S-1 1 ds1.htm FORM S-1 Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on April 21, 2011

Registration Number 333-                    

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Momentive Performance Materials Holdings LLC

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   2821   27-3262205

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

  (I.R.S. Employer
Identification Number)

 

 

180 East Broad Street

Columbus, Ohio 43215

(614) 225-4000

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

 

Douglas A. Johns, Esq.

180 East Broad Street

Columbus, Ohio 43215

(614) 225-4000

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

With copies to:

William B. Kuesel, Esq.

O’Melveny & Myers LLP 7 Times Square New York, NY 10036 (212) 326-2000

 

 

Approximate date of commencement of proposed sale to the public: As promptly as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering  ¨

Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filed, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

   
TITLE OF EACH CLASS OF
SECURITIES TO BE REGISTERED
   PROPOSED MAXIMUM
AGGREGATE
OFFERING PRICE
(1)(2)
     AMOUNT OF
REGISTRATION
FEE
 

Common Stock, $0.01 par value per share

   $ 862,500,000       $ 100,136.25   
   
(1) Estimated solely for purposes of calculating the registration fee in accordance with Rule 457(o) under the Securities Act.
(2) Includes shares that the underwriters have the option to purchase to cover over-allotments, if any.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is declared effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to Completion, Dated April 21, 2011

                 Shares

Momentive Performance Materials Holdings LLC

Common Stock

 

 

This is the initial public offering of Momentive Performance Materials Holdings LLC. We are offering                  shares of our common stock. Prior to this offering, there has been no public market for our common stock. We anticipate that the initial public offering price will be between $         and $         per share. We will apply to list our common stock on the under the symbol “    .”

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 17.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Public offering price

   $                    $                

Underwriting discounts and commissions

   $                    $                

Proceeds, before expenses, to us

   $                    $                

We have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase from us an additional                  shares of common stock to cover over-allotments, if any.

 

 

 

The date of this prospectus is                     , 2011.


Table of Contents

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     17   

CAUTIONARY STATEMENTS CONCERNING FORWARD-LOOKING STATEMENTS

     39   

USE OF PROCEEDS

     40   

DIVIDEND POLICY

     41   

CAPITALIZATION

     42   

DILUTION

     43   

SELECTED HISTORICAL FINANCIAL DATA

     45   

UNAUDITED PRO FORMA FINANCIAL DATA

     48   

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     52   

BUSINESS

     87   

MANAGEMENT

     106   
 

 

 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock.

 

 

Until                     , 2011 (25 days after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

 

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TRADEMARKS

We have rights to a number of trademarks used in this prospectus that are important to our business, including, without limitation: ADDISIL, ALBECOR-BIO, A-LINK, ANCHORSIL, BAKELITE, BAYSILONE, CARDURA, CELLOBOND, COATOSIL, DURITE, ECOBIND, EPIKOTE, EPIKURE, EPI-REZ, EPON, FORMASIL, GEOLITE, HEXITHERM, INVISISIL, LSR/LIM, MAGNASOFT, NIAX, NXT, PEARLENE, PROPTRAC, SAGTEX, SILBLOCK, SILCOOL, SILFORCE, SILGRIP, SILOPREN, SILPLUS, SILSHINE, SILSOFT, SILQUEST, SILWET, SNAPSIL, SPUR, TOSPEARL, TSE, TUFEL, ULTRA TUFEL, VELVISIL, VERSATIC, VEOVA, WETLINK and XRT. We have omitted the ® and ™ designations, as applicable, for the trademarks we name in this prospectus.

MARKET AND INDUSTRY AND FINANCIAL DATA

This prospectus includes industry data that we obtained from periodic industry publications and internal company surveys. This prospectus includes market share and industry data that we prepared primarily based on management’s knowledge of the industry and industry data. Industry publications and surveys generally state that the information contained therein has been obtained from sources believed to be reliable. Unless otherwise noted, statements as to our market share and market position relative to our competitors are approximated and based on management estimates using the above-mentioned latest-available third-party data and our internal analysis and estimates. We determined our market share and market positions utilizing periodic industry publications. If we were unable to obtain relevant periodic industry publications, we based our estimates on our knowledge of the size of our markets, our sales in each of these markets and publicly available information regarding our competitors, as well as internal estimates of competitors’ sales based on discussion with our sales force and other industry publications.

Although we believe that the industry publications and third-party sources are reliable, we have not independently verified any of the data from industry publications or third-party sources. Similarly, while we believe our internal estimates with respect to our industry are reliable, our estimates have not been verified by any independent sources. While we are not aware of any misstatements regarding any industry data presented herein, our estimates, in particular as they relate to market share and our general expectations, involve risks and uncertainties and are subject to change based on various factors, including those discussed under “Risk Factors,” “Cautionary Statement Concerning Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus.

Unless otherwise indicated, historical financial and other information for Momentive Performance Materials Holdings LLC identified in this prospectus as being presented on a “pro forma” basis gives effect to the transactions described in “Unaudited Pro Forma Financial Information.”

NON-GAAP FINANCIAL INFORMATION

We define Pro Forma Adjusted EBITDA as EBITDA, as further adjusted to exclude the effects of certain income and expense items that management believes make it more difficult to assess our actual operating performance and after giving pro forma effect to the transactions described in “Unaudited Pro Forma Financial Data” as if each had occurred on January 1, 2010. Pro Forma Adjusted EBITDA represents MSC’s Adjusted EBITDA as defined in the indentures that govern its notes and MPM’s Combined Adjusted EBITDA for the year ended December 31, 2010, in each case after giving pro forma effect to the transactions described in “Unaudited Pro Forma Financial Data.” We define MPM’s Combined Adjusted EBITDA as MPM’s Adjusted EBITDA defined in its credit agreement plus the EBITDA of its subsidiary that is designated as an unrestricted subsidiary under its credit agreement. The Adjusted EBITDA of MSC and the Combined Adjusted EBITDA of MPM each include $50 million of anticipated savings from the shared services agreement described elsewhere in this

 

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prospectus. Additional information regarding the calculation of MSC’s Adjusted EBITDA and MPM’s Combined Adjusted EBITDA under their respective debt documents and reconciliations of such measures to net income (loss) are included in “Prospectus Summary—Summary Historical and Unaudited Pro Forma and Other Financial Data.”

We present Pro Forma Adjusted EBITDA because we believe that Pro Forma Adjusted EBITDA is useful to investors since it is frequently used by securities analysts, investors and other interested parties to evaluate companies in our industry. Pro Forma Adjusted EBITDA is not a recognized term under United States generally accepted accounting principles, or U.S. GAAP, and should not be viewed in isolation and does not purport to be an alternative to Net loss as an indicator of operating performance or cash flows from operating activities as a measure of liquidity. There are material limitations associated with making the adjustments to our earnings to calculate Pro Forma Adjusted EBITDA and using this non-U.S. GAAP financial measure as compared to the most directly comparable U.S. GAAP financial measures. Pro Forma Adjusted EBITDA does not include:

 

   

interest expense, and because we have borrowed money in order to finance our operations, interest expense is a necessary element of our costs and ability to generate revenue;

 

   

depreciation and amortization expense, and because we use capital assets, depreciation and amortization expense is a necessary element of our costs and ability to generate revenue; and

 

   

tax expense, and because payment of taxes is part of our operations, tax expense is a necessary element of our costs and ability to operate.

Although the nature of many of these income and expense items is recurring, we believe that excluding items such as asset impairments, business realignment charges, non-controlling interest, loss on sale of assets and the other costs specified below, including $100 million of anticipated costs savings, helps investors compare our operating performance with our results in prior periods. We believe it is appropriate to exclude these items as they are not related to ongoing operating performance and, therefore, limit comparability between periods. In addition, we believe that Pro Forma Adjusted EBITDA is useful in evaluating our operating performance compared to that of other companies in our industry because the calculation of Pro Forma Adjusted EBITDA generally eliminates the effects of financing and income taxes and the accounting effects of capital spending and acquisitions, which items may vary for different companies for reasons unrelated to overall operating performance.

Although we believe that Pro Forma Adjusted EBITDA can make an evaluation of our operating performance more consistent because it removes items that do not reflect our core operations, other companies, even in the same industry, may define Pro Forma Adjusted EBITDA differently than we do. As a result, it may be difficult to use Pro Forma Adjusted EBITDA or similarly named non-U.S. GAAP measures that other companies may use to compare the performance of those companies to our performance. The Company does not, and investors should not, place undue reliance on Pro Forma Adjusted EBITDA as a measure of operating performance.

Pro forma Segment EBITDA represents EBITDA adjusted to exclude certain non-cash, certain non-recurring expenses and discontinued operations adjusted for the effects of the Momentive Combination as if it had occurred on January 1, 2010. Segment EBITDA is an important performance measure used by our senior management 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. Additional information regarding the calculation of Segment EBITDA is included in “Management’s Discussion and Analysis” and Note 17 to our historical audited consolidated financial statements elsewhere in this prospectus.

 

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PROSPECTUS SUMMARY

This summary highlights selected information contained in greater detail elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully, especially the risks of investing in our common stock discussed under “Risk Factors,” our consolidated financial statements and related notes, and supplemental pro forma financial data included elsewhere in this prospectus, before making an investment decision. Except as otherwise indicated herein or as the context otherwise requires, references in this prospectus to: (a) “Momentive” refers to Momentive Performance Materials Holdings LLC, which will change its name to                                                                                   upon consummation of this offering; (b) “the Company,” “we,” “our,” and “us” refer collectively to Momentive and its consolidated subsidiaries; (c) “MPM” refers to Momentive Performance Materials Inc. and its consolidated subsidiaries, which will change its name to                                                                                   upon or prior to consummation of this offering; (d) “MSC” refers to Momentive Specialty Chemicals Inc. and its consolidated subsidiaries; (e) “MPM Holdings” refers to Momentive Performance Materials Holdings Inc., which will change its name to MPM Intermediate Holdings Inc. upon or prior to consummation of this offering; (f) “MPM Group” refers collectively to MPM Holdings and its consolidated subsidiaries; (g) “MSC Holdings” refers to Momentive Specialty Chemicals Holdings LLC; and (h) “MSC Group” refers collectively to MSC Holdings and its consolidated subsidiaries.

Our Company

Overview

We are one of the world’s largest manufacturers of specialty chemicals and materials with leadership in the production of thermosetting resins, or thermosets, silicones and silicone derivatives. Our specialty chemicals and materials comprise a broad range of compounds and formulations and are marketed in more than 100 countries to a diversified group of leading consumer and industrial customers. Our specialty chemicals and materials are critical components of products that serve a diverse range of industries, end-users, and geographies and provide valuable performance characteristics of strength, adhesion, durability and resistance. Globally, our manufacturing footprint consists of 104 sites with a strong presence in both developed economies and higher-growth, emerging regions, including Asia and Latin America.

Our breadth of related products provides our operations, technology and commercial service organizations with a competitive advantage throughout the value chain. In certain areas of our specialty portfolio we have chosen to backward integrate into base formulations, including for example in our leading specialty epoxy business where we are also the largest global manufacturer of base epoxy, which allows us to capture significant incremental value and support our unique strategic position. Our businesses also benefit from large production scale in certain strategic products and proprietary manufacturing technologies, which allow us to maintain a low-cost position. In addition, our value-added, solutions-focused business model enables us to effectively participate in high-end specialty markets, while our scale has enabled us to capture value from higher volume applications. Through continued innovation supported by our research and development capabilities and partnerships with our corporate customers, we expect to witness the further migration of our portfolio towards more value-added, specialty applications over time.

We benefit from having leading positions in most of the key markets we serve. We are a leading global producer of silicones and silicone derivatives, which are used in the manufacturing of a wide range of high-performing elastomers, engineered materials and fluids; epoxy-based polymer formulations; formaldehyde; forest product resins; Versatic acid and derivatives; phenolic specialty resins; oilfield proppant resins; and fused quartz and ceramic materials. Collectively, we believe we have the broadest range of silicone and thermoset resin technologies in the world, with leading research, applications development and technical service capabilities that we believe position us as an industry-leading growth platform.

 

 

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Our specialty chemicals and materials are used in thousands of applications including those in the adhesives, packaging, architectural and industrial paints and coatings, healthcare, personal care and a variety of high-technology industries, among others. We compete effectively at the cutting-edge of a wide variety of industries, including throughout the value chain in energy (in both wind energy and oil and gas applications), aerospace, electronics, automotive, construction products, durable and non-durable consumer products, forest products, civil engineering, personal care products, agrochemicals, lubricant additives, and consumer and construction sealants. In addition, because of the diversity in the end markets where we compete, we believe we depend less on any one particular segment and are better able to withstand any downturns in individual markets. Through our worldwide network of strategically located production facilities, we serve more than 14,000 customers across six continents. Our global customers include leading companies in their respective industries, such as 3M, BASF, Bayer, DuPont, GE, Goodyear, Honeywell, L’Oreal, Louisiana Pacific, Lowe’s, Motorola, Owens Corning, PPG Industries, Procter & Gamble, Sumimoto, The Home Depot, Unilever, Valspar, and Weyerhaeuser.

LOGO

Momentive was created on October 1, 2010 through the combination of the holding companies that owned the MPM Group and the MSC Group, which we refer to in this prospectus as the Momentive Combination, establishing one of the largest specialty chemicals and materials growth platforms and integrating two advanced product portfolios. The Momentive Combination was compelled by the potential for us to realize significant cost and revenue synergies and sound industrial logic including, among other strategic benefits, complementary geographic footprints, technology cross-fertilization opportunities, and an expanded global customer base. We believe the benefits from the Momentive Combination will continue to strengthen our competitive position and enhance our financial performance.

 

 

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We had 2010 pro forma net sales of $7.4 billion and 2010 Pro Forma Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization and other items, including $100 million of anticipated cost savings) of $1.2 billion. In 2010, 40%, 30% and 30% of our pro forma net sales originated in North America, Europe and Asia Pacific, Latin America and other high-growth emerging markets, respectively.

LOGO

 

 

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Our Business

Our global specialty chemicals and materials portfolio is organized, based on technical specification and by the diverse markets that we serve, into three primary business divisions and we have three reportable segments that mirror our internal operating structure: Silicones and Quartz; Epoxy, Phenolic and Coating Resins; and Forest Products Resins. This internal operating structure became effective January 1, 2011. The table below illustrates our pro forma 2010 divisional net sales and their respective major products, major industries served, core end-use markets and key characteristics.

 

     Silicones and Quartz  

Epoxy, Phenolic and

Coating Resins

  Forest Products Resins

Pro Forma Net

Sales

  $2.6 billion   $3.2 billion   $1.6 billion

Major Products

 

•  Silicones and silicone derivatives

•  Silanes and resins

•  Fused quartz and ceramic materials

 

•  Epoxy resins and intermediates

•  Phenolic specialty resins

•  Versatic acids and derivatives

•  Phenolic encapsulated substrates

•  Polyester resins

•  Alkyd resins

•  Acrylic resins

 

•  Formaldehyde based resins and formaldehyde

Major Industries

Served

 

•  Transportation and industrial

•  Electronic products

•  Consumer durable and non-durable products

•  Consumer and construction sealants

 

•  Wind energy

•  Energy: Oil and gas field drilling and development

•  Transportation and industrial

•  Construction

•  Electrical equipment and appliances

•  Electronic products

•  Marine and recreational (boats, RVs)

•  Chemical manufacturing

•  Home building and maintenance

•  Consumer durable and non-durable products

•  General manufacturing

 

•  Home building and maintenance

•  Home repair and remodeling

•  Furniture

•  Agriculture

Core End-Use

Markets

 

•  Home care, personal care and cosmetics

•  Engineered materials

•  Oil and gas applications

•  Automotive

•  Semiconductor

•  Manufacturing and packaging

•  Fiber optics

•  Construction

 

•  Oil and gas field proppants

•  Wind energy

•  Auto coatings and friction materials

•  Marine and industrial coatings

•  Electronics

•  Commercial and residential construction

•  Engineered materials

•  Decorative paints

 

•  Commercial and residential construction

•  Plywood, particleboard, OSB, MDF

•  Furniture

•  Agrochemical

Key

Characteristics

 

•  Strength and adhesion

•  Durability

•  Resistance (heat, water, electricity)

•  High purity

 

•  Strength and adhesion

•  Durability

•  Resistance (water, UV, corrosion, temperature, electricity)

 

•  Strength and adhesion

•  Durability

•  Moisture resistance

The discussion that follows is based on our organizational structure and reportable segments in 2011.

 

 

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Silicones and Quartz

We are a leading global supplier of silicones and quartz used in a variety of industrial and consumer applications. These products serve growing geographies like Asia, where 39% of 2010 silicones and quartz net sales originated and globally exhibit high margins.

We are one of the world’s largest producers of silicones and silicone derivatives, manufacturing a wide range of high-performing elastomers, engineered materials and fluids. Silicones are developed using separate finishing processes to generate a wide variety of different performance characteristics and are typically used in applications where traditional materials cannot perform under required conditions. We have a broad range of specialty silicone technologies, with highly advanced research, applications development and technical service capabilities. Product families within our silicones business includes fluids (used in textiles, personal care, home care, agriculture and oil and gas applications), silanes and resins (used in tires, additives for coatings, masonry water repellants and protective coatings for plastics and rubber), elastomers (used in healthcare and automotive applications), intermediates, engineered materials (used in adhesives and sealants), urethane additives (used in polyurethane foam additives) and consumer and construction sealants.

We are a leading producer of quartz tubing, ingots and crucibles and high-performance, non-oxide ceramic powders, coatings and solids. Fused quartz, a man-made glass manufactured principally from quartz sand, is used in processes requiring extreme temperature, high purity and other specific characteristics. Fused quartz and ceramic materials are used in a wide range of industries, including semiconductor, lamp tubing, manufacturing, packaging, cosmetics and fiber optics.

In 2010, net sales of silicones and quartz products were $2.6 billion, and Segment EBITDA was $489 million, reflecting annual net sales growth of 24% and segment EBITDA margins of 19%. These results demonstrate the continued strong performance and development of the high technology end markets its serves and significant increase in demand and pricing support for specialty silicones and quartz products globally.

Epoxy, Phenolic and Coating Resins

We are a leading global supplier of epoxy, phenolic and coating resins used in a variety of industrial and consumer applications to increase strength, adhesion and provide durability. These products are used in numerous end-markets including: oil and gas, wind energy, electronics, protective coatings, engineered materials, automotive, decorative paints, and specialty coatings and residential, commercial and industrial construction.

Epoxy resins are the fundamental component of many types of materials and are used either as replacements for traditional materials such as metal, or in applications where traditional materials do not meet demanding engineering applications. Phenolic resins are used in applications that require extreme heat resistance and strength, such as after-market automotive and OEM truck brake pads, aircraft components and electrical laminates. Additionally, epoxy-based surface coatings are among the most widely used industrial coatings due to their structural stability and broad application functionality combined with overall economic efficiency. The demand for epoxy, phenolic and coating resins is driven by both economic growth generally and technological innovation, including environmentally friendly and energy efficient applications.

Supporting the growth in our business, we operate two of the three largest epoxy resins manufacturing facilities in the world, including the world’s only continuous-flow manufacturing process facility. We believe our global scope and our ability to internally produce key raw materials gives us a significant competitive advantage versus our non-integrated competitors. For example, we produce and internally consume the majority of our bisphenol-A, or BPA, and virtually all of our epichlorohydrin, or ECH, the key base chemicals in the downstream manufacturing of base epoxy resins and epoxy specialty resins.

 

 

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In 2010, pro forma net sales of epoxy, phenolic and coating resins products were $3.2 billion and pro forma Segment EBITDA was $494 million, reflecting annual revenue growth of 27% and pro forma Segment EBITDA margin of 15%. We expect that certain segments of the thermosetting resins industry, such as specialty epoxy resins, Versatic acids and derivatives and oilfield resins, all of which are included in this segment, will grow at rates in excess of global GDP. For instance, in the oilfield services industry, where our phenolic encapsulated proppants are used to enhance oil and gas recovery rates and extend well life, we have seen increased demand due to the growing trend of horizontal drilling in natural gas wells.

Forest Products Resins

We are a leading global supplier of formaldehyde-based resins used in a variety of industrial and consumer applications. These products are used in numerous end-markets including: residential, commercial and industrial construction, furniture, and agriculture. The demand for forest products resins is driven by general economic growth and environmental sustainability and we benefit from a manufacturing footprint that is strategically located in close proximity to our customers. Demand for our formaldehyde-based resins is also primarily driven by the residential housing market globally and in particular North America.

We are the leading producer of formaldehyde-based resins used in a wide range of applications for the North American forest products industry and also hold significant positions in Europe, Latin America, Australia and New Zealand. We are also the world’s largest producer of formaldehyde, a key raw material used to manufacture thousands of products and we internally consume the majority of our formaldehyde production. We believe this strategic back-end integration gives us a significant competitive advantage versus our non-integrated competitors and allows us to capture significant incremental economic value.

In 2010, pro forma net sales of formaldehyde-based resins and related products were $1.6 billion, and pro forma Segment EBITDA was $177 million.

Competitive Strengths

We are one of the leading specialty chemicals and materials companies in the world based on the following competitive strengths:

Leading positions in diverse end markets. We benefit from holding a longstanding number one or two position in a diverse group of consumer and industrial segments representing 80% of our $7.4 billion 2010 pro forma net sales. Markets we serve on a global basis include energy, automotive, electronics, construction and consumer products, among other markets each further stratified by our strategic regional manufacturing capabilities. We believe the diversification they provide will continue to support our ability to create significant value throughout the economic cycle and mitigate the financial impact of a downturn in a single market. Furthermore, we believe our strategic choice to backward integrate into selected base formulations gives us a competitive advantage over many of our smaller competitors.

Strong presence in high growth regions and end markets. Across our strategic manufacturing footprint serving over 100 countries, we have made tactical investments in high growth specialty formulations globally as well as in select geographies generally that are expected to generate outsized demand for our products over the next several years. For example, we have achieved 60% revenue growth in our oil field resins business since 2007, as a result of strategic capital allocation and our ongoing leadership in global shale development.

