ITEM 1. BUSINESS.
OVERVIEW
Solutia and its subsidiaries make and sell a variety of high-performance chemical-based materials, which are used in a broad range of consumer and industrial applications. For 2002, we are reporting our business under two segments: Performance Products and Services and Integrated Nylon.
Our Performance Products and Services segment comprises our Performance Film product line and Specialties. Specialties consists of Industrial Products and Pharmaceutical Services.
* Our Performance Films product line includes plastic interlayer for laminated safety glass and custom-coated films for after-market automotive and architectural applications. We market our plastic interlayer under the SAFLEX(R) brand for use in automobile windshields. In addition, our interlayer is used in Enhanced Protective Glass and VANCEVA(TM) brand design systems for side and rear windows of vehicles. We brand plastic interlayer under the KEEPSAFE(R) and KEEPSAFE MAXIMUM(R) marks and use it in VANCEVA(TM) brand design systems for architectural applications. In addition, we produce custom-coated window films, branded
as LLUMAR(R) and VISTA(R), for professional after-market automotive and architectural applications and as GILA(R) for the do-it-yourself retail market.
* Our Industrial Products product line includes specialty chemicals such as DEQUEST(R) water treatment chemicals, THERMINOL(R) heat transfer fluids and SKYDROL(R) aviation hydraulic fluids.
* Our Pharmaceutical Services include an array of integrated pharmaceutical development services ranging from process research to manufacturing, clinical trial services and advisory services, for leading pharmaceutical companies.
Our Integrated Nylon segment comprises an integrated family of nylon products.
* Our chemical intermediates are used as feedstock for fiber and resins production and are sold on the merchant market.
* Our VYDYNE(R) and ASCEND(R) nylon polymers are sold to the engineered thermoplastic and apparel markets.
* Our fibers are sold under the WEAR-DATED(R) brand for use in carpet and upholstery for customers, the ULTRON(R) brand for commercial carpet and the ACRILAN(R) brand for knit apparel.
Solutia was incorporated in Delaware in April 1997 to hold most of the chemical businesses of the former Monsanto Company, now known as Pharmacia Corporation. On September 1, 1997, Monsanto distributed our shares as a dividend to Monsanto's stockholders, and we became an independent publicly held company.
RECENT DEVELOPMENTS
On December 2, 2002, we signed a definitive agreement to sell our resins, additives and adhesives businesses to UCB S.A. for $500 million in cash. In addition, UCB paid us $10 million up front for a short period of exclusivity. The sale closed on January 31, 2003, and resulted in a modest accounting gain.
In July 2002, we amended our bank credit facility. The amendment extended the maturity of the facility until August 2004, reduced the facility from $800 million to $600 million, and separated the facility into a $300 million term loan and a $300 million revolving credit facility. Net cash proceeds from the sale to UCB S.A. were used to repay all of the borrowings outstanding under our bank credit facility, to cash collateralize letters of credit and to purchase the co-generation facility at our Pensacola, Florida plant.
Also in July 2002, we completed a private placement of 223,000 units consisting of $223 million of senior secured 7-year notes and warrants to purchase 5,533,522 shares of common stock. Part of the proceeds from this offering was used to repay the principal and interest on $150 million of 5-year notes that matured in October 2002.
SEGMENTS; PRINCIPAL PRODUCTS
In anticipation of the divestiture of our resins, additives and adhesives businesses, we reorganized our management structure and realigned our reportable segments during the fourth quarter of 2002. Our new reportable segments are:
* Performance Products and Services; and
* Integrated Nylon.
The tabular and narrative information contained in Note 19 of "Notes to Consolidated Financial Statements" appearing on pages 63 and 64 is incorporated by reference into this section.
PRINCIPAL EQUITY AFFILIATES
We participate in several joint ventures in which we share management control with other companies. Our equity earnings (loss) from affiliates were $13 million in 2002, $(13) million in 2001 and $35 million in 2000. Principal joint ventures include Flexsys, L.P. and Astaris LLC.
