HEXION INC. - FORM 10-Q - August 13, 2014

Attached files

file filename
EX-32.1 - SECTION 906 CEO AND CFO CERTIFICATION - HEXION INC.mscexhibit321.htm
EX-31.1(A) - SECTION 302 CEO CERTIFICATION - HEXION INC.mscexhibit311a.htm
EXCEL - IDEA: XBRL DOCUMENT - HEXION INC.Financial_Report.xls
EX-31.1(B) - SECTION 302 CFO CERTIFICATION - HEXION INC.mscexhibit311b.htm

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 June 30, 2014
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 1-71
 
  MOMENTIVE SPECIALTY CHEMICALS INC.
(Exact name of registrant as specified in its charter)

New Jersey
 
13-0511250
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
180 East Broad St., Columbus, OH 43215
 
614-225-4000
(Address of principal executive offices including zip code)
 
(Registrant’s telephone number including area code)
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x   No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
o
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
x
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o No  x.
Number of shares of common stock, par value $0.01 per share, outstanding as of the close of business on August 1, 2014: 82,556,847


MOMENTIVE SPECIALTY CHEMICALS INC.
INDEX
 
 
 
Page
PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
Momentive Specialty Chemicals Inc. Condensed Consolidated Financial Statements (Unaudited)
 
 
 
 
 
Condensed Consolidated Balance Sheets at June 30, 2014 and December 31, 2013
 
 
 
 
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2014 and 2013
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
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



MOMENTIVE SPECIALTY CHEMICALS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In millions, except share data)
June 30,
2014
 
December 31,
2013
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents (including restricted cash of $16 and $14, respectively)
$
135

 
$
393

Short-term investments
4

 
7

Accounts receivable (net of allowance for doubtful accounts of $16)
728

 
601

Inventories:
 
 
 
Finished and in-process goods
331

 
257

Raw materials and supplies
154

 
103

Other current assets
68

 
72

Total current assets
1,420

 
1,433

Investment in unconsolidated entities
49

 
45

Deferred income taxes
19

 
21

Other long-term assets
138

 
134

Property and equipment:
 
 
 
Land
91

 
88

Buildings
317

 
308

Machinery and equipment
2,508

 
2,427

 
2,916

 
2,823

Less accumulated depreciation
(1,834
)
 
(1,776
)
 
1,082

 
1,047

Goodwill
126

 
112

Other intangible assets, net
91

 
82

Total assets
$
2,925

 
$
2,874

Liabilities and Deficit
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
510

 
$
483

Debt payable within one year
137

 
109

Interest payable
83

 
83

Income taxes payable
17

 
12

Accrued payroll and incentive compensation
62

 
47

Other current liabilities
119

 
127

Total current liabilities
928

 
861

Long-term liabilities:
 
 
 
Long-term debt
3,709

 
3,665

Long-term pension and post employment benefit obligations
226

 
234

Deferred income taxes
22

 
21

Other long-term liabilities
157

 
163

Total liabilities
5,042

 
4,944

Commitments and contingencies (See Note 6)
 
 
 
Deficit
 
 
 
Common stock—$0.01 par value; 300,000,000 shares authorized, 170,605,906 issued and 82,556,847 outstanding at June 30, 2014 and December 31, 2013
1

 
1

Paid-in capital
525

 
522

Treasury stock, at cost—88,049,059 shares
(296
)
 
(296
)
Accumulated other comprehensive loss
(17
)
 
(21
)
Accumulated deficit
(2,329
)
 
(2,275
)
Total Momentive Specialty Chemicals Inc. shareholder’s deficit
(2,116
)
 
(2,069
)
Noncontrolling interest
(1
)
 
(1
)
Total deficit
(2,117
)
 
(2,070
)
Total liabilities and deficit
$
2,925

 
$
2,874

See Notes to Condensed Consolidated Financial Statements


3

MOMENTIVE SPECIALTY CHEMICALS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In millions)
2014
 
2013
 
2014
 
2013
Net sales
$
1,337

 
$
1,250

 
$
2,630

 
$
2,442

Cost of sales
1,174

 
1,098

 
2,303

 
2,147

Gross profit
163

 
152

 
327

 
295

Selling, general and administrative expense
95

 
89

 
191

 
181

Asset impairments
—

 
7

 
—

 
7

Business realignment costs
12

 
2

 
18

 
11

Other operating (income) expense, net
(1
)
 
5

 
3

 
2

Operating income
57

 
49

 
115

 
94

Interest expense, net
76

 
76

 
153

 
150

Loss on extinguishment of debt
—

 
—

 
—

 
6

Other non-operating expense (income), net
3

 
(2
)
 
5

 
3

Loss before income tax and earnings from unconsolidated entities
(22
)
 
(25
)
 
(43
)
 
(65
)
Income tax expense (benefit)
11

 
6

 
21

 
(26
)
Loss before earnings from unconsolidated entities
(33
)
 
(31
)
 
(64
)
 
(39
)
Earnings from unconsolidated entities, net of taxes
6

 
3

 
10

 
7

Net loss
$
(27
)
 
$
(28
)
 
$
(54
)
 
$
(32
)
See Notes to Condensed Consolidated Financial Statements



4

MOMENTIVE SPECIALTY CHEMICALS INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In millions)
2014

2013
 
2014
 
2013
Net loss
$
(27
)
 
$
(28
)
 
$
(54
)
 
$
(32
)
Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(4
)
 
(14
)
 
(1
)
 
(32
)
Gain (loss) recognized from pension and postretirement benefits
2

 
(1
)
 
5

 
3

Net losses on cash flow hedges reclassified to earnings
—

 
—

 
—

 
1

Other comprehensive (loss) income
(2
)
 
(15
)
 
4

 
(28
)
Comprehensive loss
$
(29
)
 
$
(43
)
 
$
(50
)
 
$
(60
)
See Notes to Condensed Consolidated Financial Statements

5

MOMENTIVE SPECIALTY CHEMICALS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Six Months Ended June 30,
(In millions)
2014
 
2013
Cash flows used in operating activities
 
 
 
Net loss
$
(54
)
 
$
(32
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
71

 
76

Deferred tax benefit
(2
)
 
(41
)
Non-cash asset impairments
—

 
7

Loss on extinguishment of debt
—

 
6

Unrealized foreign currency losses (gains)
8

 
(26
)
Other non-cash adjustments
(3
)
 
1

Net change in assets and liabilities:
 
 
 
Accounts receivable
(116
)
 
(159
)
Inventories
(120
)
 
(70
)
Accounts payable
24

 
119

Income taxes payable
5

 
6

Other assets, current and non-current
13

 
18

Other liabilities, current and long-term
(12
)
 
30

Net cash used in operating activities
(186
)

(65
)
Cash flows used in investing activities
 
 
 
Capital expenditures
(78
)
 
(60
)
Capitalized interest
—

 
(1
)
Purchase of businesses
(64
)
 
—

Proceeds from the sale of (purchases of) debt securities, net
3

 
(1
)
Change in restricted cash
(2
)
 
15

Disbursement of affiliated loan
(50
)
 
—

Repayment of affiliated loan
50

 
—

Investment in unconsolidated affiliates, net
(2
)
 
(13
)
Proceeds from sale of assets
—

 
1

Net cash used in investing activities
(143
)

(59
)
Cash flows provided by financing activities
 
 
 
Net short-term debt borrowings
27

 
9

Borrowings of long-term debt
160

 
1,127

Repayments of long-term debt
(117
)
 
(1,040
)
Long-term debt and credit facility financing fees
—

 
(36
)
Net cash provided by financing activities
70


60

Effect of exchange rates on cash and cash equivalents
(1
)

(5
)
Decrease in cash and cash equivalents
(260
)
 
(69
)
Cash and cash equivalents (unrestricted) at beginning of period
379

 
401

Cash and cash equivalents (unrestricted) at end of period
$
119

 
$
332

Supplemental disclosures of cash flow information
 
 
 
Cash paid for:
 
 
 
Interest, net
$
148

 
$
126

Income taxes paid, net
18

 
3

Non-cash financing activities:
 
 
 
Non-cash issuance of debt in exchange for loans of parent
$
—

 
$
200

Non-cash distribution declared to parent
—

 
208

Settlement of note receivable from parent
—

 
24

See Notes to Condensed Consolidated Financial Statements

6

MOMENTIVE SPECIALTY CHEMICALS INC.
CONDENSED CONSOLIDATED STATEMENT OF DEFICIT (Unaudited)
(In millions)
Common
Stock
 
Paid-in
Capital
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Loss
 
Accumulated
Deficit
 
Total Momentive Specialty Chemicals Inc. Deficit
 
Noncontrolling Interest
 
Total
Balance at December 31, 2013
$
1

 
$
522

 
$
(296
)
 
$
(21
)
 
$
(2,275
)
 
$
(2,069
)
 
$
(1
)
 
$
(2,070
)
Net loss
—

 
—

 
—

 
—

 
(54
)
 
(54
)
 
—

 
(54
)
Other comprehensive income
—

 
—

 
—

 
4

 
—

 
4

 
—

 
4

Purchase of business from related party (see Note 3)
—

 
3

 
—

 
—

 
—

 
3

 
—

 
3

Balance at June 30, 2014
$
1

 
$
525

 
$
(296
)
 
$
(17
)
 
$
(2,329
)
 
$
(2,116
)
 
$
(1
)
 
$
(2,117
)
 
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, Momentive Specialty Chemicals Inc., (which may be referred to as “MSC” or the “Company”) serves global industrial markets through a broad range of thermoset technologies, specialty products and technical support for customers in a diverse range of applications and industries. The Company’s business is organized based on the products offered and the markets served. At June 30, 2014, the Company had two reportable segments: Epoxy, Phenolic and Coating Resins and Forest Products Resins.
The Company’s direct parent is Momentive Specialty Chemicals Holdings LLC (“MSC Holdings”), a holding company and wholly owned subsidiary of Momentive Performance Materials Holdings LLC (“Momentive Holdings”), the ultimate parent entity of MSC. On October 1, 2010, MSC Holdings and Momentive Performance Materials Holdings Inc. (“MPM Holdings”), the parent company of Momentive Performance Materials Inc. (“MPM”), became subsidiaries of Momentive Holdings. This transaction is referred to as the “Momentive Combination.” Momentive Holdings is controlled by investment funds managed by affiliates of Apollo Management Holdings, L.P. (together with Apollo Global Management, LLC and its subsidiaries, “Apollo”). Apollo may also be referred to as the Company’s owner.
The unaudited Condensed Consolidated Financial Statements include the accounts of the Company, its majority-owned subsidiaries in which minority shareholders hold no substantive participating rights and variable interest entities (“VIEs”) in which the Company is the primary beneficiary. Intercompany accounts and transactions are eliminated in consolidation. In the opinion of management, all adjustments consisting of normal, recurring adjustments considered necessary for a fair statement have been included. Results for the interim periods are not necessarily indicative of results for the entire year.
Year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”).
Pursuant to the rules and regulations of the Securities and Exchange Commission, certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and the accompanying notes included in the Company’s most recent Annual Report on Form 10-K.
2. Summary of Significant Accounting Policies
Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and also requires the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, it requires management to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Subsequent Events—The Company has evaluated events and transactions subsequent to June 30, 2014 through August 13, 2014, the date of issuance of its unaudited Condensed Consolidated Financial Statements.
Recently Issued Accounting Standards
In May, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Board Update No. 2014-09: Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the existing revenue recognition guidance and most industry-specific guidance applicable to revenue recognition. According to the new guidance, an entity will apply a principles-based five step model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for annual periods beginning after December 15, 2016, including interim periods within that reporting period and early application is not permitted. The Company is currently assessing the potential impact of ASU 2014-09 on its financial statements.
3. Related Party Transactions
Administrative Service, Management and Consulting Arrangement
The Company is subject to an Amended and Restated Management Consulting Agreement with Apollo (the “Management Consulting Agreement”) that renews on an annual basis, unless notice to the contrary is given by either party. Under the Management Consulting Agreement, the Company receives certain structuring and advisory services from Apollo and its affiliates. The Management Consulting Agreement provides indemnification to Apollo, its affiliates and their directors, officers and representatives for potential losses arising from these services. Apollo is entitled to an annual fee equal to the greater of $3 or 2% of the Company’s Adjusted EBITDA. Apollo elected to waive charges of any portion of the annual management fee due in excess of $3 for the calendar year 2014.
During both the three months ended June 30, 2014 and 2013 and during both the six months ended June 30, 2014 and 2013, the Company recognized expense under the Management Consulting Agreement of $1 and $2, respectively. This amount is included in “Other operating (income) expense, net” in the Company’s unaudited Condensed Consolidated Statements of Operations.

