ | 469 | $ | 836 | $ | — | $ | — | $ | — | $ | 431 | $ | 521 | $ | 952 | ||||||||||||||||||
Successor | Predecessor | |||||||||||||||||||||||||||||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | ||||||||||||||||||||||||||||||||||
Forest Products Resins | Epoxy, Phenolic and Coating Resins | Total | Forest Products Resins | Epoxy, Phenolic and Coating Resins | Total | Forest Products Resins | Epoxy, Phenolic and Coating Resins | Total | ||||||||||||||||||||||||||||
North America | $ | 248 | $ | 206 | $ | 454 | $ | 519 | $ | 425 | $ | 944 | $ | 856 | $ | 695 | $ | 1,551 | ||||||||||||||||||
Europe | 42 | 184 | 226 | 90 | 431 | 521 | 155 | 709 | 864 | |||||||||||||||||||||||||||
Asia Pacific | 30 | 79 | 109 | 63 | 147 | 210 | 101 | 218 | 319 | |||||||||||||||||||||||||||
Latin America | 47 | — | 47 | 103 | — | 103 | 156 | 3 | 159 | |||||||||||||||||||||||||||
Total | $ | 367 | $ | 469 | $ | 836 | $ | 775 | $ | 1,003 | $ | 1,778 | $ | 1,268 | $ | 1,625 | $ | 2,893 |
( 1) | Intersegment sales are not significant and, as such, are eliminated within the selling segment. |
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Reconciliation of Net (Loss) Income to Segment EBITDA:
Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||
July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, 2018 | July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, 2018 | ||||||||||||||||||||
Reconciliation: | |||||||||||||||||||||||||
Net (loss) income attributable to Hexion Inc. | $ | (43 | ) | $ | 3,054 | $ | (18 | ) | $ | (43 | ) | $ | 2,894 | $ | (53 | ) | |||||||||
Net income attributable to noncontrolling interest | — | — | — | — | (1 | ) | (1 | ) | |||||||||||||||||
Net (loss) income | (43 | ) | 3,054 | (18 | ) | (43 | ) | 2,895 | (52 | ) | |||||||||||||||
Income tax (benefit) expense | (4 | ) | 207 | 6 | (4 | ) | 222 | 17 | |||||||||||||||||
Interest expense, net | 28 | — | 83 | 28 | 89 | 250 | |||||||||||||||||||
Depreciation and amortization | 55 | — | 27 | 55 | 52 | 85 | |||||||||||||||||||
Accelerated depreciation | — | — | 2 | — | — | 2 | |||||||||||||||||||
EBITDA | $ | 36 | $ | 3,261 | $ | 100 | $ | 36 | $ | 3,258 | $ | 302 | |||||||||||||
Adjustments to arrive at Segment EBITDA: | |||||||||||||||||||||||||
Asset impairments and write-downs | $ | — | $ | — | $ | 7 | $ | — | $ | — | $ | 32 | |||||||||||||
Business realignment costs | 13 | — | 5 | 13 | 15 | 19 | |||||||||||||||||||
Gain on disposition | — | — | — | — | — | (44 | ) | ||||||||||||||||||
Transaction costs | 5 | — | 4 | 5 | 26 | 10 | |||||||||||||||||||
Realized and unrealized foreign currency losses (gains) | 9 | — | 4 | 9 | (6 | ) | 26 | ||||||||||||||||||
Reorganization items, net (1) | — | (3,232 | ) | — | — | (3,076 | ) | — | |||||||||||||||||
Non-cash impact of inventory step-up (2) | 29 | (29 | ) | — | 29 | (29 | ) | — | |||||||||||||||||
Other (3) | 7 | 18 | 8 | 7 | 45 | 29 | |||||||||||||||||||
Total adjustments | 63 | (3,243 | ) | 28 | 63 | (3,025 | ) | 72 | |||||||||||||||||
Segment EBITDA | $ | 99 | $ | 18 | $ | 128 | $ | 99 | $ | 233 | $ | 374 | |||||||||||||
Segment EBITDA: | |||||||||||||||||||||||||
Forest Products Resins | $ | 66 | $ | 18 | $ | 76 | $ | 66 | $ | 152 | $ | 219 | |||||||||||||
Epoxy, Phenolic and Coating Resins | 50 | — | 66 | 50 | 111 | 208 | |||||||||||||||||||
Corporate and Other | (17 | ) | — | (14 | ) | (17 | ) | (30 | ) | (53 | ) | ||||||||||||||
Total | $ | 99 | $ | 18 | $ | 128 | $ | 99 | $ | 233 | $ | 374 |
(1) Excludes the “Non-cash impact of inventory step-up” discussed below.
(2) Represent $29 of non-cash expense related to the step up of finished goods inventory on July 1 as part of fresh start accounting that was expensed in the successor period upon the sale of the inventory (see Note 4).
(3) Includes $18 of Segment EBITDA impact related to deferred revenue that was accelerated on July 1 as part of Fresh Start accounting.
Items Not Included in Segment EBITDA
Not included in Segment EBITDA are certain non-cash items and other unusual or non-recurring income and expenses.
Reorganization items, net for the Predecessor period from January 1, 2019 through July 1, 2019 represent incremental costs incurred directly as a result of the Company’s Chapter 11 proceedings after the date of filing, gains on the settlement of liabilities under the Plan and the net impact of fresh start accounting adjustments. See Note 5 for more information.
For the Successor period from July 2, 2019 through September 30, 2019, transaction costs primarily included $4 of certain professional fees and other expenses related to the Company’s Chapter 11 proceedings incurred post-emergence. For the Predecessor period from January 1, 2019 through July 1, 2019, transaction costs primarily included $23 of certain professional fees and other expenses related to the Company’s Chapter 11 proceedings incurred prior to the date of filing. For the three and nine months ended September 30, 2018, transaction costs included certain professional fees related to strategic projects.
For the Successor period July 2, 2019 through September 30, 2019, Predecessor period from January 1, 2019 through July 1, 2019 and for the three and nine months ended September 30, 2018, business realignment costs primarily included costs related to certain in-process facility rationalizations and cost reduction programs.
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For the Successor period from July 2, 2019 through September 30, 2019, items classified as “Other” includes expenses from retention programs and expenses related to legacy liabilities. For the Predecessor period from January 1, 2019 through July 1, 2019 and for the three and nine months ended September 30, 2018, items classified as “Other” primarily included expenses from retention programs, management fees and expenses related to legacy liabilities.
16. Changes in Accumulated Other Comprehensive Loss
Following is a summary of changes in “Accumulated other comprehensive loss” for the Successor period July 2, 2019 through September 30, 2019 and the Predecessor period of January 1, 2019 through July 1, 2019 and the nine months ended September 30, 2018:
Defined Benefit Pension and Postretirement Plans | Foreign Currency Translation Adjustments | Total | ||||||||||
Predecessor | ||||||||||||
Balance at December 31, 2017 | $ | 1 | $ | (9 | ) | $ | (8 | ) | ||||
Change in value | — | (8 | ) | (8 | ) | |||||||
Balance at September 30, 2018 | $ | 1 | $ | (17 | ) | $ | (16 | ) | ||||
Balance at December 31, 2018 | $ | (1 | ) | $ | (17 | ) | $ | (18 | ) | |||
Change in value | — | (8 | ) | (8 | ) | |||||||
Elimination of Predecessor Company accumulated other comprehensive loss | 1 | 25 | 26 | |||||||||
Balance at July 1, 2019 | $ | — | $ | — | $ | — | ||||||
Successor | ||||||||||||
Balance at July 2, 2019 | $ | — | $ | — | $ | — | ||||||
Change in value | — | (16 | ) | (16 | ) | |||||||
Balance at September 30, 2019 | $ | — | $ | (16 | ) | $ | (16 | ) |
17. Income Taxes
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.
For the year ended December 31, 2018, the Company recognized income tax expense of $40, primarily as a result of income from certain foreign operations. In the United States, as a result of Tax Reform, disallowed interest expense resulted in current year taxable income which utilized a net operating loss carryforward. The disallowed interest expense carryforward of $283 generated a deferred tax asset. The decrease in the valuation allowance due to the net operating loss utilization was offset by an increase in the valuation allowance recorded on the interest expense carryforward deferred tax asset. Tax Reform also resulted in the inclusion of Global Intangible Low Tax Income (“GILTI”) of $21, which was fully offset by our net operating loss. This further reduced the Company’s valuation allowance.
Additionally, certain provisions of Tax Reform were not effective until 2018. During 201, the Company evaluated and recorded the impact of these provisions in the financial statements and the Company has made its accounting policy elections with respect to these items. The Company elected to account for GILTI as a current period expense in the reporting period in which the tax is incurred.
The income tax (benefit) expense for the Successor period July 2, 2019 through September 30, 2019, and the Predecessor periods July 1, 2019 and the three months ended September 30, 2018 was $(4), $207 and $6, respectively. The income tax (benefit) expense for the Successor period from July 2, 2019 through September 30, 2019, and for the Predecessor periods January 1, 2019 through July 1, 2019 and the nine months ended September 30, 2018 was $(4), $222 and $17, respectively.
The income tax (benefit) expense relates primarily to losses and income from certain foreign operations as well as the impacts of reorganization adjustments and fresh start accounting. In 2019 and 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.