Flexsys, headquartered in Belgium, is a leading supplier of process chemicals to the rubber industry. Its product line includes a number of branded accelerators (SANTOCURE(R), THIOFIDE(R) and THIOTAX(R)), pre-vulcanization inhibitors (SANTOGARD(R)), antidegradants and antioxidants (FLECTOL(R) and SANTOWHITE(R)) and insoluble sulphur (CRYSTEX(R)). Flexsys is a 50/50 joint venture with Akzo Nobel N.V. For additional information about Flexsys, see "Legal Proceedings--Other" on page 11 below.
Astaris, headquartered in the United States, sells phosphorus and phosphate salts. Its product line includes a number of branded products such as LEVN-LITE(R), PAN-O-LITE(R) and LEVERAGE(R) phosphate, which are sold into the bakery markets. The business also services the pharmaceutical, meat and poultry and industrial marketplaces. Astaris is a 50/50 joint venture with FMC Corporation. For additional information about Astaris, see "Contingencies" on page 27 below.
SALE OF PRODUCTS
We sell our products directly to end users in various industries, principally by using our own sales force, and, to a lesser extent, by using distributors.
On May 1, 2002, we and Dow Plastics, a business unit of The Dow Chemical Company, formally terminated the marketing alliance under which Dow had marketed our VYDYNE(R) nylon 6,6 molding resins for injection molding applications worldwide, and we resumed sole responsibility for the business.
Our marketing and distribution practices do not result in unusual working capital requirements on a consolidated basis. We maintain inventories of finished goods, goods in process and raw materials to meet customer requirements and our scheduled production. In general, we do not manufacture our products against a backlog of firm orders; we schedule production to meet the level of incoming orders and the projections of future demand. We do not have material contracts with the government of the United States or any state, local or foreign government. We are not generally dependent on one or a group of customers, and no single customer or customer group accounts for 10 percent or more of our net sales. However, sales to the carpet mill industry and the European auto glass industry each represent a significant portion of our net sales.
Our second and third quarters are typically stronger than our first and fourth quarters because sales of carpet and window films are stronger in the spring and fall.
COMPETITION
The global markets in which our chemical businesses operate are highly competitive. We expect competition from other manufacturers of the same products and from manufacturers of different products designed for the same uses as ours to continue in both U.S. and ex-U.S. markets. Depending on the product involved, we encounter various types of competition, including price, delivery, service, performance, product innovation, product recognition and quality. Overall, we regard our principal product groups as competitive with many other products of other producers and believe that we are an important producer of many of these product groups. For additional information regarding competition in specific markets, see the charts under "Segments; Principal Products" above.
RAW MATERIALS AND ENERGY RESOURCES
We buy large amounts of commodity raw materials, including propylene, cyclohexane, benzene and natural gas. We typically buy major requirements for key raw materials pursuant to medium-term contracts. We are not dependent on any one supplier for a material amount of our raw materials or energy requirements, but we obtain certain important raw materials from a few major suppliers. In general, in those cases where we have limited sources of raw materials, we have developed contingency plans to minimize the effect of any interruption or reduction in supply. For information about specific raw materials, see the charts under "Segments; Principal Products" above.
While temporary shortages of raw materials and energy may occasionally occur, these items are generally sufficiently available to cover our current and projected requirements. However, their continuing availability and price may be affected by unscheduled plant interruptions and domestic and world market conditions, political conditions and governmental regulatory actions. We cannot accurately predict the effect of any future raw material and energy prices or shortages on our business as a whole or in specific world areas.
For additional information on raw materials and energy, see "Economic Conditions and Outlook" on page 23 below.
PATENTS AND TRADEMARKS
We own a large number of patents that relate to a wide variety of products and processes and have pending a substantial number of patent applications. In addition, we are licensed under a small number of patents owned by others. We own a considerable number of established trademarks in many countries under which we market our products. These patents and trademarks in the aggregate are of material importance to our operations and to our Performance Products and Services and Integrated Nylon segments.
RESEARCH AND DEVELOPMENT
Research and development constitute an important part of our activities. Our expenses for research and development amounted to approximately $39 million in 2002, $43 million in 2001 and $57 million in 2000, or about 2 percent of sales on average. We focus our expenditures for research and development on process improvements and selected product development.