In addition to investing in various high growth technologies we have a strong presence in key emerging markets and generated 30% of our 2010 pro forma net sales from customers in countries including Brazil, China, Russia, India and other key developing economies. For example in 2008 and 2009, we invested approximately $55 million in a new forest products resins manufacturing complex to serve the growing engineered wood market in southern Brazil and approximately $85 million from 2007 to 2009 in a new manufacturing facility in Nantong, China to become one of the first silicone producers with a large presence in the growing Chinese specialty silicones end-market.

 

 

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Going forward, we believe our leading share in these key markets and technologies will allow us to outperform our peers and continue our strong financial performance.

Significant operating leverage and momentum. Due to improving economic conditions, continued growth in key markets, and ongoing product penetration, our business has achieved substantial growth in revenues and pro forma Segment EBITDA. Our 2010 pro forma net sales and pro forma Segment EBITDA grew 27% and 77%, respectively, compared to 2009. Further, we support the long-term growth of our specialty chemicals and materials platform through focused productivity and cost-savings initiatives which are ingrained as part of our corporate culture. Since 2007, we have achieved approximately $400 million of cost savings and productivity, which we believe is a permanent benefit to our business. In part as a result of these initiatives, we achieved record annual Pro Forma Adjusted EBITDA in 2010 on volumes 9% below those achieved before the global recession began in 2007, driven by cost savings and productivity measures achieved. We believe these results demonstrate our proactive management approach towards reducing both our fixed and variable cost base and position us to realize significant financial benefit from additional volumes such as the expected recovery in the U.S. housing market. Furthermore, as part of the Momentive Combination, we expect to achieve a total of approximately $100 million of cost synergies within 18 to 24 months, in addition to $24 million of other productivity programs currently underway.

Well-invested global asset base with low-cost position. We support our global market position with our strategically located, low-cost manufacturing presence. Our low-cost position is the result of our 104 production and manufacturing facilities strategically located throughout the world and our integrated supply position in several critical intermediate materials. We believe our ability to internally produce key raw materials and intermediates provides us with a cost advantage over our competitors. Furthermore, our large market position and scale in each of our key product markets provides us with purchasing and manufacturing efficiencies. We also benefit from having the contractual ability to pass-through material input price increases for many of our contracts.

Solutions-based selling proposition drives customer loyalty and sales growth. The majority of our customers require solutions that are tailored to their individual production needs and require a high degree of technical service and customized product formulations. We believe that the value-added nature of these services allow us to earn higher and more stable margins than general material producers who do not offer the same level of service. Our diverse portfolio of differentiated chemicals and materials allows us to leverage related technologies across geographies, customers and end-markets in order to provide a broad range of product and technical service solutions. As a result, we have cultivated stable, long-standing customer relationships.

Experienced and highly motivated management team with proven track record. We believe that we have a world-class management team led by Craig O. Morrison, our chairman and chief executive officer, and William H. Carter, our chief financial officer. Our management team has demonstrated expertise in growing our businesses organically, integrating acquisitions and executing on significant cost cutting programs and is highly motivated, as they own or have options and restricted shares that combined represent approximately 7% of our shares outstanding.

Strategy

We are focused on shareholder value creation, cash flow generation and driving the long-term growth of our global specialty chemicals and materials platform. We believe we can achieve these goals through the following integrated strategies:

Develop and market new products. We continue to expand our product offerings through research and development initiatives and research partnership formations with third parties. Through these innovation initiatives, we continue to innovate and create new generations of products and services that will drive revenue and earnings growth. In pro forma 2010, we invested $131 million in research and development.

 

 

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Expand our global reach in faster growing regions. We intend to continue to grow internationally by expanding our product sales to our customers around the world. Specifically, we are focused on growing our business in markets in the high growth regions of Asia-Pacific, Russia, Latin America, India and the Middle East, where the usage of our products is increasing. Furthermore, by consolidating sales and distribution infrastructures via the Momentive Combination, we expect to accelerate the penetration of our high-end, value-added products into new markets, thus further leveraging our research and applications efforts.

Increase shift to high-margin specialty products. We continue to proactively manage our product portfolio with a focus on specialty, high-margin applications and the reduction of our exposure to lower-margin products. As a result of this capital allocation strategy and strong end market growth underlying these specialty segments, including wind energy and oilfield applications, they will continue to be a larger part of our broader portfolio. Consequently, we have witnessed a strong organic improvement in our profitability profile as a whole over the last several years which we believe will continue.

Continue portfolio optimization and pursue targeted add-on acquisitions and joint ventures. The specialty chemicals and materials market is comprised of numerous small and mid-sized specialty companies focused on niche markets, as well as smaller divisions of large chemical conglomerates. As one of the world’s largest manufacturers of specialty chemicals and materials with leadership in the production of thermosets, silicones and silicone derivatives, we have a significant advantage in pursuing add-on acquisitions and joint ventures in areas that allow us to build upon our core strengths, expand our product, technology and geographic portfolio, and better serve our customers. We believe we can consummate a number of these acquisitions at relatively attractive valuations due to the scalability of our existing global operations and deal-related synergies. In addition, we have and will continue to monitor the strategic landscape for opportunistic divestments consistent with our broader specialty strategy. For example, we recently completed the sale of our global inks and adhesive resins, or IAR business, which increased our profitability margins as a whole and will allow us to focus our financial resources towards growing specialty applications within our portfolio.

Capitalize on the Momentive Combination to grow revenues and realize operational efficiencies. We believe the Momentive Combination will present opportunities to increase our revenues by leveraging each of MPM’s and MSC’s respective global footprints and technology platforms. For instance, we anticipate being able to further penetrate MPM products into Latin America, where MSC has historically maintained a larger manufacturing and selling presence. Likewise, in Asia, where MPM generated 39% of its 2010 net sales, we anticipate being able to accelerate the penetration of MSC products, where the region accounted for 16% of MSC’s 2010 net sales. Further, we anticipate the Momentive Combination will provide opportunities to streamline our business and reduce our cost structure. We are currently targeting $100 million in annual cost savings related to the Momentive Combination. We anticipate these savings to come from logistics optimization, reduction in corporate expenses, and reductions in the costs for raw materials and other inputs. Through December 31, 2010 we implemented $13 million of these savings on a run-rate basis, and anticipate fully realizing the remaining anticipated savings over the next 18 to 24 months. We believe our management team has a strong track record in realizing cost savings as a result of business combinations. When MSC was formed in 2005 through the merger of four businesses totaling $4 billion of revenues, we initially announced a target of $75 million of merger-related synergies and ultimately achieved $175 million of merger-related cost reductions.

Generate free cash flow and deleverage. We expect to generate strong free cash flow due to our size, advantaged cost structure, and reasonable ongoing capital expenditure requirements. Furthermore, we have demonstrated expertise in managing our working capital, which has been further augmented as a result of our increased scale from the Momentive Combination. Our strategy of generating significant free cash flow and deleveraging is complimented by our long-dated capital structure with no near-term maturities and strong liquidity position. This financial flexibility allows us to prudently balance deleveraging with our focus on growth and innovation.

 

 

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Ownership Structure

As a result of the Momentive Combination, Momentive became the ultimate parent of MPM and MSC and is controlled by investment funds (the “Apollo Funds”) managed by affiliates of Apollo Management Holdings, L.P. (together with Apollo Global Management, LLC and subsidiaries, “Apollo”). Prior to October 1, 2010, both MPM and MSC were also controlled by Apollo.

The chart below is a summary of our organizational structure after giving effect to the Momentive Combination and this offering. The indebtedness information below is as of December 31, 2010.

LOGO

Momentive was organized in Delaware in October 2010. In connection with the consummation of this offering, we will convert from a limited liability company to a corporation in Delaware and change our name to                                                                          . Our principal executive offices are located at 180 East Broad Street, Columbus, Ohio 43215. The telephone number of our principal executive offices is (614) 225-4000, and our main corporate website is http://www.momentive.com. The information on, or that can be accessed through, our website is not part of or incorporated into this prospectus or the registration statement of which this prospectus forms a part, and you should not rely on any such information in making your decision whether to purchase our common stock.

 

 

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Recent Divestitures and Financings

Divestiture of Ink and Adhesive Resins Business

On January 31, 2011, we completed the sale of our global IAR business to Harima Chemicals Inc. for a net cash purchase price of $120 million, which we call the IAR Divestiture. The IAR business had 2010 net sales of $356 million and its divestiture served to increase our consolidated margin profile and furthered our alignment of resources with our core specialty chemicals and materials product portfolio. We divested the complete business, including 11 manufacturing facilities on five continents, the IAR global product portfolio and all intellectual property primarily related to the IAR business.

North American Coatings and Composites Business

On April 15, 2011, we entered into a purchase agreement with PCCR USA, Inc., a subsidiary of Investindustrial, a European investment group, to sell our North American coatings and composites (“Coatings and Composites”) business to PCCR USA, Inc. The Coatings and Composites business employs 225 people at four manufacturing facilities and generated pro forma 2010 net sales of approximately $220 million.

2010 and 2011 Financings

MPM Credit Agreement Amendment

In February 2011, we amended the credit agreement governing MPM’s senior secured credit facilities, which we refer to as the MPM Credit Agreement Amendment. Under the amendment, we extended the maturity of approximately $839.5 million aggregate U.S. dollar equivalent principal amount of MPM’s U.S. dollar and Euro denominated term loans held by consenting lenders from December 4, 2013 to May 5, 2015 and increased the interest rate on these term loans to LIBOR plus 3.5% and Euro LIBOR plus 3.5%, respectively, among other actions.

November Refinancing Transactions

In November and December 2010, we refinanced $1.25 billion U.S. dollar equivalent of MPM senior unsecured notes due 2014 through the issuance of approximately $1.37 billion U.S. dollar equivalent of MPM Second-Priority Springing Lien Notes due 2021. In November 2010, we refinanced $533 million in outstanding principal amount of MSC 9.75% Second-Priority Senior Secured Notes due 2014 through the issuance of $574 million aggregate principal amount of MSC 9.00% Second-Priority Senior Secured Notes due 2020. Together, we refer to these transactions as the November Refinancing Transactions.

January Refinancing Transaction

In January 2010, we amended the credit agreement governing MSC’s senior secured credit facilities, which we refer to as the January Refinancing Transaction, extending the maturity of approximately $959 million of senior secured credit facility term loans from May 5, 2013 to May 5, 2015 and thereby increasing the interest rate with respect to such term loans from LIBOR plus 2.25% to LIBOR plus 3.75%. In addition to, and in connection with, this amendment, we issued $1,000 million aggregate principal amount of MSC 8.875% Senior Secured Notes due 2018. We used the net proceeds of $993 million from the issuance to repay $800 million of the MSC U.S. term loans under the senior secured credit facility, pay certain related transaction costs and expenses and provide additional liquidity.

We collectively refer to the MPM Credit Agreement Amendment, the November Refinancing Transactions, and the January Refinancing Transaction as the Debt Refinancing Transactions.

 

 

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The Offering

 

Common stock offered by us

                shares

 

Common stock to be outstanding after this offering

                shares

 

Underwriters’ option to purchase additional shares

We have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an additional                 shares of common stock to cover over-allotments, if any.

 

Use of proceeds

We estimate that we will receive net proceeds from this offering of approximately $         million (or approximately $         million if the underwriters exercise their over-allotment option in full), after deducting the estimated underwriting discounts and commissions and our estimated offering expenses, assuming the shares are offered at $         per share, the midpoint of the estimated offering range set forth on the cover page of this prospectus.

 

  We intend to use the net proceeds from our sale of shares of common stock in this offering for general corporate purposes.

 

Dividends

We do not anticipate paying cash dividends for the foreseeable future.

 

Proposed symbol

“        ”

 

Risk factors

You should carefully read and consider the information set forth under “Risk Factors” beginning on page 16 of this prospectus and all other information set forth in this prospectus before deciding to invest in our common stock.

 

 

Unless otherwise expressly stated or the context otherwise requires, all information contained in this prospectus:

 

   

assumes the underwriters do not exercise their option to purchase up to                  additional shares of common stock from us;

 

   

gives effect to our conversion from a limited liability company to a corporation upon consummation of this offering, including the conversion of each equity unit of Momentive outstanding immediately prior to the consummation of the offering into              shares of common stock of Momentive;

 

   

does not give effect to                  shares of our common stock issuable upon the exercise of outstanding options as of                     , 2011, at a weighted-average exercise price of $         per share;

 

   

does not give effect to                  shares of our common stock reserved for future issuance under our 2011 Equity Plan as of                      , 2011;

 

   

does not give effect to                  shares of our common stock issuable upon the exercise of an outstanding warrant held by GE Capital Equity Investments, Inc., or GE Capital Equity, as of                     , 2011, at a weighted-average exercise price of $         per share; and

 

 

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does not give effect to the issuance to Apollo of shares of our preferred stock with a liquidation preference equal to $200 million, plus accrued but unpaid dividends (or, if such preferred stock is redeemed in whole or in part by Momentive at or within 90 days following the consummation of this offering and Momentive elects to pay the redemption price in shares of common stock) and warrants to purchase                  shares of our common stock pursuant to Apollo’s commitment to purchase such preferred stock and warrants by December 31, 2011.

 

 

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Summary Historical and Unaudited Pro Forma and Other Financial Data

The following table summarizes certain of our historical consolidated and unaudited pro forma and other financial data. The summary consolidated historical financial and other data as of and for the years ended December 31, 2008, 2009 and 2010 have been derived from our audited consolidated financial statements included elsewhere is this prospectus. The Momentive Combination has been accounted for as a business combination, and MPM Holdings has been identified as the accounting acquiror and predecessor entity to the formation of Momentive. Therefore, the historical financial data includes the historical financial data of MPM Holdings prior to the Momentive Combination in 2010 and for the years ended December 31, 2009 and 2008. The summary historical financial data for the year ended December 31, 2010 includes the results of operations of MSC Holdings since the acquisition date of October 1, 2010, the date of the Momentive Combination.

The pro forma adjusted financial data below for the year ended December 31, 2010 reflects adjustments to our historical financial data to give effect to (i) the Momentive Combination, (ii) the IAR Divestiture, (iii) the Debt Refinancing Transactions; and (iv) the sale of the common stock offered by this prospectus and the use of the net sale proceeds as described in “Use of Proceeds.” See “Prospectus Summary—Recent Transactions and Financings.”

The pro forma financial data for the year ended December 31, 2010 are presented for informational purposes only, and do not purport to represent what our results of operations would actually have been if this offering, the IAR Divestiture, the Momentive Combination and the Debt Refinancing Transactions had occurred on the dates indicated, nor do such data purport to project our results of operations or financial condition that we may achieve in the future.

You should read the following summary historical and unaudited pro forma financial and other data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Capitalization,” “Unaudited Pro Forma Condensed Financial Information,” “Selected Historical Consolidated Financial Data,” and our consolidated financial statements and related notes and other information included elsewhere in this prospectus.

 

 

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     Historical     Pro Forma
Prior to This
Offering
 
     Year ended December 31,     Year ended
December 31,
 
(In millions, except share data)   2008     2009     2010 (1)     2010  

Consolidated Statements of Operations

       

Net sales

  $ 2,639      $ 2,083      $ 3,806      $ 7,406   

Cost of sales

    2,016        1,564        2,914        5,902   
                               

Gross profit

    623        519        892        1,504   

Selling, general and administrative expense

    482        393        521        782   

Research and development and technical services expense

    76        63        88        131   

Asset impairments

    857        —          9        9   

Business realignment costs

    45        23        29        45   

Other operating expense, net

    —          —          8        4   
                               

Operating (loss) income

    (837     40        237        533   

Interest expense, net

    328        314        391        638   

(Gain) loss on extinguishment of debt

    —          (179     85        —     

Other non-operating income, net

    (7     (12     (7     (6
                               

Loss from continuing operations before income tax and earnings from unconsolidated entities

    (1,158     (83     (232     (99

Income tax (benefit) expense

    (111     15        (8     12   
                               

Loss from continuing operations before earnings from unconsolidated entities

    (1,047     (98     (224     (111

Earnings from unconsolidated entities, net of taxes

    —          —          2        8   
                               

Loss from continuing operations

    (1,047     (98     (222   $ (103
             

Net loss from discontinued operations, net of taxes (2)

    —          —          (8  
                         

Net loss

    (1,047     (98     (230  
       

Net income attributable to non-controlling interest

    —          —          (1  
                         

Net loss attributable to Momentive Performance Materials Holdings LLC

    (1,047     (98     (231  

Accretion of dividends on committed preferred units

    —          —          (3  
                         

Net loss attributable to common unit holders

  $ (1,047   $ (98   $ (234  
                         

Weighted average common shares outstanding—basic and diluted

    197,433,665        197,443,492        218,232,313        279,514,962   

Loss per share from continuing operations—basic and diluted

  $ (5.30   $ (0.50   $ (1.03   $ (0.37

Pro forma as adjusted weighted average shares outstanding—basic and diluted (3)

       

Pro forma as adjusted loss per share—basic and diluted (3)

       

Balance Sheet Data (at end of period)

       

Cash and equivalents

  $ 349      $ 220      $ 450     

Working capital (4)

    270        177        587     

Total assets

    3,593        3,316        8,777     

Total debt

    3,724        3,601        7,271     

Total debt, excluding debt with controlling interest holder

    3,724        3,601        7,167     

Total liabilities

    4,621        4,433        9,590     

Total deficit

    (1,028     (1,117     (817  

Cash Flow Data

       

Cash flows provided by operating activities

  $ 77      $ 27      $ 383     

Cash flows used in investing activities

    (149     (80     (20  

Cash flows provided by (used in) financing activities

    170        (70     (133  

Depreciation and amortization

    237        192        263      $ 451   

Capital expenditures

    (139     (77     (140     (214

 

 

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     Pro Forma Prior to  This
Offering
 
     Year ended December 31,  
     2008     2009     2010  

Key Supplemental Pro Forma Financial Information (5)

      

Net sales

   $ 8,329      $ 5,834      $ 7,406   
                        

Operating (loss) income

   $ (1,806   $ 15      $ 533   
                        

Segment EBITDA:

      

Silicones and Quartz

     316        249        489   

Epoxy and Phenolic Resins

     278        267        431   

Forest Products Resins

     198        111        177   

Other

     (32     (10     (4
                        

Total

   $ 760      $ 617      $ 1,093   
                        

Pro Forma Adjusted EBITDA (6)

       $ 1,232   
            

 

(1) Includes the results of MSC Holdings from the date of its acquisition on October 1, 2010 as a result of the Momentive Combination.

 

(2) Net loss from discontinued operations for the year ended December 31, 2010 reflects the divestiture of MSC Holdings’ IAR business.

 

(3) Includes shares of common stock offered in this offering.

 

(4) We define working capital as current assets (excluding cash and cash equivalents) less current liabilities. As of December 31, 2010, the net assets and liabilities of the IAR business of $135 million were classified as current.

 

(5) The pro forma financial information is presented for informational purposes only, and does not purport to represent what our results of operations would actually have been if the Momentive Combination and IAR Divestiture had occurred as of January 1, 2008, January 1, 2009 or January 1, 2010, respectively. For further discussion and analysis of these results on a pro forma basis, and for a reconciliation of pro forma Segment EBITDA to pro forma Operating income, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this prospectus.

 

 

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(6) See below for our reconciliation of Pro forma Net loss from continuing operations to Pro Forma Adjusted EBITDA:

 

    Pro Forma
Year ended
December 31,
2010
 
Pro Forma Reconciliation of Net Loss to Adjusted EBITDA   (in millions)  

Net loss from continuing operations

  $ (103

Income taxes

    12   

Interest expense, net

    638   

Depreciation and amortization

    451   
       

Pro Forma EBITDA

    998   

Adjustments to EBITDA:

 

Non-cash items (a)

    2   

Unusual items:

 

Loss on divestiture of assets

    7   

Business realignments (b)

    45   

Asset impairments

    9   

Other (c)

    47   
       

Total unusual items

    108   

Productivity program savings (d)

    24   

Savings from shared services agreement (e)

    100   
       

Pro Forma Adjusted EBITDA

  $ 1,232   
       

 

  (a) Represents stock-based compensation, and unrealized foreign currency and derivative activity.

 

  (b) Represents plant rationalization and headcount reduction expenses incurred related to the productivity and business optimization programs and other costs associated with business realignments.

 

  (c) Primarily includes various non-recurring items including business optimization expenses, pension expenses related to formerly owned businesses, management fees, retention program costs, realized foreign currency financial impacts and debt issuance costs related to the January Refinancing Transaction.

 

  (d) Represents impact of anticipated productivity savings programs.

 

  (e) Represents impact of anticipated savings from the shared services agreement between MSC and MPM in conjunction with the Momentive Combination.

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. The risks and uncertainties below are not the only ones facing us. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, may also become important factors that affect us. If any of the following risks occur, our business, financial condition, and operating results could be materially and adversely affected. In that case, the market price of our common stock could decline, and you could lose some or all of your investment.

Risks Related to Our Business

If global economic conditions weaken again, it will negatively impact our business, results of operations and financial condition.

Global economic and financial market conditions, including severe market disruptions in late 2008 and 2009 and the potential for a significant and prolonged global economic downturn, have impacted or could impact our business operations in a number of ways including, but not limited to, the following:

 

   

reduced demand in key customer segments, such as automotive, building, construction and electronics, compared to prior years;

 

   

payment delays by customers and reduced demand for our products caused by customer insolvencies and/or the inability of customers to obtain adequate financing to maintain operations. This situation could cause customers to terminate existing purchase orders and reduce the volume of products they purchase from us and further impact our customers ability to pay our receivables, requiring us to assume additional credit risk related to these receivables or limit our ability to collect receivables from that customer;

 

   

insolvency of suppliers or the failure of suppliers to meet their commitments resulting in product delays;

 

   

more onerous credit and commercial terms from our suppliers such as shortening the required payment period for outstanding accounts receivable or reducing or eliminating the amount of trade credit available to us;

 

   

potential delays in accessing our credit facilities or obtaining new credit facilities on terms we deem commercially reasonable or at all, and the potential inability of one or more of the financial institutions included in our syndicated revolving credit facilities to fulfill their funding obligations. Should a bank in our syndicated revolving credit facilities be unable to fund a future draw request, we could find it difficult to replace that bank in the facility.