The effective tax rate for the Successor period July 2, 2019 through September 30, 2019, and the Predecessor periods July 1, 2019 and the three months ended September 30, 2018 was 8%, 6% and (50)%, respectively. The effective tax rate for the Successor period from July 2, 2019 through September 30, 2019, and for the Predecessor periods January 1, 2019 through July 1, 2019 and the nine months ended September 30, 2018 was 8%, 7% and (46)%, respectively.
The change in the effective tax rate was primarily attributable to the income tax impacts from reorganization adjustments and fresh start accounting. The effective tax rate was also impacted by the amount and distribution of income and losses among the various jurisdictions in which we operate. The operating gains and losses generated in jurisdictions where no tax expense or benefit was recognized due to the maintenance of a full valuation allowance also impacted the effective tax rate.
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Upon emergence from bankruptcy, the Successor Company applied fresh start accounting (See Note 4 for more information regarding fresh start accounting) and therefore the deferred tax assets and liabilities were adjusted based on the revised U.S. GAAP financial statements. As a result of the step-up in U.S. GAAP basis in the Successor Company’s foreign assets without a corresponding step-up in the tax basis of the foreign assets, the Successor Company’s deferred tax liability increased. An Internal Revenue Code §338(h)(10) election is expected to be made to treat the Emergence as an asset sale for U.S. income tax purposes. As a result, the Emergence is expected to be treated as a deemed sale of assets of the Predecessor Company while the Successor Company receives a step-up in U.S. tax basis to fair value. The Successor Company anticipates electing bonus depreciation (as currently permitted under Tax Reform) on the stepped-up U.S. eligible fixed assets. The Successor Company also anticipates amortizing the stepped-up basis of intangibles over a 15-year period and the Successor Company’s depreciation and amortization expense is expected to generate a U.S. net operating loss (“NOL”) for the tax year ended December 31, 2019. The NOL will be carried forward indefinitely but will be subject to an 80% limitation on U.S. taxable income.
The Company recorded income tax expense of $40 for reorganization adjustments in the Predecessor period, primarily consisting of tax expense of $50 for the gain recognized between fair value and tax basis (the gain in Predecessor Company will be substantially offset by the Predecessor Company’s tax attributes, including NOL and previously disallowed interest expense). A tax benefit of $10 was recorded for the removal of a valuation allowance for certain foreign jurisdictions. Pursuant to the Plan, the Successor Company is obligated to indemnify the Predecessor Company for any tax related liabilities. The Predecessor Company recorded income tax expense of $167 for fresh start accounting in the Predecessor period, primarily related to the increase in deferred tax liabilities resulting from fresh start accounting.
The majority of the Predecessor Company’s U.S. and certain state NOL carryforwards, along with other tax attributes, are expected to be utilized or forfeited as a result of the taxable gain realized from the Emergence. Certain foreign NOL and other carryforwards of the Predecessor Company will also be forfeited upon the Emergence.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollar amounts in millions) |
The following commentary should be read in conjunction with the audited 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 third quarter of 2019” refers to the three months ended September 30, 2019 and “the third quarter of 2018” refers to the three months ended September 30, 2018, “the first nine months of 2019” refers to the nine months ended September 30, 2019 and “the first nine months of 2018” refers to the nine months ended September 30, 2018.
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,” “might,” “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 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, the impact of our 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
Bankruptcy Filing and Going Concern
We previously disclosed, based on our financial condition and our projected operating results, the defaults under our debt agreements, and the risks and uncertainties surrounding our Chapter 11 proceedings, that there was substantial doubt as to our ability to continue as a going concern as of the issuance of our 2018 Annual Report on Form 10-K. After our emergence from Chapter 11 on July 1, 2019, based on our new capital structure, liquidity position upon emergence and projected operating results, we expect to continue as a going concern for the next twelve months. Refer to Note 3 to the Condensed Consolidated Financial Statements in Part I of this Quarterly Report on Form 10-Q for more information.
Financial Reporting in Reorganization
Financial Reporting in Reorganization
Effective on the Petition Date, we applied ASC 852, which is applicable to companies under Chapter 11 bankruptcy protection. It requires the financial statements for periods subsequent to the Chapter 11 filing to distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Expenses, realized gains and losses, and provisions for losses that are directly associated with reorganization proceedings must be reported separately as “Reorganization items, net” in the Condensed Consolidated Statements of Operations. In addition, the balance sheet must distinguish debtor pre-petition liabilities subject to compromise (“LSTC”) from liabilities of non-filing entities, pre-petition liabilities that are not subject to compromise and post-petition liabilities in the accompanying Condensed Consolidated Balance Sheet. LSTC are pre-petition obligations that are not fully secured and have at least a possibility of not being repaid at the full claim amount. LSTC related to debt, its related interest payable and certain affiliate payables were settled in accordance with the Plan, as applicable, on or shortly after we emerged from Chapter 11 bankruptcy on July 1, 2019. As of July 1, 2019, all remaining liabilities subject to compromise were not impaired and remain on the Company’s Condensed Consolidated Balance Sheets.
Our Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018 included in this Quarterly Report on Form 10-Q were prepared under the basis of accounting assuming that we will continue as a going concern, which contemplated continuity of operations, realization of assets and satisfaction of liabilities and commitments in the normal course of business.
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Fresh Start Accounting
On the Effective Date, in accordance with ASC 852, we applied fresh start accounting to our financial statements as (i) the holders of our existing voting shares prior to its emergence received less than 50% of the voting shares outstanding following our emergence from bankruptcy and (ii) the reorganization value of our assets immediately prior to confirmation of the plan of reorganization was less than the post-petition liabilities and allowed claims. Fresh start accounting was applied to our consolidated financial statements as of July 1, 2019, the date we emerged from bankruptcy, which resulted in a new basis of accounting and we became a new entity for financial reporting purposes. As a result, we allocated the reorganization value to our individual assets based on their estimated fair values. Reorganization value represents the fair value of our assets before considering liabilities. The excess reorganization value over the fair value of identified tangible and intangible assets was reported as goodwill.
As a result of the application of fresh start accounting and the effects of the implementation of the Plan, the Condensed Consolidated Financial Statements after July 1, 2019 are not comparable with the Condensed Consolidated Financial Statements prior to that date. References to “Successor” or “Successor Company” relate to our financial position and results of operations after July 1, 2019. References to “Predecessor” or “Predecessor Company” refer to our financial position and results of operations on or before July 1, 2019. For further information on comparability of Predecessor and Successor periods, see discussion within Financial Results Summary section below.
Business Overview
We are a large participant in the specialty chemicals industry, and a leading producer of adhesive and structural resins and coatings. We provide a broad array of thermosets and associated technologies and have significant market positions in all of the key markets that we serve. Thermosets are a critical ingredient for virtually all paints, coatings, glues and other adhesives produced for consumer or industrial uses.
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 3,100 customers in approximately 85 countries. Our global customers include large companies in their respective industries, such as 3M, Akzo Nobel, BASF, Bayer, Dow, Louisiana Pacific, Owens Corning, PPG Industries, Valspar and Weyerhaeuser.
Reportable Segments
Our business segments are based on the products that we offer and the markets that we serve. At September 30, 2019, we had three reportable segments: Forest Products Resins; Epoxy, Phenolic and Coating Resins; and Corporate and Other. A summary of the major products of our reportable segments follows:
• | Forest Products Resins: forest products resins and formaldehyde applications |
• | 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 |
• | Corporate and Other: primarily corporate general and administrative expenses that are not allocated to the other segments, such as shared service and administrative functions and foreign exchange gains and losses. |
Anticipated Realignment of Reportable Segments in 2020
As part of the our continuing efforts to drive growth and greater operating efficiencies, we are reviewing our reporting segments to align around our two growth platforms: adhesives; and coatings and composites which consist of the following businesses:
• | Adhesives: these businesses focus on the global adhesives market. They include our global wood adhesives business, including: forest products resin assets in North America, Latin America, Europe, Australia and New Zealand; global formaldehyde; and the global phenolic specialty resins business, which now also includes the oilfield technologies group. |
• | Coatings and Composites: these businesses focus on the global coatings and composites market. They include our base and specialty epoxy resins and Versatic™ Acids and Derivatives businesses. |
The process of reviewing our new segment reporting structure is still ongoing. Once our review is complete, we will modify our internal reporting processes and systems to accommodate our new structure and we expect to change our segment reporting effective in the first quarter of 2020.
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Financial Results Summary
Our financial results for the period from January 1, 2019 through July 1, 2019 and for fiscal year ended 2018 are referred to as those of the “Predecessor” period. Our financial results for the period from July 2, 2019 through September 30, 2019 are referred to as those of the “Successor” period. Our results of operations as reported in our Condensed Consolidated Financial Statements for these periods are prepared in accordance with U.S. GAAP, which requires that we report on our results for the period from January 1, 2019 through July 1, 2019 and the period from July 2, 2019 through September 30, 2019 separately.
We do not believe that reviewing the results of these periods in isolation would be useful in identifying any trends in or reaching any conclusions regarding our overall operating performance. Management believes that the key performance metrics such as Net sales, Operating income and Segment EBITDA for the Successor period when combined with the Predecessor period provides more meaningful comparisons to other periods and are useful in identifying current business trends. Accordingly, in addition to presenting our results of operations as reported in our Condensed Consolidated Financial Statements in accordance with U.S. GAAP, the tables and discussions below also present the combined results for the three months and nine months ended September 30, 2019.