We continued to enhance and expand our Performance Films product offerings for the automotive, architectural and specialty film markets by introducing products with new colors, patterns, textures and heat protection. We also introduced several new specialty films for the electronic and decorative markets. We developed a new heat transfer fluid for our Industrial Products portfolio to meet the growing demand for ultra-low temperature processing in the pharmaceutical industry. We continue to develop biodegradable chelates and scale inhibitors to meet market needs for more environmentally friendly products. Our Integrated Nylon segment focused on internal process improvements, resulting in lower costs and higher quality in many of our key product families.
ENVIRONMENTAL MATTERS
The narrative information appearing under "Environmental Matters" beginning on page 29 below is incorporated here by reference.
EMPLOYEE RELATIONS
On December 31, 2002, we had approximately 9,400 employees worldwide. This number decreased to approximately 7,300 following the sale of our resins, additives and adhesives businesses to UCB S.A. on January 31, 2003. In general, satisfactory relations have prevailed between our employees and us. We use self-directed work teams, incentive programs and other initiatives to keep employees actively involved in the success of the business. Approximately 16 percent of our workforce is currently represented by various labor unions.
INTERNATIONAL OPERATIONS
Solutia and its subsidiaries are engaged in manufacturing, sales and research and development in areas outside the United States. Approximately 38% of our consolidated sales from continuing operations in 2002 were made into markets outside the United States, including Europe, Canada, Latin America and Asia. Our Performance Products and Services segment is particularly dependent on its international operations. Approximately 61% of the 2002 sales of the Performance Products and Services segment were made into markets outside the United States.
Operations outside the United States are potentially subject to a number of risks and limitations that are not present in domestic operations, including trade restrictions, investment regulations, governmental instability and other potentially detrimental governmental practices or policies affecting companies doing business abroad.
Operations outside the United States are also subject to fluctuations in currency values. The functional currency of each of our non-United States operations is the local currency. Exchange rates between these currencies and U.S. dollars have fluctuated significantly in recent years and may continue to do so. In addition, we generate revenue from export sales and operations conducted outside the United States that may be denominated in currencies other than the relevant functional currency.
INTERNET ACCESS TO INFORMATION
Our Internet address is www.solutia.com. We make available free of charge through our Internet website our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission.
ITEM 2.
ITEM 2. PROPERTIES.
Our general offices are located in a leased facility in St. Louis County, Missouri. Our principal European offices are located in Louvain La Neuve, Belgium, on land leased from the University of Louvain. Information about our major manufacturing locations worldwide and segments that used these locations on February 1, 2003, appears under "Segments; Principal Products" in Item 1 of this report and is incorporated here by reference.
Our principal plants are suitable and adequate for their use. Utilization of these facilities varies with seasonal, economic and other business conditions, but none of our principal plants is substantially idle. Our facilities generally have sufficient capacity for existing needs and expected near-term growth. We have plans for some incremental capacity expansion at certain facilities in the next two to three years.
We own most of our principal plants. However, at Antwerp, Belgium and Sao Jose dos Campos, Brazil, both of which are sites belonging to Monsanto, we own certain buildings and production equipment and lease the underlying land. In addition, we lease buildings for our Pharmaceuticals Services Division, including the main production site in Aarau, Switzerland.
Monsanto and Solutia have operating agreements with respect to each of the two Monsanto facilities listed above and Solutia's Chocolate Bayou facility in Alvin, Texas. Under these operating agreements, we are the guest and Monsanto is the operator, except at the Chocolate Bayou facility at which Monsanto is the guest and we are the operator. The initial term of each of the operating agreements has 15 years remaining. After the initial term, the operating agreements continue indefinitely unless either party terminates on at least 24 months' prior written notice. Each of the operating agreements also provides that, under certain circumstances, either the operator or the guest may terminate the operating agreement before the expiration of its initial term. We operate several facilities for other third parties, principally within the Alvin (Chocolate Bayou), Texas; Sauget, Illinois; Pensacola, Florida; Trenton, Michigan; Newport Wales (U.K.) and Springfield, Massachusetts sites under long-term lease and operating agreements.