8

Transactions with MPM
Shared Services Agreement
On October 1, 2010, in conjunction with the Momentive Combination, the Company entered into a shared services agreement with MPM, as amended on March 17, 2011 (the “Shared Services Agreement”). Under this agreement, the Company provides to MPM, and MPM provides to the Company, certain services, including, but not limited to, executive and senior management, administrative support, human resources, information technology support, accounting, finance, technology development, legal and procurement services. The Shared Services Agreement is subject to termination by either the Company or MPM, without cause, on not less than 30 days’ written notice subject to a one-year transition assistance period, and expires in October 2015 (subject to one-year renewals every year thereafter; absent contrary notice from either party). The Shared Services Agreement establishes certain criteria upon which the costs of such services are allocated between the Company and MPM. Pursuant to this agreement, during the six months ended June 30, 2014 and 2013, the Company incurred approximately $67 and $61, respectively, of net costs for shared services and MPM incurred approximately $51 and $46, respectively, of net costs for shared services. Included in the net costs incurred during the six months ended June 30, 2014 and 2013, were net billings from the Company to MPM of $20 and $14, respectively, to bring the percentage of total net incurred costs for shared services under the Shared Services Agreement to the applicable allocation percentage. The allocation percentage was initially set at 51% for the Company and 49% for MPM at the inception of the agreement. Following the required annual review by the Steering Committee in accordance with the terms of the Shared Services Agreement, the allocation percentage for 2014 remains unchanged from 2013, which was 57% for the Company and 43% for MPM. The Company had accounts receivable from MPM of $13 and $4 as of June 30, 2014 and December 31, 2013, respectively, and accounts payable to MPM of less than $1 at both June 30, 2014 and December 31, 2013. During the six months ended June 30, 2014 and 2013, the Company realized approximately $2 and $5, respectively, in cost savings as a result of the Shared Services Agreement.
On April 13, 2014, MPM Holdings, MPM and certain of its U.S. subsidiaries filed voluntary petitions for reorganization (the “Bankruptcy Filing”) under Chapter 11 of the U.S. Bankruptcy Code. The Company has filed a claim in U.S. Bankruptcy Court in conjunction with the Bankruptcy Filing for the pre-petition amounts owed to it by MPM under the Shared Services Agreement. Despite the Bankruptcy Filing, we expect the Shared Services Agreement to continue in effect and for the majority of the savings from these synergies to continue.
Sales and Purchases of Products and Services with MPM
The Company also sells products to, and purchases products from, MPM pursuant to a Master Buy/Sell Agreement dated as of September 6, 2012 (the “Master Buy/Sell Agreement”). Prices under the agreement are determined by a formula based upon certain third party sales of the applicable product, or in the event that no qualifying third party sales have taken place, based upon the average contribution margin generated by certain third party sales of products in the same or a similar industry. The standard terms and conditions of the seller in the applicable jurisdiction apply to transactions under the Master Buy/Sell Agreement. A subsidiary of MPM also acts as a non-exclusive distributor in India for certain of the Company’s subsidiaries pursuant to Distribution Agreements dated as of September 6, 2012 (the “Distribution Agreements”). Prices under the Distribution Agreements are determined by a formula based on the weighted average sales price of the applicable product less a margin. The Master Buy/Sell Agreement and Distribution Agreements have initial terms of 3 years and may be terminated for convenience by either party thereunder upon 30 days’ prior notice in the case of the Master/Buy Sell Agreement and upon 90 days’ prior notice in the case of the Distribution Agreements. Pursuant to these agreements and other purchase orders, during the three months ended June 30, 2014 and 2013, the Company sold less than $1 of products to MPM and purchased $2 and $1, respectively. During the six months ended June 30, 2014 and 2013, the Company sold less than $1 of products to MPM and purchased $4 and $2, respectively. As of both June 30, 2014 and December 31, 2013, the Company had less than $1 of accounts receivable from MPM and $1 of accounts payable to MPM related to these agreements.
Other Transactions with MPM
In March 2014, the Company entered into a ground lease with a Brazilian subsidiary of MPM to lease a portion of MPM’s manufacturing site in Itatiba, Brazil for purposes of constructing and operating an epoxy production facility. In conjunction with the ground lease, the Company also entered into a site services agreement whereby MPM’s subsidiary will provide to the Company various services such as environmental, health and safety, security, maintenance and accounting, amongst others, to support the operation of this new facility. The Company paid less than $1 to MPM under this agreement during both the three and six months ended June 30, 2014.
In April 2014, the Company purchased 100% of the interests in MPM’s Canadian subsidiary for a purchase price of approximately $12. As a part of the transaction the Company also entered into a non-exclusive distribution agreement with a subsidiary of MPM, whereby the Company will act as a distributor of certain of MPM’s products in Canada. The agreement has a term of 10 years, and is cancelable by either party with 180 days’ notice. The Company is compensated for acting as distributor at a rate of 2% of the net selling price of the related products sold. Additionally, MPM is providing transitional services to the Company for a period of 6 months subsequent to the transaction date. During the three months ended June 30, 2014, the Company purchased approximately $10 of products from MPM under this distribution agreement, and earned less than $1 from MPM as compensation for acting as distributor of the products. As of June 30, 2014, the Company had $8 of accounts payable to MPM related to the distribution agreement.
As both the Company and MPM share a common ultimate parent, this purchase was accounted for as a transaction under common control as defined in the accounting guidance for business combinations, resulting in the Company recording the net assets of the acquired entity at carrying value. Additionally, the gain on the purchase of $3 was accounted for as a capital contribution, and is reflected as an addition to “Paid-in-Capital” in the unaudited Condensed Consolidated Balance Sheets. In addition, the Company has recasted its prior period financial statements on a combined basis to reflect the release of the valuation allowance related to the expected realization of deferred tax benefits attributable to MPM’s Canadian subsidiary during the year ended December 31, 2011. This retrospective adjustment to the Company’s unaudited Condensed Consolidated Financial Statements resulted in a $12 decrease in “Accumulated deficit” as of December 31, 2013.

9

Purchases and Sales of Products and Services with Affiliates Other than MPM
The Company sells products to various Apollo affiliates other than MPM. These sales were $41 and $36 for the three months ended June 30, 2014 and 2013, respectively, and $87 and $66 for the six months ended June 30, 2014 and 2013, respectively. Accounts receivable from these affiliates were $24 and $17 at June 30, 2014 and December 31, 2013, respectively. The Company also purchases raw materials and services from various Apollo affiliates other than MPM. These purchases were $2 and $4 (as revised from $32 to correct for a data accumulation error, which the Company does not believe is material) for the three months ended June 30, 2014 and 2013, respectively, and $3 and $15 (as revised from $66 to correct for a data accumulation error, which the Company does not believe is material) for the six months ended June 30, 2014 and 2013, respectively. The Company had accounts payable to these affiliates of less than $1 at both June 30, 2014 and December 31, 2013.
Other Transactions and Arrangements
Momentive Holdings purchases insurance policies which also cover the Company and MPM. Amounts are billed to the Company annually based on the Company’s relative share of the insurance premiums and amortized over the term of the policy. No amounts were billed to the Company from Momentive Holdings for either the three months or six months ended June 30, 2014 or 2013. The Company had accounts payable to Momentive Holdings of less than $1 and $4 under these arrangements at June 30, 2014 and December 31, 2013, respectively.
The Company sells finished goods to, and purchases raw materials from, its foundry joint venture between the Company and HA-USA Inc. (“HAI”). The Company also provides toll-manufacturing and other services to HAI. The Company’s investment in HAI is recorded under the equity method of accounting, and the related sales and purchases are not eliminated from the Company’s unaudited Condensed Consolidated Financial Statements. However, any profit on these transactions is eliminated in the Company’s unaudited Condensed Consolidated Financial Statements to the extent of the Company’s 50% interest in HAI. Sales and services provided to HAI were $29 and $26 for the three months ended June 30, 2014 and 2013, respectively, and $56 and $53 for the six months ended June 30, 2014 and 2013, respectively. Accounts receivable from HAI were $19 and $16 at June 30, 2014 and December 31, 2013, respectively. Purchases from HAI were $8 and $9 (as revised from $10 to correct for a data accumulation error, which the Company does not believe is material) for the three months ended June 30, 2014 and 2013, respectively, and $15 and $16 (as revised from $31 to correct for a data accumulation error, which the Company does not believe is material) for the six months ended June 30, 2014 and 2013, respectively. The Company had accounts payable to HAI of $6 at both June 30, 2014 and December 31, 2013. Additionally, HAI declared dividends to the Company of $3 and $8 during the three months ended June 30, 2014 and 2013, respectively, and $6 and $15 during the six months ended June 30, 2014 and 2013, respectively. No amounts remain outstanding related to these previously declared dividends as of June 30, 2014.
The Company’s purchase contracts with HAI represent a significant portion of HAI’s total revenue, and this factor results in the Company absorbing the majority of the risk from potential losses or the majority of the gains from potential returns. However, the Company does not have the power to direct the activities that most significantly impact HAI, and therefore, does not consolidate HAI. The carrying value of HAI’s assets were $69 and $50 at June 30, 2014 and December 31, 2013, respectively. The carrying value of HAI’s liabilities were $31 and $15 at June 30, 2014 and December 31, 2013, respectively.
In February 2013, the Company and HAI resolved a dispute regarding raw material pricing. As part of the resolution, the Company will provide discounts to HAI on future purchases of dry and liquid resins totaling $16 over a period of three years. During the three and six months ended June 30, 2014, the Company issued $1 and $3, respectively, of discounts to HAI under this agreement. During both the three and six months ended June 30, 2013, the Company issued $1 of discounts to HAI under this agreement. As of June 30, 2014 and December 31, 2013, $9 and $12, respectively, remained outstanding under this agreement. As of both June 30, 2014 and December 31, 2013, $5 of the outstanding amount was classified in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets, with the remaining amount included in “Other long-term liabilities.”
The Company had royalties receivable from its unconsolidated forest products joint venture in Russia of $6 as of both June 30, 2014 and December 31, 2013.
As of both June 30, 2014 and December 31, 2013, the Company had approximately $10 of cash on deposit as collateral for a loan that was extended by a third party to one of the Company’s unconsolidated joint ventures, which is classified as restricted cash.
In February 2014, the Company made a restricted purpose loan of $50 to Superholdco Finance Corp (“Finco”), a newly formed subsidiary of Momentive Holdings. The loan matures in February 2015, bears interest at LIBOR plus 3.75% per annum. The loan is fully collateralized by the assets of Finco. On April 7, 2014, Finco entered into an agreement with MPM under which it purchased approximately $51 of accounts receivable from MPM, paying 95% of the proceeds in cash, with the remaining 5% to be paid in cash when the sold receivables are fully collected. The agreement also appointed MPM to act as the servicer of the receivables on behalf of Finco. As of June 30, 2014, Finco had substantially repaid the loan, and the outstanding balance was less than $1. Interest incurred under the loan agreement was less than $1 for the six months ended June 30, 2014.
Finco is deemed to be a VIE, and the Company’s loan to Finco represents a variable interest in Finco. The power to direct the activities that most significantly impact the VIE is shared between the Company and the other related party variable interest entity holder. However, as of June 30, 2014, the Company does not absorb the majority of the risk from potential losses or the majority of the gains from potential returns of the VIE, and therefore, the Company does not consolidate Finco. As of June 30, 2014, the carrying value of both Finco’s assets and liabilities was $3.


10

4. 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 June 30, 2014, the Company had derivative liabilities of $1, which were measured using Level 2 inputs, and consist of derivative instruments transacted primarily in over-the-counter markets. There were no transfers between Level 1, Level 2 or Level 3 measurements during the three or six months ended June 30, 2014 or 2013.
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 June 30, 2014 and December 31, 2013, no adjustment was made by the Company to reduce its derivative liabilities for nonperformance risk.
When its financial instruments are in an asset position, the Company is exposed to credit loss in the event of nonperformance by other parties to these contracts and evaluates their credit risk as a component of fair value.
Non-derivative Financial Instruments
The following table summarizes the carrying amount and fair value of the Company’s non-derivative financial instruments:
 
 
Carrying Amount
 
Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
June 30, 2014
 
 
 
 
 
 
 
 
 
 
Debt
 
$
3,846

 
$
—

 
$
3,966

 
$
10

 
$
3,976

December 31, 2013
 
 
 
 
 
 
 
 
 
 
Debt
 
$
3,774

 
$
—

 
$
3,820

 
$
10

 
$
3,830

Fair values of debt classified as Level 2 are determined based on other similar financial instruments, or based upon interest rates that are currently available to the Company for the issuance of debt with similar terms and maturities. Level 3 amounts represent capital leases whose fair value is determined through the use of present value and specific contract terms. The carrying amounts of cash and cash equivalents, short term investments, accounts receivable, accounts payable and other accrued liabilities are considered reasonable estimates of their fair values due to the short-term maturity of these financial instruments.


11

5. Debt Obligations
Debt outstanding at June 30, 2014 and December 31, 2013 is as follows:
 
 
June 30, 2014
 
December 31, 2013
 
 
Long-Term
 
Due Within
One Year
 
Long-Term
 
Due Within
One Year
ABL Facility
 
$
65

 
$
—

 
$
—

 
$
—

Senior Secured Notes:
 
 
 
 
 
 
 
 
6.625% First-Priority Senior Secured Notes due 2020 (includes $6 and $7 of unamortized debt premium at June 30, 2014 and December 31, 2013, respectively)
 
1,556

 
—

 
1,557

 
—

8.875% Senior Secured Notes due 2018 (includes $4 of unamortized debt discount at both June 30, 2014 and December 31, 2013)
 
1,196

 
—

 
1,196

 
—

9.00% Second-Priority Senior Secured Notes due 2020
 
574

 
—

 
574

 
—

Debentures:
 
 
 
 
 
 
 
 
9.2% debentures due 2021
 
74

 
—

 
74

 
—

7.875% debentures due 2023
 
189

 
—

 
189

 
—

8.375% sinking fund debentures due 2016
 
20

 
20

 
40

 
20

Other Borrowings:
 
 
 
 
 
 
 
 
Australia Facility due 2014
 
—

 
36

 
—

 
35

Brazilian bank loans
 
12

 
55

 
13

 
45

Capital Leases
 
9

 
1

 
9

 
1

Other
 
14

 
25

 
13

 
8

Total
 
$
3,709

 
$
137

 
$
3,665

 
$
109

6. Commitments and Contingencies
Environmental Matters
The Company’s operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials. The Company is subject to extensive environmental regulation at the federal, state and local levels as well as foreign laws and regulations, and is therefore exposed to the risk of claims for environmental remediation or restoration. In addition, violations of environmental laws or permits may result in restrictions being imposed on operating activities, substantial fines, penalties, damages or other costs, any of which could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.
Environmental Institution of Paraná IAP—On August 10, 2005, the Environmental Institute of Paraná (IAP), an environmental agency in the State of Paraná, provided Hexion Quimica Industria, the Company’s Brazilian subsidiary, with notice of an environmental assessment in the amount of 12 Brazilian reais. The assessment related to alleged environmental damages to the Paranagua Bay caused in November 2004 from an explosion on a shipping vessel carrying methanol purchased by the Company. The investigations performed by the public authorities have not identified any actions of the Company that contributed to or caused the accident. The Company responded to the assessment by filing a request to have it cancelled and by obtaining an injunction precluding execution of the assessment pending adjudication of the issue. In November 2010, the Court denied the Company’s request to cancel the assessment and lifted the injunction that had been issued. The Company responded to the ruling by filing an appeal in the State of Paraná Court of Appeals. In March 2012, the Company was informed that the Court of Appeals had denied the Company’s appeal, and on June 4, 2012 the Company filed appeals to the Superior Court of Justice and the Supreme Court of Brazil. The Company continues to believe it has strong defenses against the validity of the assessment, and does not believe that a loss is probable. At June 30, 2014, the amount of the assessment, including tax, penalties, monetary correction and interest, is 39 Brazilian reais, or approximately $18.
Hillsborough County—The Company is named in a lawsuit filed on July 12, 2004 in Hillsborough County, Florida Circuit Court, for an animal feed supplement processing site formerly operated by the Company and sold in 1980. The lawsuit is filed on behalf of multiple residents of Hillsborough County living near the site and it alleges various injuries from exposure to toxic chemicals. The Company does not have adequate information from which to estimate a potential range of liability, if any. The court dismissed a similar lawsuit brought on behalf of a class of plaintiffs in November 2005.