The combined results (referenced as “Non-GAAP Combined” or “Combined”) for the third quarter ended September 30, 2019 and first nine months ended September 30, 2019, which we refer to herein as results for the “Three Months Ended September 30, 2019” and “Nine Months Ended September 30, 2019” represent the sum of the reported amounts for the Predecessor period July 1, 2019 combined with the Successor period from July 2, 2019 through September 30, 2019 and the Predecessor period from January 1, 2019 through July 1, 2019 combined with the Successor period from July 2, 2019 through September 30, 2019, respectively. These Combined results are not considered to be prepared in accordance with U.S. GAAP and have not been prepared as pro forma results under applicable regulations. The Non-GAAP Combined operating results is presented for supplemental purposes only, may not reflect the actual results we would have achieved absent our emergence from bankruptcy, may not be indicative of future results and should not be viewed as a substitute for the financial results of the Predecessor period and Successor period presented in accordance with U.S. GAAP.
2019 Overview
Following are highlights from our results of operations for the nine months ended September 30, 2019 and 2018:
Successor | Predecessor | Non-GAAP Combined | Predecessor | $ Change | % Change | ||||||||||||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, | |||||||||||||||||||||
2019 | 2018 | ||||||||||||||||||||||
Statements of Operations: | |||||||||||||||||||||||
Net sales | $ | 836 | $ | 1,778 | $ | 2,614 | $ | 2,893 | $ | (279 | ) | (10 | )% | ||||||||||
Operating (loss) income | (16 | ) | 88 | 72 | 219 | (147 | ) | (67 | )% | ||||||||||||||
(Loss) income before income tax | (48 | ) | 3,115 | 3,067 | (37 | ) | 3,104 | n/m | |||||||||||||||
Net (loss) income | (43 | ) | 2,895 | 2,852 | (52 | ) | 2,904 | n/m | |||||||||||||||
Segment EBITDA: | |||||||||||||||||||||||
Forest Products Resins | $ | 66 | $ | 152 | $ | 218 | $ | 219 | $ | (1 | ) | — | % | ||||||||||
Epoxy, Phenolic and Coating Resins | 50 | 111 | 161 | 208 | (47 | ) | (23 | )% | |||||||||||||||
Corporate and Other | (17 | ) | (30 | ) | (47 | ) | (53 | ) | 6 | (11 | )% | ||||||||||||
Total | $ | 99 | $ | 233 | $ | 332 | $ | 374 | $ | (42 | ) | (11 | )% |
• | Net Sales—In the first nine months of 2019, net sales decreased by $279, or 10%, compared to the first nine months of 2018. Volume decreases negatively impacted net sales by $114 primarily related to volume decreases in our North American resins business due to weaker demand driven by moderately lower housing starts, customer mill closures and the impact of competitive pricing pressures, and in our phenolic resins business due to an overall weakness in the market, primarily in the automotive and construction industries. These decreases were partially offset by increased volumes in our epoxy specialty business due to strong demand in China wind energy. Foreign currency translation negatively impacted net sales by $89 due to the weakening of various foreign currencies against the U.S. dollar in the first nine months 2019 compared to the first nine months of 2018. Pricing negatively impacted sales by $76 due primarily to softer market conditions in our base epoxy resins business. |
• | Net Income—In the first nine months of 2019, net income increased by $2,904 as compared to the first nine months of 2018. This increase was driven by $3,105 of net reorganization items primarily related to reorganization and fresh start adjustments associated with our emergence from bankruptcy, and a decrease in interest expense of $133 as a result of the restructuring of our debt through our Chapter 11 proceedings. These increases were partially offset by a decrease in gross profit due primarily to the margin reductions in our base epoxy resins business discussed above, increased depreciation and amortization expense related to the increase in our fixed and intangible assets as a result of fresh start adjustments and a gain on the sale of our ATG business of $44 that occurred in the first quarter of 2018. |
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• | Segment EBITDA—For the first nine months of 2019, Segment EBITDA was $332, a decrease of 11% compared with $374 in the first nine months of 2018. This decrease was primarily due to margin reductions in our base epoxy resins business driven by softer market conditions. |
• | Restructuring and Cost Reduction Programs—We have achieved $13 in cost savings related to our cost reduction programs in the first nine months of 2019. We have essentially realized all cost savings associated with the approximately $40 cost savings program announced in the fourth quarter of 2017. During 2019, we have initiated approximately $20 of new cost reduction activities, of which we have $18 of in-process cost savings that we expect to realize over the next 12 months. |
• | Network Security Incident— In March 2019, we experienced a network security incident that temporarily prevented access to certain information technology systems and data within our network, primarily impacting our corporate functions. We took immediate steps to isolate the issue and implemented our technical recovery plan. Our manufacturing sites, which rely on different networks, continued to operate safely and with limited interruption. For the three and nine months ended September 30, 2019, we incurred approximately $4 and $13, respectively, in costs related to the incident. We have received $5 of insurance recoveries to date and will seek additional reimbursement for costs incurred related to the incident, where applicable. |
• | Growth Initiatives—We recently completed construction of our new Application Development Center in Shanghai, China, which will help meet the strong growth and demand for new coatings technologies in the region. We also recently announced plans for the expansion of our adhesive resins capacity in Australia as we continue to invest in productivity projects and strategically invest in our manufacturing footprint. |
Short-term Outlook
In the fourth quarter of 2019, we expect Segment EBITDA to be relatively flat compared to 2018 in our North American forest products resins business based on the latest expectations in U.S. housing starts and remodeling. Additionally, we anticipate modest overall improvement in our Latin American business due to ongoing recovery in the Brazilian economy. We continue to expect stable volumes in our North American formaldehyde solutions business for the remainder of 2019, but we anticipate volume decreases in certain formaldehyde derivatives due to continued softness in the oil and gas markets in Western Canada.
We expect improvement in our epoxy specialty business in the remainder of 2019 due to the introduction of new products and government supported investment in the China wind energy market. We expect softer market conditions in our base epoxy business to continue in the fourth quarter of 2019.
Overall, we expect continued end market volatility, primarily in the automotive and construction industries, combined with the impacts of ongoing global trade discussions, to challenge our business results in the fourth quarter of 2019. We do anticipate that all of our businesses will continue to benefit from the savings associated with our restructuring and cost reduction initiatives. In addition, despite the prevailing economic headwinds, with our new capital structure and the benefits of decreasing working capital we expect to generate positive free cash flow in the fourth quarter of 2019. Finally, we expect raw material price volatility to continue throughout the remainder of 2019.
Matters Impacting Comparability of Results
Chapter 11 Bankruptcy and Fresh Start Accounting Impacts
As a result of the emerging from Chapter 11 and qualifying for the application of fresh-start accounting, at the Effective Date, our assets and liabilities were recorded at their estimated fair values which, in some cases, are significantly different than amounts included in our financial statements prior to the Effective Date. Accordingly, our financial condition and results of operations on and after the Effective Date are not directly comparable to our financial condition and results of operations prior to the Effective Date. The total amount of reorganization and fresh start adjustments, as well as incremental costs incurred related to our Bankruptcy Petitions incurred while we were in bankruptcy resulted in a total gain of $3,105 which is classified within “Reorganization items, net” in the unaudited Condensed Consolidated Statements of Operations. See Note 5 Item 1 of Part I of this Quarterly Report on Form 10-Q for more information on the components of “Reorganization items, net.”
In addition, we incurred costs related to our Chapter 11 proceedings both prior to filing for bankruptcy and post-emergence, which are not classified within “Reorganization items, net” as these costs were not incurred while in bankruptcy. These costs were $4 and $27 for the three and nine months ended September 30, 2019, respectively, and are classified within “Selling, general and administrative expense” in the unaudited Condensed Consolidated Statements of Operations.
Raw Material Prices
Raw materials comprise approximately 80% of our cost of sales (excluding depreciation expense). 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 nine months of 2019 compared to the first nine months of 2018, the average price of methanol decreased by approximately 18% and the average price of urea and phenol increased by approximately 3% and 1%, respectively. The impact of passing through raw material price changes to customers can result in significant variances in sales comparisons from year to year.
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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. Our non-U.S. operations accounted for approximately 55% of our sales in the first nine months of 2019. 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.