Mortgages on our plants located in Decatur, Alabama; Springfield, Massachusetts; Trenton, Michigan; Greenwood, South Carolina; Alvin (Chocolate Bayou), Texas; Pensacola, Florida; and Martinsville, Virginia constitute a portion of the collateral securing our amended credit facility, our publicly issued debt, and our obligations under certain other financing facilities. In addition, there is a mechanics' lien filed by Fluor Daniel, a division of Fluor Enterprises, Inc., against our Chocolate Bayou facility, currently in the amount of $10 million, securing the remaining payments we have agreed to make to Fluor Daniel over a three-year period in settlement of litigation arising out of the construction of an acrylonitrile facility at the Chocolate Bayou plant.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Because of the size and nature of our business, we are a party to numerous legal proceedings. Most of these proceedings have arisen in the ordinary course of business and involve claims for money damages. In addition, at the time we became an independent company, we assumed liabilities related to specified legal proceedings from the former Monsanto Company, now known as Pharmacia Corporation ("Old Monsanto"), under an agreement known as the Distribution Agreement. As a result, although Old Monsanto remains the named defendant, we are required to manage the litigation and indemnify Old Monsanto for costs, expenses and judgments arising from the litigation. While the results of litigation cannot be predicted with certainty, we do not believe, based on currently available facts, that the ultimate resolution of any of these preceding matters will have a material adverse effect on our financial position or liquidity in any one year. However, resolution in those cases described below involving the alleged discharge of polychlorinated biphenyls ("PCBs") from the Anniston, Alabama plant site and the Penndot case, also described below, may have a material adverse effect on our net income in a given year, although it is impossible at this time to estimate the range or amount of any such liability. In addition, there cannot be any assurance that any final judgment against us in the Anniston, Alabama cases, if upheld on appeal, will not have a material adverse effect on our financial position and liquidity.
The following paragraphs describe several proceedings to which we are a party or to which Old Monsanto is a party and for which we have assumed any liabilities.
ANNISTON, ALABAMA CASES
In November 1993, Old Monsanto was named as a defendant in the first of 41 lawsuits which have been filed in state or federal court in Alabama in which plaintiffs claim to have sustained personal injuries or property damage as a result of the alleged release of polychlorinated biphenyls ("PCBs") and other materials from its Anniston, Alabama plant site. To date 22 of those lawsuits, involving claims made by nearly 5,900 plaintiffs have been resolved for approximately $87 million. Currently pending are the following matters:
(1) Abernathy v. Monsanto: Four consolidated cases, the first of which was served on April 1, 1996, were originally filed in Circuit Court for Calhoun County, Alabama on behalf of 3,516 plaintiffs who own or rent homes, own or operate businesses, attend churches, or have otherwise resided in or visited neighborhoods near the Anniston plant. Plaintiffs seek compensatory and punitive damages in an unspecified amount or in the amount of $3 million for each individual and injunctive relief requiring the Company to remove alleged contamination. The individual plaintiffs claim to have suffered permanent adverse health effects and fear future disease. They assert the need for medical monitoring, diminution in the value of their properties in the case of residential and commercial property owners and commercial losses in the case of business owners. Because of significant pretrial publicity in Calhoun County, venue in these cases was transferred to Circuit Court in Etowah County. Sixteen individual plaintiffs and one business entity were selected as plaintiffs for a Phase I trial that began on January 7, 2002. On February 22, 2002, the jury returned a verdict in favor of plaintiffs on six liability issues: nuisance, trespass, negligence, wantonness, suppression of the truth and outrage.
The trial court departed from its announced trial plan and did not submit damage issues to the jury for the 17 Phase I trial plaintiffs. Instead, the parties agreed on a streamlined format for submission to the jury of property damage evidence for all plaintiffs who are making a property damage claim. In total, 907 plaintiffs are asserting claims of property damage with respect to 941 pieces of property. Hearings on plaintiffs' claims for injunctive relief, which were not tried to a jury, began on March 6, 2002, and concluded on April 12, 2002. The court then referred the issue of injunctive relief and defendants' motions to dismiss those claims to a Special Master for a recommendation. On May 31, 2002, the Special Master issued a report recommending that the court stay injunctive proceedings in view of the filing by the United States Environmental Protection Agency ("EPA") of a Partial Consent Decree, noted below.