12

The following table summarizes all probable environmental remediation, indemnification and restoration liabilities, including related legal expenses, at June 30, 2014 and December 31, 2013:
 
Number of Sites
 
Liability
 
Range of Reasonably Possible Costs
Site Description
June 30, 2014
 
December 31, 2013
 
June 30, 2014
 
December 31, 2013
 
Low
 
High
Geismar, LA
1
 
1
 
$
15

 
$
16

 
$
10

 
$
22

Superfund and offsite landfills – allocated share:
 
 
 
 
 
 
 
 
 
 
 
Less than 1%
15
 
16
 
1

 
1

 
1

 
1

Equal to or greater than 1%
12
 
12
 
7

 
8

 
5

 
14

Currently-owned
13
 
12
 
11

 
8

 
8

 
18

Formerly-owned:
 
 
 
 
 
 
 
 
 
 
 
Remediation
12
 
11
 
18

 
8

 
16

 
28

Monitoring only
4
 
4
 
1

 
1

 
—

 
1

Total
57
 
56
 
$
53

 
$
42

 
$
40

 
$
84

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 both June 30, 2014 and December 31, 2013, $14 has been included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets with the remaining amount included in “Other long-term liabilities.”
Following is a discussion of the Company’s environmental liabilities and the related assumptions at June 30, 2014:
Geismar, LA Site—The Company formerly owned a basic chemicals and polyvinyl chloride business that was taken public as Borden Chemicals and Plastics Operating Limited Partnership (“BCPOLP”) in 1987. The Company retained a 1% interest, the general partner interest and the liability for certain environmental matters after BCPOLP’s formation. Under a Settlement Agreement approved by the United States Bankruptcy Court for the District of Delaware among the Company, BCPOLP, the United States Environmental Protection Agency and the Louisiana Department of Environmental Quality, the Company agreed to perform certain of BCPOLP’s obligations for soil and groundwater contamination at BCPOLP’s Geismar, Louisiana site. The Company bears the sole responsibility for these obligations because there are no other potentially responsible parties (“PRP”) or third parties from whom the Company could seek reimbursement.
A groundwater pump and treat system to remove contaminants is operational, and natural attenuation studies are proceeding. If closure procedures and remediation systems prove to be inadequate, or if additional contamination is discovered, costs that would approach the higher end of the range of possible outcomes could result.
Due to the long-term nature of the project, the reliability of timing and the ability to estimate remediation payments, a portion of this liability was recorded at its net present value, assuming a 3% discount rate and a time period of 24 years. The range of possible outcomes is discounted in a similar manner. The undiscounted liability, which is expected to be paid over the next 24 years, is approximately $20. Over the next five years, the Company expects to make ratable payments totaling $6.
 Superfund Sites and Offsite Landfills—The Company is currently involved in environmental remediation activities at a number of sites for which it has been notified that it is, or may be, a PRP under the United States Comprehensive Environmental Response, Compensation and Liability Act or similar state “superfund” laws. The Company anticipates approximately 50% of the estimated liability for these sites will be paid within the next five years, with the remainder over the next twenty-five years. The Company generally does not bear a significant level of responsibility for these sites, and as a result, has little control over the costs and timing of cash flows.
The Company’s ultimate liability will depend on many factors including its share of waste volume, the financial viability of other PRPs, the remediation methods and technology used, the amount of time necessary to accomplish remediation and the availability of insurance coverage. The range of possible outcomes takes into account the maturity of each project, resulting in a more narrow range as the project progresses. To estimate both its current reserves for environmental remediation at these sites and the possible range of additional costs, the Company has not assumed that it will bear the entire cost of remediation of every site to the exclusion of other known PRPs who may be jointly and severally liable. The Company has limited information to assess the viability of other PRPs and their probable contribution on a per site basis. The Company’s insurance provides very limited, if any, coverage for these environmental matters.
Sites Under Current Ownership—The Company is conducting environmental remediation at a number of locations that it currently owns, of which ten sites are no longer in operation. As the Company is performing a portion of the remediation on a voluntary basis, it has some control over the costs to be incurred and the timing of cash flows. The Company expects to pay approximately $5 of these liabilities within the next five years, with the remainder over the next ten years. The factors influencing the ultimate outcome include the methods of remediation elected, the conclusions and assessment of site studies remaining to be completed, and the time period required to complete the work. No other parties are responsible for remediation at these sites.

13

Formerly-Owned Sites—The Company is conducting, or has been identified as a PRP in connection with, environmental remediation at a number of locations that it formerly owned and/or operated. Remediation costs at these former sites, such as those associated with our former phosphate mining and processing operations, could be material. The Company has accrued those costs for formerly-owned sites which are currently probable and reasonably estimable. One such site is the Coronet Industries, Inc. Superfund Alternative Site in Plant City, Florida. The current owner of the site has alleged that it has incurred environmental costs at the site for which it believes it has a contribution claim against the Company, and that additional future costs are likely to be incurred. In July 2014, the Company reached a non-binding agreement with the current owner of the site, subject to negotiation of an acceptable settlement agreement and required approvals. Pursuant to the agreement, the Company would pay $10 in fulfillment of the contribution claim against the Company for past remediation costs. Additionally, the Company would accept a 40% allocable share of specified future remediation costs at this site. At this time, the Company does not have adequate information to enable it to estimate a potential range of liability for such future remediation costs. The final costs to the Company will depend on the method of remediation chosen and the level of participation of third parties.
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 $14 and $16 at June 30, 2014 and December 31, 2013, respectively, for all non-environmental legal defense costs incurred and settlement costs that it believes are probable and estimable. At both June 30, 2014 and December 31, 2013, $7 has been included in “Other current liabilities” in the unaudited Condensed Consolidated Balance Sheets, with the remaining amount included in “Other long-term liabilities.”
Following is a discussion of significant non-environmental legal proceedings:
Brazil Tax Claim— On October 15, 2012, the Appellate Court for the State of Sao Paulo rendered a unanimous decision in favor of the Company on this claim, which has been pending since 1992. In 1992, the State of Sao Paulo Administrative Tax Bureau issued an assessment against the Company’s Brazilian subsidiary claiming that excise taxes were owed on certain intercompany loans made for centralized cash management purposes. These loans and other internal flows of funds were characterized by the Tax Bureau as intercompany sales. Since that time, management and the Tax Bureau have held discussions and the Company filed an administrative appeal seeking cancellation of the assessment. The Administrative Court upheld the assessment in December 2001. In 2002, the Company filed a second appeal with the highest-level Administrative Court, again seeking cancellation of the assessment. In February 2007, the highest-level Administrative Court upheld the assessment. The Company requested a review of this decision. On April 23, 2008, the Brazilian Administrative Tax Tribunal issued its final decision upholding the assessment against the Company. The Company filed an Annulment action in the Brazilian Judicial Courts in May 2008 along with a request for an injunction to suspend the tax collection. The injunction was granted upon the Company pledging certain properties and assets in Brazil during the pendency of the Annulment action in lieu of depositing an amount equivalent to the assessment with the Court. In September 2010, in the Company’s favor, the Court adopted its appointed expert’s report finding that the transactions in question were intercompany loans and other legal transactions. The State Tax Bureau appealed this decision in December 2010, and the Appellate Court ruled in the Company’s favor on October 15, 2012. On January 7, 2013, the State Tax Bureau appealed the decision to the Superior Court of Justice. The Company has replied to the appeal, and continues to believe that a loss contingency is not probable. At June 30, 2014, the amount of the assessment, including tax, penalties, monetary correction and interest, is 71 Brazilian reais, or approximately $32.
Other Legal Matters—The Company is involved in various other product liability, commercial and employment litigation, personal injury, property damage and other legal proceedings in addition to those described above, including actions that allege harm caused by products the Company has allegedly made or used, containing silica, vinyl chloride monomer and asbestos. The Company 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.


14

7. Pension and Postretirement Benefit Plans
Following are the components of net pension and postretirement expense recognized by the Company for the three and six months ended June 30, 2014 and 2013:
 
Pension Benefits
 
Non-Pension Postretirement Benefits
 
Three Months Ended June 30,
 
Three Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
Service cost
$
—

 
$
4

 
$
—

 
$
4

 
$
—

 
$
—

 
$
—

 
$
—

Interest cost on projected benefit obligation
4

 
4

 
2

 
5

 
—

 
1

 
—

 
—

Expected return on assets
(4
)
 
(3
)
 
(3
)
 
(4
)
 
—

 
—

 
—

 
—

Amortization of prior service cost
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1

Amortization of net losses
2

 
1

 
3

 
2

 
—

 
—

 
—

 
—

Net expense
$
2

 
$
6

 
$
2

 
$
7

 
$
—

 
$
1

 
$
—

 
$
1


 
Pension Benefits
 
Non-Pension Postretirement Benefits
 
Six Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
 
U.S.
Plans
 
Non-U.S.
Plans
Service cost
$
1

 
$
8

 
$
1

 
$
8

 
$
—

 
$
—

 
$
—

 
$
—

Interest cost on projected benefit obligation
6

 
8

 
5

 
9

 
—

 
1

 
—

 
—

Expected return on assets
(8
)
 
(7
)
 
(7
)
 
(6
)
 
—

 
—

 
—

 
—

Amortization of prior service cost
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1

Amortization of net losses
4

 
2

 
5

 
4

 
—

 
—

 
—

 
—

Net expense
$
3

 
$
11

 
$
4

 
$
15

 
$
—

 
$
1

 
$
—

 
$
1

8. Segment Information
The Company’s business segments are based on the products that the Company offers and the markets that it serves. At June 30, 2014, the Company had two reportable segments: Epoxy, Phenolic and Coating Resins and Forest Products Resins. A summary of the major products of the Company’s reportable segments follows:
 
•
Epoxy, Phenolic and Coating Resins: epoxy specialty resins, phenolic encapsulated substrates, versatic acids and derivatives, basic epoxy resins and intermediates, phenolic specialty resins and molding compounds, polyester resins, acrylic resins and vinylic resins
 
•
Forest Products Resins: forest products resins and formaldehyde applications

Reportable Segments
Following are net sales and Segment EBITDA (earnings before interest, income taxes, depreciation and amortization) by reportable segment. Segment EBITDA is defined as EBITDA adjusted for certain non-cash items and other income and expenses. Segment EBITDA is the primary performance measure used by the Company’s senior management, the chief operating decision-maker and the board of directors to evaluate operating results and allocate capital resources among segments. Segment EBITDA is also the profitability measure used to set management and executive incentive compensation goals. Corporate and Other is primarily corporate general and administrative expenses that are not allocated to the segments, such as shared service and administrative functions, foreign exchange gains and losses and legacy company costs not allocated to continuing segments.
Net Sales (1):

Three Months Ended June 30,

Six Months Ended June 30,
 
2014

2013

2014

2013
Epoxy, Phenolic and Coating Resins
$
862


$
799


$
1,679


$
1,564

Forest Products Resins
475


451


951


878

Total
$
1,337


$
1,250


$
2,630


$
2,442

(1)
Intersegment sales are not significant and, as such, are eliminated within the selling segment.

15

Segment EBITDA:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Epoxy, Phenolic and Coating Resins
$
72

 
$
73

 
$
148

 
$
141

Forest Products Resins
65

 
59

 
125

 
114

Corporate and Other
(17
)
 
(14
)
 
(36
)
 
(32
)
Reconciliation of Segment EBITDA to Net Loss:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Segment EBITDA:
 
 
 
 
 
 
 
Epoxy, Phenolic and Coating Resins
$
72

 
$
73

 
$
148

 
$
141

Forest Products Resins
65

 
59

 
125

 
114

Corporate and Other
(17
)
 
(14
)
 
(36
)
 
(32
)
 
 
 
 
 
 
 
 
Reconciliation:
 
 
 
 
 
 
 
Items not included in Segment EBITDA:
 
 
 
 
 
 
 
Asset impairments
—

 
(7
)
 
—

 
(7
)
Business realignment costs
(12
)
 
(2
)
 
(18
)
 
(11
)
Integration costs
(3
)
 
(2
)
 
(5
)
 
(5
)
Other
(9
)
 
(15
)
 
(23
)
 
(26
)
Total adjustments
(24
)
 
(26
)
 
(46
)
 
(49
)
Interest expense, net
(76
)
 
(76
)
 
(153
)
 
(150
)
Loss on extinguishment of debt
—

 
—

 
—

 
(6
)
Income tax (expense) benefit
(11
)
 
(6
)
 
(21
)
 
26

Depreciation and amortization
(36
)
 
(38
)
 
(71
)
 
(76
)
Net loss
$
(27
)
 
$
(28
)
 
$
(54
)
 
$
(32
)

Items Not Included in Segment EBITDA
Not included in Segment EBITDA are certain non-cash items and other income and expenses. For the three and six months ended June 30, 2014, these items primarily include expenses from retention programs, stock-based compensation expense, losses on the disposal of assets and unrealized foreign exchange transaction gains and losses. For the three and six months ended June 30, 2013, these items primarily include expenses from retention programs and unrealized foreign exchange losses. Business realignment costs for the three and six months ended June 30, 2014 and June 30, 2013 primarily relate to costs for environmental remediation at certain formerly owned locations and expenses from minor restructuring programs. Integration costs for the three and six months ended June 30, 2014 and 2013 primarily represent integration costs associated with the Momentive Combination.
9. Summarized Financial Information of Unconsolidated Affiliate
Summarized financial information of the unconsolidated affiliate HAI as of June 30, 2014 and December 31, 2013 and for the three and six months ended June 30, 2014 and 2013 is as follows:
 
June 30,
2014
 
December 31,
2013
Current assets
$
42

 
$
29

Non-current assets
27

 
21

Current liabilities
30

 
15

Non-current liabilities
1

 
—

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net sales
$
49

 
$
44

 
$
94

 
$
89

Gross profit
12

 
11

 
23

 
22

Pre-tax income
8

 
24

 
15

 
31

Net income
8

 
23

 
15

 
30



16

10. Changes in Accumulated Other Comprehensive Loss
Following is a summary of changes in “Accumulated other comprehensive loss” for the three and six months ended June 30, 2014 and 2013:
 
Three Months Ended June 30, 2014
 
Three Months Ended June 30, 2013
 
Defined Benefit Pension and Postretirement Plans
 
Foreign Currency Translation Adjustments
 
Total
 
Defined Benefit Pension and Postretirement Plans
 
Foreign Currency Translation Adjustments
 
Total
Beginning balance
$
(148
)
 
$
133

 
$
(15
)
 
$
(215
)
 
$
125

 
$
(90
)
Other comprehensive loss before reclassifications, net of tax
—

 
(4
)
 
(4
)
 
(6
)
 
(14
)
 
(20
)
Amounts reclassified from Accumulated other comprehensive loss, net of tax
2

 
—

 
2

 
5

 
—

 
5

Net other comprehensive income (loss)
2

 
(4
)
 
(2
)
 
(1
)
 
(14
)
 
(15
)
Ending balance
$
(146
)
 
$
129

 
$
(17
)
 
$
(216
)
 
$
111

 
$
(105
)

 
Six Months Ended June 30, 2014
 
Six Months Ended June 30, 2013
 
Defined Benefit Pension and Postretirement Plans
 
Foreign Currency Translation Adjustments
 
Total
 
Gains and (Losses) on Cash Flow Hedges
 
Defined Benefit Pension and Postretirement Plans
 
Foreign Currency Translation Adjustments
 
Total
Beginning balance
$
(151
)
 
$
130

 
$
(21
)
 
$
(1
)
 
$
(219
)
 
$
143

 
$
(77
)
Other comprehensive loss before reclassifications, net of tax
—

 
(1
)
 
(1
)
 
—

 
(6
)
 
(32
)
 
(38
)
Amounts reclassified from Accumulated other comprehensive loss, net of tax
5

 
—

 
5

 
1

 
9

 
—

 
10

Net other comprehensive income (loss)
5

 
(1
)
 
4

 
1

 
3

 
(32
)
 
(28
)
Ending balance
$
(146
)
 
$
129

 
$
(17
)
 
$
—

 
$
(216
)
 
$
111

 
$
(105
)

 
 
Amount Reclassified From Accumulated Other Comprehensive Loss for the Three Months Ended:
 
 
Amount Reclassified From Accumulated Other Comprehensive Loss
 
June 30, 2014
 
June 30, 2013
 
Location of Reclassified Amount in Income
Amortization of defined benefit pension and other postretirement benefit items:
 
 
 
 
 
 
Prior service costs
 
$
—

 
$
1

 
 
Actuarial losses
 
3

 
5

 
(1) 
Total before income tax
 
3

 
6

 
 
Income tax benefit
 
(1
)
 
(1
)
 
Income tax expense (benefit)
Total
 
$
2

 
$
5

 
 

17

 
 
Amount Reclassified From Accumulated Other Comprehensive Loss for the Six Months Ended:
 
 
Amount Reclassified From Accumulated Other Comprehensive Loss
 
June 30, 2014
 
June 30, 2013
 
Location of Reclassified Amount in Income
Gains and losses on cash flow hedges:
 
 
 
 
 
 
Interest rate swaps
 
$
—

 
$
—

 
Interest expense, net
Total before income tax
 
—

 
—

 
 
Income tax benefit
 
—

 
1

 
Income tax expense (benefit)
Total
 
$
—

 
$
1

 
 
 
 
 
 
 
 
 
Amortization of defined benefit pension and other postretirement benefit items:
 
 
 
 
 
 
Prior service costs
 
$
—

 
$
1

 
 
Actuarial losses
 
6

 
9

 
(1) 
Total before income tax
 
6

 
10

 
 
Income tax benefit
 
(1
)
 
(1
)
 
Income tax expense (benefit)
Total
 
5

 
9

 
 
Total
 
$
5

 
$
10

 
 
(1)
These accumulated other comprehensive income components are included in the computation of net pension and postretirement benefit expense (see Note 7).
11. Acquisition
In January 2014, the Company acquired a manufacturing facility in Shreveport, Louisiana, which increased the Company’s capacity to provide resin coated proppants to its customers in this region, which has a high concentration of shale and natural gas wells. The allocation of the consideration exchanged was based upon a valuation of the acquired company’s net identifiable assets and liabilities as of the transaction date. The allocation of fair value to the assets acquired and liabilities assumed at the date of acquisition resulted in $5 allocated to working capital, $18 allocated to property and equipment, $16 allocated to other intangible assets and $13 allocated to goodwill.
Other intangible assets primarily consist of customer relationships, which are being amortized on a straight-line basis over their estimated useful life of 10 years.
The pro forma impacts of this acquisition are not material to the Company’s unaudited Condensed Consolidated Financial Statements.

