The following commentary should be read in conjunction with the audited Consolidated Financial Statements and the accompanying notes and Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's most recent Annual Report on Form 10-K. Within the following discussion, unless otherwise stated, "the first quarter of 2021" refers to the three months endedMarch 31, 2021 and "the first quarter of 2020" refers to the three months endedMarch 31, 2020 . Forward-Looking and Cautionary Statements Certain statements in this report, including without limitation, certain statements made under the caption "Overview and Outlook," are forward-looking statements within the meaning of and made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, our management may from time to time make oral forward-looking statements. All statements, other than statements of historical facts, are forward-looking statements. Forward-looking statements may be identified by the words "believe," "expect," "anticipate," "project," "might," "plan," "estimate," "may," "will," "could," "should," "seek" or "intend" and similar expressions. Forward-looking statements reflect our current expectations and assumptions regarding our business, the economy and other future events and conditions and are based on currently available financial, economic and competitive data and our current business plans. Actual results could vary materially depending on risks and uncertainties that may affect our operations, markets, services, prices and other factors as discussed in the Risk Factors section of this report and our other filings with theSEC . While we believe our assumptions are reasonable, we caution you against relying on any forward-looking statements as it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, a weakening of global economic and financial conditions, interruptions in the supply of or increased cost of raw materials, the loss of, or difficulties with the further realization of, cost savings in connection with our strategic initiatives, the impact of our indebtedness, our failure to comply with financial covenants under our credit facilities or other debt, pricing actions by our competitors that could affect our operating margins, changes in governmental regulations and related compliance and litigation costs, uncertainties related to COVID-19 and the impact of our responses to it and the other factors listed in the Risk Factors section of this report and in our otherSEC 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 theSEC . All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The forward-looking statements made by us speak only as of the date on which they are made. Factors or events that could cause our actual results to differ may emerge from time to time. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. Overview and Outlook Business Overview We are a large participant in the specialty chemicals industry, one of the world's largest producers of thermosetting resins, or thermosets, and a leading producer of adhesive and structural resins and coatings. Thermosets are a critical ingredient for most paints, coatings, glues and other adhesives produced for consumer or industrial uses. We provide a broad array of thermosets and associated technologies and have significant market positions in all of the key markets that we serve. Our products are used in thousands of applications and are sold into diverse markets, such as forest products, architectural and industrial paints, packaging, consumer products and automotive coatings, as well as higher growth markets, such as wind energy and electrical composites. Major industry sectors that we serve include industrial/marine, construction, consumer/durable goods, automotive, wind energy, aviation, electronics, architectural, civil engineering, repair/remodeling and oil and gas drilling. Key drivers for our business include general economic and industrial conditions, including housing starts and auto build rates. In addition, due to the nature of our products and the markets we serve, competitor capacity constraints and the availability of similar products in the market may impact our results. As is true for many industries, our financial results are impacted by the effect on our customers of economic upturns or downturns, as well as by the impact on our own costs to produce, sell and deliver our products. Our customers use most of our products in their production processes. As a result, factors that impact their industries can and have significantly affected our results. Through our worldwide network of strategically located production facilities, we serve more than 2,900 customers in approximately 86 countries. Our global customers include large companies in their respective industries, such asAkzo Nobel , BASF,Norbord , Louisiana Pacific, Bayer, Owens Corning, PPG Industries,Sherwin Williams , Sinoma, Aeolon and Weyerhaeuser. COVID-19 Impact InMarch 2020 , theWorld Health Organization categorized COVID-19 as a global pandemic. Around the world, local governments' responses to COVID-19 continue to evolve, which has led to stay-at-home orders, social distancing guidelines and other preventative measures that have disrupted various industries in the global economy and the markets in which our products are manufactured, distributed and sold. Hexion Inc. | 21 | Q1 2021 Form 10-Q -------------------------------------------------------------------------------- Table of Content s During this pandemic, we have implemented additional guidelines to further protect the health and safety of our employees as we continue to operate with our suppliers and customers. We have committed to maintaining a paramount focus on the safety of our employees while minimizing potential disruptions caused by COVID-19. For example, we are following all legislatively-mandated travel directives in the various countries where we operate, and we have also put additional travel restrictions in place for our associates designed to reduce the risk from COVID-19. Additionally, we are utilizing extended work from home options to protect