Results of Operations
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Successor | Predecessor | Non-GAAP Combined | Predecessor | ||||||||||||||||||
July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, | |||||||||||||||||||
2019 | 2018 | ||||||||||||||||||||
$ | $ | $ | % of Net Sales | $ | % of Net Sales | ||||||||||||||||
Net sales | $ | 836 | $ | — | $ | 836 | 100 | % | 952 | 100 | % | ||||||||||
Cost of sales (exclusive of depreciation and amortization shown below, see Note 2) | 710 | — | 710 | 85 | % | 773 | 81 | % | |||||||||||||
Selling, general and administrative expense (see Note 2) | 69 | — | 69 | 8 | % | 68 | 7 | % | |||||||||||||
Depreciation and amortization (see Note 2) | 55 | — | 55 | 7 | % | 27 | 3 | % | |||||||||||||
Asset impairments | — | — | — | — | % | 3 | — | % | |||||||||||||
Business realignment costs | 13 | — | 13 | 2 | % | 5 | 1 | % | |||||||||||||
Other operating expense, net | 5 | — | 5 | 1 | % | 6 | 1 | % | |||||||||||||
Operating (loss) income | (16 | ) | — | (16 | ) | (2 | )% | 70 | 7 | % | |||||||||||
Interest expense, net | 28 | — | 28 | 3 | % | 83 | 9 | % | |||||||||||||
Other non-operating expense (income), net | 4 | — | 4 | — | % | (1 | ) | — | % | ||||||||||||
Reorganization items, net (see Note 5) | — | (3,261 | ) | (3,261 | ) | (390 | )% | — | — | % | |||||||||||
Total non-operating expense (income) | 32 | (3,261 | ) | (3,229 | ) | (387 | )% | 82 | 9 | % | |||||||||||
(Loss) income before income tax and earnings from unconsolidated entities | (48 | ) | 3,261 | 3,213 | 385 | % | (12 | ) | (2 | )% | |||||||||||
Income tax (benefit) expense | (4 | ) | 207 | 203 | 24 | % | 6 | 1 | % | ||||||||||||
(Loss) income before earnings from unconsolidated entities | (44 | ) | 3,054 | 3,010 | 361 | % | (18 | ) | (3 | )% | |||||||||||
Earnings from unconsolidated entities, net of taxes | 1 | — | 1 | — | % | — | — | % | |||||||||||||
Net (loss) income | (43 | ) | 3,054 | 3,011 | 361 | % | (18 | ) | (3 | )% | |||||||||||
Net income attributable to noncontrolling interest | — | — | — | — | % | — | — | % | |||||||||||||
Net (loss) income attributable to Hexion Inc. | $ | (43 | ) | $ | 3,054 | $ | 3,011 | 361 | % | (18 | ) | (3 | )% | ||||||||
Other comprehensive loss | $ | (16 | ) | $ | — | $ | (16 | ) | (6 | ) |
Three Months Ended September 30, 2019 vs. Three Months Ended September 30, 2018
Net Sales
In the third quarter of 2019, net sales decreased by $116, or 12%, compared to the third quarter of 2018. Volume decreases negatively impacted net sales by $54, which was primarily related to volume decreases in our North American resins business due to weaker demand driven by customer mill closures and the impact of competitive pricing pressures, and in our base epoxy and phenolic resins businesses due to overall weakness in the market, primarily in the automotive and construction industries. Pricing negatively impacted sales by $46 due primarily to softer market conditions in our base epoxy resins business and methanol price decreases contractually passed through to customers across many of our businesses. Foreign currency translation negatively impacted net sales by $16 due to weakening of various foreign currencies against the U.S. dollar in the third quarter of 2019 compared to the third quarter of 2018.
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Operating Income
In the third quarter of 2019, operating income decreased by $86 compared to the third quarter of 2018, driven by margin reductions in our base epoxy resins business discussed above, $29 of non-cash expense related to the step up of finished goods inventory on July 1 as part of fresh start accounting that was expensed in the successor period upon the sale of the inventory, increases in depreciation and amortization of $28 and an increase in business realignment costs of $8. The increase in depreciation and amortization is due to the increase in our fixed and intangible assets as a result of fresh start adjustments and the increase in business realignment costs is driven by higher severance expenses related to current cost reduction actions.
Non-Operating Expense
In the third quarter of 2019, total non-operating expense decreased by $3,311 compared to the third quarter of 2018. This was driven by $3,261 of reorganization items, net primarily related to reorganization and fresh start adjustments associated with our emergence from bankruptcy and an increase of $5 in other non-operating expense driven by higher realized and unrealized foreign currency losses, partially offset by a decrease in interest expense of $55 as a result of the restructuring of our debt through our Chapter 11 proceedings.
Income Tax Expense
The income tax (benefit) expense for the Successor period July 2, 2019 through September 30, 2019, and the Predecessor periods July 1, 2019 and the three months ended September 30, 2018 was $(4), $207 and $6, respectively. The income tax (benefit) expense relates primarily to losses and income from certain foreign operations as well as the impacts of reorganization adjustments and fresh start accounting. In 2019 and 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.
The effective tax rate for the Successor period July 2, 2019 through September 30, 2019, and the Predecessor periods July 1, 2019 and the three months ended September 30, 2018 was 8%, 6% and (50)%, respectively. The change in the effective tax rate was primarily attributable to the income tax impacts from reorganization adjustments and fresh start accounting. The effective tax rate was also impacted by the amount and distribution of income and losses among the various jurisdictions in which we operate. The operating gains and losses generated in jurisdictions where no tax expense or benefit was recognized due to the maintenance of a full valuation allowance also impacted the effective tax rate. Refer to Note 17 to the Condensed Consolidated Financial Statements in Part I of this Quarterly Report on Form 10-Q for more information.
Other Comprehensive Income
For the third quarter of 2019, foreign currency translation negatively impacted other comprehensive loss by $16, due to an overall weakening of various foreign currencies against the U.S. dollar in the third quarter of 2019.
For the third quarter of 2018, foreign currency translation positively impacted other comprehensive loss by $6, primarily due to the weakening of various foreign currencies against the U.S. dollar in the third quarter of 2018.
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Successor | Predecessor | Non-GAAP Combined | Predecessor | |||||||||||||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, | ||||||||||||||||||||
2019 | 2018 | |||||||||||||||||||||
$ | $ | $ | % of Net Sales | $ | % of Net Sales | |||||||||||||||||
Net sales | $ | 836 | 1,778 | 2,614 | 100 | % | $ | 2,893 | 100 | % | ||||||||||||
Cost of sales (exclusive of depreciation and amortization shown below, see Note 2) | 710 | 1,462 | 2,172 | 83 | % | 2,343 | 81 | % | ||||||||||||||
Selling, general and administrative expense (see Note 2) | 69 | 145 | 214 | 8 | % | 217 | 8 | % | ||||||||||||||
Depreciation and amortization (see Note 2) | 55 | 52 | 107 | 4 | % | 85 | 3 | % | ||||||||||||||
Gain on disposition | — | — | — | — | % | (44 | ) | (2 | )% | |||||||||||||
Asset impairments | — | — | — | — | % | 28 | 1 | % | ||||||||||||||
Business realignment costs | 13 | 15 | 28 | 1 | % | 19 | 1 | % | ||||||||||||||
Other operating expense, net | 5 | 16 | 21 | 1 | % | 26 | 1 | % | ||||||||||||||
Operating (loss) income | (16 | ) | 88 | 72 | 3 | % | 219 | 8 | % | |||||||||||||
Interest expense, net | 28 | 89 | 117 | 4 | % | 250 | 9 | % | ||||||||||||||
Other non-operating expense (income), net | 4 | (11 | ) | (7 | ) | — | % | 6 | — | % | ||||||||||||
Reorganization items, net (see Note 5) | — | (3,105 | ) | (3,105 | ) | (119 | )% | — | — | % | ||||||||||||
Total non-operating expense | 32 | (3,027 | ) | (2,995 | ) | (115 | )% | 256 | 9 | % | ||||||||||||
(Loss) income before income tax and earnings from unconsolidated entities | (48 | ) | 3,115 | 3,067 | 117 | % | (37 | ) | (1 | )% | ||||||||||||
Income tax (benefit) expense | (4 | ) | 222 | 218 | 8 | % | 17 | 1 | % | |||||||||||||
(Loss) income before earnings from unconsolidated entities | (44 | ) | 2,893 | 2,849 | 109 | % | (54 | ) | (2 | )% | ||||||||||||
Earnings from unconsolidated entities, net of taxes | 1 | 2 | 3 | — | % | 2 | — | % | ||||||||||||||
Net (loss) income | (43 | ) | 2,895 | 2,852 | 109 | % | (52 | ) | (2 | )% | ||||||||||||
Net income attributable to noncontrolling interest | — | (1 | ) | (1 | ) | — | % | (1 | ) | — | % | |||||||||||
Net (loss) income attributable to Hexion Inc. | $ | (43 | ) | $ | 2,894 | $ | 2,851 | 109 | % | $ | (53 | ) | (2 | )% | ||||||||
Other comprehensive loss | $ | (16 | ) | $ | (8 | ) | $ | (24 | ) | $ | (8 | ) |
Nine Months Ended September 30, 2019 vs. Nine Months Ended September 30, 2018
Net Sales
In the first nine months of 2019, net sales decreased by $279, or 10%, compared to the first nine months of 2018. Volume decreases negatively impacted net sales by $114 primarily related to volume decreases in our North American resins business due to weaker demand driven by moderately lower housing starts, customer mill closures and the impact of competitive pricing pressures, and in our phenolic resins business due to an overall weakness in the market, primarily in the automotive and construction industries. These decreases were partially offset by increased volumes in our epoxy specialty business due to strong demand in China wind energy. Foreign currency translation negatively impacted net sales by $89 due to the weakening of various foreign currencies against the U.S. dollar in the first nine months 2019 compared to the first nine months of 2018. Pricing negatively impacted sales by $76 due primarily to softer market conditions in our base epoxy resins business.
Operating Income
In the first nine months of 2019, operating income decreased by $147 compared to the first nine months of 2018, driven by margin reductions in our base epoxy resins business discussed above, the gain on the disposition of our ATG business of $44 that occurred in the first quarter 2018, $29 of non-cash expense related to the step up of finished goods inventory on July 1 as part of fresh start accounting that was expensed in the successor period upon the sale of the inventory, increases in depreciation and amortization of $22 and increases in business realignment costs of $9. The increase in depreciation and amortization is due to the increase in our fixed and intangible assets as a result of fresh start adjustments and the increase in business realignment costs is driven by higher severance expenses related to current cost reduction actions. These decreases to operating income were partially offset by an asset impairment of $28 that occurred in third quarter of 2018 within our oilfield business, as well as decreases in selling, general and administrative expense of $3 and in our other operating expense of $5. The decrease in selling, general and administrative expense was due primarily to our ongoing cost savings and productivity actions, as well as timing of variable compensation costs, partially offset by approximately $23 of certain professional fees and other expenses incurred in the first quarter of 2019 related to our Chapter 11 proceedings. The decrease in other operating expense is due to lower realized and unrealized foreign currency losses.