12. Income Taxes

The effective tax rate was (50)% and (24)% for the second quarter of 2014 and 2013, respectively. The effective tax rate was (49)% and 40% for the first half of 2014 and 2013, respectively. The change in the effective tax rate was primarily attributable to the amount and distribution of income and losses among the various jurisdictions in which we operate. The effective tax rates were also impacted by operating losses generated in jurisdictions where no tax benefit was recognized due to the maintenance of a full valuation allowance.

For the three and six months ended June 30, 2014, income tax expense relates primarily to income from certain foreign operations. 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.

For the three months ended June 30, 2013, income tax expense relates primarily to income from certain foreign operations. For the first half of 2013, income tax benefit relates primarily to a discrete tax benefit of $29 related to the signing of the American Taxpayer Relief Act of 2012 during the first quarter of 2013, which provided for the exclusion of certain foreign earnings from U.S. federal taxation from January 1, 2012 through December 31, 2013.


18

13. Guarantor/Non-Guarantor Subsidiary Financial Information
The Company and certain of its U.S. subsidiaries guarantee debt issued by its wholly owned subsidiaries Hexion Nova Scotia, ULC and Hexion U.S. Finance Corporation (together, the “Subsidiary Issuers”), which includes the 6.625% First-Priority Senior Secured Notes due 2020, 8.875% Senior Secured Notes due 2018 and the 9.00% Second-Priority Senior Secured Notes due 2020.
The following information contains the condensed consolidating financial information for MSC (the parent), the Subsidiary Issuers, the combined subsidiary guarantors (Momentive Specialty Chemical Investments Inc.; Borden Chemical Foundry, LLC; Lawter International, Inc.; HSC Capital Corporation; Momentive International, Inc.; Momentive CI Holding Company; NL COOP Holdings LLC and Oilfield Technology Group, Inc.) and the combined non-guarantor subsidiaries, which includes all of the Company’s foreign subsidiaries.
All of the Subsidiary Issuers and Subsidiary Guarantors are 100% owned by MSC. All guarantees are full and unconditional, and are joint and several. There are no significant restrictions on the ability of the Company to obtain funds from its domestic subsidiaries by dividend or loan. While the Company’s Australian and Brazilian subsidiaries are restricted in the payment of dividends and intercompany loans due to the terms of their credit facilities, there are no material restrictions on the Company’s ability to obtain cash from the remaining non-guarantor subsidiaries.
This information includes allocations of corporate overhead to the combined non-guarantor subsidiaries based on net sales. Income tax expense has been provided on the combined non-guarantor subsidiaries based on actual effective tax rates.


19

MOMENTIVE SPECIALTY CHEMICALS INC.
JUNE 30, 2014
CONDENSED CONSOLIDATING BALANCE SHEET (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (including restricted cash of $0, $0 and $16, respectively)
$
30

 
$
2

 
$
—

 
$
103

 
$
—

 
$
135

Short-term investments
—

 
—

 
—

 
4

 
—

 
4

Accounts receivable, net
213

 
3

 
2

 
510

 
—

 
728

Intercompany accounts receivable
115

 
89

 
—

 
370

 
(574
)
 
—

Intercompany loans receivable - current portion
211

 
—

 
—

 
245

 
(456
)
 
—

Inventories:
 
 
 
 
 
 
 
 
 
 
 
Finished and in-process goods
124

 
—

 
—

 
207

 
—

 
331

Raw materials and supplies
65

 
—

 
—

 
89

 
—

 
154

Other current assets
23

 
—

 
—

 
45

 
—

 
68

Total current assets
781

 
94

 
2

 
1,573

 
(1,030
)
 
1,420

Investment in unconsolidated entities
359

 
—

 
32

 
30

 
(372
)
 
49

Deferred income taxes
—

 
—

 
—

 
19

 
—

 
19

Other assets, net
23

 
58

 
1

 
56

 
—

 
138

Intercompany loans receivable
1,165

 
3,364

 
30

 
2,517

 
(7,076
)
 
—

Property and equipment, net
517

 
—

 
—

 
565

 
—

 
1,082

Goodwill
66

 
—

 
—

 
60

 
—

 
126

Other intangible assets, net
59

 
—

 
—

 
32

 
—

 
91

Total assets
$
2,970

 
$
3,516

 
$
65

 
$
4,852

 
$
(8,478
)
 
$
2,925

Liabilities and (Deficit) Equity
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$
160

 
$
—

 
$
—

 
$
350

 
$
—

 
$
510

Intercompany accounts payable
136

 
4

 
—

 
434

 
(574
)
 
—

Debt payable within one year
20

 
—

 
—

 
117

 
—

 
137

Intercompany loans payable within one year
56

 
—

 
—

 
400

 
(456
)
 
—

Interest payable
9

 
73

 
—

 
1

 
—

 
83

Income taxes payable
4

 
—

 
—

 
13

 
—

 
17

Accrued payroll and incentive compensation
26

 
—

 
—

 
36

 
—

 
62

Other current liabilities
64

 
—

 
—

 
55

 
—

 
119

Total current liabilities
475

 
77

 
—

 
1,406

 
(1,030
)
 
928

Long-term liabilities:
 
 
 
 
 
 
 
 
 
 
 
Long-term debt
354

 
3,326

 
—

 
29

 
—

 
3,709

Intercompany loans payable
3,402

 
—

 
8

 
3,666

 
(7,076
)
 
—

Accumulated losses of unconsolidated subsidiaries in excess of investment
699

 
—

 
266

 
—

 
(965
)
 
—

Long-term pension and post employment benefit obligations
43

 
—

 
—

 
183

 
—

 
226

Deferred income taxes
8

 
2

 
—

 
12

 
—

 
22

Other long-term liabilities
105

 
6

 
—

 
46

 
—

 
157

Total liabilities
5,086

 
3,411

 
274

 
5,342

 
(9,071
)
 
5,042

Total Momentive Specialty Chemicals Inc. shareholders (deficit) equity
(2,116
)
 
105

 
(209
)
 
(489
)
 
593

 
(2,116
)
Noncontrolling interest
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Total (deficit) equity
(2,116
)
 
105

 
(209
)
 
(490
)
 
593

 
(2,117
)
Total liabilities and (deficit) equity
$
2,970

 
$
3,516

 
$
65

 
$
4,852

 
$
(8,478
)
 
$
2,925


20


MOMENTIVE SPECIALTY CHEMICALS INC.
DECEMBER 31, 2013
CONDENSED CONSOLIDATING BALANCE SHEET
  
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Assets
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents (including restricted cash of $0, $0 and $14, respectively)
$
165

 
$
5

 
$
—

 
$
223

 
$
—

 
$
393

Short-term investments
—

 
—

 
—

 
7

 
—

 
7

Accounts receivable, net
179

 
—

 
—

 
422

 
—

 
601

Intercompany accounts receivable
190

 
89

 
—

 
374

 
(653
)
 
—

Intercompany loans receivable - current portion
216

 
—

 
—

 
278

 
(494
)
 
—

Inventories:
 
 
 
 
 
 
 
 
 
 
 
Finished and in-process goods
105

 
—

 
—

 
152

 
—

 
257

Raw materials and supplies
38

 
—

 
—

 
65

 
—

 
103

Other current assets
27

 
—

 
—

 
45

 
—

 
72

Total current assets
920

 
94

 
—

 
1,566

 
(1,147
)
 
1,433

Investment in unconsolidated entities
351

 
—

 
29

 
28

 
(363
)
 
45

Deferred income taxes
—

 
—

 
—

 
21

 
—

 
21

Other assets, net
31

 
59

 
2

 
42

 
—

 
134

Intercompany loans receivable
1,251

 
3,355

 
29

 
4,221

 
(8,856
)
 
—

Property and equipment, net
491

 
—

 
—

 
556

 
—

 
1,047

Goodwill
52

 
—

 
—

 
60

 
—

 
112

Other intangible assets, net
47

 
—

 
—

 
35

 
—

 
82

Total assets
$
3,143

 
$
3,508

 
$
60

 
$
6,529

 
$
(10,366
)
 
$
2,874

Liabilities and (Deficit) Equity
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
Accounts payable
$
165

 
$
—

 
$
—

 
$
318

 
$
—

 
$
483

Intercompany accounts payable
130

 
—

 
—

 
523

 
(653
)
 
—

Debt payable within one year
20

 
—

 
—

 
89

 
—

 
109

Intercompany loans payable within one year
173

 
—

 
—

 
321

 
(494
)
 
—

Interest payable
10

 
72

 
—

 
1

 
—

 
83

Income taxes payable
4

 
—

 
—

 
8

 
—

 
12

Accrued payroll and incentive compensation
19

 
—

 
—

 
28

 
—

 
47

Other current liabilities
65

 
—

 
—

 
62

 
—

 
127

Total current liabilities
586

 
72

 
—

 
1,350

 
(1,147
)
 
861

Long term liabilities:
 
 
 
 
 
 
 
 
 
 
 
Long-term debt
309

 
3,326

 
—

 
30

 
—

 
3,665

Intercompany loans payable
3,388

 
—

 
7

 
5,461

 
(8,856
)
 
—

Accumulated losses of unconsolidated subsidiaries in excess of investment
762

 
—

 
261

 
—

 
(1,023
)
 
—

Long-term pension and post employment benefit obligations
50

 
—

 
—

 
184

 
—

 
234

Deferred income taxes
7

 
2

 
—

 
12

 
—

 
21

Other long-term liabilities
110

 
6

 
—

 
47

 
—

 
163

Total liabilities
5,212

 
3,406

 
268

 
7,084

 
(11,026
)
 
4,944

Total Momentive Specialty Chemicals Inc. shareholders (deficit) equity
(2,069
)
 
102

 
(208
)
 
(554
)
 
660

 
(2,069
)
Noncontrolling interest
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Total (deficit) equity
(2,069
)
 
102

 
(208
)
 
(555
)
 
660

 
(2,070
)
Total liabilities and (deficit) equity
$
3,143

 
$
3,508

 
$
60

 
$
6,529

 
$
(10,366
)
 
$
2,874


21

MOMENTIVE SPECIALTY CHEMICALS INC.
THREE MONTHS ENDED JUNE 30, 2014
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net sales
$
595

 
$
—

 
$
—

 
$
804

 
$
(62
)
 
$
1,337

Cost of sales
524

 
—

 
—

 
712

 
(62
)
 
1,174

Gross profit
71

 
—

 
—

 
92

 
—

 
163

Selling, general and administrative expense
27

 
—

 
—

 
68

 
—

 
95

Business realignment costs
10

 
—

 
—

 
2

 
—

 
12

Other operating expense (income), net
2

 
—

 
—

 
(3
)
 
—

 
(1
)
Operating income
32

 
—

 
—

 
25

 
—

 
57

Interest expense, net
7

 
67

 
—

 
2

 
—

 
76

Intercompany interest expense (income), net
44

 
(68
)
 
—

 
24

 
—

 
—

Other non-operating expense (income), net
5

 
—

 
—

 
(2
)
 
—

 
3

(Loss) income before income tax and (losses) earnings from unconsolidated entities
(24
)
 
1

 
—

 
1

 
—

 
(22
)
Income tax expense
—

 
—

 
—

 
11

 
—

 
11

(Loss) income before (losses) earnings from unconsolidated entities
(24
)
 
1

 
—

 
(10
)
 
—

 
(33
)
(Losses) earnings from unconsolidated entities, net of taxes
(3
)
 
—

 
5

 
1

 
3

 
6

Net (loss) income
$
(27
)
 
$
1

 
$
5

 
$
(9
)
 
$
3

 
$
(27
)
Comprehensive (loss) income
$
(29
)
 
$
—

 
$
6

 
$
(16
)
 
$
10

 
$
(29
)

22

MOMENTIVE SPECIALTY CHEMICALS INC.
THREE MONTHS ENDED JUNE 30, 2013
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net sales
$
572

 
$
—

 
$
—

 
$
729

 
$
(51
)
 
$
1,250

Cost of sales
485

 
—

 
—

 
664

 
(51
)
 
1,098

Gross profit
87

 
—

 
—

 
65

 
—

 
152

Selling, general and administrative expense
29

 
—

 
—

 
60

 
—

 
89

Asset impairments
—

 
—

 
—

 
7

 
—

 
7

Business realignment costs
2

 
—

 
—

 
—

 
—

 
2

Other operating (income) expense, net
(1
)
 
—

 
—

 
6

 
—

 
5

Operating income (loss)
57

 
—

 
—

 
(8
)
 
—

 
49

Interest expense, net
8

 
67

 
—

 
1

 
—

 
76

Intercompany interest expense (income), net
47

 
(67
)
 
—

 
20

 
—

 
—

Other non-operating (income) expense, net
(8
)
 
—

 
—

 
6

 
—

 
(2
)
Income (loss) before income tax and (losses) earnings from unconsolidated entities
10

 
—

 
—

 
(35
)
 
—

 
(25
)
Income tax (benefit) expense
(4
)
 
—

 
—

 
10

 
—

 
6

Income (loss) before (losses) earnings from unconsolidated entities
14

 
—

 
—

 
(45
)
 
—

 
(31
)
(Losses) earnings from unconsolidated entities, net of taxes
(42
)
 
—

 
(17
)
 
1

 
61

 
3

Net loss
$
(28
)
 
$
—

 
$
(17
)
 
$
(44
)
 
$
61

 
$
(28
)
Comprehensive (loss) income
$
(43
)
 
$
1

 
$
(16
)
 
$
(62
)
 
$
77

 
$
(43
)



23

MOMENTIVE SPECIALTY CHEMICALS INC.
SIX MONTHS ENDED JUNE 30, 2014
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)

 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net sales
$
1,173

 
$
—

 
$
—

 
$
1,576

 
$
(119
)
 
$
2,630

Cost of sales
1,029

 
—

 
—

 
1,393

 
(119
)
 
2,303

Gross profit
144

 
—

 
—

 
183

 
—

 
327

Selling, general and administrative expense
55

 
—

 
—

 
136

 
—

 
191

Business realignment costs
15

 
—

 
—

 
3

 
—

 
18

Other operating expense, net
3

 
—

 
—

 
—

 
—

 
3

Operating income
71

 
—

 
—

 
44

 
—

 
115

Interest expense, net
15

 
134

 
—

 
4

 
—

 
153

Intercompany interest expense (income), net
87

 
(136
)
 