Global economic conditions may weaken again. Any further weakening of economic conditions would likely exacerbate the negative effects described above, could significantly affect our liquidity which may cause us to defer needed capital expenditures, reduce research and development or other spending, defer costs to achieve productivity and synergy programs or sell assets or incur additional borrowings which may not be available or may only be available terms significantly less advantageous than our current credit terms and could result in a wide-ranging and prolonged impact on general business conditions, thereby negatively impacting our business, results of operations and financial condition.

Fluctuations in direct or indirect raw material costs could have an adverse impact on our business.

Raw materials costs made up 70% of our pro forma cost of sales in 2010. The prices of our direct and indirect raw materials have been, and we expect them to continue to be, volatile. If the cost of direct or indirect

 

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raw materials increases significantly and we are unable to offset the increased costs with higher selling prices, our profitability will decline. Increases in prices for our products could also hurt our ability to remain both competitive and profitable in the markets in which we compete.

Although some of our materials contracts include competitive price clauses that allow us to buy outside the contract if market pricing falls below contract pricing, and certain contracts have minimum-maximum monthly volume commitments that allow us to take advantage of spot pricing, we may be unable to purchase raw materials at market prices. In addition, some of our customer contracts have fixed prices for a certain term, and as a result, we may not be able to pass on raw material price increases to our customers immediately, if at all. Due to differences in timing of the pricing trigger points between our sales and purchase contracts, there is often a “lead-lag” impact that can negatively impact our margins in the short term in periods of rising raw material prices and positively impact them in the short term in periods of falling raw material prices. Future raw material prices may be impacted by new laws or regulations, suppliers’ allocations to other purchasers, changes in our supplier manufacturing processes as some of our products are byproducts of these processes, interruptions in production by suppliers, natural disasters, volatility in the price of crude oil and related petrochemical products and changes in exchange rates.

An inadequate supply of direct or indirect raw materials and intermediate products could have an adverse effect on our business.

Our manufacturing operations require adequate supplies of raw materials and intermediate products on a timely basis. The loss of a key source or a delay in shipments could have an adverse effect on our business. Raw material availability may be subject to curtailment or change due to, among other things:

 

   

new or existing laws or regulations;

 

   

suppliers’ allocations to other purchasers;

 

   

interruptions in production by suppliers; and

 

   

natural disasters.

Many of our raw materials and intermediate products are available in the quantities we require from a limited number of suppliers.

For example, our silicones business is highly dependent upon access to silicon metal, a key raw material, and siloxane, an intermediate product that is derived from silicon metal. While silicon is itself abundant, silicon metal is produced through a manufacturing process and, in certain geographic areas, is currently available through a limited number of suppliers. In North America, there are only two significant silicon metal suppliers. Two of our competitors have also recently acquired silicon metal manufacturing assets in North America and Europe, respectively, becoming vertically integrated in silicon metal for a portion of their supply requirements and reducing the manufacturing base of certain independent silicon metal producers. In addition, silicon metal producers face a number of regulations that affect the supply or price of silicon metal in some or all of the jurisdictions in which we operate. For example, significant anti-dumping duties of up to 139.5% imposed by the United States Department of Commerce and the International Trade Commission against producers of silicon metal in China and Russia effectively block the sale by all or most producers in these jurisdictions to U.S. purchasers, which restricts the supply of silicon metal and results in increased prices. We currently purchase silicon metal under multi-year, one-year or short-term fixed-price contracts and in the spot market.

Our silicones business also relies heavily on siloxane as an intermediate product. We maintain our own manufacturing capacity sufficient to meet the substantial majority of our current siloxane requirements and purchase a portion of our requirements from Asia Silicones Monomer Limited, or ASM, under an existing off-take agreement. In addition, from time to time we enter into supply agreements with other third parties to take

 

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advantage of favorable pricing and minimize our cost. There are also a limited number of third-party siloxane providers, and the supply of siloxane may be limited from time to time. In addition, regulation of siloxane producers can also affect the supply of siloxane. For example, in January 2006, the Ministry of Commerce of the People’s Republic of China issued a final determination of an anti-dumping investigation that imposed anti-dumping duties on all siloxane manufacturers, including us, ranging from 13% to 22%. These duties were terminated in January 2011. In late May 2009, China’s Ministry of Commerce also concluded an anti-dumping investigation of siloxane manufacturers in Thailand and South Korea, which resulted in an imposition of a 5.4% duty against our supplier, ASM, in Thailand, a 21.8% duty against other Thailand companies and a 25.1% duty against Korean companies.

Our quartz production relies heavily on a specific type of sand, which is currently available in the necessary quality and quantity from one supplier, Unimin Corporation. Our long-term agreement with Unimin that spanned from 2005-2010 expired on December 31, 2010. We recently amended this agreement to extend the term through December 31, 2011 and amend certain provisions regarding pricing and volume purchase requirements, among others. We anticipate ultimately negotiating a long-term contract with Unimin.

Should any of our key suppliers fail to deliver these or other raw materials or intermediate products to us or no longer supply us, we may be unable to purchase these materials in necessary quantities, which could adversely affect our volumes, or may not be able to purchase them at prices that would allow us to remain competitive. During the past several years, certain of our suppliers have experienced force majeure events rendering them unable to deliver all, or a portion of, the contracted-for raw materials. On these occasions, we were forced to purchase replacement raw materials in the open market at significantly higher costs or place our customers on an allocation of our products. In addition, we cannot predict whether new regulations or restrictions may be imposed in the future on silicon metal, siloxane or other key materials, which may result in reduced supply or further increases in prices. We cannot assure investors that we will be able to renew our current materials contracts or enter into replacement contracts on commercially acceptable terms, or at all. Fluctuations in the price of these or other raw materials or intermediate products , the loss of a key source of supply or any delay in the supply could result in a material adverse effect on our business.

Our production facilities are subject to significant operating hazards which could cause environmental contamination, personal injury and loss of life, and severe damage to, or destruction of, property and equipment.

Our production facilities are subject to hazards associated with the manufacturing, handling, storage and transportation of chemical materials and products, including human exposure to hazardous substances, pipeline and equipment leaks and ruptures, explosions, fires, inclement weather and natural disasters, mechanical failures, unscheduled downtime, transportation interruptions, remedial complications, chemical spills, discharges or releases of toxic or hazardous substances or gases, storage tank leaks and other environmental risks. Additionally a number of our operations, are adjacent to operations of independent entities that engage in hazardous and potentially dangerous activities. Our operations or adjacent operations could result in personal injury or loss of life, severe damage to or destruction of property or equipment, environmental damage, or a loss of the use of all or a portion of one of our key manufacturing facilities. Such events at our facilities or adjacent third-party facilities, could have a material adverse effect on us.

We may incur losses beyond the limits or coverage of our insurance policies for liabilities that are associated with these hazards. In addition, various kinds of insurance for companies in the chemical industry have not been available on commercially acceptable terms, or, in some cases, have been unavailable altogether. In the future, we may not be able to obtain coverage at current levels, and our premiums may increase significantly on coverage that we maintain.

 

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Environmental obligations and liabilities could have a substantial negative impact on our financial condition, cash flows and profitability.

Our operations involve the use, handling, processing, storage, transportation and disposal of hazardous materials and are subject to extensive and complex U.S. Federal, state, local and non-U.S. national, provincial, and local environmental, health and safety laws and regulations. These environmental laws and regulations include those that govern the discharge of pollutants into the air and water, the generation, use, storage, transportation, treatment and disposal of hazardous materials and wastes, the cleanup of contaminated sites, occupational health and safety and those requiring permits, licenses, or other government approvals for specified operations or activities. Our products are also subject to a variety of national, regional, state, and provincial requirements and restrictions applicable to the manufacture, import, export or subsequent use of such products. In addition, we are required to maintain, and may be required to obtain in the future, environmental, health and safety permits, licenses, or government approvals to continue current operations at most of our manufacturing and research facilities throughout the world.

Compliance with environmental, health and safety laws and regulations, and maintenance of permits, can be costly and complex, and we have incurred and will continue to incur costs, including capital expenditures and costs associated with the issuance and maintenance of letters of credit, to comply with these requirements. If we are unable to comply with environmental, health and safety laws and regulations, or maintain our permits, we could incur substantial costs, including fines and civil or criminal sanctions, third party property damage or personal injury claims or costs associated with upgrades to our facilities or changes in our manufacturing processes in order to achieve and maintain compliance, and may also be required to halt permitted activities or operations until any necessary permits can be obtained or complied with. In addition, future developments or increasingly stringent regulations could require us to make additional unforeseen environmental expenditures.

Actual and alleged environmental violations have previously been, and continue to be, identified at our facility in Waterford, New York. We are cooperating with the New York State Department of Environmental Conservation and the U.S. Environmental Protection Agency, or USEPA, and Department of Justice in their respective investigations of that facility’s compliance with certain applicable environmental requirements, including certain requirements governing the operation of the facility’s hazardous waste incinerators. These investigations may result in administrative, civil or criminal enforcement by the State of New York and/or the United States and resolution of such enforcement actions will likely require payment of a monetary penalty and/or the imposition of other civil or criminal sanctions.

Environmental, health and safety requirements change frequently and have tended to become more stringent over time. We cannot predict what environmental, health and safety laws and regulations or permit requirements will be enacted or amended in the future, how existing or future laws or regulations will be interpreted or enforced or the impact of such laws, regulations or permits on future production expenditures, supply chain or sales. Our costs of compliance with current and future environmental, health and safety requirements could be material. Such future requirements include legislation designed to reduce emissions of carbon dioxide and other substances associated with climate change (“greenhouse gases”). The European Union has enacted greenhouse gas emissions legislation, and is considering expanding the scope of such legislation. The USEPA has promulgated new regulations applicable to projects involving greenhouse gas emissions above a certain threshold, and the U.S. and certain states within the U.S. have enacted, or are considering, limitations on greenhouse gas emissions. These requirements to limit greenhouse gas emissions could increase our energy costs, and may also require us to incur capital costs to modify our manufacturing facilities.

Even if we fully comply with environmental laws, we are subject to liability associated with hazardous substances in soil, groundwater and elsewhere at a number of sites. These include sites that we formerly owned or operated and sites where hazardous wastes and other substances from our current and former facilities and operations have been treated, stored or disposed of, as well as sites that we currently own or operate. Depending upon the circumstances, our liability may be joint and several, meaning that we may be held responsible for more

 

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than our proportionate share, or even all, of the liability involved. Environmental conditions at these sites can lead to environmental cleanup liability and claims against us for personal injury or wrongful death, property damages and natural resource damages, as well as to claims and obligations for the investigation and cleanup of environmental conditions. The extent of any of these liabilities is difficult to predict, but in the aggregate such liabilities could be material.

We have been notified that we are or may be responsible for environmental remediation at a number of sites in the United States, Europe and South America. We are also performing a number of voluntary cleanups. One of the most significant sites is a site formerly owned by us in Geismar, Louisiana. As the result of former, current or future operations, there may be additional environmental remediation or restoration liabilities or claims of personal injury by employees or members of the public due to exposure or alleged exposure to hazardous materials in connection with our operations, properties or products. Sites sold by us in past years may have significant site closure or remediation costs and our share, if any, may be unknown to us at this time. These environmental liabilities or obligations, or any that may arise or become known to us in the future, could have a material adverse effect on our financial condition, cash flows and profitability.

Future chemical regulatory actions may decrease our profitability.

Several governmental entities have enacted, are considering or may consider in the future, regulations that may impact our ability to sell certain chemical products in certain geographic areas. In December 2006, the European Union enacted a regulation known as REACH, which stands for Registration, Evaluation and Authorization of Chemicals. This regulation requires manufacturers, importers and consumers of certain chemicals manufactured in, or imported into, the European Union to register such chemicals and evaluate their potential impacts on human health and the environment. The implementing agency is currently in the process of determining if any chemicals should be further tested, regulated, restricted or banned from use in the European Union. Other countries have implemented, or are considering implementation of, similar chemical regulatory programs. When fully implemented, REACH and other similar regulatory programs may result in significant adverse market impacts on the affected chemical products. If we fail to comply with REACH or other similar laws and regulations, we may be subject to civil remedies, including fines, injunctions, recalls or seizures, which would have an adverse effect on our financial condition, cash flows and profitability.

Similarly, the Canadian government is implementing an initiative to review certain chemical products for potential environmental and human health and safety impacts. The list of products being reviewed includes several chemicals sold by us. We are part of an industry organization that is working with the Canadian government to develop relevant data and information. Upon review of such data and information, the Canadian government may enact regulations that would limit our ability to sell the affected chemicals in Canada. As part of this initiative, based upon modeled potential impacts on the aquatic environment, the Canadian government has listed as environmentally toxic octamethylcyclotetrasiloxane, or D4, a chemical substance that we manufacture, and has proposed listing as environmentally toxic decamethylcyclopentasiloxane, or D5, another chemical substance that we manufacture. The Canadian government is developing, and will likely finalize, regulations to limit the discharge of D4 into the aquatic environment. The Canadian Minister of Environment has convened a Board of Review to assess whether D5 warrants listing as environmentally toxic. If the Board concludes that D5 meets the statutory criteria for environmental toxicity, D5 will also be subject to similar regulations. These regulations may include limitations on the import into Canada, or the use in Canada, of certain products containing more than a specified amount of these chemical substances. The European Union is also reviewing these two chemicals, and may, pursuant to REACH, regulate the manufacture, import and/or use of these two chemical substances in the European Union. Finally, the USEPA has stated that they are reviewing the potential risks posed by these two substances to the aquatic environment to determine whether regulatory measures are warranted. Regulation of our products containing such substances by the European Union, Canada and/or the United States would likely reduce our sales within the jurisdiction and possibly in other geographic areas as well. These reductions in sales could be material depending upon the extent of any such additional regulations.

 

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We participate with other companies in trade associations and regularly contribute to the research and study of the safety and environmental impact of our products and raw materials, including siloxanes, silica, formaldehyde and BPA. These programs are part of a program to review the environmental impacts, safety and efficacy of our products. In addition, government and academic institutions periodically conduct research on potential environmental and health concerns posed by various chemical substances, including substances we manufacture and sell. These research results are periodically reviewed by state, national and international regulatory agencies and potential customers. Such research could result in future regulations restricting the manufacture or use of our products, liability for adverse environmental or health effects linked to our products, and/or de-selection of our products for specific applications. These restrictions, liability, and product de-selection could have an adverse effect on our business, our financial condition and/or liquidity.

Because of potential adverse human health effects, formaldehyde is regulated and various public health agencies continue to evaluate it. In 2004, the International Agency for Research on Cancer, or IARC, 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 human beings of a causal association between formaldehyde exposure and leukemia. Soon thereafter, an expert panel of the National Toxicology Program, or NTP, issued its draft 12th Report on Carcinogens, or RoC, which included a recommendation that formaldehyde be listed as “known to be a human carcinogen.” This NTP recommendation was based in part upon its conclusion that available evidence supported a causal link between formaldehyde exposure and leukemia. 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, has also released a draft of its toxicological review of formaldehyde. 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 assessment. 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 report did not clearly support a conclusion of a causal link between formaldehyde exposure and leukemia. It is possible that USEPA and NTP may revise the IRIS toxicological review and the RoC, respectively, to reflect the NAS findings, including the conclusions regarding a causal link between formaldehyde exposure and leukemia. Based upon further government reviews, 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 these chemicals and products that contain them. These additional costs and reduced demand could have a material adverse effect on our operations and profitability.

BPA, which is used as an intermediate at our Deer Park, Texas and Pernis, Netherlands manufacturing facilities, and is also sold directly to third parties, is currently under evaluation as an “endocrine disrupter.” Endocrine disrupters are chemicals that have been alleged to interact with the endocrine systems of human beings and wildlife and disrupt their normal processes. BPA continues to be subject to scientific, regulatory and legislative review and negative publicity. We do not believe it is possible to predict the outcome of regulatory and legislative initiatives. In the event that BPA is further regulated or banned for use in certain products, substantial additional operating costs would be likely in order to meet more stringent regulation of this chemical and could reduce demand for the chemical and have a material adverse effect on our operations and profitability.

We manufacture resin-encapsulated sand. Because sand consists primarily of crystalline silica, potential exposure to silica particulate exists. Overexposure to crystalline silica is a recognized health hazard. The Occupational Safety and Health Administration, or OSHA, continues to maintain on its regulatory calendar the possibility of promulgating a comprehensive occupational health standard for crystalline silica within the next few years. We may incur substantial additional costs to comply with any new OSHA regulations.

In addition, we sell resin-encapsulated sand to natural gas drilling operators for use in extracting natural gas from wells that were drilled by a method called hydraulic or horizontal fracturing. This drilling method has been

 

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under public and legislative scrutiny recently as a potential source of contamination of groundwater and drinking water. Currently, studies of this method are underway by the USEPA, with oversight provided by a congressional committee, and legislation is being considered in Congress, as well as in some states, to regulate this drilling method. New laws and regulations could affect the number of wells drilled by operators, decrease demand for our resin-coated sands, and cause a decline in our operations and financial performance. Such a decline in demand could also increase competition and decrease pricing of our products, which could also have a negative impact on our profitability and financial performance.

We are subject to certain risks related to litigation filed by or against us, and adverse results may harm our business.

We cannot predict with certainty the cost of defense, of prosecution or of the ultimate outcome of litigation and other proceedings filed by or against us, including penalties or other civil or criminal sanctions, or remedies or damage awards, and adverse results in any litigation and other proceedings may materially harm our business. Litigation and other proceedings may include, but are not limited to, actions relating to intellectual property, international trade, commercial arrangements, product liability, environmental, health and safety, joint venture agreements, labor and employment or other harms resulting from the actions of individuals or entities outside of our control. In the case of intellectual property litigation and proceedings, adverse outcomes could include the cancellation, invalidation or other loss of material intellectual property rights used in our business and injunctions prohibiting our use of business processes or technology that are subject to third-party patents or other third-party intellectual property rights. Litigation based on environmental matters or exposure to hazardous substances in the workplace or from our products could result in significant liability for us.

Because we manufacture and use materials that are known to be hazardous, we are subject to, or affected by, certain product and manufacturing regulations, for which compliance can be costly and time consuming. In addition, we may be subject to personal injury or product liability claims as a result of human exposure to such hazardous materials.

We produce hazardous chemicals that require care in handling and use that are subject to regulation by many U.S. and non-U.S. national, international, state and local governmental authorities. In some circumstances, these authorities must approve our products and manufacturing processes and facilities before we may sell some of these chemicals. To obtain regulatory approval of certain new products, we must, among other things, demonstrate to the relevant authority that the product is safe for its intended uses and that we are capable of manufacturing the product in compliance with current regulations. The process of seeking approvals can be costly, time consuming and subject to unanticipated and significant delays. Approvals may not be granted to us on a timely basis, or at all. Any delay in obtaining, or any failure to obtain or maintain, these approvals would adversely affect our ability to introduce new products and to generate revenue from those products. New laws and regulations may be introduced in the future that could result in additional compliance costs, bans on product sales or use, seizures, confiscation, recall or monetary fines, any of which could prevent or inhibit the development, distribution or sale of our products and could increase our customers’ efforts to find less hazardous substitutes for our products. We are subject to ongoing reviews of our products and manufacturing processes.

As discussed above, we manufacture and sell products containing formaldehyde, and certain governmental bodies have concluded that there is a causal link between formaldehyde exposure and certain types of cancer, possibly including leukemia. These conclusions could also become the basis of product liability litigation.

Other products we have made or used have been the focus of legal claims based upon allegations of harm to human health. While we cannot predict the outcome of pending suits and claims, we believe that we maintain adequate reserves, in accordance with our policy, to address currently pending litigation and are adequately insured to cover currently pending and foreseeable future claims. However, an unfavorable outcome in these litigation matters may cause our profitability, business, financial condition and reputation to decline.

 

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We are subject to claims from our customers and their employees, environmental action groups and neighbors living near our production facilities.

We produce and use hazardous chemicals that require appropriate procedures and care to be used in handling or in using them to manufacture other products. As a result of the hazardous nature of some of the products we produce and use, we may face claims relating to incidents that involve our customers’ improper handling, storage and use of our products. We have historically faced lawsuits, including class action lawsuits, that claim liability for death, injury or property damage caused by products that we manufacture or that contain our components. These lawsuits, and any future lawsuits, could result in substantial damage awards against us, which in turn could encourage additional lawsuits and could cause us to incur significant legal fees to defend such lawsuits, either of which could have a material adverse effect on our financial condition and profitability. In addition, the activities of environmental action groups could result in litigation or damage to our reputation.

As a global business, we are subject to numerous risks associated with our international operations that could have a material adverse effect on our business.

We have significant manufacturing and other operations outside the United States. Some of these operations are in jurisdictions with unstable political or economic conditions. There are numerous inherent risks in international operations, including, but not limited to:

 

   

exchange controls and currency restrictions;

 

   

currency fluctuations and devaluations;

 

   

tariffs and trade barriers;

 

   

export duties and quotas;

 

   

changes in local economic conditions;

 

   

changes in laws and regulations;

 

   

exposure to possible expropriation or other government actions;

 

   

hostility from local populations;

 

   

diminished ability to legally enforce our contractual rights in non-U.S. countries;

 

   

restrictions on our ability to repatriate dividends from our subsidiaries;

 

   

unsettled political conditions and possible terrorist attacks against U.S. interests; and

 

   

natural disasters or other catastrophic events.

Our international operations expose us to different local political and business risks and challenges. For example, we face potential difficulties in staffing and managing local operations, and we have to design local solutions to manage credit risks of local customers and distributors. In addition, some of our operations are located in regions that may be politically unstable, having particular exposure to riots, civil commotion or civil unrests, acts of war (declared or undeclared) or armed hostilities or other national or international calamity. In some of these regions, our status as a United States company also exposes us to increased risk of sabotage, terrorist attacks, interference by civil or military authorities or to greater impact from the national and global military, diplomatic and financial response to any future attacks or other threats.