Non-Operating Expense
In the first nine months of 2019, total non-operating expense decreased by $3,251 compared to the first nine months of 2018. This was due to a $3,105 of reorganization items, net primarily related to reorganization and fresh start adjustments associated with our emergence from bankruptcy, partially offset by a decrease in interest expense of $133 as a result of our the restructuring of our debt through our Chapter 11 proceedings and an increase of $13 in other non-operating income driven by higher realized and unrealized foreign currency gains.
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Income Tax Expense
The income tax (benefit) expense for the Successor period from July 2, 2019 through September 30, 2019, and for the Predecessor periods January 1, 2019 through July 1, 2019 and the nine months ended September 30, 2018 was $(4), $222 and $17, respectively. The income tax (benefit) expense relates primarily to losses and income from certain foreign operations as well as the impacts of reorganization adjustments and fresh start accounting. In 2019 and 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.
The effective tax rate for the Successor period from July 2, 2019 through September 30, 2019, and for the Predecessor periods January 1, 2019 through July 1, 2019 and the nine months ended September 30, 2018 was 8%, 7% and (46)%, respectively. The change in the effective tax rate was primarily attributable to the income tax impacts from reorganization adjustments and fresh start accounting. The effective tax rate was also impacted by the amount and distribution of income and losses among the various jurisdictions in which we operate. The operating gains and losses generated in jurisdictions where no tax expense or benefit was recognized due to the maintenance of a full valuation allowance also impacted the effective tax rate. Refer to Note 17 to the Condensed Consolidated Financial Statements in Part I of this Quarterly Report on Form 10-Q for more information.
Other Comprehensive Income
For the first nine months of 2019, foreign currency translation negatively impacted other comprehensive loss by $24, due to an overall weakening of various foreign currencies against the U.S. dollar in the first nine months of 2019.
For the first nine months of 2018, foreign currency positively impacted other comprehensive loss by $8, primarily due to an overall weakening of various foreign currencies against the U.S. dollar in the first nine months of 2018.
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.
The combined results (referenced as “Non-GAAP Combined” or “Combined”) for the third quarter ended September 30, 2019 and first nine months ended September 30, 2019, which we refer to herein as results for the “Three Months Ended September 30, 2019” and “Nine Months Ended September 30, 2019” represent the sum of the reported amounts for the Predecessor period July 1, 2019 combined with the Successor period from July 2, 2019 through September 30, 2019 and the Predecessor period from January 1, 2019 through July 1, 2019 combined with the Successor period from July 2, 2019 through September 30, 2019, respectively. These Combined results are not considered to be prepared in accordance with U.S. GAAP and have not been prepared as pro forma results under applicable regulations. The Non-GAAP Combined operating results is presented for supplemental purposes only, may not reflect the actual results we would have achieved absent our emergence from bankruptcy, may not be indicative of future results and should not be viewed as a substitute for the financial results of the Predecessor period and Successor period presented in accordance with U.S. GAAP. See Note 15 in Part I of this Quarterly Report on Form 10-Q and below for reconciliation of net (loss) income to Segment EBITDA for the Successor and Predecessor.
Non-GAAP Combined | Predecessor | |||||||
Three Months Ended September 30, | ||||||||
2019 | 2018 | |||||||
Net Sales (1): | ||||||||
Forest Products Resins | $ | 367 | $ | 431 | ||||
Epoxy, Phenolic and Coating Resins | 469 | 521 | ||||||
Total | $ | 836 | $ | 952 | ||||
Segment EBITDA: | ||||||||
Forest Products Resins | $ | 84 | $ | 76 | ||||
Epoxy, Phenolic and Coating Resins | 50 | 66 | ||||||
Corporate and Other | (17 | ) | (14 | ) | ||||
Total | $ | 117 | $ | 128 |
(1) Intersegment sales are not significant and, as such, are eliminated within the selling segment.
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Three Months Ended September 30, 2019 vs. Three Months Ended September 30, 2018 Segment Results
Following is an analysis of the percentage change in net sales by segment from the three months ended September 30, 2018 to the three months ended September 30, 2019:
Volume | Price/Mix | Currency Translation | Total | ||||||||
Forest Products Resins | (8 | )% | (6 | )% | (1 | )% | (15 | )% | |||
Epoxy, Phenolic and Coating Resins | (4 | )% | (4 | )% | (2 | )% | (10 | )% |
Forest Products Resins
Net sales in the third quarter of 2019 decreased by $64, or 15%, when compared to the third quarter of 2018. Volumes negatively impacted net sales by $34, due to volume decreases in our North American resins businesses due to weaker demand driven by customer mill closures and the impact of competitive pricing pressures, and decreases in certain derivatives within our North American formaldehyde business driven by softness in the oil and gas markets in Western Canada. Pricing negatively impacted net sales by $25, which was primarily due to methanol price decreases contractually passed through to customers across many of our businesses. Foreign currency translation negatively impacted net sales by $5 mainly due to the strengthening of the U.S dollar against various foreign currencies in the third quarter of 2019 compared to the third quarter of 2018.
Segment EBITDA in the third quarter of 2019 increased by $8, to $84, compared to the third quarter of 2018. This increase was primarily driven by $18 of previously recorded deferred contract revenue that was accelerated during the period as a result of the application of fresh start accounting, partially offset by the negative volume impacts within our North American resins and formaldehyde businesses discussed above.
Epoxy, Phenolic and Coating Resins
Net sales in the third quarter of 2019 decreased by $52, or 10%, when compared to the third quarter of 2018. Pricing negatively impacted net sales by $21, primarily due to softer market conditions in our base epoxy resins business as compared to the third quarter of 2018. Volumes negatively impacted net sales by $20, which was primarily related to volume decreases in our base epoxy and phenolic specialty resins businesses driven by overall weakness in the market, primarily in the automotive and construction industries. Lastly, foreign currency translation negatively impacted net sales by $11, due primarily to the strengthening of the U.S. dollar against the Euro and Chinese yuan in the third quarter of 2019 compared to the third quarter of 2018.
Segment EBITDA in the third quarter of 2019 decreased by $16 to $50 compared to the third quarter of 2018. The decrease was primarily driven by the margin reductions in our base epoxy resins business due to softer market conditions discussed above.
Corporate and Other
Corporate and Other is primarily corporate, general and administrative expenses that are not allocated to the other segments, such as shared service and administrative functions and unallocated foreign exchange gains and losses. Corporate and Other charges in the third quarter of 2019 increased by $3 compared to the third quarter of 2018 due primarily to timing of variable compensation costs.
Non-GAAP Combined | Predecessor | ||||||
Nine Months Ended September 30, | |||||||
2019 | 2018 | ||||||
Net Sales (1): | |||||||
Forest Products Resins | $ | 1,142 | $ | 1,268 | |||
Epoxy, Phenolic and Coating Resins | 1,472 | 1,625 | |||||
Total | $ | 2,614 | $ | 2,893 | |||
Segment EBITDA: | |||||||
Forest Products Resins | $ | 218 | $ | 219 | |||
Epoxy, Phenolic and Coating Resins | 161 | 208 | |||||
Corporate and Other | (47 | ) | (53 | ) | |||
Total | $ | 332 | $ | 374 |
(1) Intersegment sales are not significant and, as such, are eliminated within the selling segment.
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Nine Months Ended September 30, 2019 vs. Nine Months Ended September 30, 2018 Segment Results
Following is an analysis of the percentage change in net sales by segment from the nine months ended September 30, 2018 to the nine months ended September 30, 2019:
Volume | Price/Mix | Currency Translation | Total | ||||||||
Forest Products Resins | (5 | )% | (2 | )% | (3 | )% | (10 | )% | |||
Epoxy, Phenolic and Coating Resins | (3 | )% | (3 | )% | (3 | )% | (9 | )% |
Forest Products Resins
Net sales in the first nine months of 2019 decreased by $126, or 10%, when compared to the first nine months of 2018. Volumes negatively impacted net sales by $61, primarily related to volume decreases in our North American resins business due to weaker demand driven by moderately lower housing starts, customer mill closures and the impact of competitive pricing pressures. Foreign currency translation negatively impacted net sales by $37, due largely to the strengthening of the U.S. dollar against various foreign currencies in the first nine months of 2019 compared to the first nine months of 2018. Lastly, pricing negatively impacted net sales by $28, primarily due to methanol price decreases contractually passed through to customers across many of our businesses.
Segment EBITDA in the first nine months of 2019 decreased by $1 to $218, when compared to the first nine months of 2018. This decrease was primarily driven by the volume decreases in our North American resins business discussed above, largely offset by $18 of previously recorded deferred contract revenue that was accelerated during the period as a result of the application of fresh start accounting.
Epoxy, Phenolic and Coating Resins
Net sales in the first nine months of 2019 decreased by $153, or 9%, when compared to the first nine months of 2018. Volumes negatively impacted net sales by $53, which was primarily related to volume decreases in our phenolic specialty resins and versatic acids businesses driven by overall weakness in the market, primarily in the automotive and construction industries. These decreases were partially offset by increased volumes in our epoxy specialty business due to [stronger demand in China wind energy]. Foreign currency translation negatively impacted net sales by $52, due primarily to the strengthening of the U.S. dollar against various foreign currencies in the first nine months of 2019 compared to the first nine months of 2018. Lastly, pricing negatively impacted net sales by $48, primarily due to softer market conditions in our base epoxy resins business as compared to the first nine months of 2018.