—

 
49

 
—

 
—

Other non-operating expense, net
5

 
—

 
—

 
—

 
—

 
5

(Loss) income before income tax and (losses) earnings from unconsolidated entities
(36
)
 
2

 
—

 
(9
)
 
—

 
(43
)
Income tax (benefit) expense
(1
)
 
—

 
—

 
22

 
—

 
21

(Loss) income before (losses) earnings from unconsolidated entities
(35
)
 
2

 
—

 
(31
)
 
—

 
(64
)
(Losses) earnings from unconsolidated entities, net of taxes
(19
)
 
—

 
4

 
2

 
23

 
10

Net (loss) income
$
(54
)
 
$
2

 
$
4

 
$
(29
)
 
$
23

 
$
(54
)
Comprehensive (loss) income
$
(50
)
 
$
1

 
$
5

 
$
(25
)
 
$
19

 
$
(50
)


24

MOMENTIVE SPECIALTY CHEMICALS INC.
SIX MONTHS ENDED JUNE 30, 2013
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (Unaudited)
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Net sales
$
1,109

 
$
—

 
$
—

 
$
1,437

 
$
(104
)
 
$
2,442

Cost of sales
949

 
—

 
—

 
1,302

 
(104
)
 
2,147

Gross profit
160

 
—

 
—

 
135

 
—

 
295

Selling, general and administrative expense
57

 
—

 
—

 
124

 
—

 
181

Asset impairments
—

 
—

 
—

 
7

 
—

 
7

Business realignment costs
6

 
—

 
—

 
5

 
—

 
11

Other operating expense (income), net
3

 
(4
)
 
—

 
3

 
—

 
2

Operating income (loss)
94

 
4

 
—

 
(4
)
 
—

 
94

Interest expense, net
18

 
128

 
—

 
4

 
—

 
150

Intercompany interest expense (income), net
91

 
(130
)
 
—

 
39

 
—

 
—

Loss on extinguishment of debt
2

 
—

 
—

 
4

 
—

 
6

Other non-operating expense (income), net
7

 
—

 
—

 
(4
)
 
—

 
3

(Loss) income before income tax and (losses) earnings from unconsolidated entities
(24
)
 
6

 
—

 
(47
)
 
—

 
(65
)
Income tax (benefit) expense
(42
)
 
1

 
—

 
15

 
—

 
(26
)
Income (loss) before (losses) earnings from unconsolidated entities
18

 
5

 
—

 
(62
)
 
—

 
(39
)
(Losses) earnings from unconsolidated entities, net of taxes
(50
)
 
—

 
(23
)
 
2

 
78

 
7

Net (loss) income
$
(32
)
 
$
5

 
$
(23
)
 
$
(60
)
 
$
78

 
$
(32
)
Comprehensive (loss) income
$
(60
)
 
$
5

 
$
(23
)
 
$
(78
)
 
$
96

 
$
(60
)

25

MOMENTIVE SPECIALTY CHEMICALS INC.
SIX MONTHS ENDED JUNE 30, 2014
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Cash flows (used in) provided by operating activities
$
(267
)
 
$
(3
)
 
$
6

 
$
84

 
$
(6
)
 
$
(186
)
Cash flows provided by (used in) investing activities
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures
(41
)
 
—

 
—

 
(37
)
 
—

 
(78
)
Acquisition of businesses
(52
)
 
—

 
—

 
(12
)
 
—

 
(64
)
Proceeds from sale of debt securities, net
—

 
—

 
—

 
3

 
—

 
3

Change in restricted cash
—

 
—

 
—

 
(2
)
 
—

 
(2
)
Disbursement of affiliated loan
—

 
—

 
—

 
(50
)
 
—

 
(50
)
Repayment of affiliated loan
—

 
—

 
—

 
50

 
—

 
50

Capital contribution to subsidiary
(16
)
 
—

 
(10
)
 
—

 
26

 
—

Investment in unconsolidated affiliates, net
—

 
—

 
—

 
(2
)
 
—

 
(2
)
Return of capital from subsidiary from sales of accounts receivable
186

(a)
—

 
—

 
—

 
(186
)
 
—

 
77

 
—

 
(10
)
 
(50
)
 
(160
)
 
(143
)
Cash flows provided by (used in) financing activities
 
 
 
 
 
 
 
 
 
 
 
Net short-term debt borrowings
—

 
—

 
—

 
27

 
—

 
27

Borrowings of long-term debt
115

 
—

 
—

 
45

 
—

 
160

Repayments of long-term debt
(69
)
 
—

 
—

 
(48
)
 
—

 
(117
)
Net intercompany loan borrowings (repayments)
9

 
—

 
—

 
(9
)
 
—

 
—

Capital contribution from parent
—

 
—

 
10

 
16

 
(26
)
 
—

Common stock dividends paid
—

 
—

 
(6
)
 
—

 
6

 
—

Return of capital to parent from sales of accounts receivable
—

 
—

 
—

 
(186
)
(a)
186

 
—

 
55

 
—

 
4

 
(155
)
 
166

 
70

Effect of exchange rates on cash and cash equivalents
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Decrease in cash and cash equivalents
(135
)
 
(3
)
 
—

 
(122
)
 
—

 
(260
)
Cash and cash equivalents (unrestricted) at beginning of period
165

 
5

 
—

 
209

 
—

 
379

Cash and cash equivalents (unrestricted) at end of period
$
30

 
$
2

 
$
—

 
$
87

 
$
—

 
$
119

(a)
During the six months ended June 30, 2014, Momentive Specialty Chemicals Inc. contributed receivables of $186 to a non-guarantor subsidiary as capital contributions, resulting in a non-cash transaction. During the six months ended June 30, 2014, the non-guarantor subsidiary sold the contributed receivables to certain banks under various supplier financing agreements. The cash proceeds were returned to Momentive Specialty Chemicals Inc. by the non-guarantor subsidiary as a return of capital. The sale of receivables has been included within cash flows from operating activities on the Combined non-guarantor subsidiaries. The return of the cash proceeds from the sale of receivables has been included as a financing outflow and an investing inflow on the Combined Non-Guarantor Subsidiaries and Momentive Specialty Chemicals Inc., respectively.

26

MOMENTIVE SPECIALTY CHEMICALS INC.
SIX MONTHS ENDED JUNE 30, 2013
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (Unaudited)
 
 
Momentive
Specialty
Chemicals
Inc.
 
Subsidiary
Issuers
 
Combined
Subsidiary
Guarantors
 
Combined
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
Cash flows provided by (used in) operating activities
$
7

 
$
1

 
$
13

 
$
9

 
$
(95
)
 
$
(65
)
Cash flows provided by (used in) investing activities
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures
(29
)
 
—

 
—

 
(31
)
 
—

 
(60
)
Capitalized interest
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Purchases of debt securities, net
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Capital contribution to subsidiary
(15
)
 
—

 
(10
)
 
—

 
25

 
—

Change in restricted cash
—

 
—

 
—

 
15

 
—

 
15

Proceeds from sale of assets
—

 
—

 
—

 
1

 
—

 
1

Return of capital from subsidiary from sales of accounts receivable
75

(a)
—

 
—

 
—

 
(75
)
 
—

Investment in unconsolidated affiliates, net
—

 
—

 
—

 
(13
)
 
—

 
(13
)
 
31

 
—

 
(10
)
 
(30
)
 
(50
)
 
(59
)
Cash flows (used in) provided by financing activities
 
 
 
 
 
 
 
 
 
 
 
Net short-term debt borrowings
—

 
—

 
—

 
9

 
—

 
9

Borrowings of long-term debt
—

 
1,108

 
—

 
19

 
—

 
1,127

Repayments of long-term debt
(544
)
 
(120
)
 
—

 
(376
)
 
—

 
(1,040
)
Net intercompany loan borrowings (repayments)
467

 
(882
)
 
(1
)
 
416

 
—

 
—

Long-term debt and credit facility financing fees
(12
)
 
(24
)
 
—

 
—

 
—

 
(36
)
Capital contribution from parent
—

 
—

 
10

 
15

 
(25
)
 
—

Common stock dividends paid
—

 
(83
)
 
(12
)
 
—

 
95

 
—

Return of capital to parent from sales of accounts receivable
—

 
—

 
—

 
(75
)
(a)
75

 
—

 
(89
)
 
(1
)
 
(3
)
 
8

 
145

 
60

Effect of exchange rates on cash and cash equivalents
—

 
—

 
—

 
(5
)
 
—

 
(5
)
Decrease in cash and cash equivalents
(51
)
 
—

 
—

 
(18
)
 
—

 
(69
)
Cash and cash equivalents (unrestricted) at beginning of period
276

 
—

 
—

 
125

 
—

 
401

Cash and cash equivalents (unrestricted) at end of period
$
225

 
$
—

 
$
—

 
$
107

 
$
—

 
$
332

(a)
During the six months ended June 30, 2013, Momentive Specialty Chemicals Inc. contributed receivables of $75 to a non-guarantor subsidiary as capital contributions, resulting in a non-cash transaction. During the six months ended June 30, 2013, the non-guarantor subsidiary sold the contributed receivables to certain banks under various supplier financing agreements. The cash proceeds were returned to Momentive Specialty Chemicals Inc. by the non-guarantor subsidiary as a return of capital. The sale of receivables has been included within cash flows from operating activities on the Combined non-guarantor subsidiaries. The return of the cash proceeds from the sale of receivables has been included as a financing outflow and an investing inflow on the Combined Non-Guarantor Subsidiaries and Momentive Specialty Chemicals Inc., respectively.

27

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 financial statements and the accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report on Form 10-K.
Within the following discussion, unless otherwise stated, “the second quarter of 2014” refers to the three months ended June 30, 2014, “the second quarter of 2013” refers to the three months ended June 30, 2013, “the first half of 2014” refers to the six months ended June 30, 2014 and “the first half of 2013” refers to the six months ended June 30, 2013.
Forward-Looking and Cautionary Statements
Certain statements in this report, including without limitation, certain statements made under the caption “Overview and Outlook,” are forward-looking statements within the meaning of and made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, our management may from time to time make oral forward-looking statements. All statements, other than statements of historical facts, are forward-looking statements. Forward-looking statements may be identified by the words “believe,” “expect,” “anticipate,” “project,” “plan,” “estimate,” “may,” “will,” “could,” “should,” “seek” or “intend” and similar expressions. Forward-looking statements reflect our current expectations and assumptions regarding our business, the economy and other future events and conditions and are based on currently available financial, economic and competitive data and our current business plans. Actual results could vary materially depending on risks and uncertainties that may affect our operations, markets, services, prices and other factors as discussed in the Risk Factors section of this report and our other filings with the Securities and Exchange Commission (the “SEC”). While we believe our assumptions are reasonable, we caution you against relying on any forward-looking statements as it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, a weakening of global economic and financial conditions, interruptions in the supply of or increased cost of raw materials, the loss of, or difficulties with the further realization of, cost savings in connection with our strategic initiatives, including transactions with our affiliate, Momentive Performance Materials Inc., the impact of our substantial indebtedness, our failure to comply with financial covenants under our credit facilities or other debt, pricing actions by our competitors that could affect our operating margins, changes in governmental regulations and related compliance and litigation costs and the other factors listed in the Risk Factors section of this report and in our other SEC filings. For a more detailed discussion of these and other risk factors, see the Risk Factors section of this report and our most recent filings made with the SEC. All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The forward-looking statements made by us speak only as of the date on which they are made. Factors or events that could cause our actual results to differ may emerge from time to time. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.
Overview and Outlook
Business Overview
We are the world’s largest producer of thermosetting resins, or thermosets, and a leading producer of adhesive and structural resins and coatings. Thermosets are a critical ingredient for virtually all paints, coatings, glues and other adhesives produced for consumer or industrial uses. We provide a broad array of thermosets and associated technologies and have significant market positions in all of the key markets that we serve.
Our products are used in thousands of applications and are sold into diverse markets, such as forest products, architectural and industrial paints, packaging, consumer products and automotive coatings, as well as higher growth markets, such as composites, UV cured coatings 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 field support. Key drivers for our business include general economic and industrial conditions, including housing starts, auto build rates and active 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 have significantly affected our results.
Through our worldwide network of strategically located production facilities, we serve more than 5,400 customers in over 100 countries. Our global customers include large companies in their respective industries, such as 3M, Akzo Nobel, BASF, Bayer, Dow, EP Energy, GE, Louisiana Pacific, Monsanto, Owens Corning, PPG Industries, Valspar and Weyerhaeuser.
Momentive Combination and Shared Services Agreement
In October 2010, our parent, Momentive Specialty Chemicals Holdings LLC (“MSC Holdings”), and Momentive Performance Materials Holdings Inc., the parent company of Momentive Performance Materials Inc. (“MPM”), became subsidiaries of a newly formed holding company, Momentive Performance Materials Holdings LLC (“Momentive Holdings”). We refer to this transaction as the “Momentive Combination.” In connection with the closing of the Momentive Combination, we entered into a shared services agreement with MPM, as amended on March 17, 2011 (the “Shared Services Agreement”), pursuant to which we provide to MPM, and MPM provides to us, certain services, including, but not limited to, executive and senior management, administrative support, human resources, information technology support, accounting, finance, technology development, legal and procurement services. The Shared Services Agreement is subject to termination

28

by either the Company or MPM, without cause, on not less than 30 days’ written notice subject to a 180 day transition assistance period, and expires in October 2015 (subject to one-year renewals every year thereafter; absent contrary notice from either party). The Shared Services Agreement establishes certain criteria upon which the costs of such services are allocated between us and MPM and requires that the Steering Committee formed under the agreement meet no less than annually to evaluate and determine an equitable allocation percentage. The allocation percentage for 2014 remains unchanged from 2013, which was 57% for us and 43% for MPM.
The Momentive Combination, including the Shared Services Agreement, has resulted in significant synergies for us, including shared services and logistics optimization, best-of-source contractual terms, procurement savings, regional site rationalization and administrative and overhead savings. We projected achieving a total of approximately $64 of cost savings in connection with the Shared Services Agreement, and through June 30, 2014, we have realized all of these savings on a run-rate basis.
On April 13, 2014, MPM Holdings, MPM and certain of its U.S. subsidiaries filed voluntary petitions for reorganization (the “Bankruptcy Filing”) under Chapter 11 of the U.S. Bankruptcy Code. The Company has filed a claim in U.S. Bankruptcy Court in conjunction with the Bankruptcy Filing for the pre-petition amounts owed to it by MPM under the Shared Services Agreement. Despite the Bankruptcy Filing, we expect the Shared Services Agreement to continue in effect and for the majority of the savings from these synergies to continue.
Reportable Segments
The Company’s business segments are based on the products that we offer and the markets that we serve. At June 30, 2014, the Company had two reportable segments: Epoxy, Phenolic and Coating Resins and Forest Products Resins. A summary of the major products of the Company’s reportable segments follows:
 
•
Epoxy, Phenolic and Coating Resins: epoxy specialty resins, phenolic encapsulated substrates, versatic acids and derivatives, basic epoxy resins and intermediates, phenolic specialty resins and molding compounds, polyester resins, acrylic resins and vinylic resins
 
•
Forest Products Resins: forest products resins and formaldehyde applications
First Half of 2014 Overview
 