Some of our operations are located in regions with particular exposure to natural disasters such as storms, floods, fires and earthquakes. It would be difficult or impossible for us to relocate these operations and, as a result, any of the aforementioned occurrences could materially adversely affect our business.

In addition, intellectual property rights may be more difficult to enforce in non-U.S. or non-Western Europe countries.

 

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Our overall success as a global business depends, in part, upon our ability to succeed under different economic, social and political conditions. We may fail to develop and implement policies and strategies that are effective in each location where we do business, and failure to do so could have a material adverse effect on our business, financial condition and results of operations.

Our business is subject to foreign currency risk.

In 2010, 60% of our pro forma net sales originated outside the United States. In our consolidated financial statements, we translate our local currency financial results into U.S. dollars based on average exchange rates prevailing during a reporting period or the exchange rate at the end of that period. During times of a strengthening U.S. dollar, at a constant level of business, our reported international revenues and earnings would be reduced because the local currency would translate into fewer U.S. dollars.

In addition to currency translation risks, we incur a currency transaction risk whenever one of our operating subsidiaries enters into either a purchase or a sales transaction using a different currency from the currency in which it records revenues. Given the volatility of exchange rates, we may not manage our currency transaction and/or translation risks effectively, and volatility in currency exchange rates may materially adversely affect our financial condition or results of operations. Since most of our indebtedness is denominated in U.S. dollars, a strengthening of the U.S. dollar could make it more difficult for us to repay our indebtedness.

We have entered and expect to continue to enter into various hedging and other programs in an effort to protect against adverse changes in the non-U.S. exchange markets and attempt to minimize potential adverse effects. These hedging and other programs may be unsuccessful in protecting against these risks. Our results of operations could be materially adversely affected if the U.S. dollar strengthens against non-U.S. currencies and our protective strategies are not successful. Likewise, a strengthening U.S. dollar provides opportunities to source raw materials more cheaply from foreign countries.

Increased energy costs could increase our operating expenses, reduce net income and negatively affect our financial condition.

Natural gas and electricity are essential to our manufacturing processes, which are energy-intensive. Oil and natural gas prices have fluctuated greatly over the past several years and we anticipate that they will continue to do so. Our energy costs represented 5% of our total pro forma costs of sales in 2010, and 8%, in each of 2009 and 2008.

Our operating expenses will increase if our energy prices increase. Increased energy prices may also result in greater raw materials costs. If we cannot pass these costs through to our customers, our profitability may decline. In addition, increased energy costs may also negatively affect our customers and the demand for our products.

We face increased competition from other companies and from substitute products, which could force us to lower our prices, which would adversely affect our profitability and financial condition.

The markets that we operate in are highly competitive, and this competition could harm our results of operations, cash flows and financial condition. Our competitors include major international producers as well as smaller regional competitors. We believe that the most significant competitive factor that impacts demand for certain of our products is selling price. We may be forced to lower our selling price based on our competitors’ pricing decisions, which would reduce our profitability. Certain markets that we serve have become commoditized in recent years and have given rise to several industry participants, resulting in fierce price competition in these markets. This has been further magnified by the impact of the recent global economic downturn, as companies have focused more on price to retain business and market share. In addition, we face competition from a number of products that are potential substitutes for our products. Growth in substitute products could adversely affect our market share, net sales and profit margins.

 

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Additional trends include current and anticipated consolidation among our competitors and customers which may cause us to lose market share as well as put downward pressure on pricing. There is also a trend in our industries toward relocating manufacturing facilities to lower cost regions, such as Asia, which may permit some of our competitors to lower their costs and improve their competitive position. Furthermore, there has been an increase in new competitors based in these regions.

Some of our competitors are larger, have greater financial resources, have a lower cost structure, and/or have less debt than we do. As a result, those competitors may be better able to withstand a change in conditions within our industry and in the economy as a whole. If we do not compete successfully, our operating margins, financial condition, cash flows and profitability could be adversely affected. Furthermore, if we do not have adequate capital to invest in technology, including expenditures for research and development, our technology could be rendered uneconomical or obsolete, negatively affecting our ability to remain competitive.

We may be unable to achieve the cost savings or synergies that we expect to achieve from our strategic initiatives, including the Momentive Combination, which would adversely affect our profitability and financial condition.

We have not yet realized all of the cost savings and synergies we expect to achieve from our current strategic initiatives, including the Momentive Combination and those related to shared services and logistics optimization, best-of-source contractual terms, procurement savings, regional site rationalization, administrative and overhead savings, and new product development, and may not be able to realize such cost savings or synergies. A variety of risks could cause us not to realize the expected cost savings and synergies, including but not limited to, the following: the shared services agreement may be viewed negatively by vendors, customers or financing sources, negatively impacting potential benefits; any difficulty or inability to integrate shared services with our business; 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; increased complexity and cost in collaborating between MSC and MPM and establishing and maintaining shared services; and other unexpected costs associated with operating our business.

Our ability to realize the benefits of the Momentive Combination also may be limited by applicable limitations under the terms of our debt instruments. These debt instruments generally require that transactions between MPM and MSC with a value in excess of a de minimis threshold be entered into on an arm’s-length basis. These constraints could result in significantly fewer cost savings and synergies than would occur if these limitations did not exist. Our ability to realize intended savings also may be limited by existing contracts to which we are a party, the need for consents with respect to agreements with third parties, and other logistical difficulties associated with integration.

If we are unable to achieve the cost savings or synergies that we expect to achieve from our strategic initiatives, including the shared services agreement, it would adversely affect our profitability and financial condition. In addition, while we have been successful in reducing costs and generating savings, factors may arise that may not allow us to sustain our current cost structure. As market and economic conditions change, we may also make changes to our operating cost structure. To the extent we are permitted to include the pro forma impact of such cost savings initiatives in the calculation of financial covenant ratios under our senior credit agreements, our failure to realize such savings could impact our compliance with such covenants.

 

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Momentive and certain of its subsidiaries are holding companies that rely on dividends and other payments, advances and transfers of funds from other subsidiaries to meet our respective obligations, and these dividends, other payments, advances and transfers are restricted by our subsidiaries’ debt agreements and may be unavailable or inadequate to meet such obligations, if at all.

Momentive and its subsidiary holding companies have no direct operations and derive all of their cash flow (excluding cash flow from financing activities) from their subsidiaries. Because we conduct our operations through our subsidiaries, we depend on those entities for dividends and other payments to generate the funds necessary to meet our financial obligations, including the debt payment obligations of our subsidiary holding companies. Legal and contractual restrictions in the credit facilities, indentures and other agreements governing our subsidiaries’ indebtedness, as well as the financial condition and operating requirements of our subsidiaries, may limit our ability to obtain cash from our subsidiaries. Our subsidiaries may not be able to, or may not be permitted to, make distributions to us. Each subsidiary is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. While there are limitations on the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make intercompany payments to us, these limitations are subject to certain qualifications and exceptions. In the event that we are unable to receive distributions from our subsidiaries we may be unable to meet our obligations. Further, the earnings from, or other available assets of, our subsidiaries may be insufficient to pay dividends or make distributions or loans to enable us to meet our obligations.

Our success depends in part on our ability to protect our intellectual property rights, and our inability to enforce these rights could have an adverse effect on our competitive position.

We rely on the patent, trademark, copyright and trade-secret laws of the United States and the countries where we do business to protect our intellectual property rights. We may be unable to prevent third parties from using our intellectual property without our authorization. The unauthorized use of our intellectual property could reduce any competitive advantage we have developed, reduce our market share or otherwise harm our business. In the event of unauthorized use of our intellectual property, litigation to protect or enforce our rights could be costly, and we may not prevail.

Many of our technologies are not covered by any patent or patent application, and our issued and pending U.S. and non-U.S. patents may not provide us with any competitive advantage and could be challenged by third parties. Our inability to secure issuance of our pending patent applications may limit our ability to protect the intellectual property rights these pending patent applications were intended to cover. Our competitors may attempt to design around our patents to avoid liability for infringement and, if successful, our competitors could adversely affect our market share. Furthermore, the expiration of our patents may lead to increased competition.

Our pending trademark applications may not be approved by the responsible governmental authorities and, even if these trademark applications are granted, third parties may seek to oppose or otherwise challenge these trademark applications. A failure to obtain trademark registrations in the United States and in other countries could limit our ability to protect our products and their associated trademarks and impede our marketing efforts in those jurisdictions.

In addition, effective patent, trademark, copyright and trade secret protection may be unavailable or limited in some foreign countries. In some countries we do not apply for patent, trademark or copyright protection. We also rely on unpatented proprietary manufacturing expertise, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we generally enter into confidentiality agreements with our employees and third parties to protect our intellectual property, these confidentiality agreements are limited in duration and could be breached, and may not provide meaningful protection of our trade secrets or proprietary manufacturing expertise. Adequate remedies may not be available if there is an unauthorized use or disclosure of our trade secrets and manufacturing expertise. In addition, others may obtain knowledge about our trade secrets through independent development or by legal means. The failure to protect our processes, apparatuses, technology, trade secrets and proprietary manufacturing expertise, methods and compounds could have an adverse effect on our business by jeopardizing critical intellectual property.

 

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Where a product formulation or process is kept as a trade secret, third parties may independently develop or invent and patent products or processes identical to our trade-secret products or processes. This could have an adverse impact on our ability to make and sell products or use such processes and could potentially result in costly litigation in which we might not prevail.

We could face intellectual property infringement claims that could result in significant legal costs and damages and impede our ability to produce key products, which could have a material adverse effect on our business, financial condition and results of operations.

Conversely, we could face intellectual property infringement claims from our competitors or others alleging that our processes or products infringe on their proprietary technology. If we were subject to an infringement suit, we may be required to change our processes or products, or stop using certain technologies or producing the infringing product entirely. Even if we ultimately prevail in an infringement suit, the existence of the suit could cause our customers to seek other products that are not subject to infringement suits. Any infringement suit could result in significant legal costs and damages and impede our ability to produce key products, which could have a material adverse effect on our business, financial condition and results of operations.

We depend on certain of our key executives and our ability to attract and retain qualified employees.

Our ability to operate our business and implement our strategies depends, in part, on the efforts of Craig O. Morrison, our chief executive officer, and William H. Carter, our chief financial officer, and other key members of our leadership team. In addition, our success will depend on, among other factors, our ability to attract and retain other qualified personnel, particularly research scientists, technical sales professionals and engineers. The loss of the services of any of our key employees or the failure to attract or retain other qualified personnel could have a material adverse effect on our business or business prospects.

If we fail to extend or renegotiate our collective bargaining agreements with our works councils and labor unions as they expire from time to time, if disputes with our works councils or unions arise, or if our unionized or represented employees were to engage in a strike or other work stoppage, our business and operating results could be materially adversely affected.

As of December 31, 2010, 45% of our employees were unionized or represented by works councils that were covered by collective bargaining agreements. In addition, some of our employees reside in countries in which employment laws provide greater bargaining or other employee rights than the laws of the United States. These rights may require us to expend more time and money altering or amending employees’ terms of employment or making staff reductions. For example, most of our employees in Europe are represented by works councils, which generally must approve changes in conditions of employment, including restructuring initiatives and changes in salaries and benefits. A significant dispute could divert our management’s attention and otherwise hinder our ability to conduct our business or to achieve planned cost savings.

We may be unable to timely extend or renegotiate our collective bargaining agreements as they expire. For example, a majority of our manufacturing personnel at our Waterford, New York; Sistersville, West Virginia and Willoughby, Ohio sites are covered by collective bargaining agreements that expire in the summer of 2013. In addition, we have other collective bargaining agreements which will expire during the next two years. We also may be subject to strikes or work stoppages by, or disputes with, our labor unions. In January 2011, the union at our Waterford, New York facility representing approximately 780 employees went on strike for two days in response to specific grievances that are now concluded. In addition, in January and November 2009, this union filed a variety of unfair labor practice charges against us with the National Labor Relations Board, or NLRB, arising from our implementation of a new wage rate schedule, a new job classification structure and a new overtime procedure at our Waterford, New York facility. In January 2010, the NLRB filed a complaint against us relating to a portion of these charges, and in July 2010 we reached a settlement with respect to these claims and

 

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the complaint was withdrawn. If we fail to extend or renegotiate our collective bargaining agreements, if additional disputes with our works councils or unions arise or if our unionized or represented workers engage in a further strike or other work stoppage, we could incur higher labor costs or experience a significant disruption of operations, which could have a material adverse effect on our business, financial position and results of operations.

Our pension plans are unfunded or under-funded, and our required cash contributions could be higher than we expect, having an adverse effect on our financial condition and liquidity.

We sponsor various pension and similar benefit plans worldwide.

Our non-U.S. defined benefit pension plans were under-funded in the aggregate by $220 million as of December 31, 2010. Our U.S. defined benefit pension plans were under-funded in the aggregate by $127 million as of December 31, 2010.

We are legally required to make contributions to our pension plans in the future, and those contributions could be material. The need to make these cash contributions will reduce the amount of cash that would be available to meet other obligations or the needs of our business, which could have an adverse effect on our financial condition and liquidity.

In 2011, we expect to contribute approximately $29 million and $14 million to our U.S. and non-U.S. defined benefit pension plans, respectively, which we believe is sufficient to meet the minimum funding requirements as set forth in employee benefit and tax laws. The terms of the respective indebtedness of the MPM Group and the MSC Group restrict their ability to make funds available for contribution to the others’ defined benefit plans.

Our future funding obligations for our employee benefit plans depend upon the levels of benefits provided for by the plans, the future performance of assets set aside for these plans, the rates of interest used to determine funding levels, the impact of potential business dispositions, actuarial data and experience, and any changes in government laws and regulations. In addition, our employee benefit plans hold a significant amount of equity securities. If the market values of these securities decline, our pension expense and funding requirements would increase and, as a result, could have a material adverse affect on our business.

Any decrease in interest rates and asset returns, if and to the extent not offset by contributions, could increase our obligations under these plans. If the performance of assets in the funded plans does not meet our expectations, our cash contributions for these plans could be higher than we expect, which could have an adverse effect on our financial condition and liquidity.

Natural or other disasters have, and could in the future disrupt our business and result in loss of revenue or higher expenses.

Any serious disruption at any of our facilities or our suppliers’ facilities due to hurricane, fire, earthquake, flood, terrorist attack or any other natural or man-made disaster could impair our ability to use our facilities and have a material adverse impact on our revenues and increase our costs and expenses. If there is a natural disaster or other serious disruption at any of our facilities or our suppliers’ facilities, it could impair our ability to adequately supply our customers and negatively impact our operating results. For example, our siloxane manufacturing facility in Ohta, Japan and the manufacturing facilities of certain of our suppliers were impacted by earthquakes in Japan and related events in 2011. Our manufacturing facilities in the U.S. Gulf Coast region were also impacted by Hurricanes Katrina and Rita in 2005 and Hurricanes Gustav and Ike in 2008. In addition, many of our current and potential customers are concentrated in specific geographic areas. A disaster in one of these regions could have a material adverse impact on our operations, operating results and financial condition. Our business interruption insurance may not be sufficient to cover all of our losses from a disaster, in which case our unreimbursed losses could be substantial.

 

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Acquisitions and joint ventures that we pursue may present unforeseen integration obstacles and costs, increase our leverage and negatively impact our performance. Divestitures that we pursue also may present unforeseen obstacles and costs and alter the synergies we expect to achieve from the Momentive Combination.

We have made acquisitions of related businesses, and entered into joint ventures in the past and intend to selectively pursue acquisitions of, and joint ventures with, related businesses as one element of our growth strategy. Acquisitions may require us to assume or incur additional debt financing, resulting in additional leverage and complex debt structures. If such acquisitions are consummated, the risk factors we describe below, and for our business generally, may be intensified.

Our ability to implement our growth strategy is limited by covenants in our senior secured credit facilities, indentures and other indebtedness, our financial resources, including available cash and borrowing capacity, and our ability to integrate or identify appropriate acquisition and joint venture candidates.

The expense incurred in consummating acquisitions of related businesses, or our failure to integrate such businesses successfully into our existing businesses, could result in our incurring unanticipated expenses and losses. Furthermore, we may not be able to realize any anticipated benefits from acquisitions or joint ventures. The process of integrating acquired operations into our existing operations may result in unforeseen operating difficulties and may require significant financial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the risks associated with our acquisition and joint venture strategy include:

 

   

potential disruptions of our ongoing business and distraction of management;

 

   

unexpected loss of key employees or customers of the acquired company;

 

   

conforming the acquired company’s standards, processes, procedures and controls with our operations;

 

   

coordinating new product and process development;

 

   

hiring additional management and other critical personnel; and

 

   

increasing the scope, geographic diversity and complexity of our operations

In addition, we may encounter unforeseen obstacles or costs in the integration of acquired businesses. For example, if we were to acquire an international business, the preparation of the U.S. GAAP financial statements could require significant management resources. Also, the presence of one or more material liabilities of an acquired company that are unknown to us at the time of acquisition may have a material adverse effect on our business. Our acquisition and joint venture strategy may not be successfully received by customers, and we may not realize any anticipated benefits from acquisitions or joint ventures.

In addition we have selectively made, and intend to pursue, divestitures of certain of our businesses as one element of our portfolio optimization strategy. Divestitures may require us to separate integrated assets and personnel from our retained businesses and devote our resources to transitioning assets and services to purchasers, resulting in disruptions to our ongoing business and distraction of management. Divestitures may alter synergies we expect to achieve from the Momentive Combination.

Risks Related to Our Indebtedness

We may be unable to generate sufficient cash flows from operations to meet our consolidated debt service payments.

We have substantial consolidated indebtedness. As of December 31, 2010, we had $7,271 million of consolidated outstanding indebtedness, including payments due within the next twelve months and short-term borrowings. In 2011, based on our consolidated indebtedness outstanding at December 31, 2010 our annualized

 

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cash interest expense is projected to be approximately $555 million based on interest rates at December 31, 2010, of which $413 million represents cash interest expense on fixed-rate obligations, including variable rate debt subject to interest rate swap agreements.

Our ability to generate sufficient cash flows from operations to make scheduled debt service payments depends on a range of economic, competitive and business factors, many of which are outside of our control. Our business may generate insufficient cash flows from operations to meet our debt service and other obligations, and currently anticipated cost savings, working capital reductions and operating improvements may not be realized on schedule, or at all. If we are unable to meet our expenses and debt service obligations, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or issue additional equity securities. We may be unable to refinance any of our indebtedness, sell assets or issue equity securities on commercially reasonable terms, or at all, which could cause us to default on our obligations and result in the acceleration of our debt obligations. Our inability to generate sufficient cash flow to satisfy our outstanding debt obligations, or to refinance our obligations on commercially reasonable terms, would have a material adverse effect on our business, financial condition and results of operations.

The MPM Group and the MSC Group do not provide credit support for each other’s indebtedness, and their ability to share liquidity and cash resources with each other is restricted by the terms of their respective indebtedness.

Our substantial indebtedness exposes us to significant interest expense increases if interest rates increase.

$2.9 billion, or approximately 40% of our borrowings as of December 31, 2010, were at variable interest rates and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income would decrease. Assuming our consolidated variable interest rate indebtedness outstanding as of December 31, 2010 remains the same, an increase of 1% in the interest rates payable on our variable rate indebtedness would increase our 2011 annual estimated debt-service requirements by approximately $25 million. Accordingly, an increase in interest rates from current levels could cause our annual debt-service obligations to increase significantly.

Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations and limit our ability to react to changes in the economy or our industry.

Our substantial consolidated indebtedness could have other important consequences, including but not limited to the following:

 

   

it may limit our flexibility in planning for, or reacting to, changes in our operations or business;

 

   

we are more highly leveraged than many of our competitors, which may place us at a competitive disadvantage;

 

   

it may make us more vulnerable to downturns in our business or the economy;

 

   

a substantial portion of our cash flows from operations will be dedicated to the repayment of our indebtedness and will not be available for other purposes;

 

   

it may restrict us from making strategic acquisitions, introducing new technologies, or exploiting business opportunities;

 

   

it may make it more difficult for us to satisfy our obligations with respect to our existing indebtedness;

 

   

it may adversely affect terms under which suppliers provide material and services to us;

 

   

it may limit our ability to borrow additional funds or dispose of assets; and

 

   

it may limit our ability to fully achieve possible cost savings from the Momentive Combination.

 

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There would be a material adverse effect on our business and financial condition if we were unable to service our indebtedness or obtain additional financing, as needed.

Despite our substantial indebtedness, we may still be able to incur significant additional indebtedness. This could intensify the risks described above.

We may be able to incur substantial additional indebtedness in the future. Although the terms governing our indebtedness contain restrictions on our ability to incur additional indebtedness, these restrictions are subject to numerous qualifications and exceptions, and the indebtedness we may incur in compliance with these restrictions could be substantial. Increasing our indebtedness could intensify the risks described above.

The terms governing our outstanding debt, including restrictive covenants, may adversely affect our operations.

The terms governing our outstanding debt contain, and any future indebtedness we incur would likely contain, numerous restrictive covenants that impose significant operating and financial restrictions on our ability to, among other things:

 

   

incur or guarantee additional debt;

 

   

pay dividends and make other distributions to our stockholders;

 

   

create or incur certain liens;

 

   

make certain loans, acquisitions, capital expenditures or investments;

 

   

engage in sales of assets and subsidiary stock;

 

   

enter into sale/leaseback transactions;

 

   

enter into transactions with affiliates; and

 

   

transfer all or substantially all of our assets or enter into merger or consolidation transactions.

In particular, each of MPM Holdings, MPM, MSC Holdings and MSC have separate debt financing under their own respective debt agreements, each of which contains restrictive covenants that impose significant restrictions on their ability to operate together, other than on an arms-length basis in accordance with the terms of such agreements. As a result, we have significant restrictions on our ability to transfer assets, or otherwise enter into non-arms length transactions, between members of the MPM Group and the MSC Group. Such agreements also contain restrictive covenants that impose significant restrictions on the ability to pay dividends and make other distributions from MPM to MPM Holdings, from MSC to MSC Holdings, and from each of MPM Holdings and MSC Holdings to Momentive. As a result of these covenants, we are limited in the manner in which we conduct our business, and we may be unable to engage in favorable business activities or finance future operations or capital needs.