Segment EBITDA in the first nine months of 2019 decreased by $47 to $161 compared to the first nine months of 2018. The decrease was primarily driven by the margin reductions in our base epoxy resins business due to softer market conditions discussed above.
Corporate and Other
Corporate and Other is primarily corporate, general and administrative expenses that are not allocated to the other segments, such as shared service and administrative functions and unallocated foreign exchange gains and losses. Corporate and Other charges in the first nine months of 2019 decreased by $6 compared to the first nine months of 2018 due primarily to our ongoing cost reduction efforts, the timing of variable compensation costs and favorable foreign exchange impacts.
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Reconciliation of Net (Loss) Income to Segment EBITDA:
Successor | Predecessor | Non-GAAP Combined | Predecessor | |||||||||||||
July 2, 2019 through September 30, 2019 | July 1, 2019 | Three Months Ended September 30, | ||||||||||||||
2019 | 2018 | |||||||||||||||
Reconciliation: | ||||||||||||||||
Net (loss) income | $ | (43 | ) | $ | 3,054 | $ | 3,011 | $ | (18 | ) | ||||||
Income tax (benefit) expense | (4 | ) | 207 | 203 | 6 | |||||||||||
Interest expense, net | 28 | — | 28 | 83 | ||||||||||||
Depreciation and amortization | 55 | — | 55 | 27 | ||||||||||||
Accelerated depreciation | — | $ | — | $ | — | $ | 2 | |||||||||
EBITDA | $ | 36 | $ | 3,261 | $ | 3,297 | $ | 100 | ||||||||
Adjustments to arrive at Segment EBITDA: | ||||||||||||||||
Asset impairments and write-downs | $ | — | $ | — | $ | — | $ | 7 | ||||||||
Business realignment costs | 13 | — | 13 | 5 | ||||||||||||
Transaction costs | 5 | — | 5 | 4 | ||||||||||||
Realized and unrealized foreign currency losses (gains) | 9 | — | 9 | 4 | ||||||||||||
Reorganization items, net (1) | — | (3,232 | ) | (3,232 | ) | — | ||||||||||
Non-cash impact of inventory step-up (2) | 29 | (29 | ) | — | — | |||||||||||
Other (3) | 7 | 18 | 25 | 8 | ||||||||||||
Total adjustments | 63 | (3,243 | ) | (3,180 | ) | 28 | ||||||||||
Segment EBITDA | $ | 99 | $ | 18 | $ | 117 | $ | 128 | ||||||||
Segment EBITDA: | ||||||||||||||||
Forest Products Resins | $ | 66 | $ | 18 | $ | 84 | $ | 76 | ||||||||
Epoxy, Phenolic and Coating Resins | 50 | — | 50 | 66 | ||||||||||||
Corporate and Other | (17 | ) | — | (17 | ) | (14 | ) | |||||||||
Total | $ | 99 | $ | 18 | $ | 117 | $ | 128 |
(1) Excludes the “Non-cash impact of inventory step-up” discussed below.
(2) | Represents $29 of non-cash expense related to the step up of finished goods inventory on July 1 as part of fresh start accounting that was expensed in the successor period upon the sale of the inventory (see Note 4). |
(3) Includes $18 of Segment EBITDA impact related to deferred revenue that was accelerated on July 1 as part of Fresh Start accounting.
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Successor | Predecessor | Non-GAAP Combined | Predecessor | |||||||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | |||||||||||||||
Reconciliation: | ||||||||||||||||
Net (loss) income attributable to Hexion Inc. | $ | (43 | ) | $ | 2,894 | $ | 2,851 | $ | (53 | ) | ||||||
Net income attributable to noncontrolling interest | — | (1 | ) | (1 | ) | (1 | ) | |||||||||
Net (loss) income | (43 | ) | 2,895 | 2,852 | (52 | ) | ||||||||||
Income tax (benefit) expense | (4 | ) | 222 | 218 | 17 | |||||||||||
Interest expense, net | 28 | 89 | 117 | 250 | ||||||||||||
Depreciation and amortization | 55 | 52 | 107 | 85 | ||||||||||||
Accelerated depreciation | — | — | — | 2 | ||||||||||||
EBITDA | $ | 36 | $ | 3,258 | $ | 3,294 | $ | 302 | ||||||||
Adjustments to arrive at Segment EBITDA: | ||||||||||||||||
Asset impairments and write-downs | $ | — | $ | — | $ | — | $ | 32 | ||||||||
Business realignment costs | 13 | 15 | 28 | 19 | ||||||||||||
Gain on disposition | — | — | — | (44 | ) | |||||||||||
Transaction costs | 5 | 26 | 31 | 10 | ||||||||||||
Realized and unrealized foreign currency losses (gains) | 9 | (6 | ) | 3 | 26 | |||||||||||
Reorganization items, net (1) | — | (3,076 | ) | (3,076 | ) | — | ||||||||||
Non-cash impact of inventory step-up (2) | 29 | (29 | ) | — | — | |||||||||||
Other (3) | 7 | 45 | 52 | 29 | ||||||||||||
Total adjustments | 63 | (3,025 | ) | (2,962 | ) | 72 | ||||||||||
Segment EBITDA | $ | 99 | $ | 233 | $ | 332 | $ | 374 | ||||||||
Segment EBITDA: | ||||||||||||||||
Forest Products Resins | $ | 66 | $ | 152 | $ | 218 | $ | 219 | ||||||||
Epoxy, Phenolic and Coating Resins | 50 | 111 | 161 | 208 | ||||||||||||
Corporate and Other | (17 | ) | (30 | ) | (47 | ) | (53 | ) | ||||||||
Total | $ | 99 | $ | 233 | $ | 332 | $ | 374 |
(1) Excludes the “Non-cash impact of inventory step-up” discussed below.
(2) | Represents $29 of non-cash expense related to the step up of finished goods inventory on July 1 as part of fresh start accounting that was expensed in the successor period upon the sale of the inventory (see Note 4). |
(3) Includes $18 of Segment EBITDA impact related to deferred revenue that was accelerated on July 1 as part of Fresh Start accounting.
Items Not Included in Segment EBITDA
Not included in Segment EBITDA are certain non-cash items and other unusual or non-recurring income and expenses.
Reorganization items, net for the Predecessor period from January 1, 2019 through July 1, 2019 represent incremental costs incurred directly as a result of our Chapter 11 proceedings after the date of filing, gains on the settlement of liabilities under the Plan and the net impact of fresh start accounting adjustments. See Note 5 for more information.
For the Successor period from July 2, 2019 through September 30, 2019, transaction costs primarily included $4 of certain professional fees and other expenses related to our Chapter 11 proceedings incurred post-emergence. For the Predecessor period from January 1, 2019 through July 1, 2019, transaction costs primarily included $23 of certain professional fees and other expenses related to our Chapter 11 proceedings incurred prior to the date of filing. For the three and nine months ended September 30, 2018, transaction costs included certain professional fees related to strategic projects.
For the Successor period July 2, 2019 through September 30, 2019, Predecessor period from January 1, 2019 through July 1, 2019 and for the three and nine months ended September 30, 2018, business realignment costs primarily included costs related to certain in-process facility rationalizations and cost reduction programs.
For the Successor period from July 2, 2019 through September 30, 2019, items classified as “Other” included expenses from retention programs and expenses related to legacy liabilities. For the Predecessor period from January 1, 2019 through July 1, 2019 and for the three and nine months ended September 30, 2018, items classified as “Other” primarily included expenses from retention programs, management fees and expenses related to legacy liabilities.
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Liquidity and Capital Resources
2019 Outlook
Following our emergence from our Chapter 11 proceedings, we believe we are favorably positioned to fund our ongoing liquidity requirements for the foreseeable future through cash generated from operations, as well as available borrowings under our ABL Facility. The additional liquidity provided by the Rights Offerings and the impact of the Plan on our capital structure, resulting in reduced annual debt service obligations of approximately $210, will increase our future operational and financial flexibility and leave us well positioned to make strategic capital investments, leverage our leadership positions with both our customers and suppliers, optimize our portfolio and drive new growth programs.
At September 30, 2019, we had $1,789 of outstanding debt and $442 in liquidity consisting of the following:
• | $93 of unrestricted cash and cash equivalents (of which $49 is maintained in foreign jurisdictions); |
• | $300 of borrowings available under our ABL Facility ($350 borrowing base less $50 of outstanding letters of credit); and |
• | $49 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 September 30, 2019 and December 31, 2018 was $537 and $362, respectively. A summary of the components of our net working capital as of September 30, 2019 and December 31, 2018 is as follows:
Successor | Predecessor | |||||||||||||
September 30, 2019 | % of LTM Net Sales | December 31, 2018 | % of LTM Net Sales | |||||||||||
Accounts receivable | $ | 471 | 13 | % | $ | 412 | 11 | % | ||||||
Inventories | 342 | 10 | % | 334 | 9 | % | ||||||||
Accounts payable | (276 | ) | (8 | )% | (384 | ) | (10 | )% | ||||||
Net working capital (1) | $ | 537 | 15 | % | $ | 362 | 10 | % |
(1) | Management believes that this non-GAAP measure is useful supplemental information. This non-GAAP measure should be considered by the reader in addition to but not instead of, the financial statements prepared in accordance with GAAP. |
The increase in net working capital of $175 from December 31, 2018 was driven by an increase in accounts receivable of $59 and an increase in inventory of $8, as well as a decrease in accounts payable of $108. The increases in accounts receivable and inventory were primarily the result of increased volumes in the third quarter of 2019 compared to the fourth quarter of 2018 due to seasonality of our businesses. The decrease in accounts payable was largely related to timing of vendor payments, primarily as a result of our Chapter 11 proceedings. Based on our new capital structure, we expect continued structural improvement in our vendor terms going forward.