•
Net sales increased $188, or 8%, in the first half of 2014 as compared to the first half of 2013 due primarily to an increase in demand in our oil field, epoxy specialty, North American formaldehyde and Latin American forest products resins businesses, which was partially offset by pricing decreases in certain businesses driven by increased competition, which outpaced raw-material-driven pricing increases in certain other businesses.
•
Segment EBITDA increased by $14, or 6%, in the first half of 2014 compared to the first half of 2013 due to the increase in sales volumes, cost control and productivity initiatives, as well as favorable product mix.
•
In early 2014 we acquired a manufacturing facility in Shreveport, Louisiana, which increased our capacity to provide resin coated proppants to our customers in this region, which has a high concentration of shale and natural gas wells.
•
As of June 30, 2014, we have realized cumulative savings of $62 as a result of the Shared Services Agreement with MPM and cumulative savings of $23 related to other cost reduction programs. As of June 30, 2014, we have approximately $2 of in-process cost savings in connection with the Shared Services Agreement and $4 of in-process cost savings in connection with other initiatives that we expect to achieve over the next 12 to 15 months.
•
Future growth initiatives include:
•
A joint venture to construct a phenolic specialty resins manufacturing facility in China, which is expected to be operational in the fourth quarter of 2014. The new facility will produce a full range of specialty novolac and resole phenolic resins used in a diverse range of applications, including refractories, friction and abrasives to support the growing auto and consumer markets in China.
•
The expansion of our forest products resins manufacturing capacity in Brazil and construction of a new formaldehyde plant in North America.
Short-term Outlook
Our business is impacted by general economic and industrial conditions, including housing starts, automotive builds, oil and natural gas drilling activity and general industrial production. Our business has both geographic and end market diversity which often reduces the impact of any one of these factors on our overall performance.
Due to continued worldwide economic volatility and uncertainty, the short-term outlook for our business is difficult to predict. Although we expect certain global markets to begin to stabilize, a continued lack of consumer confidence could lead to stagnant demand for many of our products within both of our reportable segments into 2014; however, we expect overall volumes to be moderately higher in the second half of 2014 as compared to same period in 2013.
We expect moderate increases in volumes within our oil field business during the second half of 2014 due to key innovations in new product development and strategic acquisitions; however, the use of alternative products by our customers can cause volatility in volumes in this business. We anticipate moderate general economic growth in the North American automobile and industrial markets to positively impact

29

our Epoxy, Phenolic and Coating Resins segment during the remainder of 2014; however, we expect the European automobile and construction industries to remain weak due to the continuing economic concerns in this region. We anticipate moderate increases in volumes within our epoxy specialty business during the second half of 2014 due to increasing global demand for wind energy. We also expect continued pressures in our base epoxy business during the remainder of 2014, as a result of overcapacity in the market and increased competition from Asian imports.
We anticipate volumes in our North American forest products resins business will continue to grow during the remainder of 2014, reflecting recovering U.S. housing starts; however, we anticipate some volatility in this market, and such growth could be uneven. We also anticipate moderate growth in volumes in our Latin American forest products business due to continued growth in the furniture, housing construction and industrial markets within this region, although growth in the region recently slowed during the World Cup tournament. Due to our past and present cost reduction efforts, we expect this volume growth to have a significant positive impact on our future results.
In response to the uncertain economic outlook, we continue to execute cost reduction programs, with $4 of in-process cost savings. We continue to evaluate additional actions, as well as productivity measures, that could lead to further savings. Such actions could result in more significant restructuring, exit and disposal costs and asset impairments in the future.
An additional economic recession or further postponement of the modest economic recovery could have an adverse impact on our business and results of operations. If global economic growth remains slow for an extended period of time, or another economic recession occurs, the fair value of our reporting units and long-lived assets could be more adversely affected than we estimated in earlier periods. This may result in goodwill or other additional asset impairments beyond amounts that have already been recognized.
We expect long-term raw material cost volatility to continue because of price movements of key feedstocks. To help mitigate raw material volatility, we have purchase and sale contracts and commercial arrangements with many of our vendors and customers that contain periodic price adjustment mechanisms. 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. We continue to implement pricing actions to compensate for the increase in raw material prices experienced during 2013, and expected to continue into the second half of 2014, which should benefit our operating cash flows in 2014.
We remain optimistic about our position in the global markets when they do recover to more stable conditions.
Matters Impacting Comparability of Results
Raw Material Prices
Raw materials comprise approximately 70% of our cost of sales. The three largest raw materials used in our production processes are phenol, methanol and urea. These materials represent about half of our total raw material costs. Fluctuations in energy costs, such as volatility in the price of crude oil and related petrochemical products, as well as the cost of natural gas have historically caused volatility in our raw material and utility costs. The average prices of phenol, methanol and urea (decreased) increased by approximately (1)%, 16% and (3)%, respectively, in the first six months of 2014 compared to the first six months of 2013. The impact of passing through raw material price changes to customers can result in significant variances in sales comparisons from year to year.
Other Comprehensive Income
Our other comprehensive income is significantly impacted by foreign currency translation and defined benefit pension and postretirement benefit adjustments. The impact of foreign currency translation is driven by the translation of assets and liabilities of our foreign subsidiaries which are denominated in functional currencies other than the U.S. dollar. The primary assets and liabilities driving the adjustments are cash and cash equivalents; accounts receivable; inventory; property, plant and equipment; accounts payable; pension and other postretirement benefit obligations and certain intercompany loans payable and receivable. The primary currencies in which these assets and liabilities are denominated are the euro, Brazilian real, Canadian dollar and Australian dollar. The impact of defined benefit pension and postretirement benefit adjustments is primarily driven by unrecognized actuarial gains and losses related to our defined benefit and other postretirement benefit plans, as well as the subsequent amortization of gains and losses from accumulated other comprehensive income in periods following the initial recording such items. These actuarial gains and losses are determined using various assumptions, the most significant of which are (i) the weighted average rate used for discounting the liability, (ii) the weighted average expected long-term rate of return on pension plan assets, (iii) the method used to determine market-related value of pension plan assets, (iv) the weighted average rate of future salary increases and (v) the anticipated mortality rate tables.


30

Results of Operations
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
Three Months Ended June 30,
 
2014
 
2013
 
$
 
% of Net Sales
 
$
 
% of Net Sales
Net sales
$
1,337

 
100
 %
 
$
1,250

 
100
 %
Cost of sales
1,174

 
88
 %
 
1,098

 
88
 %
Gross profit
163

 
12
 %
 
152

 
12
 %
Selling, general and administrative expense
95

 
7
 %
 
89

 
7
 %
Asset impairments
—

 
—
 %
 
7

 
1
 %
Business realignment costs
12

 
1
 %
 
2

 
—
 %
Other operating (income) expense, net
(1
)
 
—
 %
 
5

 
—
 %
Operating income
57

 
4
 %
 
49

 
4
 %
Interest expense, net
76

 
6
 %
 
76

 
6
 %
Other non-operating expense (income), net
3

 
—
 %
 
(2
)
 
—
 %
Total non-operating expense
79

 
6
 %
 
74

 
6
 %
Loss before income tax and earnings from unconsolidated entities
(22
)
 
(2
)%
 
(25
)
 
(2
)%
Income tax expense
11

 
1
 %
 
6

 
—
 %
Loss before earnings from unconsolidated entities
(33
)
 
(3
)%
 
(31
)
 
(2
)%
Earnings from unconsolidated entities, net of taxes
6

 
—
 %
 
3

 
—
 %
Net loss
$
(27
)
 
(3
)%
 
$
(28
)
 
(2
)%
Other comprehensive loss
$
(2
)
 
 
 
$
(15
)
 
 
Three Months Ended June 30, 2014 vs. Three Months Ended June 30, 2013
Net Sales
In the second quarter of 2014, net sales increased by $87, or 7%, compared to the second quarter of 2013. Volume increases positively impacted net sales by $71, and were primarily driven by our oil field, epoxy specialty and North American formaldehyde businesses. Volume increases in our oil field business were a result of key customer wins and new product development, and volume increases in our epoxy specialty business were driven by improving demand in the Asian wind energy market. Increases in volumes in our North American formaldehyde business were driven by key customer wins and timing of customer downtimes. These increases were partially offset by volume decreases in our base epoxy business driven by market share loss, as well as increased competition from Asian imports. Pricing had a positive impact of $6 due to raw material price increases passed through to customers in our North American formaldehyde and Latin American forest products resins businesses, which were partially offset by pricing decreases in our base epoxy business due to competitive pricing pressures. In addition, foreign currency translation positively impacted net sales by $10, primarily as a result of the strengthening U.S. dollar against the Australian dollar, Brazilian real and Canadian dollar, partially offset by the weakening of the U.S. dollar against the euro in the second quarter of 2014 compared to the second quarter of 2013.
Gross Profit
In the second quarter of 2014, gross profit increased by $11 compared to the second quarter of 2013. As a percentage of sales, gross profit remained flat, as raw material productivity initiatives were offset by the impact of the competitive pricing pressures discussed above.
Operating Income
In the second quarter of 2014, operating income increased by $8 compared to the second quarter of 2013. The increase was partially due to the $11 increase in gross profit as discussed above, but was partially offset by an increase in selling, general and administrative expense of $6 compared to the second quarter of 2013. The increase in selling, general and administrative expense was due primarily to increased compensation and project costs, which was partially offset by a decrease in pension and postretirement benefit expense driven by increases in the discount rates used to calculate our pension liabilities. In the second quarter of 2013, we recorded asset impairments of $7 as a result of the likelihood that certain assets would be disposed of before the end of their estimated useful lives, which did not recur in the second quarter of 2014. Other operating expense, net decreased by $6, from an expense of $5 to an income of $1, compared to the second quarter of 2013. This increase was primarily due to lower foreign currency losses recognized during the second quarter of 2014 as compared to the second quarter of 2013. Business realignment costs increased by $10 due primarily to an increase in costs related to environmental remediation at certain formerly owned locations.

31

Non-Operating Expense
In the second quarter of 2014, total non-operating expense increased by $5 compared to the second quarter of 2013, primarily due to higher realized and unrealized foreign currency transaction losses. Interest expense in the second quarter of 2014 remained flat compared to the second quarter of 2013.
Income Tax Expense

The effective tax rate was (50)% and (24)% for the second quarter of 2014 and 2013, respectively. The change in the effective tax rate was primarily attributable to the amount and distribution of income and losses among the various jurisdictions in which we operate. The effective tax rates were also impacted by operating losses generated in jurisdictions where no tax benefit was recognized due to the maintenance of a full valuation allowance.

For the second quarter of 2014, income tax expense relates primarily to income from certain foreign operations. 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. For the second quarter of 2013, income tax expense relates primarily to income from certain foreign operations.
Other Comprehensive Loss
For the second quarter of 2014, foreign currency translation negatively impacted other comprehensive income by $4, primarily due to the strengthening of the U.S. dollar against the Brazilian real and the Australian dollar, partially offset by the weakening of the U.S. dollar against the euro. For the second quarter of 2014, pension and postretirement benefit adjustments positively impacted other comprehensive income by $2, primarily due to the amortization of unrecognized actuarial losses recorded in prior periods.
For the second quarter of 2013, foreign currency translation negatively impacted other comprehensive income by $14, primarily due to the strengthening of the U.S. dollar against the Australian dollar, Canadian dollar and Brazilian real, partially offset by the weakening of the U.S. dollar against the euro. For the second quarter of 2013, pension and postretirement benefit adjustments negatively impacted other comprehensive income by $1, primarily due to a loss recognized related to certain postretirement benefit obligations, partially offset by amortization of unrecognized actuarial losses recorded in prior periods.
 
Six Months Ended June 30,
 
2014
 
2013
 
$
 
% of Net Sales
 
$
 
% of Net Sales
Net sales
$
2,630

 
100
 %
 
$
2,442

 
100
 %
Cost of sales
2,303

 
88
 %
 
2,147

 
88
 %
Gross profit
327

 
12
 %
 
295

 
12
 %
Selling, general and administrative expense
191

 
7
 %
 
181

 
7
 %
Asset impairments
—

 
—
 %
 
7

 
—
 %
Business realignment costs
18

 
1
 %
 
11

 
—
 %
Other operating expense, net
3

 
—
 %
 
2

 
—
 %
Operating income
115

 
4
 %
 
94

 
5
 %
Interest expense, net
153

 
6
 %
 
150

 
6
 %
Loss on extinguishment of debt
—

 
—
 %
 
6

 
—
 %
Other non-operating expense, net
5

 
—
 %
 
3

 
—
 %
Total non-operating expense
158

 
6
 %
 
159

 
6
 %
Loss before income tax and earnings from unconsolidated entities
(43
)
 
(2
)%
 
(65
)
 
(1
)%
Income tax expense (benefit)
21

 
1
 %
 
(26
)
 
(1
)%
Loss before earnings from unconsolidated entities
(64
)
 
(3
)%
 
(39
)
 
—
 %
Earnings from unconsolidated entities, net of taxes
10

 
—
 %
 
7

 
—
 %
Net loss
$
(54
)
 
(3
)%
 
$
(32
)
 
—
 %
Other comprehensive income (loss)
$
4

 
 
 
$
(28
)
 
 
Six Months Ended June 30, 2014 vs Six Months Ended June 30, 2013
Net Sales
In the first half of 2014, net sales increased by $188, or 8%, compared to the first half of 2013. Volume increases positively impacted net sales by $164, and were primarily driven by our oil field, epoxy specialty, North American formaldehyde and Latin American forest products resins businesses. Volume increases in our oil field business were a result of key customer wins and new product development, and volume increases in our epoxy specialty business were driven by improving demand in the Asian wind energy market. Increases in volumes in our North American formaldehyde business were driven by major customer outages in the first half of 2013 which did not recur in the first half of 2014, and increases in our Latin American forest products resins business were driven by increases in the furniture, housing construction and industrial

32

markets in this region. These increases were partially offset by volume decreases in our base epoxy business driven by market share loss, as well as increased competition from Asian imports. Pricing had a positive impact of $25 due to raw material price increases passed through to customers in our North American formaldehyde and Latin American forest products resins businesses, which were partially offset by pricing decreases in our base epoxy business due to competitive pricing pressures. In addition, foreign currency translation negatively impacted net sales by $1, primarily as a result of the strengthening U.S. dollar against the Australian dollar, Brazilian real and Canadian dollar, partially offset by the weakening of the U.S. dollar against the euro in the first half of 2014 compared to the first half of 2013.
Gross Profit
In the first half of 2014, gross profit increased by $32 compared to the first half of 2013. As a percentage of sales, gross profit remained flat, as raw material productivity initiatives were offset by the impact of the competitive pricing pressures discussed above.
Operating Income
In the first half of 2014, operating income increased by $21 compared to the first half of 2013. The increase was partially due to the $32 increase in gross profit as discussed above, but was partially offset by an increase in selling, general and administrative expense of $10 compared to the first half of 2013. The increase in selling, general and administrative expense was due primarily to increased compensation and project costs, which was partially offset by a decrease in pension and postretirement benefit expense driven by increases in the discount rates used to calculate our pension liabilities. In the first half of 2013, we recorded asset impairments of $7 as a result of the likelihood that certain assets would be disposed of before the end of their estimated useful lives, which did not recur in the first half of 2014. Other operating expense, net remained flat compared to the first half of 2013. Business realignment costs increased by $7 due primarily to an increase in costs related to environmental remediation at certain formerly owned locations.
Non-Operating Expense
In the first half of 2014, total non-operating expense decreased by $1 compared to the first half of 2013, primarily due to the loss on extinguishment of debt recognized in the first half of 2013 as a result of the refinancing transactions in early 2013, which did not recur in the first half of 2014. Interest expense increased slightly in the first half of 2014 compared to the first half of 2013 due primarily to higher average outstanding debt balances.
Income Tax Expense (Benefit)

The effective tax rate was (49)% and 40% for the first half of 2014 and 2013, respectively. The change in the effective tax rate was primarily attributable to the amount and distribution of income and losses among the various jurisdictions in which we operate. The effective tax rates were also impacted by operating losses generated in jurisdictions where no tax benefit was recognized due to the maintenance of a full valuation allowance.