In addition, at any time that loans or letters of credit are outstanding and not cash collateralized thereunder, the agreements governing our revolving credit facilities, which are part of our separate senior secured credit facilities for MPM and MSC, require us to maintain a specified leverage ratio. At December 31, 2010, we were in compliance with our leverage ratio maintenance covenants set forth in our senior secured credit facilities. If business conditions weaken, we may not comply with our leverage ratio covenants for future periods. If we are at risk of failing to comply with a leverage ratio covenant, we would pursue additional cost saving actions, restructuring initiatives or other business or capital structure optimization measures available to us to remain in compliance with these covenants, but any such measures may be unsuccessful or may be insufficient to maintain compliance with our leverage ratio covenants.

A failure to comply with the covenants contained in our senior secured credit facilities, the indentures governing notes issued or guaranteed by our subsidiaries or their other existing indebtedness could result in an

 

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event of default under the existing agreements that, if not cured or waived, would have a material adverse effect on our business, financial condition and results of operations.

In particular, a breach of a leverage ratio covenant would result in an event of default under the applicable revolving credit facility. Pursuant to the terms of the applicable credit agreement for such facility, we have the right but not the obligation to cure such default through the purchase of additional equity in MPM or MSC (as the case may be) in up to three of any four consecutive quarters. If a breach of a leverage ratio covenant is not cured or waived, or if any other event of default under a senior secured credit facility occurs, the lenders under such credit agreement:

 

   

would not be required to lend any additional amounts to us;

 

   

could elect to declare all borrowings outstanding under such revolving credit facility, together with accrued and unpaid interest and fees, due and payable and could demand cash collateral for all letters of credit issued thereunder;

 

   

could elect to declare all borrowings outstanding under the term loan facilities, together with accrued and unpaid interest and fees, due and payable and, in the case of MPM’s facility, could demand cash collateral for all letters of credit issued under the synthetic letter of credit facility (provided that, if triggered by a breach of the leverage ratio covenant, certain other conditions are met);

 

   

could require us to apply all of our available cash to repay these borrowings; and/or

 

   

could prevent us from making payments on our notes;

any or all of which could result in an event of default under our notes.

If the indebtedness under our senior secured credit facilities or our existing notes were to be accelerated after an event of default, our respective assets may be insufficient to repay such indebtedness in full and our lenders could foreclose on the assets pledged under the applicable facility. Under these circumstances, a refinancing or additional financing may not be obtainable on acceptable terms, or at all, and we may be forced to explore a restructuring.

In addition the terms governing our indebtedness limit our ability to sell assets and also restrict the use of proceeds from that sale, including restrictions on transfers from MPM to MSC and vice versa. Our subsidiaries may be unable to sell assets quickly enough or for sufficient amounts to enable them to meet their obligations. Furthermore, a substantial portion of our assets are, and may continue to be, intangible assets. Therefore, it may be difficult for us to pay our consolidated debt obligations in the event of an acceleration of any of their consolidated indebtedness.

Our operating subsidiaries may be unable to generate sufficient cash flow from operations to pay dividends or distributions to their respective holding companies in amounts sufficient for them to pay their debt.

Momentive’s direct subsidiary holding companies each have incurred substantial indebtedness, and likely will need to rely upon distributions from their respective separate subsidiaries to pay such indebtedness. As of December 31, 2010, the aggregate principal amount outstanding of MPM Holdings’ PIK notes due 2017 was $611 million. These notes accrue interest in-kind until maturity. As of December 31, 2010, the aggregate principal amount outstanding of MSC Holdings’ term loans was $208 million. These notes accrue interest in-kind until maturity if elected by MSC Holdings.

Our operating subsidiaries may not generate sufficient cash flow from operations to pay dividends or distributions to their respective holding companies in amounts sufficient to allow such holding companies to pay principal and cash interest on their respective debt upon maturity. In addition, the ability of our operating subsidiaries to make distributions to their respective holding companies are subject to restrictions in their various respective debt instruments. If either of our direct subsidiary holding companies is unable to meet its respective

 

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debt service obligations, they could attempt to restructure or refinance their indebtedness or seek additional equity capital. They may be unable to accomplish these actions on satisfactory terms, if at all. A default under either of our direct subsidiary holding company’s debt instruments could lead to a change of control under their respective subsidiaries’ other debt instruments and lead to an acceleration of all outstanding loans under their respective subsidiaries’ senior secured credit facilities and other indebtedness.

Repayment of our subsidiaries’ debt, including required principal and interest payments, depends on cash flow generated by their respective subsidiaries, which may be subject to limitations beyond our control.

Our indirect subsidiaries own a significant portion of our consolidated assets and conduct a significant portion of our consolidated operations. Repayment of the indebtedness of our subsidiaries depends, to a significant extent, on the separate generation of cash flow and the ability of their respective subsidiaries to make cash available by dividend, debt repayment or otherwise. These subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments on indebtedness. Each subsidiary is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit the ability of the obligors with respect to such debt to obtain cash from their respective subsidiaries. While there are limitations on the ability of our subsidiaries to incur consensual restrictions on their ability to pay dividends or make intercompany payments, these limitations are subject to certain qualifications and exceptions. In the event that certain of our subsidiaries with indebtedness are unable to receive distributions from their respective subsidiaries, they may be unable to make required principal and interest payments on their respective indebtedness.

A downgrade in our debt ratings could restrict our access to, and negatively impact the terms of, current or future financings or trade credit.

Standard & Poor’s Ratings Services and Moody’s Investors Service maintain credit ratings on each of MPM and MSC and certain of their debt. Each of these ratings is currently below investment grade. Any decision by these ratings agencies to downgrade such ratings or put them on negative watch in the future could restrict our or their access to, and negatively impact the terms of, current or future financings and trade credit extended by our or their suppliers of raw materials or other vendors.

Risks Related to Our Common Stock and this Offering

There is no existing market for our common stock and we do not know if one will develop, which could impede your ability to sell your shares and depress the market price of our common stock.

There has not been a public market for our common stock prior to this offering. We cannot predict the extent to which investor interest in us will lead to the development of an active trading market or otherwise or how liquid that market might become. If an active trading market does not develop, you may have difficulty selling any of our common stock that you buy. The initial public offering price for the common stock will be determined by negotiations between us and the underwriters and may not be indicative of prices that will prevail in the open market following this offering. See “Underwriting.” Consequently, you may be unable to sell our common stock at prices equal to or greater than the price you pay in this offering.

Apollo controls us and its interests may conflict with or differ from your interests as a stockholder.

After the consummation of this offering, Apollo will beneficially own approximately     % of our common stock, assuming the underwriters do not exercise their option to purchase additional shares (or     % if the underwriters exercise their option in full). In addition, representatives of Apollo comprise six of our thirteen directors. As a result, Apollo will continue to have the ability to prevent any transaction that requires the approval of our board of directors or stockholders, including the approval of significant corporate transactions such as mergers and the sale of substantially all of our assets.

 

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In addition, we have an executive committee that serves at the discretion of our Board and is authorized to take such actions as it reasonably determines appropriate. Currently, the executive committee, which may act by a majority of its members, is controlled by Apollo. See “Management — Executive Committee” for a further discussion.

The interests of Apollo could conflict with or differ from your interests as a holder of our common stock. For example, the concentration of ownership held by Apollo could delay, defer or prevent a change of control of us or impede a merger, takeover or other business combination that you as a stockholder may otherwise view favorably. Apollo is in the business of making or advising on investments in companies and holds, and may from time to time in the future acquire, interests in or provide advice to businesses that directly or indirectly compete with certain portions of our business or are suppliers or customers of ours. They may also pursue acquisitions that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us.

So long as Apollo continues to indirectly own a significant amount of our equity, even if such amount is less than 50%, they will continue to be able to strongly influence or effectively control our decisions.

We will be a “controlled company” within the meaning of the                      rules and, as a result, will qualify for, and intend to rely on, exemptions from certain corporate governance requirements.

Upon the closing of this offering, Apollo will continue to control a majority of our voting common stock. As a result, we are a “controlled company” within the meaning of              corporate governance standards. Under                      rules, a company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain              corporate governance requirements, including:

 

   

the requirement that a majority of the board of directors consists of independent directors;

 

   

the requirement that we have a nominating/governance committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities;

 

   

the requirement that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

   

the requirement for an annual performance evaluation of the nominating/governance and compensation committees.

Following this offering, we intend to utilize the exemptions from                     corporate governance requirements, including the foregoing. As a result, we will not have a majority of independent directors nor will our nominating/governance and compensation committees consist entirely of independent directors and we will not be required to have an annual performance evaluation of the nominating/governance and compensation committees. See “Management.” Accordingly, you will not have the same protections afforded to stockholders of companies that are subject to all corporate governance requirements.

The price of our common stock may fluctuate significantly and you could lose all or part of your investment.

Volatility in the market price of our common stock price may prevent you from being able to sell your common stock at or above the price you paid for your common stock. The market price for our common stock could fluctuate significantly for various reasons, including but not limited to:

 

   

our operating and financial performance and prospects;

 

   

our quarterly or annual earnings or those of other companies in our industry;

 

   

conditions that impact demand for our products and services;

 

   

future announcements concerning our business or our competitors’ businesses;

 

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the public’s reaction to our press releases, other public announcements and filings with the U.S. Securities and Exchange Commission, or SEC;

 

   

changes in earnings estimates or recommendations by securities analysts who track our common stock;

 

   

market and industry perception of our success, or lack thereof, in pursuing our growth strategy;

 

   

strategic actions by us or our competitors, such as acquisitions or restructurings;

 

   

changes in government and environmental regulation;

 

   

general market, economic and political conditions;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

arrival and departure of key personnel;

 

   

the number of shares to be publicly traded after this offering;

 

   

sales of common stock by us, Apollo or its affiliated funds or members of our management team;

 

   

adverse resolution of new or pending litigation against us; and

 

   

changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural disasters, terrorist attacks, acts of war and responses to such events.

In addition, the stock market has experienced significant price and volume fluctuations in recent years. This volatility has had a significant impact on the market price of securities issued by many companies, including companies in our industries. The changes frequently appear to occur without regard to the operating performance of the affected companies. Hence, the price of our common stock could fluctuate based upon factors that have little or nothing to do with us, and these fluctuations could materially reduce our share price.

We have no plans to pay regular dividends on our common stock, so you may not receive funds without selling your common stock.

We have no plans to pay regular dividends on our common stock. Any payment of future dividends will be at the discretion of our board of directors and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends, and other considerations that our board of directors deems relevant. The terms governing our subsidiaries’ outstanding debt also include limitations on the ability of our subsidiaries to pay dividends to us. Accordingly, you may have to sell some or all of your common stock in order to generate cash flow from your investment.

Future sales or the possibility of future sales of a substantial amount of our common stock may depress the price of shares of our common stock.

We may sell additional shares of common stock in subsequent public offerings or otherwise, including to finance acquisitions. We have                  authorized shares of common stock, of which              shares will be outstanding upon consummation of this offering. This number includes shares that we are selling in this offering, which may be resold immediately in the public market. Of the remaining shares,                 , or     %, are restricted from immediate resale under the federal securities laws and the lock-up agreements with the underwriters described in the “Underwriting” section of this prospectus, but may be sold into the market in the near future. These shares will become available for sale at various times following the expiration of the lock-up agreements, which, without the prior consent of                     , is      days after the date of this prospectus. Immediately after the expiration of the lock-up period, the shares will be eligible for resale under Rule 144 or Rule 701 of the Securities Act subject to volume limitations and applicable holding period requirements.

 

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We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares issued in connection with an acquisition), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock.

Our organizational documents may impede or discourage a takeover, which could deprive our investors of the opportunity to receive a premium for their shares.

Provisions of our certificate of incorporation and bylaws may make it more difficult for, or prevent a third party from, acquiring control of us without the approval of our board of directors. These provisions include:

 

   

establishing limitations on the removal of directors;

 

   

prohibiting cumulative voting in the election of directors;

 

   

empowering only the board to fill any vacancy on our board of directors, whether such vacancy occurs as a result of an increase in the number of directors or otherwise;

 

   

authorizing the issuance of “blank check” preferred stock without any need for action by stockholders;

 

   

eliminating the ability of stockholders to call special meetings of stockholders;

 

   

prohibiting stockholders to act by written consent if less than 50.1% of our outstanding common stock is controlled by Apollo;

 

   

establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings; and

 

   

waiver of Section 203 of the General Corporate Law of Delaware.

Our issuance of shares of preferred stock could delay or prevent a change of control of us. Our board of directors has the authority to cause us to issue, without any further vote or action by the stockholders, shares of preferred stock, par value $0.01 per share, in one or more series, to designate the number of shares constituting any series, and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, voting rights, rights and terms of redemption, redemption price or prices and liquidation preferences of such series. The issuance of shares of our preferred stock may have the effect of delaying, deferring or preventing a change in control without further action by the stockholders, even where stockholders are offered a premium for their shares.

Together, these charter and statutory provisions could make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock. Furthermore, the existence of the foregoing provisions, as well as the significant common stock beneficially owned by Apollo, could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of us, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.

You will experience an immediate and substantial dilution in the net tangible book value (deficit) of the common stock you purchase.

Prior investors have paid substantially less per share than the price in this offering. We will have a net tangible book deficit after this offering. Based on an assumed initial public offering price of $         per share, the midpoint of the estimated offering range set forth on the cover page of this prospectus, you will experience immediate and substantial dilution of approximately $         per share in net tangible book value (deficit) of the common stock you purchase in this offering. See “Dilution,” including the discussion of the effects on dilution from a change in the price of this offering.

 

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The additional requirements of having a class of publicly traded equity securities may strain our resources and distract management.

Even though two of our operating subsidiaries currently file reports with the SEC, after the consummation of this offering, we will be subject to additional reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank. Dodd-Frank, signed into law on July 21, 2010, effects comprehensive changes to the regulation of financial services in the United States and will subject us to additional federal regulation. We cannot predict with any certainty the requirements of the regulations ultimately adopted or how Dodd-Frank and such regulations will impact the cost of compliance for a company with publicly traded common stock. We are currently evaluating and monitoring developments with respect to Dodd-Frank and other new and proposed rules and cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed. We also expect that being a company with publicly traded common stock and these new rules and regulations will make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive officers.

The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures and internal control for financial reporting. These requirements may place a strain on our systems and resources. Under Section 404 of the Sarbanes-Oxley Act, we are currently required to include a report of management on our internal control over financial reporting in our Annual Reports on Form 10-K. After consummation of this offering, our independent public accountants auditing our financial statements must attest to the effectiveness of our internal control over financial reporting. This requirement will first apply to our Annual Report on Form 10-K for our year ending December 31, 2012. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight will be required. This may divert management’s attention from other business concerns, which could have a material adverse effect on our business, financial condition, results of operations and cash flows. If we are unable to conclude that our disclosure controls and procedures and internal control over financial reporting are effective, or if our independent public accounting firm is unable to provide us with an unqualified report as to management’s assessment of the effectiveness of our internal control over financial reporting in future years, investors may lose confidence in our financial reports and our stock price may decline.

 

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CAUTIONARY STATEMENTS CONCERNING FORWARD-LOOKING STATEMENTS

This prospectus contains “forward-looking statements” within the meaning of the federal securities laws, which involve substantial risks and uncertainties. You can identify forward-looking statements because they contain words such as “believes,” “projects,” “might,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates,” or “anticipates” or similar expressions that concern our strategy, plans or intentions. All statements we make in this prospectus relating to our estimated and projected revenue, margins, costs, expenditures, cash flows, growth rates, financial results, and prospects are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may change at any time, and, therefore, our actual results may differ materially from those we expect. We derive many of our forward-looking statements from our operating budgets and forecasts, which we base upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that 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.

We disclose important factors that could cause actual results to differ materially from our expectations under “Risk Factors” and elsewhere in this prospectus, including, without limitation, in conjunction with the forward-looking statements included in this prospectus. Some of the factors that we believe could affect our revenue, margins, costs, expenditures, cash flows, growth rates, financial results, business, condition and prospects include:

 

   

global economic conditions;

 

   

raw material costs and supply availability;

 

   

environmental regulations and related compliance and litigation costs;

 

   

litigation costs;

 

   

manufacturing regulations and related compliance and litigation costs;

 

   

risks associated with international operations;

 

   

foreign currency fluctuations;

 

   

rising energy costs;

 

   

increased competition;

 

   

the success of our strategic initiatives;

 

   

our holding company structure;

 

   

intellectual property protection and litigation;

 

   

our reliance on our key executives;

 

   

relations and costs associated with our workforce;

 

   

our pension liabilities;

 

   

natural disasters, acts of war, terrorism and other acts beyond our control;

 

   

the impact of our substantial indebtedness;

 

   

our incurring additional debt;

 

   

acquisitions, divestitures and joint ventures that we may pursue;

 

   

restrictive covenants related to our indebtedness; and

 

   

other factors presented under the heading “Risk Factors.”

We caution you that the foregoing list of important factors may not contain all of the material factors that are important to you. In addition, in light of these risks and uncertainties, the matters referred to in the forward-looking statements contained in this prospectus may not in fact occur. 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 required by law.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of the common stock that we are offering will be approximately $         million, based on an assumed initial public offering price of $         per share, which is the midpoint of the estimated offering range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. Our net proceeds will increase by approximately $         million if the underwriters exercise in full their option to purchase additional shares from us. Each $1.00 increase (decrease) in the assumed initial public offering price of $         per share, which is the midpoint of the estimated offering range set forth on the cover page of this prospectus, would increase (decrease) the net proceeds to us of this offering by approximately $         million, assuming the number of shares offered by us, as listed on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The principal purposes of this offering are to obtain additional capital, create a public market for our common stock and to facilitate our future access to the public equity markets.

We intend to use the net proceeds from our sale of shares of common stock in this offering for general corporate purposes.

 

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DIVIDEND POLICY

We do not currently anticipate paying any dividends on our common stock in the foreseeable future. Any future determination as to our dividend policy will be made at the discretion of our board of directors and will depend upon many factors, including our financial condition, earnings, business opportunities, legal requirements, restrictions in our debt agreements and other contracts, and other factors our board of directors deems relevant. The terms of the indebtedness of our subsidiaries may also restrict them from paying cash dividends to us. See “Description of Certain Indebtedness” and “Description of Capital Stock—Common Stock.”

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of December 31, 2010:

 

   

on an actual basis; and

 

   

on a pro forma as adjusted basis to reflect                      and the sale                      of              shares of common stock by us in this offering at an assumed initial public offering price of $             per share, the midpoint of the estimated offering range set forth on the cover of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

You should read this table in conjunction with our consolidated financial statements and related notes and the sections entitled “Selected Historical Financial Data,” “Unaudited Pro Forma Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Use of Proceeds,” and “Description of Capital Stock” appearing elsewhere in this prospectus.

 

     As of December 31, 2010  
     Actual     Pro Forma As
Adjusted
 
     (in millions)  

Cash and cash equivalents

   $ 450      $                
                

Debt:

    

MPM and MSC senior secured credit facilities

     2,349     

MSC senior secured notes

     1,657     

MSC senior unsecured debentures

     261     

MPM senior notes

     1,532     

MPM senior subordinated notes

     379     

MSC Holdings unsecured PIK term loan

     172     

MPM Holdings PIK notes

     611     

MSC borrowings from Apollo affiliates

     104     

Other debt and capital leases

     206     
                

Total debt

     7,271     
                

Deficit:

    

Members’ Deficit

     (1,075  

Accumulated other comprehensive income

     252     
                

Total Momentive deficit

     (823  

Noncontrolling interest

     6     
                

Total deficit

     (817  
                

Total capitalization

   $ 6,454      $     
                

 

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DILUTION

If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of common stock you pay and the as adjusted net tangible book value deficit per share of our common stock after this offering. Our net tangible book deficit as of December 31, 2010 was $4,249 million, or $             per share of common stock. We calculate net tangible book deficit per share by calculating the total assets less goodwill and other intangible assets and total liabilities, and dividing by the number of shares of common stock outstanding prior to this offering.

Net tangible book deficit dilution per share represents the difference between the amount per share paid by new investors who purchase shares from us in this offering and the as adjusted net tangible book deficit per share of common stock immediately after completion of this offering. As of December 31, 2010, after giving effect to the application of the estimated net proceeds to us in this offering as described under “Use of Proceeds,” our as adjusted net tangible book deficit would have been $         million, or $         per share, assuming that the shares offered under this prospectus are sold at a public offering price of $         per share, the midpoint of the estimated offering range set forth on the cover page of this prospectus. This represents an immediate decrease in net tangible book deficit of $         per share to existing stockholders, and an immediate dilution in net tangible book value (deficit) of $         per share to new investors in the offering. The table below illustrates this per share dilution as of December 31, 2010:

 

            Per Share  

Assumed initial public offering price per share

      $     

Net tangible book deficit as of December 31, 2010

   $ 4,249      

Increase attributable to new investors

   $        
           

Pro forma net tangible book deficit as adjusted to give effect to this offering

      $                
           

Dilution in pro forma net tangible book value (deficit) to new investors in this offering

      $     
           

A $1.00 increase (decrease) in the assumed public offering price of $         per share would increase (decrease) our as adjusted net tangible book value per share after this offering by $        , and the dilution to new investors by $         per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

If the underwriters exercise their over-allotment option in full, our as adjusted net tangible book value will increase to $         per share, representing an increase to existing holders of $         per share, and there will be an immediate dilution of $         per share to new investors.