Sources and Uses of Cash
Following are highlights from our unaudited Condensed Consolidated Statements of Cash Flows:
Successor | Predecessor | Non-GAAP Combined | Predecessor | |||||||||||||
July 2, 2019 through September 30, 2019 | January 1, 2019 through July 1, 2019 | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | |||||||||||||||
(Uses) sources of cash: | ||||||||||||||||
Operating activities | $ | 25 | $ | (173 | ) | $ | (148 | ) | $ | (49 | ) | |||||
Investing activities | (22 | ) | (42 | ) | (64 | ) | (12 | ) | ||||||||
Financing activities | (17 | ) | 212 | 195 | 87 | |||||||||||
Effect of exchange rates on cash flow | (3 | ) | — | (3 | ) | (4 | ) | |||||||||
Net change in cash and cash equivalents | $ | (17 | ) | $ | (3 | ) | $ | (20 | ) | $ | 22 |
Operating Activities
In the first nine months of 2019, operations used $148 of cash. Net income of $2,852 included $3,293 of net non-cash income items related to our reorganization and unrealized foreign currency gains of $1, partially offset by deferred tax expense of $148, depreciation and amortization of $107 and loss on the sale of assets of $3. Net working capital used $151, which was largely driven by increases in accounts receivable due primarily to seasonality of our businesses, and decreases in accounts payable related to timing of vendor payments, primarily as a result of our Chapter 11 proceedings. Changes in other assets and liabilities and income taxes payable provided $50 due to the timing of when items were expensed versus paid, which primarily included operating lease expense, interest expense, employee retention programs, incentive compensation, pension plan contributions and taxes.
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In the first nine months of 2018, operations used $49 of cash. Net loss of $52 included $99 of net non-cash expense items consisting of depreciation and amortization of $85, non-cash asset impairments and accelerated depreciation of $30, amortization of deferred financing fees of $13, unrealized foreign currency losses of $12 and loss on sale of assets of $3, partially offset by a gain on disposition of $44. Net working capital used $106, which was largely driven by increases in inventories due primarily to inventory build for turnarounds, raw material price increases and seasonality. Changes in other assets and liabilities and income taxes payable used $10 due to the timing of when items were expensed versus paid, which primarily included interest expense, employee retention programs, incentive compensation, pension plan contributions and taxes.
Investing Activities
In the first nine months of 2019, investing activities used $64 of cash primarily related to capital expenditures of $65, partially offset by proceeds from sale of assets of $1.
In the first nine months of 2018, investing activities provided $12 of cash, primarily driven by capital expenditures of $62 (including capitalized interest), partially offset by net proceeds from the ATG disposition of $49 and proceeds from sale of assets of $1.
Financing Activities
In the first nine months of 2019, financing activities provided $195 of cash. Net short-term debt borrowings were $10, net long-term debt borrowings were $43, proceeds received from the rights offering were $300 and payment of $138 of financing fees. Our long-term debt borrowings primarily consisted of the proceeds from our new Senior Secured Term loans and Senior Notes, offset by the debt repayments made as part of the Plan.
In the first nine months of 2018, financing activities provided $87 of cash. Net short-term debt borrowings were $6 and net long-term debt borrowings were $82. Our long-term debt borrowings primarily consisted of $69 of additional ABL borrowings in the first half of 2018.
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.
Covenant Compliance
New Credit Facilities and Senior Notes
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, events of bankruptcy, a change of control, and most covenant defaults. 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 indenture that governs our 7.875% Senior Notes due 2027 (the “Indenture”) contains a Pro Forma 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 Pro Forma EBITDA to Fixed Charges Ratio under the Indenture is generally defined as the ratio of (a) Pro Forma 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 Pro Forma 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) $30 and (b) 10.0% 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) Pro Forma 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.
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Reconciliation of Last Twelve Months Net Income to Pro Forma EBITDA
Pro Forma 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. We believe that including the supplemental adjustments that are made to calculate Pro Forma EBITDA provides additional information to investors about our ability to comply with our financial covenants and to obtain additional debt in the future. Pro Forma EBITDA and Fixed Charges are not defined terms under U.S. GAAP. Pro Forma 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 Indenture should not be considered an alternative to interest expense.
The following table reconciles net income to EBITDA and Pro Forma EBITDA for the twelve month period [that includes combined information from the Predecessor Company from October 1, 2018 through July 1, 2019 and the Successor Company from July 2, 2019 through September 30, 2019], and calculates the ratio of Pro Forma EBITDA to Fixed Charges as calculated under our Indenture for the period presented:
September 30, 2019 | |||
LTM Period | |||
Net income | $ | 2,741 | |
Income tax expense | 241 | ||
Interest expense, net | 232 | ||
Depreciation and amortization | 135 | ||
Accelerated depreciation | 2 | ||
EBITDA | 3,351 | ||
Adjustments to arrive at Pro Forma EBITDA: | |||
Business realignment costs (1) | 38 | ||
Realized and unrealized foreign currency losses | 5 | ||
Unrealized gains on pension and postretirement benefits (2) | (13 | ) | |
Transaction costs (3) | 34 | ||
Reorganization items, net (4) | (3,105 | ) | |
Non-cash impact of inventory step-up (5) | 29 | ||
Acceleration of deferred revenue (6) | 18 | ||
Other (7) | 45 | ||
Cost reduction programs savings (8) | 18 | ||
Pro Forma EBITDA | $ | 420 | |
Pro forma fixed charges (9) | $ | 107 | |
Ratio of Pro Forma EBITDA to Fixed Charges (10) | 3.92 |
(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 gains resulting from pension and postretirement benefit plan liability remeasurements. |
(3) | Represents certain professional fees related to strategic projects, including $27 of certain professional fees and other expenses related to our Chapter 11 proceedings incurred prior to filing and post-emergence. |
(4) | Represents incremental costs incurred directly as a result of our Chapter 11 proceedings after the date of filing, gains on the settlement of liabilities under the Plan and the net impact of fresh start accounting adjustments. |
(5) | Represents $29 of non-cash expense related to the step up of finished goods inventory on July 1 as part of fresh start accounting that was expensed in the successor period upon the sale of the inventory. |
(6) | Represents the impact of deferred revenue that was accelerated on July 1 as part of fresh start accounting. |
(7) | Represents retention program costs, business optimization expenses, IT outage costs and expenses related to legacy liabilities. |
(8) | 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. We expect the savings to be realized within the next 18 months. |
(9) | Reflects pro forma interest expense based on interest rates at September 30, 2019. |
(10) | The Company’s ability to incur additional indebtedness, among other actions, is restricted under the Secured Indentures, unless the Company has a Pro Forma EBITDA to Fixed Charges ratio of at least 2.0 to 1.0. |
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.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
The emergence from Chapter 11 on the Effective Date, in accordance with the Plan, resulted in the restructuring of the Company’s pre-petition funded debt obligations with an issuance of a new Senior Secured Term Loan of $1,208,000,000 and new Senior Notes of $450. This restructuring event is deemed to be a material development during the first nine months of 2019 compared to 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, 2018. See Note 3 in Item 1 of Part I of this Quarterly Report on Form 10-Q for more information on our emergence from Chapter 11.
Interest Rate Risk
We have exposure to interest rate risk through our variable rate borrowing activities. As a result of our emergence from Chapter 11, approximately 30% of our outstanding debt within our new capital structure has interest rates that are fixed. Assuming the amounts of our fixed and variable debt remains the same, an increase of 1% in the interest rates on our variable rate debt would increase our estimated annual debt service requirements by approximately $12. As of the quarter ended September 30, 2019, we did not use derivative financial instruments in our investment portfolios to manage our interest rate risk, and we did not use derivative instruments for speculative purposes.
On October 10, 2019, we executed an interest rate swap agreement to hedge interest rate variability caused by quarterly changes in cash flow due to associated changes in LIBOR under the Company’s Senior Secured Term Loan. In this arrangement, we receive a variable 3-month LIBOR and pay fixed interest rate swaps, effective January 1, 2020 and expiring January 1, 2025, and we have designated $300 of our variable rate Senior Secured Term Loan as the notional amount for the future interest rate payments. As a result of this transaction 46% of our outstanding debt will be fixed.
On October 22, 2019, the Company executed an interest rate cap derivative instrument for a premium amount of less than $1. The objective of this instrument is to partially eliminate the variability of cash flows in future interest payments for a notional amount of $375 of its variable rate Senior Secured Term Loan when 3-month LIBOR is above 2.50%. This transaction becomes effective January 1, 2020 and expires January 1, 2023. This transaction further mitigates the impact of future interest rate increases.
Following is a summary of our outstanding debt as of September 30, 2019 and 2018 (see Note 9 in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on our debt). The fair value of our publicly held debt is based on the price at which the bonds are traded or quoted at September 30, 2019 and 2018. All other debt fair values are based on other similar financial instruments, or based upon interest rates that are currently available to us for the issuance of debt with similar terms and maturities. This table does not reflect the derivative instrument transactions that were executed in October 2019 described above.