For the first half of June 30, 2014, income tax expense relates primarily to income from certain foreign operations. 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. For the first half of 2013, income tax benefit relates primarily to a discrete tax benefit of $29 related to the signing of the American Taxpayer Relief Act of 2012 during the first quarter of 2013, which provided for the exclusion of certain foreign earnings from U.S. federal taxation from January 1, 2012 through December 31, 2013.
Other Comprehensive Income (Loss)
For the first half of 2014, foreign currency translation negatively impacted other comprehensive income by $1, primarily due to the strengthening of the U.S. dollar against the Australian dollar, Canadian dollar and Brazilian real, partially offset by the weakening of the U.S. dollar against the euro. For the first half of 2014, pension and postretirement benefit adjustments positively impacted other comprehensive income by $5, primarily due to the amortization of unrecognized actuarial losses recorded in prior periods.
For the first half of 2013, foreign currency translation negatively impacted other comprehensive income by $32, primarily due to the strengthening of the U.S. dollar against the Australian dollar, Canadian dollar and Brazilian real, partially offset by the weakening of the U.S. dollar against the euro. For the first half of 2013, pension and postretirement benefit adjustments positively impacted other comprehensive income by $3, primarily due to the amortization of unrecognized actuarial losses recorded in prior periods, partially offset by a loss recognized related to certain postretirement benefit obligations. Additionally, for the first half of 2013, the reclassification of net losses on cash flow hedges positively impacted other comprehensive income by $1.

33

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.
 
Three Months Ended June 30,
 
Six Months Ended June 30,

2014
 
2013
 
2014
 
2013
Net Sales (1):
 
 
 
 
 
 
 
Epoxy, Phenolic and Coating Resins
$
862

 
$
799

 
$
1,679

 
$
1,564

Forest Products Resins
475

 
451

 
951

 
878

Total
$
1,337

 
$
1,250

 
$
2,630

 
$
2,442

 
 
 
 
 
 
 
 
Segment EBITDA:
 
 
 
 


 
 
Epoxy, Phenolic and Coating Resins
$
72

 
$
73

 
$
148

 
$
141

Forest Products Resins
65

 
59

 
125

 
114

Corporate and Other
(17
)
 
(14
)
 
(36
)
 
(32
)
(1)
Intersegment sales are not significant and, as such, are eliminated within the selling segment.
Three Months Ended June 30, 2014 vs. Three Months Ended June 30, 2013 Segment Results
Following is an analysis of the percentage change in sales by segment from the three months ended June 30, 2013 to the three months ended June 30, 2014:
 
Volume
 
Price/Mix
 
Currency
Translation
 
Total
Epoxy, Phenolic and Coating Resins
9
%
 
(3
)%
 
2
 %
 
8
%
Forest Products Resins
1
%
 
6
 %
 
(2
)%
 
5
%
Epoxy, Phenolic and Coating Resins
Net sales in the second quarter of 2014 increased by $63, or 8%, when compared to the second quarter of 2013. Higher volumes positively impacted net sales by $68, which were primarily driven by increased demand within our oil field, phenolic specialty and epoxy specialty businesses. Volume increases in our oil field business were a result of key customer wins and new product development, and volume increases in our phenolic specialty business were driven by increased industrial demand, primarily in Europe. Increases in volumes in our epoxy specialty business were driven by improving demand in the Asian wind energy market. These increases were partially offset by volume decreases in our base epoxy business driven by market share loss, as well as increased competition from Asian imports. Pricing had a negative impact of $23, which was primarily driven by pricing decreases in our base epoxy business due to competitive pricing pressures. Foreign exchange translation positively impacted net sales by $18, primarily due to the weakening of the U.S. dollar against the euro in the second quarter of 2014 compared to the second quarter of 2013.
Segment EBITDA in the second quarter of 2014 decreased by $1 to $72 compared to the second quarter of 2013. The positive impact of the volume increases discussed above was offset by margin compression in certain businesses.
Forest Products Resins
Net sales in the second quarter of 2014 increased by $24, or 5%, when compared to the second quarter of 2013. Higher volumes positively impacted sales by $3, and were primarily driven by increases in our North American formaldehyde business. Volume increases in our North American formaldehyde business were due to key customer wins and the timing of customer downtimes. Raw material price increases passed through to customers led to pricing increases of $29. Foreign exchange translation negatively impacted net sales by $8, primarily due to the strengthening of the U.S. dollar against the Brazilian real and Australian dollar in the second quarter of 2014 compared to the second quarter of 2013.
Segment EBITDA in the second quarter of 2014 increased by $6 to $65 compared to the second quarter of 2013. Segment EBITDA increases were primarily driven by the increase in net sales discussed above, cost control and productivity initiatives and favorable product mix.
Corporate and Other
Corporate and Other is primarily corporate, general and administrative expenses that are not allocated to the segments, such as shared service and administrative functions, unallocated foreign exchange gains and losses and legacy company costs not allocated to continuing segments. Corporate and Other charges increased by $3 to $17 compared to the second quarter of 2013 primarily due to higher costs to support initiatives in our information technology, human resources and environmental, health and safety functions.

34

Six Months Ended June 30, 2014 vs Six Months Ended June 30, 2013 Segment Results
Following is an analysis of the percentage change in sales by segment from the six months ended June 30, 2013 to the six months ended June 30, 2014:
 
Volume
 
Price/Mix
 
Currency
Translation
 
Total
Epoxy, Phenolic and Coating Resins
8
%
 
(3
)%
 
2
 %
 
7
%
Forest Products Resins
4
%
 
7
 %
 
(3
)%
 
8
%
Epoxy, Phenolic and Coating Resins
Net sales in the first half of 2014 increased by $115, or 7%, when compared to the first half of 2013. Higher volumes positively impacted net sales by $131, which were primarily driven by increased demand within our oil field, phenolic specialty and epoxy specialty businesses. Volume increases in our oil field business were a result of key customer wins and new product development, and volume increases in our phenolic specialty business were driven by increased industrial demand, primarily in Europe. Increases in volumes in our epoxy specialty business were driven by improving demand in the Asian wind energy market. These increases were partially offset by volume decreases in our base epoxy business driven by market share loss, as well as increased competition from Asian imports. Pricing had a negative impact of $42, which was primarily driven by pricing decreases in our base epoxy business due to competitive pricing pressures. Foreign exchange translation positively impacted net sales by $26, primarily due to the weakening of the U.S. dollar against the euro in the first half of 2014 compared to the first half of 2013.
Segment EBITDA in the first half of 2014 increased by $7 to $148 compared to the first half of 2013. The positive impact of the volume increases discussed above was partially offset by margin compression in certain businesses.
Forest Products Resins
Net sales in the first half of 2014 increased by $73, or 8%, when compared to the first half of 2013. Higher volumes positively impacted sales by $33, and were primarily driven by increases in our North American formaldehyde and Latin American forest products businesses. Volume increases in our North American formaldehyde business were due to major customer outages in the first half of 2013 that did not recur in the first half of 2014, and increases in our Latin American forest products resins business were driven by increases in the furniture, housing construction and industrial markets in this region. Raw material price increases passed through to customers led to pricing increases of $67. Foreign exchange translation negatively impacted net sales by $27, primarily due to the strengthening of the U.S. dollar against the Brazilian real and Australian dollar in the first half of 2014 compared to the first half of 2013.
Segment EBITDA in the first half of 2014 increased by $11 to $125 compared to the first half of 2013. Segment EBITDA increases were primarily driven by the increase in net sales discussed above, cost control and productivity initiatives, as well as favorable product mix.
Corporate and Other
Corporate and Other is primarily corporate, general and administrative expenses that are not allocated to the segments, such as shared service and administrative functions, unallocated foreign exchange gains and losses and legacy company costs not allocated to continuing segments. Corporate and Other charges increased by $4 to $36 compared to the first half of 2013 primarily due to higher costs to support initiatives in our information technology, human resources and environmental, health and safety functions.

35

Reconciliation of Segment EBITDA to Net Loss:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Segment EBITDA:
 
 
 
 
 
 
 
Epoxy, Phenolic and Coating Resins
$
72

 
$
73

 
$
148

 
$
141

Forest Products Resins
65

 
59

 
125

 
114

Corporate and Other
(17
)
 
(14
)
 
(36
)
 
(32
)
 
 
 
 
 
 
 
 
Reconciliation:
 
 
 
 
 
 
 
Items not included in Segment EBITDA
 
 
 
 
 
 
 
Asset Impairments
—

 
(7
)
 
—

 
(7
)
Business realignment costs
(12
)
 
(2
)
 
(18
)
 
(11
)
Integration costs
(3
)
 
(2
)
 
(5
)
 
(5
)
Other
(9
)
 
(15
)
 
(23
)
 
(26
)
Total adjustments
(24
)
 
(26
)
 
(46
)
 
(49
)
Interest expense, net
(76
)
 
(76
)
 
(153
)
 
(150
)
Loss on extinguishment of debt
—

 
—

 
—

 
(6
)
Income tax (expense) benefit
(11
)
 
(6
)
 
(21
)
 
26

Depreciation and amortization
(36
)
 
(38
)
 
(71
)
 
(76
)
Net loss
$
(27
)
 
$
(28
)
 
$
(54
)
 
$
(32
)
 Items Not Included in Segment EBITDA
Not included in Segment EBITDA are certain non-cash items and other income and expenses. For the three and six months ended June 30, 2014, these items primarily include expenses from retention programs, stock-based compensation expense, losses on the disposal of assets and unrealized foreign exchange transaction gains and losses. For the three and six months ended June 30, 2013, these items primarily include expenses from retention programs and unrealized foreign exchange losses. Business realignment costs for the three and six months ended June 30, 2014 and June 30, 2013 primarily relate to costs for environmental remediation at certain formerly owned locations and expenses from minor restructuring programs. Integration costs for the three and six months ended June 30, 2014 and 2013 primarily represent integration costs associated with the Momentive Combination.


36

Liquidity and Capital Resources
We are a highly leveraged company. Our primary sources of liquidity are cash flows generated from operations and availability under our asset-based revolving loan facility (the “ABL Facility”). Our primary liquidity requirements are interest, working capital and capital expenditures.
 
At June 30, 2014, we had $3,846 of outstanding debt, including $137 of short-term debt and capital lease maturities. In addition, at June 30, 2014, we had $466 in liquidity consisting of the following:
•$119 of unrestricted cash and cash equivalents (of which $87 is maintained in foreign jurisdictions);
•
$4 of short-term investments;
•
$303 of borrowings available under our ABL Facility ($400 borrowing base, less $65 of outstanding borrowings and $32 of outstanding letters of credit); and
•
$40 of borrowings available under credit facilities at certain international subsidiaries
We do not believe there is any risk to funding our liquidity requirements in any particular jurisdiction for the next twelve months.
Our net working capital (defined as accounts receivable and inventories less accounts payable) at June 30, 2014 and December 31, 2013 was $703 and $478, respectively. A summary of the components of our net working capital as of June 30, 2014 and December 31, 2013 is as follows:
 
June 30, 2014
 
% of LTM Net Sales
 
December 31, 2013
 
% of LTM Net Sales
Accounts receivable
$
728

 
14
 %
 
$
601


12
 %
Inventories
485

 
10
 %
 
360


8
 %
Accounts payable
(510
)
 
(10
)%
 
(483
)

(10
)%
Net working capital
$
703

 
14
 %
 
$
478

 
10
 %
The increase in net working capital of $225 from December 31, 2013 was a result of the increase in sequential quarter volumes due primarily to the impacts of seasonality, which drove increases in accounts receivable and inventory, and was partially offset by increases in accounts payable, driven by the same factors. The increase in inventory was also driven by inventory builds in the second quarter of 2014 in preparation for planned maintenance shutdowns at certain facilities in the third quarter of 2014. To minimize the impact of net working capital on cash flows, we continue to review inventory safety stock levels, focus on receivable collections by offering incentives to customers to encourage early payment or accelerating receipts through the sale of receivables and negotiate with vendors to contractually extend payment terms whenever possible.
During the first half of 2014, gross borrowings under the ABL Facility were $156, and as of June 30, 2014, there was $65 outstanding under the ABL Facility.
Short-term Outlook
Capital spending in 2014 is expected to be between $185 and $210. The increase in capital spending over 2013 will be primarily driven by investment in our growth and specialty businesses by increasing capacity to meet customer demand. We anticipate a slight increase in working capital in 2014, reflecting moderate expected volume increases. Working capital trends are expected to be consistent with 2013, with increases in the first half of the year and decreases in the second half. Additionally, we expect the following significant cash outflows in 2014: interest payments on our fixed rate First-Priority Senior Secured Notes, Senior Secured Notes, Second-Priority Senior Secured Notes and Debentures (due semi-annually) of approximately $286 in total (with first quarter and third quarter payments of approximately $128, and second and fourth quarter payments of approximately $158); and income tax payments estimated at $27. We plan to fund these significant outflows with available cash and cash equivalents, cash from operations and, if necessary, through available borrowings under our ABL Facility. Based on our liquidity position as of June 30, 2014, and projections of operating cash flows in 2014, we feel that we are favorably positioned to maintain adequate liquidity throughout the remainder of 2014 and the foreseeable future to fund our ongoing operations, cash debt service obligations and any additional investment in net working capital.
We continue to review possible sales of certain non-core assets, which would further increase our liquidity. Opportunities for these sales could depend to some degree on conditions in the credit markets. If the global economic environment begins to weaken again or remains slow for an extended period of time our liquidity, future results of operations and flexibility to execute liquidity enhancing actions could be negatively impacted.