The following table sets forth, on an as adjusted basis as of December 31, 2010, the number of shares of common stock purchased or to be purchased from us, the total consideration paid or to be paid and the average price per share paid or to be paid by existing holders of common stock and by new investors, at an assumed initial public offering price of $         per share, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

     Shares Purchased     Total Consideration     Average Price
Per Share
 
     Number      Percent     Amount
(In Millions)
     Percent    

Existing stockholders

               $                             $                

New investors

            
                                          

Total

               $                  $     
                                          

 

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To the extent any options to purchase shares of common stock are granted or exercised, the warrant held by GE Capital Equity is exercised, Apollo purchases preferred stock that is redeemed with the redemption price being paid in common stock, or Apollo exercises its warrants, or the underwriters exercise their over-allotment option, there will be further dilution to new investors.

 

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SELECTED HISTORICAL FINANCIAL DATA

The following table presents certain of our selected historical financial data. The selected historical financial and other financial data as of December 31, 2009 and 2010 and for the years ended December 31, 2008, 2009 and 2010 have been derived from our audited consolidated financial statements, included elsewhere in this prospectus. The financial data as of December 31, 2008, 2007 and 2006 and for the years ended December 31, 2007 and 2006 have been derived from our audited consolidated or combined financial statements and related notes thereto.

The Momentive Combination has been accounted for as a business combination and MPM Holdings has been identified as the accounting acquiror and predecessor entity to the formation of Momentive. Therefore, the historical financial data includes the historical financial data of MPM Holdings prior to the Momentive Combination in 2010 and for the years ended December 31, 2009, 2008, 2007 and 2006 and as of December 31, 2009, 2008, 2007 and 2006. The selected historical financial data as of and for the year ended December 31, 2010 includes MSC Holdings since the acquisition date of October 1, 2010, the date of the Momentive Combination. The period from January 1, 2006 to December 3, 2006 includes the accounts of the businesses acquired from GE, which we refer to as the MPM Formation. The period from December 4, 2006 to December 31, 2006 includes our accounts after the MPM Formation. These two periods are combined to account for our year ended December 31, 2006 and are considered a non-US GAAP presentation. We refer to the financial statements prior to the MPM Formation as “Predecessor” and those subsequent to the MPM Formation as “Successor.” As a result of the application of purchase accounting as of the date of the MPM Formation, the financial information for the Successor period and Predecessor periods are presented on different bases and are, therefore, not comparable.

You should read the selected historical financial data in conjunction with all of the historical financial statements and related notes and other financial information included elsewhere in this prospectus, including information contained in “Unaudited Pro Forma Financial Data,” “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Risk Factors.”

 

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    Predecessor     Successor     Combined
Predecessor
and
Successor
    Successor  

(In millions)

  Period from
January 1,
2006 through
December 3,
2006
    Period from
December 4,
2006 through
December 31,
2006
    Year ended
December 31,
2006 (5)
    Year ended December 31,  
        2007     2008     2009     2010 (1)  

Statements of Operations

               

Net sales

  $ 2,168      $ 246      $ 2,414      $ 2,538      $ 2,639      $ 2,083      $ 3,806   

Cost of sales

    1,513        205        1,718        1,874        2,016        1,564        2,914   
                                                       

Gross profit

    655        41        696        664        623        519        892   

Selling, general and administrative expense

    419        33        452        463        482        393        521   

Research and development and technical services expense

    73        59        132        79        76        63        88   

Asset impairments

    —          —          —          —          857        —          9   

Business realignment costs

    11        —          11        40        45        23        29   

Other operating expense, net

    —          —          —          —          —          —          8   
                                                       

Operating income (loss)

    152        (51     101        82        (837     40        237   

Interest expense, net

    12        25        37        327        328        314        391   

(Gain) loss on extinguishment of debt

    —          —          —          —          —          (179     85   

Other non-operating expense (income), net

    4        —          4        20        (7     (12     (7
                                                       

Income (loss) from continuing operations before income tax and earnings from unconsolidated entities

    136        (76     60        (265     (1,158     (83     (232

Income tax expense (benefit)

    58        (2     56        35        (111     15        (8
                                                       

Income (loss) from continuing operations before earnings from unconsolidated entities

    78        (74     4        (300     (1,047     (98     (224

Earnings from unconsolidated entities, net of taxes

    —          —          —          —          —          —          2   
                                                       

Income (loss) from continuing operations

    78        (74     4        (300     (1,047     (98     (222

Net loss from discontinued operations, net of taxes (2)

    —          —          —          —          —          —          (8
                                                       

Net income (loss)

    78        (74     4        (300     (1,047     (98     (230

Net income attributable to non-controlling interest

    (44     —          (44     —          —          —          (1
                                                       

Net income (loss) attributable to Momentive Performance Materials Holdings LLC

    34        (74     (40     (300     (1,047     (98     (231

Accretion of dividends on committed preferred units

    —          —          —          —          —          —          (3
                                                       

Net loss attributable to common unit holders

  $ 34      $ (74   $ (40   $ (300   $ (1,047   $ (98   $ (234
                                                       

Loss per share from continuing operations—basic and diluted

      $ (4.80     $ (1.53   $ (5.30   $ (0.50   $ (1.03
                                             

Cash Flows (used in) provided by

               

Operating activities

  $ (201   $ 100      $ (101   $ 301      $ 77      $ 27      $ 383   

Investing activities

    (244     (3,726     (3,970     (240     (149     (80     (20

Financing activities

    40        3,799        3,839        31        170        (70     (133
 

Balance Sheet Data (at end of period)

               

Cash and cash equivalents

      $ 198        $ 257      $ 349      $ 220      $ 450   

Short-term investments

        —            —          —          —          6   

Working capital (3)

        543          340        270        177        587   

Total assets

        4,418          4,455        3,593        3,316        8,777   

Total debt

        3,363          3,513        3,724        3,601        7,271   

Total debt, excluding debt with controlling interest holder

        3,363          3,513        3,724        3,601        7,167   

Total net debt (4)

        3,167          3,261        3,382        3,381        6,815   

Total liabilities

        4,232          4,565        4,617        4,433        9,590   

Stock options exercisable in redeemable units

        —            —          —          —          4   

Total equity (deficit)

        186          (110     (1,024     (1,117     (817

 

(1) Includes the results of MSC Holdings from the date of its acquisition of October 1, 2010 as a result of the Momentive Combination.

 

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(2) Net loss from discontinued operations for the year ended December 31, 2010 reflects the IAR divestiture.

 

(3) We define working capital as current assets (excluding cash and cash equivalents) less current liabilities. As of December 31, 2010, the net assets and liabilities of the IAR business, of $135 million, have been classified as current.

 

(4) Net debt is defined as long-term debt plus short-term debt less cash and cash equivalents and short-term investments.

 

(5) For comparison purposes, the financial information for December 31, 2007, 2008, 2009 and 2010 are presented on a consolidated basis; the year ended December 31, 2006 is presented on a non-U.S. GAAP basis, as it combines the historical financial information of our predecessor for the period from January 1, 2006 to December 3, 2006, and the financial information of the successor for the period from December 4, 2006 to December 31, 2006. The Predecessor and Successor use different accounting bases and methods.

 

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UNAUDITED PRO FORMA FINANCIAL DATA

The following unaudited pro forma condensed combined statement of operations has been prepared by applying the pro forma adjustments, as described below, to our historical audited financial statements included elsewhere in this prospectus. Our audited statement of operations for the year ended December 31, 2010 includes MSC Holdings from the date of the Momentive Combination on October 1, 2010 through December 31, 2010. The historical financial statements of MSC Holdings through the date of the Momentive Combination are included elsewhere in this prospectus as MSC Holdings represents a significant acquisition.

The unaudited pro forma condensed combined statement of operations for the year ended December 31, 2010 gives pro forma effect to the following transactions as if they occurred on January 1, 2010:

 

   

full year of results of operations of MSC Holdings, including purchase price allocation adjustments as a result of the Momentive Combination;

 

   

the IAR Divestiture;

 

   

the Debt Refinancing Transactions; and supplementally

 

   

the sale of the common stock offered by this prospectus and the use of the net sale proceeds as described in “Use of Proceeds.”

Pro forma adjustments for the Momentive Combination were made to reflect:

 

   

increases in depreciation and amortization expense resulting from fair value adjustments to net tangible assets and amortization expense related to amortizable intangible assets in connection with the Momentive Combination; and

 

   

increases in interest expense resulting from amortization of debt discounts/premiums resulting from fair value adjustments to our long-term debt.

An unaudited pro forma balance sheet has not been presented, as MSC Holdings has been consolidated in our historical audited consolidated balance sheet as of December 31, 2010 and the February 2011 MPM Credit Agreement Amendment has been deemed immaterial to the unaudited pro forma balance sheet. The pending coatings and composites divestiture is not considered a significant divestiture.

The unaudited pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable and directly attributable to the respective transaction, factually supportable and expected to have a continuing impact on our future results. The unaudited pro forma condensed combined financial information has been prepared by management for illustrative purposes only and are not necessarily indicative of the combined results of operations that would have been realized had the transactions occurred on January 1, 2010.

You should read the unaudited pro forma financial information and the accompanying notes in conjunction with our historical audited financial statements and related notes and other financial information included elsewhere in this prospectus, including information contained in “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Risk Factors.”

 

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Momentive Performance Materials Holdings LLC

Unaudited Pro Forma Condensed Combined Statement of Operations

For the Year Ended December 31, 2010

 

    Actuals                                            
    Momentive     MSC
Holdings
                                           

(In millions, except
share data)

  Year Ended
December 31,
2010
    Nine Months
Ended
September 30,
2010 (1)
    Momentive
Combination
(2)
    IAR
Divestiture
(3)
    Pro Forma for
Momentive
Combination
and IAR
Divestiture
    Debt
Refinancing
Transactions
(4)
    Pro Forma
Prior to
This
Offering
    This
Offering
    Pro Forma
As
Adjusted
 

Net sales

  $ 3,806      $ 3,852      $ —        $ (252   $ 7,406      $ —        $ 7,406       

Cost of sales

    2,914        3,267        (56 )(a)      (223     5,902        —          5,902       
                                                           

Gross profit

    892        585        56        (29     1,504        —          1,504       

Selling, general and administrative expense

    521        246        31 (b)      (16     782        —          782       

Research and development and technical services expense

    88        46        —          (3     131        —          131       

Asset impairments

    9        —          —          —          9        —          9       

Business realignment costs

    29        17        —          (1     45        —          45       

Other operating expense (income), net

    8        (90     86 (c)      —          4        —          4       
                                                           

Operating income (loss)

    237        366        (61     (9     533        —          533       

Interest expense, net

    391        220        18 (d)      —          629        9 (a)      638       

Loss on extinguishment of debt

    85        7        —          —          92        (92 )(b)      —         

Other non-operating (income) expense, net

    (7     2        —          (1     (6     —          (6    
                                                           

(Loss) income from continuing operations before income tax and earnings from unconsolidated entities

    (232     137        (79     (8     (182     83        (99    

Income tax (benefit) expense

    (8     22        —   (e)      (2     12        —   (a)(b)      12       
                                                           

(Loss) income from continuing operations before earnings from unconsolidated entities

    (224     115        (79     (6     (194     83        (111    

Earnings from unconsolidated entities, net of taxes

    2        6        —          —          8        —          8       
                                                           

Net (loss) income from continuing operations

  $ (222   $ 121      $ (79   $ (6   $ (186   $ 83      $ (103    
                                                           

Weighted average common shares outstanding—basic and diluted

    218,232,313                  279,514,962       

Loss per share from continuing operations—basic and diluted

  $ (1.03             $ (0.37    

 

(1)

Represents the unaudited Condensed Statement of Operations of the acquiree, MSC Holdings, as reported for the nine months ended September 30, 2010. MSC Holdings was acquired as a result of the Momentive Combination on October 1, 2010. The consideration transferred was in the form of newly-issued shares of member units of Momentive in exchange for the outstanding units in MSC Holdings. The allocation of the consideration

 

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transferred was based upon the fair value of MSC Holdings net identifiable assets and liabilities as of the acquisition date. See Note 3 to our historical audited consolidated financial statements included elsewhere in this prospectus for the allocation of the purchase price and resulting goodwill.

 

(2) Reflects the following adjustments to record the pro forma effects of purchase accounting adjustments related to the Momentive Combination:

 

  (a) Reflects an increase of $9 million in depreciation expense resulting from the estimated fair value adjustments to certain property and equipment. Also reflects an adjustment to amortization expense resulting from the estimated fair value adjustments made to certain amortizable intangible assets.

 

(In millions)

   Weighted
Average Useful
Life (in years)
     Estimated Fair
Value
     Amortization  

Technology

     14       $ 304       $ 16   

Land rights

     26         59         2   
                    

Total identifiable intangible assets

     16       $ 363         18   
              

Historical intangible amortization

           (16
              

Net pro forma change in amortization

         $ 2   
              

Also reflects an adjustment to eliminate the $67 million non-recurring write-up of inventory in connection with purchase price allocation for the Momentive Combination.

 

  (b) Reflects an increase of less than $1 million in depreciation expense resulting from the estimated fair value adjustments to certain property and equipment. Also reflects an adjustment to amortization expense resulting from the estimated fair value adjustments made to certain amortizable intangible assets.

 

(In millions)

   Weighted
Average Useful
Life (in years)
     Estimated Fair
Value
     Amortization  

Customer relationships

     16       $ 871       $ 40   

Tradenames

     19         149         6   
                    

Total identifiable intangible assets

     17       $ 1,020         46   
              

Historical intangible amortization

           (15
              

Net pro forma change in amortization

         $ 31   
              

 

  (c) Reflects an adjustment to remove amortization of deferred revenue from other operating expenses for which no value was assigned as part of the purchase price allocation. Also reflects an adjustment to remove the non cash push-down of insurance recoveries of MSC’s owner associated with the non-cash push-down of expense that was treated as an expense of MSC Holdings in 2008, prior to the Momentive Combination. Due to the change in control and resulting change in accounting basis as a direct result of the Momentive Combination, the non-cash push-down of insurance recoveries associated with the previous principal shareholder has been removed.

 

(In millions)

      

Non-cash push-down of income recovered by owner

   $ 83   

Historical deferred revenue amortization

     3   
        

Net pro forma change in other

   $ 86   
        

 

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  (d) Reflects an adjustment to remove deferred financing fee amortization and increase debt discount amortization resulting from fair value adjustments to our long-term debt, in millions:

 

Historical deferred financing fee amortization

   $ (6

Historical debt discount amortization

     (3

New debt discount amortization

     27   
        

Net pro forma change in amortization

   $ 18   
        

 

  (e) The appropriate statutory tax rate of the respective tax jurisdictions to which the pro forma adjustments relate and which are reasonably expected to occur have been applied. The effective tax rate of the combined company could be significantly different depending on post-acquisition integration activities, including repatriation decisions, cash needs, and the geographical mix of taxable income.

 

(3) Reflects the adjustments to remove the results of the IAR business included in the unaudited Condensed Statement of Operations of MSC Holdings for the nine months ended September 30, 2010.

 

(4) Reflects the following adjustments to record the pro forma effects of the Debt Refinancing Transactions:

 

  (a) Represents the change in net interest expense related to the new debt, the extension of maturities of term loans under our senior secured credit facilities and the settlement of existing debt as part of the November Refinancing Transactions, in millions:

 

Refinanced debt:

  

MPM senior secured credit facilities

   $ 41   

MPM 9.0% springing lien dollar notes due 2021

     99   

MPM 9.5% springing lien euro notes due 2021

     18   

MSC senior secured credit facilities

     56   

MSC 8.875% senior secured notes due 2018

     89   

MSC 9.0% second-priority senior secured notes due 2020

     52   

Existing debt:

  

MPM senior notes

     25   

MPM senior subordinated notes

     44   

MSC floating rate second-priority senior secured notes

     6   

MSC senior unsecured debentures

     27   

Other debt and capital leases

     33   

Affiliated debt

     63   

Revolver commitment fee

     8   

Interest rate swaps

     27   

Amortization of deferred debt issuance costs and discount

     50   
        

Total

     638   

Historic interest expense

     (629
        

Net pro forma change in interest

   $ 9   
        

The pro forma adjustments were calculated using one month and three month U.S. LIBOR rates of 0.23% and 0.29%, respectively, and one month and three month Euribor rates of 1.08% and 1.29%, respectively, per annum as of April 8, 2011. Each one-eighth point change in the assumed interest rates would result in a $3 million change in annual interest expense. As a result of both MPM’s and MSC’s existing income tax loss carry-forwards in the U.S., for which full valuation allowances have been provided, no deferred income taxes have been established, and no income tax has been provided related to the pro forma adjustments in connection with the Debt Refinancing Transactions, as these all occur in the U.S.

 

  (b) Reflects the adjustment to eliminate the extinguishment loss related to the Debt Refinancing Transactions. Similar to interest expense on the new and refinanced debt there are no pro forma tax effects on the extinguishment losses because the jurisdictions to which these relate carry full valuation allowances.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with “Selected Historical Financial Data,” “Unaudited Pro Forma Financial Data,” and our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion and analysis of our business, financial condition and results of operations includes forward-looking statements based upon current expectations that involve substantial risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements for many reasons, including those set forth under the caption “Risk Factors” or in other parts of this prospectus.

The purpose of the following discussion is to provide relevant information to investors who use our financial statements so they can assess our financial condition and results of operations by evaluating the amounts and certainty of cash flows from our operations and from outside sources. The three principal objectives of Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, are: to provide a narrative explanation of financial statements that enables investors to see our company through the eyes of management; to enhance overall financial disclosure and provide the context within which financial information should be analyzed; and to provide information about the quality and potential variability of earnings and cash flows so that investors can judge the likelihood that past performance is indicative of future performance.

We present MD&A in seven sections: Overview and Outlook, Supplemental Pro Forma Results of Operations, Historical Results of Operations, Liquidity and Capital Resources, Critical Accounting Policies and Estimates, Recently Issued Accounting Standards and Qualitative and Quantitative Disclosures About Market Risk.

Overview and Outlook

Momentive Combination

Momentive was formed on October 1, 2010 through the Momentive Combination and is the ultimate parent of MPM and MSC. In connection with the closing of the Momentive Combination, MPM and MSC entered into a shared services agreement, as amended on March 17, 2011, pursuant to which they will provide each other 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. As a result, we expect that the Momentive Combination, including the shared services agreement, will result in significant synergies for us, including logistics optimization, best-of-source contractual terms, procurement savings, regional site rationalization, technology development, and administrative and overhead savings. We expect to achieve a total of approximately $100 million of cost savings in connection with the shared services agreement. Through December 31, 2010, we realized $13 million of these savings on a run-rate basis, and anticipate fully realizing the remaining anticipated savings over the next 18 to 24 months.

Matters Impacting Comparability of Results

Our results of operations include MSC Holdings since our deemed acquisition of MSC Holdings on October 1, 2010 as a result of the Momentive Combination. Due to the inclusion of MSC Holdings’ results since October 1, 2010, the results for the years ended December 31, 2010 to 2009 and 2008 are not comparable.

Therefore, we have supplemented our selected historical financial data with pro forma financial data for the years ended December 31, 2010, 2009 and 2008, which give effect to the Momentive Combination, including the purchase accounting adjustments related thereto, and the IAR Divestiture as if they had occurred on January 1, 2010, 2009 and 2008, respectively.

We believe presenting this supplemental pro forma financial information and discussion and analysis is beneficial to the reader because it provides a meaningful comparison of operating results enabling 2008 to be

 

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compared with 2009, and 2009 to be compared with 2010, adjusting for the impact of the Momentive Combination. This pro forma financial information also provides you with additional information from which to analyze our financial results and understand how our business will be operated on an ongoing basis. The pro forma effects of the Momentive Combination as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” do not include the $100 million of cost savings related to the shared services agreement between MSC and MPM.

You should read the unaudited pro forma financial information in conjunction with all of the historical financial statements and related notes and other financial information included elsewhere in this prospectus, including “—Historical Results of Operations” which follows “—Supplemental Pro Forma Results of Operations.”

Business Overview

We are one of the world’s largest manufacturers of specialty chemicals and materials, and a leader in the development and manufacture of thermoset resins, or thermosets, silicones and silicone derivatives, as well as a global leader in the development and manufacture of fused quartz and ceramic materials. 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. Silicones are a multi-functional family of materials used in a wide variety of products and industries, and are generally used as an additive to a wide variety of end products in order to provide or enhance certain of the attributes, such as resistance, lubrication, adhesion or viscosity. Quartz and specialty ceramics are used as a superior substitute for glass in a number of industries, including semiconductor, lamp tubing, manufacturing, packaging, cosmetics and fiber optics.

Our products are used in thousands of applications and are sold into diverse markets, such as aerospace, energy (wind energy and oil and gas applications), electronics, automotive, construction products, durable and non-durable consumer products, forest products, power generation, civil engineering, personal care products, agrochemicals, lubricant additives, and consumer and construction sealants. Major industry sectors that we serve include industrial/marine, construction, consumer/durable goods, automotive, transportation, agricultural, wind energy, aviation, electronics, architectural, civil engineering, graphic arts, oil and gas field development and support, healthcare and personal care. 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 14,000 customers in over 100 countries. Our global customers include large companies in their respective industries, such as 3M, BASF, Bayer, DuPont, GE, Goodyear, Honeywell, L’Oreal, Louisiana Pacific, Lowe’s, Motorola, Owens Corning, PPG Industries, Procter & Gamble, Sumitomo, The Home Depot, Unilever, Valspar, and Weyerhaeuser.

We are focused on shareholder value creation, cash flow generation and driving the long-term growth and sustainability of our global specialty chemicals and materials platform. We believe we can achieve these goals through the following integrated strategies:

Develop and market new products. We continue to expand our product offerings through research and development initiatives and research partnership formations with third parties. Through these innovation initiatives we continue to create new generations of products and services which will drive revenue and earnings growth. In pro forma 2010, we invested $131 million in research and development.

 

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Expand our global reach in faster growing regions. We intend to continue to grow internationally by expanding our product sales to our customers around the world. Specifically, we are focused on growing our business in markets in the high growth regions of Asia-Pacific, Eastern Europe, Latin America, India and the Middle East, where the usage of our products is increasing. Furthermore, by consolidating sales and distribution infrastructures via the Momentive Combination, we expect to accelerate the penetration of our high-end, value-added products into new markets, thus further leveraging our research and applications efforts and existing global footprint.