our office associates, while adjusting our meeting protocols and processes at our manufacturing sites. Our businesses have been designated by many governments as essential businesses and our operations have continued throughMarch 31, 2021 . The ultimate impact that COVID-19 will have on our future financial position, operating results and cash flows involves numerous risks and uncertainties, including new information which may emerge concerning the severity and duration of COVID-19 and actions to contain the virus or treat its impact. Sale of Phenolic Specialty Resins Business OnSeptember 27, 2020 , we entered into a definitive agreement (the "Purchase Agreement") for the sale of our Phenolic Specialty Resins ("PSR"), Hexamine and European-based Forest Products Resins businesses (together with PSR, the "Held for Sale Business") toBlack Diamond Capital Management, LLC andInvestindustrial (the "Buyers") for a purchase price of approximately$425 . The consideration consists of$335 in cash and certain assumed liabilities with the remainder in future contingent proceeds based on the performance of the Held for Sale Business. The final purchase price is subject to customary post-closing adjustments. The Held for Sale Business was formerly included in the Company's Adhesives reportable segment. OnApril 30, 2021 , we completed the sale of our Held for Sale Business pursuant to the terms of the Purchase Agreement with the Buyers. We received gross cash consideration for the Held for Sale Business in the amount of$304 . In addition, the Buyers assumed approximately$31 of certain liabilities, net of preliminary working capital and other closing adjustments as part of the Purchase Agreement. A subsequent post-closing adjustment to the initial cash consideration will be made in accordance with the Purchase Agreement.Hexion expects to use a portion of the net proceeds to invest in its business, and inMay 2021 , we used a portion of its net proceeds to reduce our borrowings under our Senior Secured Term Loan, in accordance with our credit agreement. As ofMarch 31, 2021 , we reclassified the assets and liabilities of our Held for Sale Business as held for sale on the unaudited Condensed Consolidated Balance Sheets and reported the results of the operations for the three months endedMarch 31, 2021 as "Loss from discontinued operations, net of taxes" on the unaudited Condensed Consolidated Statements of Operations. Amounts for prior periods have similarly been retrospectively reclassified for all periods presented. Unless otherwise noted, the tables and discussion below represent the Company's continuing operations and excludes the Held for Sale Business. Reportable Segments in 2021 Our reporting segments are aligned around our two growth platforms: (i) Adhesives and (ii) Coatings and Composites. AtMarch 31, 2021 , we have three reportable segments, which consist of the following businesses: •Adhesives: these businesses are focused on the global adhesives market. They include the Company's global wood adhesives business, which also includes the oilfield technologies group, as well as the forest products resin assets inNorth America ,Latin America ,Australia and New Zealand ; and global formaldehyde. •Coatings and Composites: these businesses are focused on the global coatings and composites market. They include our base and specialty epoxy resins and Versatic™ Acids and Derivatives businesses. •Corporate and Other: primarily corporate general and administrative expenses that are not allocated to the other segments, such as shared service and administrative functions and foreign exchange gains and losses. Hexion Inc. | 22 | Q1 2021 Form 10-Q
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2021 Overview Following are highlights from our results of continuing operations for the three months endedMarch 31, 2021 and 2020: Three Months Three Months Ended March 31, Ended March 31, 2021 2020 $ Change % Change Statements of Operations: Net sales $ 753 $ 687$ 66 10 % Operating income (loss) 48 (34) 82 n/m Income (loss) before income tax 28 (60) 88 n/m Net income (loss) from continuing operations 12 (56) 68 n/m Segment EBITDA: Adhesives $ 68 $ 55 13 24 % Coatings and Composites 65 39 26 67 % Corporate and Other (19) (21) 2 (10) % Total $ 114 $ 73$ 41 56 % •Net Sales-In the first three months of 2021, net sales increased by$66 , or 10%, compared to the first three months of 2020. Pricing positively impacted sales by$64 due to raw material price increases contractually passed through to customers across many of our businesses, as well as favorable product mix and improved market conditions in our base epoxy resins and specialty epoxy resins businesses. Foreign currency translation positively impacted net sales by$13 due to the strengthening of various foreign currencies against theU.S. dollar in the first three months of 2021 compared to the first three months of 2020. Volumes negatively impacted net sales by$11 , primarily due to the impact of winter storm Uri in theU.S. gulf coast on several of our businesses, offset by volume increases in our specialty epoxy resins and global resins businesses. •Net Income (Loss) from continuing operations-In the first three months of 2021, net income from continuing operations increased by$68 from a net loss of$56 as compared to the first three months of 2020. The increase was driven by an increase in operating income of$82 , primarily due to an increase in gross profit as a result of improved market conditions across many of our businesses mentioned above as well as the absence of a$16 asset impairment charge related to our oilfield and phenolic specialty resins businesses in the first quarter of 2020, and a$15 decrease in business realignment costs driven by lower severance expenses. •Segment EBITDA-For the first three months of 2021, Segment EBITDA was$114 , an increase of 56% compared with$73 in the first three months of 2020. This increase was primarily due to improved market conditions in our base epoxy resins, specialty epoxy resins business, and due to raw material productivity impacting our forest