37

Sources and Uses of Cash
Following are highlights from our unaudited Condensed Consolidated Statements of Cash Flows:
 
Six Months Ended June 30,
 
2014
 
2013
Sources (uses) of cash:
 
 
 
Operating activities
$
(186
)
 
$
(65
)
Investing activities
(143
)
 
(59
)
Financing activities
70

 
60

Effect of exchange rates on cash flow
(1
)
 
(5
)
Net decrease in cash and cash equivalents
$
(260
)
 
$
(69
)
Operating Activities
In the first half of 2014, operations used $186 of cash. Net loss of $54 included $74 of net non-cash expense items, of which $71 was for depreciation and amortization and $8 was for unrealized foreign currency losses. Working capital (defined as accounts receivable and inventories less accounts payable) used $212, which was driven by increases in accounts receivable of $116 and inventory of $120 due to seasonality-driven sequential sales volume increases, which were partially offset by an increase in accounts payable of $24, driven by the same factors. Changes in other assets and liabilities and income taxes payable provided $6 due to the timing of when items were expensed versus paid, which primarily included interest expense, employee retention programs, pension plan contributions and taxes.
In the first half of 2013, operations used $65 of cash. Net loss of $32 included $23 of net non-cash expense items, of which $76 was for depreciation and amortization, $6 was for loss on extinguishment of debt and $7 was for non-cash asset impairments. These items were partially offset by $41 of deferred tax benefit and $26 of unrealized foreign currency gains. Working capital used $110, which was driven by increases in accounts receivable and inventory due to sequential sales volume increases, which were partially offset by increases in accounts payable, driven by the same factors. Changes in other assets and liabilities and income taxes payable provided $54 due to the timing of when items were expensed versus paid, which primarily included interest expense, employee retention programs, pension plan contributions and taxes.
Investing Activities
In the first half of 2014, investing activities used $143 of cash. We spent $78 for capital expenditures, which primarily related to plant expansions, improvements and maintenance related capital expenditures. We also used cash of $52 for the acquisition of a manufacturing facility in Shreveport, Louisiana and $12 of cash to purchase a subsidiary of MPM. The loan extended to Finco resulted in a $50 decrease in cash, which was offset by the subsequent $50 repayment of the loan by Finco. Additionally, we generated cash of $3 from the sale of debt securities, and the change in restricted cash provided $2.
In the first half of 2013, investing activities used $59. We spent $61 for capital expenditures (including capitalized interest), which primarily related to plant expansions, improvements and maintenance related capital expenditures. We also used $15 of restricted cash to purchase an interest in an unconsolidated joint venture.
Financing Activities
In the first half of 2014, financing activities provided $70 of cash. Net short-term debt borrowings were $27, and net long-term debt borrowings were $43, which primarily consisted of net borrowings under the ABL Facility.
In the first half of 2013, financing activities provided $60. Net long-term debt borrowings of $87 primarily consisted of proceeds of $1,108 ($1,100 plus a premium of $8) from the issuance of 6.625% First-Priority Senior Secured Notes due 2020, which was partially offset by the paydown of approximately $910 of term loans under our senior secured credit facilities and the purchase and discharge of $120 of our Floating Rate Second-Priority Senior Secured Notes due 2014, all as a result of the refinancing transactions in early 2013. We also paid $36 of financing fees related to these transactions.

There are certain restrictions on the ability of certain of our subsidiaries to transfer funds to the parent 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.
Debt Repurchases and Other Financing Transactions
From time to time, depending upon market, pricing and other conditions, as well as our cash balances and liquidity, we or our affiliates, may seek to acquire notes or other indebtedness of the Company through open market purchases, privately negotiated transactions, tender offers, redemption or otherwise, upon such terms and at such prices as we or our affiliates may determine (or as may be provided for in the indentures governing the notes), for cash or other consideration. In addition, we have considered and will continue to evaluate potential transactions to reduce net debt, such as debt for debt exchanges or other transactions. There can be no assurance as to which, if any, of these alternatives or combinations thereof we or our affiliates may choose to pursue in the future, as the pursuit of any alternative will depend upon numerous factors such as market conditions, our financial performance and the limitations applicable to such transactions under our financing documents.

38

Covenant Compliance
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 one case, the maintenance of a financial ratio (depending on certain conditions). Payment of borrowings under the ABL Facility and our notes may be accelerated if there is an event of default as determined under the governing debt instrument. Events of default under the credit agreement governing our ABL Facility includes the failure to pay principal and interest when due, a material breach of representations or warranties, most covenant defaults, events of bankruptcy and a change of control. Events of default under the indentures governing our notes include the failure to pay principal and interest, a failure to comply with covenants, subject to a 30-day grace period in certain instances, and certain events of bankruptcy.
The indentures that govern our 6.625% First-Priority Senior Secured Notes, 8.875% Senior Secured Notes and 9.00% Second-Priority Senior Secured Notes (the “Secured Indentures”) contain an Adjusted EBITDA to Fixed Charges ratio incurrence test which restricts our ability to take certain actions such as incurring additional debt or making acquisitions if we are unable to meet this ratio (measured on a last twelve months, or LTM, basis) of at least 2.0:1. The Adjusted EBITDA to Fixed Charges Ratio under the Secured Indentures is generally defined as the ratio of (a) Adjusted EBITDA to (b) net interest expense excluding the amortization or write-off of deferred financing costs, each measured on an LTM basis.
Our ABL Facility, which is subject to a borrowing base, replaced our senior secured credit facilities in March 2013. The ABL Facility 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) $40 and (b) 12.5% of the lesser of the borrowing base and the total ABL Facility commitments at such time. The fixed charge coverage ratio under the credit agreement governing the ABL Facility is generally defined as the ratio of (a) Adjusted EBITDA minus non-financed capital expenditures and cash taxes to (b) debt service plus cash interest expense plus certain restricted payments, each measured on an LTM basis. At June 30, 2014, our availability under the ABL Facility exceeded the minimum requirements, as did our fixed charge coverage ratio.
Adjusted EBITDA is defined as EBITDA adjusted for certain non-cash and certain non-recurring items and other adjustments calculated on a pro-forma basis, including the expected future cost savings from business optimization programs or other programs and the expected future impact of acquisitions, in each case as determined under the governing debt instrument. As we are highly leveraged, we believe that including the supplemental adjustments that are made to calculate Adjusted EBITDA provides additional information to investors about our ability to comply with our financial covenants and to obtain additional debt in the future. Adjusted EBITDA and Fixed Charges are not defined terms under U.S. GAAP. Adjusted EBITDA is not a measure of financial condition, liquidity or profitability, and should not be considered as an alternative to net income (loss) determined in accordance with U.S. GAAP or operating cash flows determined in accordance with U.S. GAAP. Additionally, EBITDA is not intended to be a measure of free cash flow for management’s discretionary use, as it does not take into account certain items such as interest and principal payments on our indebtedness, depreciation and amortization expense (because we use capital assets, depreciation and amortization expense is a necessary element of our costs and ability to generate revenue), working capital needs, tax payments (because the payment of taxes is part of our operations, it is a necessary element of our costs and ability to operate), non-recurring expenses and capital expenditures. Fixed Charges under the Secured Indentures should not be considered an alternative to interest expense.
As of June 30, 2014, we were in compliance with all covenants that govern the ABL Facility. We do not believe that a covenant default under the ABL Facility is reasonably likely to occur in the foreseeable future. During the first half of 2014, gross borrowings under the ABL Facility were $156, and as of June 30, 2014, there was $65 outstanding under the ABL Facility.

39

Reconciliation of Net Loss to Adjusted EBITDA
The following table reconciles net loss to EBITDA and Adjusted EBITDA, and calculates the ratio of Adjusted EBITDA to Fixed Charges as calculated under certain of our indentures for the period presented:
 
June 30, 2014
 
LTM Period
Net loss
$
(656
)
Income tax expense
396

Interest expense, net
306

Depreciation and amortization
143

EBITDA
189

Adjustments to EBITDA:
 
Asset impairments
174

Business realignments (1)
29

Integration costs (2)
10

Other (3)
50

Savings from Shared Services Agreement (4)
2

Cost reduction programs savings (5)
4

Pro forma EBITDA adjustment for acquisition (6)
16

Adjusted EBITDA
$
474

Pro forma fixed charges (7)
$
295

Ratio of Adjusted EBITDA to Fixed Charges (8)
1.61

(1)
Represents headcount reduction expenses and plant rationalization costs related to cost reduction programs and other costs associated with business realignments.
(2)
Primarily represents integration costs associated with the Momentive Combination.
(3)
Primarily includes pension expense related to formerly owned businesses, business optimization expenses, management fees, retention program costs, stock-based compensation and realized and unrealized foreign exchange and derivative activity.
(4)
Primarily represents pro forma impact of expected savings from the Shared Services Agreement with MPM. Savings from the Shared Services Agreement represent the unrealized savings from shared services and logistics optimization, best-of-source contractual terms, procurement savings, and regional site rationalization as a result of the Momentive Combination, 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 LTM period. Best of source contractual terms, procurement and logistics savings relate to cost savings as a result of lower cost contracts for raw materials and logistics as a result of better leverage with vendors.
(5)
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 LTM period. The savings are calculated based on actual costs of exiting headcount and elimination or reduction of site costs.
(6)
Reflects pro forma impact of the acquisition of a manufacturing facility in Shreveport, Louisiana in early 2014, and represents our estimate of incremental annualized EBITDA when the facility is operating at full capacity, as well as related synergies.
(7)
Reflects pro forma interest expense based on interest rates at June 30, 2014.
(8)
The Company’s ability to incur additional indebtedness, among other actions, is restricted under the indentures governing certain notes, unless the Company has an Adjusted EBITDA to Fixed Charges ratio of 2.0 to 1.0. As of June 30, 2014, we did not satisfy this test. As a result, we are subject to restrictions on our ability to incur additional indebtedness and to make investments; however, there are exceptions to these restrictions, including exceptions that permit indebtedness under our ABL Facility (available borrowings of which were $303 at June 30, 2014).
Recently Issued Accounting Standards
In May, 2014, the FASB issued Accounting Standards Board Update No. 2014-09: Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the existing revenue recognition guidance and most industry-specific guidance applicable to revenue recognition. According to the new guidance, an entity will apply a principles-based five step model to recognize revenue upon the transfer of promised goods or services to customers and in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for annual periods beginning after December 15, 2016, including interim periods within that reporting period and early application is not permitted. We are currently assessing the potential impact of ASU 2014-09 on our financial statements.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
There have been no material developments during the first six months of 2014 on the matters we have previously disclosed about quantitative and qualitative market risk in our Annual Report on Form 10-K for the year ended December 31, 2013.


40

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 June 30, 2014. 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 June 30, 2014.
Changes in Internal Control Over Financial Reporting
The remediation efforts noted below represent changes in our internal control over financial reporting during the quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Remediation of Material Weakness  
As described in the Company’s Annual Report on Form 10-K for the period ended December 31, 2013, we did not maintain effective controls over the preparation and review of the calculation of valuation allowances recorded for deferred tax assets as the review of the valuation allowance did not consider all relevant facts and circumstances. This resulted in the Company’s restatement of its consolidated financial statements as of and for the year ended December 31, 2012.
In response to the identification of the material weakness, beginning in the fourth quarter of 2013 and first quarter of 2014, management took actions to remediate its controls over the preparation and review of the calculation of valuation allowances recorded for deferred tax assets. The Company has implemented more robust reviews over the determination of valuation allowances recognized, including more formal comparisons between deferred tax assets and all sources of future taxable income. In addition, the Company has added resources that will enable management review and oversight for those valuation allowances that involve a higher degree of inherent complexity and judgment required on the part of management.
We tested the newly implemented controls and the enhanced controls at the end of March and June 2014 and found them to be effective and in operation for a sufficient period of time to effectively measure their operating effectiveness. Therefore, we have concluded that the material weakness has been fully remediated as of June 30, 2014.
Part II
Item 1.
Legal Proceedings
There have been no other material developments during the second quarter of 2014 in any of the ongoing legal proceedings that are included in our Annual Report on Form 10-K for the year ended December 31, 2013.
Item 1A.
Risk Factors
Except as noted below, the risk factors that were disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 (the “10-K”) and in the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2014 (the “10-Q”) have not materially changed since we filed the 10-K and 10-Q. See Item 1A to Part I of the 10-K and Item 1A to Part II of the 10-Q for a complete discussion of these risk factors.
We have achieved significant cost savings as a result of the Shared Services Agreement with MPM, and expect additional cost savings from our other strategic initiatives. If the Shared Services Agreement is terminated or materially amended, or we are unable to achieve cost savings from our other strategic initiatives, it could have a material adverse effect on our business operations, results of operations, and financial condition.
In connection with the closing of the Momentive Combination, we entered into the Shared Services Agreement with MPM, as amended on March 17, 2011, pursuant to which we provide to MPM and MPM provides to us, certain services, including, but not limited to, executive and senior management, administrative support, human resources, information technology support, accounting, finance, technology development, legal and procurement services. We have realized significant cost savings under the Shared Service Agreement, including savings related to shared services and logistics optimization, best-of-source contractual terms, procurement savings, regional site rationalization, administrative and overhead savings. The Shared Services Agreement is subject to termination by MPM (or us), without cause, on not less than thirty days prior written notice, subject to a 180 day transition assistance period, and expires in October 2015 (subject to one-year renewals every year thereafter, absent contrary notice from either party). On April 13, 2014, MPM Holdings, MPM and certain of its U.S. subsidiaries filed voluntary petitions for reorganization (the “Bankruptcy Filing”) under Chapter 11. Included in MPM’s plan of reorganization under the Bankruptcy Filing is the requirement for certain amendments to the Shared Services Agreement. If the Shared Services Agreement is materially amended or terminated, it could have a material adverse effect on our business operations, results of operations and financial condition, as we would need to replace the services no longer being provided by MPM, and would lose the benefits being generated under the agreement at the time.

41

Furthermore, we have not yet realized all of the cost savings and synergies we expect to achieve from our other 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-saving plan; and other unexpected costs associated with operating our business.
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 launch other cost savings initiatives. To the extent we are permitted to include the pro forma impact of cost savings initiatives in the calculation of financial covenant ratios or incurrence tests under our ABL Facility or our indentures, our failure to realize such savings could impact our compliance with such covenants or tests..
Future chemical regulatory actions may decrease our profitability.
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. In 2004, a division of the World Health Organization, the International Agency for Research on Cancer, or IARC, based on an alleged stronger relationship with nasopharyngeal cancer ("NPC"), reclassified formaldehyde as “carcinogenic to humans,” a higher classification than set forth in previous IARC evaluations. In 2009, the IARC determined that there is sufficient evidence in humans of a causal association between formaldehyde exposure and leukemia. In 2011, the National Toxicology Program within the U.S. Department of Health and Human Services, or NTP, issued its 12th Report on Carcinogens, or RoC, which lists formaldehyde as “known to be a human carcinogen.” This NTP listing was based, in part, upon certain studies reporting an increased risk of certain types of cancers, including myeloid leukemia, in individuals with higher measures of formaldehyde exposure (exposure level or duration). The USEPA is considering regulatory options for setting limits on formaldehyde emissions from composite wood products that use formaldehyde-based adhesives. The USEPA, under its Integrated Risk Information System, or IRIS, released a draft of its toxicological review of formaldehyde in 2010. This draft review states that formaldehyde meets the criteria to be described as “carcinogenic to humans” by the inhalation route of exposure based upon evidence of causal links to certain cancers, including leukemia. The National Academy of Sciences, or NAS, was requested by the USEPA to serve as the external peer review body for the draft review. The NAS 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. It is possible that USEPA may revise its draft IRIS toxicological review to reflect the NAS findings, including the conclusions regarding a causal link between formaldehyde exposure and leukemia. In December 2011, the conference report for the FY 2012 Omnibus Appropriations bill included a provision directing HHS to refer the NTP 12th RoC file for formaldehyde to the NAS for further review. On August 8, 2014 the NAS accepted the listing of formaldehyde as a “known human carcinogen” in the 12th RoC, with no changes recommended. According to NTP, a listing in the RoC indicates a potential hazard and does not assess cancer risks to individuals associated with exposures in their daily lives. However, the 12th RoC listing could have material adverse effects on our business. 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.
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.


42

Item 6.    Exhibits
31.1
Rule 13a-14 Certifications:
 
 
 
(a) Certificate of the Chief Executive Officer
 
 
 
(b) Certificate of the Chief Financial Officer
 
 
32.1
Section 1350 Certifications
 
 
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.”

43

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.
 
 
 
 
MOMENTIVE SPECIALTY CHEMICALS INC.
 
 
 
Date:
August 13, 2014
 
/s/ William H. Carter
 
 
 
William H. Carter
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
(Principal Financial Officer)

44

HEXION INC. Reports