Increase shift to high-margin specialty products. We continue to proactively manage our product portfolio with a focus on specialty, high-margin applications and the reduction of our exposure to lower-margin products. As a result of this capital allocation strategy and strong end market growth underlying these specialty segments including wind energy and oilfield applications, they will continue to be a larger part of our broader portfolio. Consequently, we have witnessed a strong organic improvement in our profitability profile as a whole over the last several years which we believe will continue.

Continue portfolio optimization and pursue targeted add-on acquisitions and joint ventures. The specialty chemicals and materials market is comprised of numerous small and mid-sized specialty companies focused on niche markets, as well as smaller divisions of large chemical conglomerates. As one of the world’s largest manufacturers of specialty chemicals and materials with leadership in the production of thermosets, silicones and silicone derivatives, we have a significant advantage in pursuing add-on acquisitions and joint ventures in areas that allow us to build upon our core strengths, expand our product, technology and geographic portfolio, and better serve our customers. We believe we can consummate a number of these acquisitions at relatively attractive valuations due to the scalability of our existing global operations and deal-related synergies. In addition, we have and will continue to monitor the strategic landscape for opportunistic divestments consistent with our broader specialty strategy. For example, we recently completed the sale of our global inks and adhesive resins, or IAR business, which increased our profitability margins as a whole and will allow us to focus our financial resources towards growing specialty applications within our portfolio.

Capitalize on the Momentive Combination to grow revenues and realize operational efficiencies. We believe the Momentive Combination will present opportunities to increase our revenues by leveraging each of MPM’s and MSC’s respective global footprints and technology platforms. For instance, we anticipate being able to further penetrate MPM products into Latin America, where MSC has historically maintained a larger manufacturing and selling presence. Likewise, in Asia, where MPM generated 39% of its 2010 net sales, we anticipate being able to accelerate the penetration of MSC products, where the region accounted for 16% of MSC’s 2010 net sales. Further, we anticipate the Momentive Combination will provide opportunities to streamline our business and reduce our cost structure. We are currently targeting $100 million in annual cost savings related to the Momentive Combination. We anticipate these savings to come from logistics optimization, reduction in corporate expenses, and reductions in the costs for raw materials and other inputs. Through December 31, 2010 we implemented $13 million of these savings on a run-rate basis, and anticipate fully realizing the remaining anticipated savings over the next 18 to 24 months. We believe our management team has a strong track record in realizing cost savings as a result of business combinations. When MSC was formed in 2005 through the merger of four businesses totaling $4 billion of revenues, we initially announced a target of $75 million of merger-related synergies and ultimately achieved $175 million of merger-related cost reductions.

Generate free cash flow and deleverage. We expect to generate strong free cash flow due to our size, advantaged cost structure, and reasonable ongoing capital expenditure requirements. Furthermore, we have demonstrated expertise in managing our working capital, which has been further augmented as a result of our increased scale from the Momentive Combination. Our strategy of generating significant free cash flow and deleveraging is complimented by our long-dated capital structure with no near-term maturities and strong liquidity position. This financial flexibility allows us to prudently balance deleveraging with our focus on growth and innovation.

 

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Reportable Segments

Our business divisions and reportable segments are based on the products that we offer and the markets that we serve. At December 31, 2010, we had three primary reportable segments: Silicones and Quartz; Epoxy and Phenolic Resins; and Forest Products Resins. The major products of our primary reportable segments are as follows:

 

   

Silicones and Quartz: elastomers, silicone fluids, engineered materials, fused quartz and ceramic materials.

 

   

Epoxy and Phenolic Resins: epoxy specialty resins, oil field product applications, Versatic acids and derivatives, basic epoxy resins and intermediates, molding compounds and phenolic specialty resins.

 

   

Forest Products Resins: forest products resins and formaldehyde applications.

2010 Overview

 

   

As a result of the Momentive Combination, for accounting purposes we are deemed to have acquired the shares of MSC Holdings. Through its operating subsidiary, MSC, MSC Holdings is a large participant in the specialty chemicals industry, and a leading producer of adhesive and structural coatings. MSC generated pro forma net sales of $4,818 million in 2010. We believe our and MSC’s complimentary technologies, global footprint and specialty products strategically position us as one of the largest specialty chemicals and materials companies in the world.

 

   

Net sales increased 83% in 2010 as compared to 2009 due primarily to the acquisition of MSC Holdings and higher demand, as the global economy experienced modest recovery. The increase was driven by stabilizing and slightly increasing demand in the automotive, housing and durable goods markets. Net sales also increased due to raw material-driven price increases to our customers compared to 2009, as well as inventory restocking. On a pro forma basis net sales increased 27% in 2010 as compared to 2009 due primarily to the modest increases in U.S. housing starts and automotive builds, increased demand in the construction, semiconductor, electronics, transportation, wind energy and alternative energy, oil and gas and furniture markets, and also due to short-term capacity constraints in certain of our markets.

 

   

We experienced significantly higher profitability during 2010, as Segment EBITDA increased $380 million, or 153%, in 2010 as compared to 2009. This increase was primarily due to the Momentive Combination, as well as modest recovery in volumes across most of our businesses, the favorable impact of pricing and cost savings initiatives and the favorable impact of product mix and short-term capacity constraints in certain of our markets. On a pro forma basis Segment EBITDA increased $476 million, or 77%, in 2010 as compared to 2009, primarily due to modest volume recoveries, favorable pricing and short-term capacity constraints in certain of our markets.

 

   

In November and December 2010 we refinanced $533 million in outstanding principal amount of MSC 9.75% Second-Priority Senior Secured Notes due 2014 through the issuance of $574 million aggregate principal amount of MSC 9.00% second-priority senior secured notes due 2020. We also refinanced $1,250 million U.S. dollar equivalent in outstanding principal amount of MPM senior unsecured notes due 2014 through the issuance of $1,370 million U.S. dollar equivalent aggregate principal amount of MPM second-priority springing lien notes due 2021. Collectively, we refer to the aforementioned refinancings as the Debt Refinancing Transactions. As a result of the Debt Refinancing Transactions, we effectively extended our total weighted average debt maturities by two years.

 

   

We expanded in markets in which we expect opportunities for growth.

During 2010, we continued to expand our market share and invest in markets in which we expect significant opportunities for growth. Recently completed efforts by the pro forma business in 2010 include:

 

   

Completion of a formaldehyde and forest products resins manufacturing complex to serve the engineered wood products market in southern Brazil.

 

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Commencement of operations to manufacture siloxane in Jiande, China in connection with our joint venture.

 

   

Launch of a joint venture to construct a forest products resins manufacturing facility in Russia.

 

   

Commencement of operations at a new finishing plant in Chennai, India to manufacture specialty silicone products for the growing automotive and construction markets.

 

   

Relocation of a specialty epoxy facility to a larger facility in Esslingen, Germany to support the growing wind energy market.

 

   

Completion of a new oil field manufacturing plant and the opening of additional transload facilities to provide resin-encapsulated proppants to fracturing service companies and operators in the oil and gas industry.

 

   

Construction of a Versatic manufacturing facility in Korea that will produce Cardura monomers, a Versatic acid derivative, used as a key raw material in environmentally advanced paints and coatings for the automotive industry. We expect that this facility will be fully operational in the second quarter of 2011.

In addition to the aforementioned growth initiatives completed in 2010 and other pipeline projects, we also have entered into a joint venture to construct a Versatic manufacturing facility in China, which we expect to be completed by the second half of 2011. The new facility will produce VeoVa monomers, a Versatic acid derivative, used as a key raw material in environmentally advanced paints and coatings. The facility is expected to be fully operational in the first half of 2012.

2011 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. During 2010, we experienced significant increases in volumes in virtually all businesses compared to 2009 due to the modest economic recovery globally. U.S. housing starts improved modestly in 2010 compared to their low points in early 2009; however, they remain at historically low levels. We anticipate U.S. housing starts to remain relatively flat in 2011 compared to 2010 as the U.S. housing market continues a gradual, multi-year recovery. We also anticipate moderate increases in U.S. durable goods and industrial production, which will positively impact our silicones and formaldehyde businesses during 2011. Additionally, we expect moderate increases in U.S. automobile production, which will positively impact our silicones business and Epoxy and Phenolic Resins segment. However we expect European production in both of these markets to remain relatively flat versus 2010 due to continued economic concerns in this region.

Overall, the aforementioned factors should continue to lead to volume increases throughout 2011 as compared to 2010 for all of our reportable segments. However, certain industries appear to be recovering more rapidly than others and thus, some of our reportable segments may grow faster than others in 2011.

We are currently assessing the impact of, and are proactively working to mitigate the effects of, the recent earthquake and related events in Japan on our business and results of operations.

After significant shortages in the marketplace within our monomers and base epoxies businesses, we expect worldwide capacity to return to historically normal levels in 2011. We anticipate continued strength in volumes in our epoxy specialty resins business, driven primarily by the growth in the wind and alternative energy markets. However, the growth in these businesses may be slowed temporarily by restrictions on government subsidies to these industries. In addition, we anticipate the continued growth of horizontal fracturing and drilling activities within the oil and gas industry to positively impact demand for products within our oil field business. Overall, these trends should have positive impacts on volumes in our Epoxy and Phenolic Resins segment. However, we expect competitive pricing pressures in these markets to continue for the foreseeable future.

 

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We also anticipate continued growth in the Latin American market for our Forest Products Resins segment, and believe we are well positioned to serve customers through the additional production capacity at our new manufacturing facility in southern Brazil.

We expect long-term raw material cost volatility to continue because of price movements of key feedstocks and increasing global demand. To help mitigate raw material volatility, we have purchase and sale contracts with many of our vendors and customers that contain periodic price adjustment mechanisms. Due to differences in the timing of pricing mechanism trigger points between our sales and purchase contracts, there is often a lead-lag impact during which margins are negatively impacted in the short term when raw material prices increase and are positively impacted in the short term when raw material prices fall. Although we expect to benefit from increasing volumes in 2011 as a result of modest improvements in global economic conditions, our costs for raw materials will likely be higher based on current market prices and negotiated supply agreements. We believe the pricing actions we took in 2010 and early 2011 will compensate for the increase in raw materials and energy costs.

If the global economic environment begins to weaken again or remains slow for an extended period of time, the fair value of our reporting units could be more adversely affected than we estimated in our analysis of reporting unit fair values at October 1, 2010. This could result in additional goodwill or other asset impairments.

Recent Developments

In January 2011, we sold our IAR business to Harima Chemicals, Inc. for a purchase price of approximately $120 million. The IAR business is reported as a discontinued operation as of December 31, 2010.

In February 2011, MPM amended the credit agreement governing its senior secured credit facilities. Under the amendment, MPM extended the maturity of $840 million aggregate U.S. dollar equivalent principal amount of our U.S. dollar and euro denominated term loans held by consenting lenders from December 4, 2013 to May 5, 2015 and increased the interest rate on these term loans from LIBOR plus 2.25% and euro LIBOR plus 2.25% to LIBOR plus 3.50% and euro LIBOR plus 3.50%, respectively.

On April 15, 2011, we entered into a purchase agreement with PCCR USA, Inc., a subsidiary of Investindustrial, a European investment group, to sell our North American coatings and composites (“Coatings and Composites”) business to PCCR USA, Inc. The Coatings and Composites business employs 225 people at four manufacturing facilities and generated pro forma 2010 net sales of approximately $220 million.

 

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SUPPLEMENTAL PRO FORMA RESULTS OF OPERATIONS

 

    Historical     Pro Forma for Momentive
Combination and IAR
Divestiture
 
    Year ended December 31,     Year ended December 31,  

(In millions)

  2008     2009     2010     2008 (3)     2009 (2)     2010 (1)  

Net sales

  $ 2,639      $ 2,083      $ 3,806      $ 8,329      $ 5,834      $ 7,406   

Cost of sales

    2,016        1,564        2,914        7,141        4,858        5,902   
                                               

Gross profit

    623        519        892        1,188        976        1,504   

Selling, general and administrative expense

    482        393        521        831        714        782   

Research and development and technical services expense

    76        63        88        144        120        131   

Asset impairments

    857        —          9        872        48        9   

Business realignment costs

    45        23        29        77        64        45   

Other operating expense, net

    —          —          8        1,070        15        4   
                                               

Operating (loss) income

    (837     40        237      $ (1,806   $ 15      $ 533   
                             

Interest expense, net

    328        314        391         

(Gain) loss on extinguishment of debt

    —          (179     85         

Other non-operating income, net

    (7     (12     (7      
                             

Total non-operating expense

    321        123        469         

Loss from continuing operations before income tax and earnings from unconsolidated entities

    (1,158     (83     (232      

Income tax (benefit) expense

    (111     15        (8      
                             

Loss from continuing operations before earnings from unconsolidated entities

    (1,047     (98     (224      

Earnings from unconsolidated entities, net of taxes

    —          —          2         
                             

Net loss from continuing operations

    (1,047     (98     (222      

Net loss from discontinued operations, net of taxes

    —          —          (8      
                             

Net loss

    (1,047     (98     (230      

Net income attributable to non-controlling interest

    —          —          (1      
                             

Net loss attributable to Momentive Performance Materials Holdings LLC

    (1,047     (98     (231      

Accretion of dividends on committed units

    —          —          (3      
                             

Net loss attributable to common unitholders

  $ (1,047   $ (98   $ (234      
                             

 

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(1) This unaudited supplemental pro forma condensed combined statement of operations for the year ended December 31, 2010 was derived from the “Pro Forma for Momentive Combination and IAR Divestiture” column in the unaudited pro forma condensed combined statement of operations for the year ended December 31, 2010 contained in “Unaudited Pro Forma Financial Data” section included elsewhere in this prospectus.

 

(2) This unaudited supplemental pro forma condensed combined statement of operations for the year ended December 31, 2009, reflects the pro forma assumptions and adjustments as if the Momentive Combination occurred on January 1, 2009. Also reflected is the removal of the results of the IAR business included in the consolidated statement of operations of MSC Holdings for the year ended December 31, 2009.

 

    Actuals                    
    MPM
Holdings
    MSC
Holdings
                Pro Forma
Year Ended
December 31,
2009
 

(In millions)

  Year Ended
December 31,
2009
    Year Ended
December 31,
2009 (a)
    Momentive
Combination
(b)
    IAR
Divestiture
(c)
   

Net sales

  $ 2,083      $ 4,030      $ —        $ (279   $ 5,834   

Cost of sales

    1,564        3,531        14 (i)      (251     4,858   
                                       

Gross profit

    519        499        (14     (28     976   

Selling, general and administrative expense

    393        300        42 (ii)      (21     714   

Research and development and technical services expense

    63        61        —          (4     120   

Asset impairments

    —          49        —          (1     48   

Business realignment costs

    23        56        —          (15     64   

Other operating (income) expense, net

    —          (49     67 (iii)      (3     15   
                                       

Operating income (loss)

  $ 40      $ 82      $ (123   $ 16      $ 15   
                                       

 

  (a) Represents the consolidated statement of operations of the acquiree, MSC Holdings, as reported for the year ended December 31, 2009.

 

  (b) Reflects the following adjustments to record the pro forma effects of purchase accounting adjustments related to the Momentive Combination:

 

  (i) Reflects increases in depreciation expense of $11 million and amortization expense of $3 million resulting from the estimated fair value adjustments to certain property and equipment and amortizable intangible assets.

 

  (ii) Reflects an adjustment to amortization expense resulting from the estimated fair value adjustments to certain amortizable intangible assets.

 

  (iii) Reflects an adjustment to remove the non cash push-down of insurance recoveries of MSC’s owner associated with the non-cash push-down of expense that was treated as an expense of MSC Holdings in 2008, prior to the Momentive Combination. Due to the change in control for accounting purposes and resulting change in accounting basis as a direct result of the Momentive Combination, the non-cash push-down of insurance recoveries associated with the previous principal shareholder have been removed. Also reflects an adjustment to remove amortization of deferred revenue from other operating expenses for which no value was assigned as part of the purchase price allocation.

 

(In millions)

      

Non-cash push-down of income recovered by owner

   $ 62   

Historical deferred revenue amortization

     5   
        

Net pro forma change in other operating expense, net

   $ 67   
        

 

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  (c) Represents the adjustments to remove the results of the IAR business included in the Consolidated Statement of Operations of MSC Holdings for the year ended December 31, 2009.

 

(3) This unaudited supplemental pro forma condensed combined statement of operations for the year ended December 31, 2008, reflects the pro forma assumptions and adjustments as if the Momentive Combination occurred on January 1, 2008. Also reflected is the removal of the results of the IAR business included in the consolidated statement of operations of MSC Holdings for the year ended December 31, 2008.

 

     Actuals                    
     MPM
Holdings
    MSC
Holdings
                Pro Forma
Year Ended
December 31,
2008
 

(In millions)

   Year Ended
December 31,
2008
    Year Ended
December 31,
2008 (a)
    Momentive
Combination
(b)
    IAR
Divestiture
(c)
   

Net sales

   $ 2,639      $ 6,093      $ —        $ (403   $ 8,329   

Cost of sales

     2,016        5,489        12  (i)      (376     7,141   
                                        

Gross profit

     623        604        (12     (27     1,188   

Selling, general and administrative expense

     482        335        41  (ii)      (27     831   

Research and development and technical services expense

     76        73        —          (5     144   

Asset impairments

     857        21        —          (6     872   

Business realignment costs

     45        41        —          (9     77   

Other operating expense, net

     —          1,066 (d)      (iii)      (1     1,070   
                                        

Operating (loss) income

   $ (837   $ (932   $ (58   $ 21      $ (1,806
                                        

 

  (a) Represents the consolidated statement of operations of the acquiree, MSC Holdings, as reported for the year ended December 31, 2008.

 

  (b) Reflects the following adjustments to record the pro forma effects of purchase accounting adjustments related to the Momentive Combination:

 

  (i) Reflects increases in depreciation expense of $9 million and amortization expense of $3 million resulting from the estimated fair value adjustments to certain property and equipment and amortizable intangible assets.

 

  (ii) Reflects an adjustment to amortization expense resulting from the estimated fair value adjustments to certain amortizable intangible assets.

 

  (iii) Reflects an adjustment to remove amortization of deferred revenue from other operating expenses for which no value was assigned as part of the purchase price allocation.

 

  (c) Represents the adjustments to remove the results of the IAR business included in the Consolidated Statement of Operations of MSC Holdings for the year ended December 31, 2008.

 

  (d) Represents accounting, legal and settlement costs associated with a terminated merger.

 

The unaudited supplemental pro forma statements of operations do not reflect the effect of one-time costs incurred in connection with the Momentive Combination, including the expense for non-capitalized costs associated with the Momentive Combination and the write-up of inventory to fair value in connection with purchase accounting.

Pro Forma Net Sales

In pro forma 2010, net sales increased by $1,572 million, or 27%, compared with pro forma 2009. Volume increases across substantially all of our product lines positively impacted sales by $1,080 million. These increases were primarily a result of the modest increases in U.S. housing starts and automotive builds, increased

 

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demand in the construction, semiconductor, electronics, transportation, wind energy and alternative energy, oil and gas and furniture markets. The pass through of raw material driven price increases primarily in our North American and European formaldehyde and forest products resins, phenolic specialty resins and dispersions product lines, as well as short-term capacity shortages in the market for base epoxies and monomers, positively impacted sales by $509 million. In addition, foreign currency translation negatively impacted sales by $17 million primarily as a result of the strengthening of the U.S. dollar against the euro compared to pro forma 2009.

In pro forma 2009, net sales decreased by $2,495 million, or 30%, compared with pro forma 2008. Volume declines across all of our product lines negatively impacted sales by $1,566 million. These declines were primarily a result of the continued weakness in the housing, construction, semiconductor, electronics, industrial and automotive markets as a result of the global economic downturn. The pass through of raw material driven price decreases primarily in our forest products resins and formaldehyde, phenolic specialty resins and base epoxies and intermediates product lines, negatively impacted sales by $753 million. In addition, foreign currency translation negatively impacted sales by $176 million primarily as a result of the strengthening of the U.S. dollar against the euro compared to pro forma 2008.

Pro Forma Gross Profit

In pro forma 2010, gross profit increased by $528 million, compared with pro forma 2009 primarily as a result of the increase in sales. As a percentage of sales, gross profit increased 3% as a result of the positive impact of pricing initiatives, favorable product mix, the positive impact of productivity project initiatives and the impact of increased product volumes that outpaced the increase in fixed processing costs.

In pro forma 2009, gross profit decreased by $212 million, compared with pro forma 2008 primarily as a result of the decrease in sales, offset by lower raw material and processing costs, as discussed above. The impact of lower sales was partially offset by favorable impacts of productivity savings programs on manufacturing and processing costs. This resulted in an increase of 3% in gross profit as a percentage of sales as the positive impact of lower processing costs and productivity projects more than offset the impact of lower volumes on fixed manufacturing costs during pro forma 2009.

Pro Forma Operating (Loss) Income

In pro forma 2010, operating income increased by $518 million, compared with pro forma 2009. The primary driver of the increase was the increase in gross profits, as discussed above.

In pro forma 2010, business realignment costs decreased $19 million due to the reduction in productivity and cost reduction program costs, but was offset by an increase in Selling, general and administrative expense of $68 million due primarily to higher compensation costs. As a percentage of sales, Selling, general and administrative expense decreased due to the positive impacts of productivity and cost reduction initiatives. Research and development and technical service expense increased by $11 million due primarily to new projects and the restoration of pay and benefits for certain employees whose compensation was temporarily reduced in pro forma 2009. Asset impairments decreased by $39 million, compared to pro forma 2009 due mainly to impairments in our Epoxy and Phenolic Resins segment in pro forma 2009 that did not recur in pro forma 2010.