2019 | 2018 | ||||||||||||||||||||
Year | Debt Maturities | Weighted Average Interest Rate | Fair Value | Debt Maturities | Weighted Average Interest Rate | Fair Value | |||||||||||||||
2019 | $ | 25 | 8.4 | % | $ | 25 | $ | 3,716 | 8.2 | % | $ | 2,646 | |||||||||
2020 | 95 | 5.2 | % | 95 | 49 | 6.7 | % | 49 | |||||||||||||
2021 | 25 | 6.1 | % | 25 | 11 | 10.1 | % | 11 | |||||||||||||
2022 | 33 | 5.8 | % | 33 | 24 | 10.1 | % | 24 | |||||||||||||
2023 | 15 | 5.6 | % | 14 | 8 | 10.1 | % | 8 | |||||||||||||
2024 | 7 | 5.9 | % | 7 | 1 | 10.1 | % | 1 | |||||||||||||
2025 and beyond | 1,589 | 5.9 | % | 1,585 | 6 | 10.0 | % | 6 | |||||||||||||
$ | 1,789 | $ | 1,784 | $ | 3,815 | $ | 2,745 |
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 September 30, 2019. 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 September 30, 2019.
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.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The United States Environmental Protection Agency (“U.S. EPA”) issued the Company a Notice of Intent to File Administrative Complaint related to alleged violations of the Emergency Right-to-Know Act identified in a 2017 voluntary self-disclosure made by the Company. The Company paid an assessed penalty less than $0.1 million and agreed to implement a supplemental environmental project valued in the Consent Agreement at $0.1 million.
The Company entered into an Agreed Board Order with the Louisville Metro Air Pollution Control Board, approved by the Board on October 16, 2019, related to alleged violations of the Louisville Metro Air Pollution Control District regulations between January 2018 and May 2019. The Company agreed to pay a $0.1 million penalty.
Item 1A. Risk Factors
(In millions, except share data)
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 Chapter 11 Proceedings and Emergence
Our actual financial results may vary significantly from the projections that were filed with the Bankruptcy Court.
In connection with our disclosure statement relating to the Plan (the “Disclosure Statement”), and the hearing to consider confirmation of the Plan, we prepared projected financial information to demonstrate to the Bankruptcy Court the feasibility of the Plan and our ability to continue operations upon Emergence. This projected financial information was prepared by, and is the responsibility of, our management. PricewaterhouseCoopers LLP neither examined, compiled nor performed any procedures with respect to the projected financial information and, accordingly, PricewaterhouseCoopers LLP does not express an opinion or any other form of assurance with respect thereto. Those projections were prepared solely for the purpose of the Bankruptcy Petitions and have not been, and will not be, updated on an ongoing basis. At the time they were prepared, the projections reflected numerous assumptions concerning our anticipated future performance and with respect to prevailing and anticipated market and economic conditions that were and remain beyond our control and that may not materialize. Projections are inherently subject to substantial and numerous uncertainties and to a wide variety of significant business, economic and competitive risks and the assumptions underlying the projections and/or valuation estimates may prove to be wrong in material respects. Actual results may vary significantly from those contemplated by the projections that were prepared in connection with the Disclosure Statement and the hearing to consider confirmation of the Plan.
Our financial condition or results of operations will not be comparable to the financial condition or results of operations reflected in our historical financial statements.
Following our emergence from bankruptcy, we have been operating our existing business under a new capital structure. In addition, we have been subject to the “fresh-start” accounting rules. As required by “fresh-start” accounting, assets and liabilities will be recorded at fair value, based on values determined in connection with the implementation of the Plan. Certain reported assets do not yet give effect to the adjustments that may result from the adoption of “fresh-start” accounting and, as a result, would change materially. Accordingly, our financial condition and results of operations from and after the Emergence Date will not be comparable to the financial condition or results of operations reflected in our historical financial statements included in this Quarterly Report on Form 10-Q.
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 building, construction, wind energy, oil and gas, automotive 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 |
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• | potential delays in accessing our ABL Facility 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 80% of our cost of sales(excluding depreciation expense) in 2019. 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. Additionally, 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.
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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 2018, we incurred capital expenditures of $19 to comply with environmental, health and safety laws and regulations and to make other environmental and safety 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.
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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 or may not issue a revised draft IRIS toxicological review to reflect the NAS findings, including the conclusions regarding a causal link between formaldehyde exposure and leukemia. On March 20, 2019, EPA announced the next set of candidate chemical substances that will undergo review by its LCSA/TSCA risk evaluation program. This announcement formally begins the prioritization process and starts a 9- to 12-month statutory time frame during which the Agency must designate 20 chemical substances as high priority. Formaldehyde was identified as a high-priority candidate chemical for TSCA risk evaluation. Designation of formaldehyde as a high-priority chemical “does not constitute a finding of risk.” A high-priority designation means the EPA has nominated formaldehyde for further risk evaluation. 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 was effective beginning 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 2018, NTP released the results of the CLARITY Core Study. Senior scientists at FDA’s National Center for Toxicological Research (NCTR) conducted the study with funding from NTP. The study involved exposure of laboratory animals to BPA beginning during pregnancy and continuing in the offspring throughout their entire lifetime. A wide range of dose levels were examined, from low doses close to actual consumer exposure to doses about 250,000 times higher. As stated in the conclusion of the study report, “BPA produced minimal effects that were distinguishable from background.” NTP selected a panel of six independent expert scientists to conduct a formal peer review of the study. In general, the peer review panel supported the design and conduct of the study and agreed with the overall conclusion that the study found minimal effects for the range of doses studied. 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.
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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.
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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; |
• | 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 2019, approximately 55% 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 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 three months ended September 30, 2019.
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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 fierce 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. During the first nine months of 2019, we achieved $13 in cost savings related to our cost reduction programs and as of September 30, 2019, we have approximately $18 of additional in-process cost savings.
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.
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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.
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, 2018, approximately 40% 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 $31 and $179, respectively, as of December 31, 2018. We are legally required to make contributions to our pension plans in the future, and those contributions could be material.
In 2019, we do not expect to make any contributions to our U.S. defined benefit pension plan and we expect to contribute approximately $24 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.
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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.
In March 2019, we experienced a network security incident that temporarily prevented access to certain information technology systems and data within our network, primarily impacting our corporate functions. We took immediate steps to isolate the issue and implemented our technical recovery plan. Our manufacturing sites, which rely on different networks, continued to operate safely and with limited interruption.
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.
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We could face additional tax obligations based on tax reform and the Emergence.
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. Furthermore, the legislation includes a one-time transition tax on accumulated foreign earnings and profits.
Some aspects of the Tax Reform remain unclear, and although further clarifying guidance was issued and more 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, some 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.
According to the Plan, the Successor Company indemnified the Predecessor Company for historical tax liabilities, including those related to the Emergence and prior tax contingencies. Tax laws are complex and subject to various interpretations. Tax authorities often challenge certain of our tax positions and may challenge other historical tax positions that are subject to indemnification under the Plan. If these challenges are successful, they could adversely affect the Successor Company’s effective tax rate and/or cash tax payments.
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.
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. 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.
Availability under the ABL Facility is subject to a borrowing base based on a specified percentage of eligible accounts receivable and inventory and, with respect to the foreign loan parties, a specified percentage of eligible machinery, equipment and real property, subject to certain limitations. To the extent the borrowing base is lower than we expect, that could significantly impair our liquidity. In addition, if our fixed charge coverage ratio falls to less than 1.0 to 1.0, we will need to ensure that our availability under the ABL Facility is at least the greater of $30 (or $1.0 after giving effect to the Transactions) and 10% of the lesser of the borrowing base and the total ABL commitments.
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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.
As of September 30, 2019, we had approximately $1.8 billion of consolidated outstanding indebtedness, including payments due within the next twelve months and short-term borrowings.
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; and |
• | it may limit our ability to borrow additional funds or dispose of assets. |
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 significant additional indebtedness. This could intensify the risks described above and below.
We may be able to incur substantial 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; |
• | enter into agreements that restrict dividends from subsidiaries; 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 excess availability is less than the greater of (x) $30 and (y) 10% of the lesser of the (i) borrowing base at such time and (ii) 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) Pro Forma EBITDA minus non-financed capital expenditures and cash taxes during such period 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.
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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 Credit Facilities, 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 Credit Facilities 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) $30 and (y) 10.0% of the lesser of the (i) borrowing base at such time and (ii) the total ABL Facility commitments at such time. Such cash sweep, if in effect, will cause substantially 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 may not have sufficient cash to satisfy our working capital and other operational needs.
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
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Mine Safety Disclosures
This item is not applicable to the registrant.
Item 5. Other Information
None.
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Item 6. Exhibits
10.1† | |
10.2† | |
10.3† | |
10.4† | |
31.1 | Rule 13a-14 Certifications: |
32.1 | |
101.INS* | XBRL Instance Document |
101.SCH* | XBRL Schema Document |
101.CAL* | XBRL Calculation Linkbase Document |
101.DEF* | XBRL Definition Linkbase Document |
101.LAB* | XBRL Label Linkbase Document |
101.PRE* | XBRL Presentation Linkbase Document |
* | 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
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HEXION INC. | |||
Date: | November 14, 2019 | /s/ George F. Knight | |
George F. Knight | |||
Executive Vice President and Chief Financial Officer | |||
(Principal Financial Officer) |
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