products resins and formaldehyde businesses, partially offset by$6 of repair costs and$12 of lost volume due to temporary manufacturing outages caused by winter storm Uri in theU.S. gulf coast . Additionally, our Corporate and Other charges in the first three months of 2021 decreased by$2 compared to the first three months of 2020. •Growth Initiatives and New Product Development- We continue to focus on new product development to further strengthen our industry-leading research and development, technical services capabilities, and to strategically invest in our R&D footprint to increase opportunities for innovation and stimulate growth. These growth activities include the following: •Our new Adhesives product Armorbuilt™, which is designed to protect the critical utility pole infrastructure against wildfires. We expect incremental growth in 2021 from this product. •Extensive conversions were initiated at several major customers in 2020 for next generation OSB PF technology for board surface applications and additional applications are scheduled for 2021 as productivity gains and further reduction in resin usage, positions our products favorably compared to pMDI. •As an alternative technology, we have also developed BPA-free alternative coating technologies to address changing consumer preferences. •An expansion of our Brimbank,Australia facility to develop fire-resistant cladding materials leveraging proprietary phenolic resin technology. Short-term Outlook As we look towards the remainder of 2021, we anticipate continued strong economic recovery from the COVID-19 global pandemic resulting in increased demand in many of our key end markets. While our businesses have been designated by many governments as essential businesses, which has allowed our operations to continue during the pandemic, we saw weak economic conditions develop in the first half of 2020, specifically within automotive and certain industrial markets. In the second half of 2020 and in the first quarter of 2021, we saw sequential improvement in many of the industries in which our businesses operate and year-over-year Segment EBITDA improvement as the overall economy continued to recover from the global pandemic. We expect these strong tailwinds to continue into the second quarter and second half of 2021. Hexion Inc. | 23 | Q1 2021 Form 10-Q -------------------------------------------------------------------------------- Table of Content s While we expect these current positive economic trends to continue during 2021, delays in COVID-19 vaccine distributions, increases in COVID-19 cases, hospitalizations, deaths, restrictions on trade or government lock-downs could disrupt the current recovery and our expectations. The ultimate impact that COVID-19 will have on our operating results will depend on the overall severity and duration of the COVID-19 pandemic and actions to contain the virus or treat its impact. Within our Coatings and Composites segment, we continue to expect significant year over year improvement in our base epoxy business in 2021 due to strong improvements in market conditions. Our Versatic AcidsTM and Derivatives business should continue to benefit from modest growth in architectural coatings. Additionally, within our epoxy specialty resins business we anticipate lower demand in theChina wind energy market in the second half of 2021. Within our Adhesives segment, we anticipate improvement in Segment EBITDA within our North American forest products resins business in 2021 based on the latest expectations inU.S. and Canadian housing starts, remodeling and ongoing macroeconomic recovery from the COVID-19 pandemic. We also expect that continued economic recovery and strong market demand will positively impact our North American formaldehyde business in 2021. We also anticipate that our businesses will continue to benefit from the savings associated with our restructuring and cost reduction initiatives. Further, we are in the process of implementing various efficiency initiatives, which include process improvement and other productivity projects. Lastly, we completed the sale of our Phenolic Specialty Resin, Hexamine and European-based Forest Products Resins businesses, onApril 30, 2021 , which will further streamline our portfolio and improve our specialty product mix. We expect to use the proceeds to further reduce our indebtedness as well as for general corporate purposes including investments in our business. Matters Impacting Comparability of Results Raw Material Prices Raw materials comprise approximately 75% of our cost of sales (excluding depreciation expense). The three largest raw materials used in our production processes are phenol, methanol and urea. These materials represent about half of our total raw material costs. Fluctuations in energy costs, such as volatility in the price of crude oil and related petrochemical products, as well as the cost of natural gas have historically caused volatility in our raw material and utility costs. In the first three months of 2021 compared to the first three months of 2020, the average price of phenol, urea and methanol increased by approximately 3%, 45% and 30%, respectively. The impact of passing through raw material price changes to customers can result in significant variances in sales comparisons from year to year. 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. Foreign Currency Exchange 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 theU.S. dollar. Our non-U.S. operations accounted for approximately 56% of our sales in the first three months of 2021. The primary assets and liabilities driving the adjustments are cash and cash equivalents; accounts receivable; inventory; property, plant and equipment; accounts payable; pension and other postretirement benefit obligations and certain intercompany loans payable and receivable. The primary currencies in which these assets and liabilities are denominated are the euro, Brazilian real, Chinese yuan, Canadian dollar and Australian dollar. Hexion Inc. | 24 | Q1 2021 Form 10-Q
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