In pro forma 2009, operating loss decreased by $1,821 million to income of $15 million, compared with pro forma 2008. The primary drivers of the decrease were the reduction in expenses related to a terminated merger and the positive impacts of productivity program and cost reduction initiatives. In pro forma 2008, Other operating expense, net primarily consisted of $1,027 million related to a terminated merger, which consists of the write-off of previously deferred acquisition costs, legal fees and $750 million in litigation settlement costs, of which $200 million represents the non-cash push-down of costs paid by Apollo, prior to the Momentive Combination. Selling, general and administrative expenses decreased due primarily to the positive impacts of productivity savings programs and other cost savings initiatives. These favorable impacts were partially offset by increases in Asset impairments and Business realignment costs incurred to implement productivity and cost savings initiatives.

 

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In pro forma 2009, we recorded impairments of $44 million in our Epoxy and Phenolic Resins and $2 million in our Other segments as a result of our decision to indefinitely idle certain production lines. In addition, we recorded miscellaneous impairments of $2 million related to the closure of R&D facilities in our Forest Products Resins and our Epoxy and Phenolic Resins segments. In pro forma 2008, we also recognized goodwill impairments of $857 million in our Silicones and Quartz segment, which did not recur in pro forma 2009. Business realignment costs decreased by $13 million primarily due to decreases in restructuring and headcount reduction costs. Furthermore, Operating income was also impacted by the decline in Gross profit discussed above.

Supplemental Pro Forma Results of Operations by Segment

Following are net historical and unaudited pro forma sales and Segment EBITDA (earnings before interest, income taxes, depreciation and amortization) by reportable segment. Segment EBITDA is an important performance measure used by our senior management and our 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. Other consists of our coatings operating segment and also includes corporate general and administrative expenses that are not allocated to the segments, such as shared service and administrative functions, certain foreign exchange transaction gains and losses.

Historical net sales and Segment EBITDA amounts for the Epoxy and Phenolic Resins, Forest Products Resins and Other represent results since the completion of the Momentive Combination on October 1, 2010.

We believe presenting this pro forma information is beneficial to the reader because the impact of the purchase accounting associated with the Momentive Combination, the inclusion of MSC Holdings’ results since the completion of the Momentive Combination on October 1, 2010 and the removal of the results of the IAR business impacts the comparability of the financial information for the historic periods presented. We believe this pro forma presentation provides the reader with additional information from which to analyze our financial results.

 

     Historical     Pro Forma for
Momentive Combination
and IAR Divestiture
 
     Year ended December 31,     Year ended December 31,  
     2008      2009      2010     2008     2009     2010  
     (in millions)  

Net Sales to Unaffiliated Customers(1):

              

Silicones and Quartz

   $ 2,639       $ 2,083       $ 2,588      $ 2,639      $ 2,083      $ 2,588   

Epoxy and Phenolic Resins

     —           —           655        2,795        1,944        2,530   

Forest Products Resins

     —           —           401        2,049        1,198        1,607   

Other

     —           —           162        846        609        681   
                                                  
   $ 2,639       $ 2,083       $ 3,806      $ 8,329      $ 5,834      $ 7,406   
                                                  

Segment EBITDA:

              

Silicones and Quartz

   $ 316       $ 249       $ 489      $ 316      $ 249      $ 489   

Epoxy and Phenolic Resins

     —           —           102        278        267        431   

Forest Products Resins

     —           —           39        198        111        177   

Other

     —           —           (1     (32     (10     (4
                                                  
   $ 316       $ 249       $ 629      $ 760      $ 617      $ 1,093   
                                                  

 

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

 

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Pro Forma 2010 vs. Pro Forma 2009 Segment Results

The table below provides additional detail of the percentage change in sales by segment from pro forma 2009 to pro forma 2010.

 

     Volume             Price/Mix             Currency
Translation
    Total  

Silicones and Quartz

     23     1     —       24

Epoxy and Phenolic Resins

     18     14     (2 )%      30

Forest Products Resins

     18     12     4     34

Other

     3     12     (3 )%      12

Silicones and Quartz

Net sales in pro forma 2010 increased by $505 million, or 24%, when compared to pro forma 2009. Volume increases positively impacted net sales by $492 million. Sales volume for our silicones business was positively impacted by stronger demand in the construction, automotive, electronics, transportation, oil and gas and furniture markets. Most product groups and all geographic regions saw increases in pro forma 2010, compared to pro forma 2009. Increases in our quartz businesses were primarily a result of strong overall demand for semiconductor related products. Selling price increases positively impacted sales by $19 million, which was partially offset by unfavorable currency translation of $6 million, as the U.S. dollar strengthened against the euro and Japanese yen in pro forma 2010 compared to pro forma 2009.

Segment EBITDA in pro forma 2010 increased by $240 million to $489 million compared to pro forma 2009. The increase was primarily attributable to the volume increases discussed above, as well as our continued focus on providing more high-value specialty products to our customers versus lower-margin commoditized or core products.

Epoxy and Phenolic Resins

Net sales in pro forma 2010 increased by $586 million, when compared to pro forma 2009. Volume increases positively impacted net sales by $352 million as the global economy stabilized. Volumes increased in virtually all businesses, but most significantly in our oil field, versatics, epoxy specialty and base epoxy businesses. The volume increases in our base epoxy business were attributable to the stabilization of the automotive and durable goods markets relative to the low point of the economic downturn, which began in late 2008 and continued into 2009, and were also impacted by short-term capacity constraints. The pass through of higher raw material costs in most businesses, the favorable product mix in our phenolic business and short-term capacity shortages in the sales were negatively impacted by competitive pricing pressures in our oil field and epoxy specialty businesses. Foreign currency translation had a negative impact of $44 million primarily due to the strengthening of the U.S. dollar against the euro in pro forma 2010 compared to pro forma 2009.

Segment EBITDA in pro forma 2010 increased by $164 million to $431 million compared to pro forma 2009. Segment EBITDA increased primarily due to the increased growth in demand discussed above due to a modest economic recovery and due to short term capacity constraints in certain markets. The remaining overall increase was primarily attributable to the accelerated recognition of unabsorbed processing costs that occurred in pro forma 2009 compared to pro forma 2010 and the favorable impact of productivity driven cost savings. This increase was partially offset by additional maintenance and turnaround costs in pro forma 2010 compared to pro forma 2009.

Forest Products Resins

Net sales in pro forma 2010 increased by $409 million or 34% when compared to pro forma 2009. Higher volumes positively impacted sales by $218 million, with increases across all businesses and regions. The

 

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strongest increases in volumes were in our Latin American markets, where we served the growing southern Brazil markets through the opening of our Montenegro plant in 2010, and our North American formaldehyde business, due to modest market recoveries in the demand for durable goods. In addition, we experienced strong volume increases in our North American forest products resins business, primarily driven by the restocking of inventory by our customers, compared to the de-stocking of inventory that occurred in pro forma 2009, coupled with the modest increase in U.S. housing starts and household remodeling compared to the same period of pro forma 2009. Higher raw material prices passed through to customers in most regions, combined with positive product mix within our North American formaldehyde business, led to a sales increase of $141 million due to pricing. Although raw material prices generally increased during pro forma 2010 and we passed through to customers as allowed under our contracts, the significant strengthening of the Brazilian real, Australian dollar and New Zealand dollar against the U.S. dollar resulted in lower raw material prices in these local currencies, which were passed through to customers in these regions. In addition, we experienced favorable currency translation of $50 million due to the weakening of the U.S. dollar against the Brazilian real, Australian dollar and Canadian dollar in pro forma 2010 compared to pro forma 2009.

Segment EBITDA in pro forma 2010 increased by $66 million to $177 million compared to pro forma 2009. The increasae was primarily attributable to the impact of the volume increases discussed above and recent product development initiatives, as well as the favorable impact of productivity driven cost savings.

Other

Net sales in pro forma 2010 increased by $72 million, or 12%, when compared to pro forma 2009. Volume increases positively impacted sales by $19 million, with increases across virtually all coatings businesses. The most significant increases were in our U.S. based dispersions and U.S. coatings businesses, which were negatively impacted by the global economic downturn during pro forma 2009. The pass through of higher raw material costs and favorable pricing resulted in pricing increases of $71 million, reflecting short-term capacity constraints in the market for our monomers business. Unfavorable currency translation of $17 million contributed to lower sales, as the U.S. dollar strengthened against the euro in pro forma 2010 compared to pro forma 2009.

Segment EBITDA in pro forma 2010 improved by $6 million to a loss of $4 million compared to pro forma 2009. The increase was primarily attributable to the global shortage of monomers and volume increases as discussed above, partially offset by an increase in corporate and other charges of $11 million due primarily to increased compensation costs. These increases were partially offset by higher unallocated foreign currency translation gains and the impact of productivity-driven cost savings.

Pro Forma 2009 vs. Pro Forma 2008 Segment Results

The table below provides additional detail of the percentage change in sales by segment from pro forma 2008 to pro forma 2009.

 

     Volume     Price/
Mix
    Currency
Translations
    Total  

Silicones and Quartz

     (22 )%      2     (1 )%      (21 )% 

Epoxy and Phenolic Resins

     (18 )%      (9 )%      (3 )%      (30 )% 

Forest Product Resins

     (16 )%      (23 )%      (3 )%      (42 )% 

Other

     (19 )%      (6 )%      (3 )%      (28 )% 

Silicones and Quartz

Net sales in pro forma 2009 decreased by $556 million, or 21%, when compared to pro forma 2008. Volume decreases negatively impacted sales by $571 million. These declines were primarily a result of weak consumer demand in the electronics, automotive, construction, textiles, industrial, furniture and semiconductor markets as a result of the global economic downturn. The volume declines were partially offset by modest pricing increases of $39 million. Foreign currency translation negatively impacted sales by $24 million, primarily, as a result of the strengthening of the U.S. dollar against the euro and Japanese yen, as compared to pro forma 2008.

 

 

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Segment EBITDA in pro forma 2009 decreased by $67 million to $249 million compared to pro forma 2008. The decrease was primarily attributable to the volume decreases discussed above.

Epoxy and Phenolic Resins

Net sales in pro forma 2009 decreased by $851 million, or 30%, compared to 2008. Volume declines negatively impacted sales by $504 million as the global economic downturn had an adverse impact on our volumes. Volumes declined across all businesses, with our precursors business showing the largest decline over the prior year and our specialty epoxy and Versatics businesses experiencing relatively lesser amounts of volume decline during pro forma 2009 compared to pro forma 2008. These declines were primarily attributable to the decrease in the automotive, construction, housing, foundry, oilfield and durable goods markets, as well as increased worldwide capacity in base epoxies. The lower volume decline in Versatics is due to the absence of the shortage of certain raw materials that occurred in pro forma. The pass through of lower raw material costs and competitive pricing pressures, primarily in our major resins and specialty phenolics businesses, resulted in pricing decreases of $277 million. Foreign currency translation had a negative impact of $70 million as the U.S. dollar strengthened against the euro and the Canadian dollar in pro forma compared to pro forma.

Segment EBITDA in pro forma decreased by $11 million to $267 million compared to pro forma. The decrease was primarily due to volume and pricing declines, as discussed above. These declines were largely offset by decreases in raw material prices, freight costs and the impact of productivity driven cost savings impacting processing costs. The base epoxies and specialty phenolics, businesses experienced the largest declines during the year with these declines being offset by increases in the specialty epoxy and Versatics businesses.

Formaldehyde and Forest Products Resins

Net sales in pro forma 2009 decreased by $851 million or 42%, compared to pro forma 2008. Lower volumes negatively impacted sates by $333 million. The volume decrease occurred in most of our businesses, including our European and North American forest products resins business, due to the continued decline in the worldwide housing and construction markets, as well as in our North American formaldehyde business due to decreased demand in the durable goods market resulting from the adverse impacts of the global economic downturn. We realized modest increases in volumes in the Latin American market due to lesser impacts of the worldwide economic downturn in this region. Lower prices resulted in a sales decrease of $464 million as we passed through raw material price decreases to our customers primarily in North America and Europe. Unfavorable currency translation of $54 million contributed to lower sales as the U.S. dollar strengthened against the euro in pro forma 2009 compared to pro forma 2008.

Segment EBITDA in pro forma 2009 decreased by $87 million to $111 million compared to pro forma 2008. The decrease was primarily attributable to the loss of volume and pricing impacts, as discussed above, partially offset by the impact of productivity driven cost savings. In addition, the prior year was impacted by favorable raw material purchase contracts in certain of our international forest products and resins businesses of $32 million.

Other

Net sales in pro forma 2009 decreased by $237 million, or 28%, compared to pro forma 2008. Volume declines negatively impacted sales by $158 million. Worldwide coatings volume declines were primarily attributable to the downturn in the international housing, construction and automotive markets due to the impact of the global economic downturn. These declines were experienced throughout the business with our global dispersions business experiencing relatively lower volume declines. The pass through of lower raw material costs and competitive pricing pressures resulted in pricing decreases of $51 million. Unfavorable currency translation of $28 million contributed to lower sales, as the U.S. dollar strengthened against the euro in pro forma 2009 compared to pro forma 2008.

 

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Segment EBITDA in pro forma 2009 improved by $22 million to a loss of $10 million compared to pro forma 2008, with the dispersions business providing half of the increase over the prior year. The overall increase was the result of the impact of productivity driven cost savings and lower raw material costs, which was partially offset by volume declines and competitive market pressures, as discussed above. Corporate and other charges remained relatively flat as compared to pro forma 2008. The impact of foreign currency transaction losses and additional compensation costs were offset by the positive impact of productivity driven cost savings.

Pro Forma Reconciliation of Segment EBITDA to Operating (Loss) Income

 

     Pro Forma Year Ended
December 31,
 
     2008     2009     2010  
     (in millions)  

Segment EBITDA:

      

Silicones and Quartz

   $ 316      $ 249      $ 489   

Epoxy and Phenolic Resins

     278        267        431   

Forest Products Resins

     198        111        177   

Other

     (32     (10     (4

Reconciliation:

      

Items not included in Segment EBITDA

      

Non-cash charges

     (40     12        (2

Unusual items:

      

Gain (loss) on divestiture of assets

     3        (6     (7

Settlement of derivative

     —          (12     —     

Business realignments

     (77     (64     (45

Asset impairments

     (872     (48     (9

Other

     (1,068     (36     (39
                        

Total unusual items

     (2,014     (166     (100
                        

Total adjustments

     (2,054     (154     (102

Earnings from unconsolidated entities

     (2     (2     (8

Net income attributable to noncontrolling interest

     5        3        1   

Depreciation and amortization

     (515     (449     (451
                        

Operating (loss) income

   $ (1,806   $ 15      $ 533   
                        

Items Not Included in Pro Forma Segment EBITDA

For pro forma 2010, pro forma 2009 and pro forma 2008, non-cash charges primarily represent stock-based compensation expense and unrealized derivative and foreign exchange gains and losses.

Not included in pro forma Segment EBITDA are certain non-cash and certain non-recurring income or expenses that are deemed by management to be unusual in nature, including business realignment costs, which are primarily related to expenses from our productivity and business optimization programs, asset impairments, realized foreign exchange gains and losses and retention program costs. For pro forma 2009, these items consisted of business realignment costs, primarily related to expenses from our business optimization program, asset impairments, derivative settlements and realized foreign exchange gains and losses. For pro forma 2008, these items consisted of business realignment costs primarily related to accounting, consulting, tax and legal costs related to a terminated merger, expenses from our business optimization program, asset and goodwill impairments and realized foreign exchange gains and losses.

 

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HISTORICAL RESULTS OF OPERATIONS

 

     Historical     Pro Forma for
Momentive
Combination and
IAR Divestiture
 
     Year ended December 31,     Year ended December 31,  

(In millions)

   2008     2009     2010     2008     2009      2010  

Net sales

   $ 2,639      $ 2,083      $ 3,806      $ 8,329      $ 5,834       $ 7,406   

Cost of sales

     2,016        1,564        2,914        7,141        4,858         5,902   
                                                 

Gross profit

     623        519        892        1,188        976         1,504   

Selling, general and administrative expense

     482        393        521        831        714         782   

Research and development and technical services expense

     76        63        88        144        120         131   

Asset impairments

     857        —          9        872        48         9   

Business realignment costs

     45        23        29        77        64         45   

Other operating expense, net

     —          —          8        1,070        15         4   
                                                 

Operating (loss) income

     (837     40        237      $ (1,806   $ 15       $ 533   
                               

Interest expense, net

     328        314        391          

(Gain) loss on extinguishment of debt

     —          (179     85          

Other non-operating income, net

     (7     (12     (7       
                               

Total non-operating expense

     321        123        469          

Loss from continuing operations before income tax and earnings from unconsolidated entities

     (1,158     (83     (232       

Income tax (benefit) expense

     (111     15        (8       
                               

Loss from continuing operations before earnings from unconsolidated entities

     (1,047     (98     (224       

Earnings from unconsolidated entities, net of taxes

     —          —          2          
                               

Net loss from continuing operations

     (1,047     (98     (222       

Net loss from discontinued operations, net of taxes

     —          —          (8       
                               

Net loss

     (1,047     (98     (230       

Net income attributable to non-controlling interest

     —          —          (1       
                               

Net loss attributable to Momentive Performance Materials Holdings LLC

     (1,047     (98     (231       

Accretion of dividends on committed units

     —          —          (3       
                               

Net loss attributable to common unitholders

   $ (1,047   $ (98   $ (234       
                               

Net Sales

In 2010, net sales increased by $1,723 million, or 83%, compared with 2009. The acquisition of MSC Holdings positively impacted net sales by $1,218 million. Volume increases across our silicones and quartz product lines positively impacted net sales by $492 million. These increases were primarily a result of the increased demand in the construction, automotive, semiconductor, electronics, transportation, oil and gas and furniture markets. Increases in selling prices positively impacted net sales by $19 million. In addition, foreign currency translation negatively impacted net sales by $6 million, primarily as a result of the strengthening of the U.S. dollar against the euro compared to 2009.

In 2009, net sales decreased by $556 million, or 21%, compared with 2008. Volume declines negatively impacted net sales by $571 million. These declines were primarily a result of weak consumer demand in the electronics, automotive, construction, textiles, industrial, furniture and semiconductor markets as a result of the

 

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global economic downturn. The volume declines were partially offset by modest pricing increases of $39 million. Foreign currency translation negatively impacted net sales by $24 million, primarily as a result of the strengthening of the U.S. dollar against the euro and Japanese yen, as compared to 2008.

Gross Profit

In 2010, gross profit increased by $373 million compared with 2009 primarily as a result of the increase in sales. The acquisition of MSC Holdings positively impacted gross profit by $98 million. As a percentage of sales, gross profit decreased 2%, which was partially driven by lower overall gross margins within the fourth quarter results of MSC Holdings, due partially to the seasonality of MSC Holdings’ business. This was partially offset by higher factory leverage, savings from restructuring and cost actions and deflation in energy related costs.

In 2009, gross profit decreased by $104 million compared with 2008 primarily as a result of the decrease in sales, as discussed above, partially offset by lower raw material and energy related costs.

Operating (Loss) Income

In 2010, operating income increased by $197 million compared with 2009. The primary driver of the increase was the increase in gross profit, as discussed above. The overall increase was partially offset by the negative impact of $23 million due to the acquisition of MSC Holdings, which was primarily driven by the non-recurring write-up of inventory of $67 million related to the purchase price allocation for the Momentive Combination.

In 2010, selling, general and administrative expense increased by $128 million compared with 2009 due primarily to higher compensation costs, as well as the acquisition of MSC Holdings, which had an impact of $96 million. As a percentage of sales, selling, general and administrative expense decreased due to the positive impacts of cost savings initiatives. Research and development and technical service expense increased by $25 million due primarily to new projects and the restoration of pay and benefits for certain employees whose compensation was temporarily reduced in 2009, as well as the acquisition of MSC Holdings, which had an impact of $15 million. In 2010, asset impairments increased by $9 million compared to 2009.

In 2009, operating loss decreased by $877 million, to income of $40 million, compared with 2008. The primary drivers of the decrease were a reduction in asset impairments and the positive impacts of business optimization programs and cost reduction initiatives. In 2008, we recognized goodwill impairments of $857 million in our Silicones and Quartz segment, which did not recur in 2009. In 2009, selling, general and administrative expenses decreased compared to 2008 due primarily to the positive impacts of productivity programs and other cost savings initiatives. Operating income was also impacted by the decline in gross profit discussed above.

Non-Operating Expense

In 2010, total non-operating expense increased by $346 million compared to 2009 due to the gain of $179 million recognized on the extinguishment of debt securities in 2009 that did not recur in 2010. In addition, a loss on extinguishment of debt of $85 million was recognized in 2010 as a result of the Debt Refinancing Transactions. Other non-operating income, net decreased by $5 million compared to 2009 due to gains recognized on the settlement of our foreign currency forward contracts in 2009, which did not recur in 2010. This decrease was partially offset by higher foreign exchange transaction gains in 2010 compared to 2009. Interest expense, net increased by $77 million compared to 2009 primarily as a result of the acquisition of MSC Holdings, which contributed $79 million to the increase, and was partially offset by lower interest rates on our variable-rate term loans in 2010.

In 2009, total non-operating expense decreased by $198 million compared with 2008. We recognized a gain of $179 million on the extinguishment of outstanding debt securities in 2009. Other non-operating income, net

 

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increased by $5 million compared to 2008, due to gains recognized on the settlement of our foreign currency forward contracts in March 2009. Interest expense, net decreased by $14 million compared to 2008 as a result of lower interest rates and due to lower debt levels.

Income Tax (Benefit) Expense

In 2010, income tax expense decreased by $23 million to a benefit of $8 million, compared with 2009. This change is primarily due to the geographic mix of foreign earnings, which includes a decrease in pre-tax income and the release of a valuation allowance in certain foreign jurisdictions.

In 2009, income tax benefit decreased by $126 million to expense of $15 million, compared with 2008. This change is primarily due to a goodwill impairment recorded in 2008, and to the geographic mix of U.S. and foreign earnings, which includes an increase in pre-tax income and an increase in the valuation allowance where the Company does not recognize a tax benefit.

Historical Results of Operations by Segment

 

<
     Historical     Pro Forma for
Momentive
Combination and
IAR Divestiture