On March 29, 2002, we filed a motion to recuse the Abernathy trial judge because of the appearance of bias or lack of impartiality created by frequent ex parte interviews given to the media on issues in the case, and because of improper actions at a court-ordered settlement conference on March 12, 2002. On November 8, 2002, following additional briefing and a hearing on August 8, 2002, an Etowah County judge to whom the matter had been referred, denied our recusal motion. On August 19, 2002, the Alabama Supreme Court issued an order in response to our request staying all proceedings in this case other than the presentation of written evidence regarding property damage claims pending further order by the Supreme Court on the recusal issue. On February 26, 2003, the Alabama Supreme Court denied our mandamus petition and upheld the ruling of the Etowah County judge denying our recusal motion.
On July 1, 2002, Solutia, Pharmacia and the new Monsanto Company ("Monsanto") entered into an agreement pursuant to which Pharmacia agreed to post an appeal bond in the Abernathy case if needed, and if Solutia is unable to obtain such a bond. Pursuant to the agreement, if Pharmacia is not required to provide collateral in order to obtain an appeal bond, then Solutia, Pharmacia and Monsanto will have shared control over any decision to settle the Abernathy case. If Pharmacia is required to provide collateral in order to obtain an appeal bond, then Pharmacia will have control of any settlement decision but has an obligation to consult with Solutia and Monsanto before agreeing to any settlement.
(2) Tolbert v. Monsanto: Monsanto, Pharmacia and Solutia are defendants in this action, served on June 4, 2001, and filed in the United States District Court for the Northern District of Alabama initially on behalf of 1,116 plaintiffs. On January 18, 2002, plaintiffs filed an amended complaint adding approximately 14,000 additional plaintiffs to the action. As a result of further amendments, there are now 16,695 plaintiffs in this case. Plaintiffs claim they were exposed to PCBs and suffer from unspecified physical injuries and emotional distress. They seek compensatory and punitive damages in unspecified amounts and request medical testing, monitoring and treatment, as well as unspecified injunctive relief. The court has ordered that trial in this matter will proceed in phases. The parties have designated eight plaintiffs for a Phase I trial, four of whom claim liver disease and four of whom claim cancer. Trial is currently scheduled to commence after July 31, 2003, the date of the final pretrial conference. Our outside counsel in this matter have been advised by counsel representing a group of plaintiffs in the Tolbert case that those counsel represent approximately 2,000 additional individuals who intend to file suit. We are negotiating an acceptable tolling agreement that will preserve the parties' respective rights and defenses without the filing of an additional action.
(3) Payton v. Monsanto: This case was brought in Circuit Court in Shelby County, Alabama on July 15, 1997, on behalf of a purported class of all owners, lessees and licensees of properties located on Lay Lake, which is downstream from Lake Logan Martin on the Coosa River. Plaintiffs seek compensatory and punitive damages in an unspecified amount for an alleged increased risk of physical injury and illness, emotional distress caused by fear of future injury or illness, medical monitoring and diminishment in the value of their properties and their riparian rights. On October 5, 1999, the trial court granted Solutia's motion for summary judgment, and plaintiffs appealed to the Supreme Court of Alabama. On May 4, 2001, the Supreme Court issued an opinion affirming in part and reversing in part the order of the trial court. The Supreme Court held that summary judgment was properly granted with respect to claims relating to the period up to the date of settlement of a previous action which did not involve Monsanto, Pharmacia or us, but which did seek compensation for the presence of PCBs on plaintiffs' properties. However, the Supreme Court held that plaintiffs were permitted to maintain their claims relating to the period from the settlement of the prior action until the filing of the instant action. The case has been remanded to the trial court, where the parties currently await a decision by the trial court on plaintiffs' motion for class certification.
(4) Other Anniston Cases: There are twelve other cases on behalf of a total of 24 additional plaintiffs, four pending in Circuit Court for Calhoun County, three pending in Circuit Court for Jefferson County, one pending in Circuit Court for Dekalb County and three pending in United States District Court for the Northern District of Alabama. Plaintiffs in these actions own or rent homes, own or operate businesses, attend churches, or have otherwise resided or visited in neighborhoods near the Anniston plant, or are commercial entities which own or have conducted business on property near the Anniston plant. Two of these cases are brought on behalf of purported classes of Alabama residents exposed to PCBs from the Anniston plant. Plaintiffs seek compensatory and punitive damages in unspecified amounts and injunctive relief requiring the Company to remove alleged contamination. The individual plaintiffs claim to have suffered permanent adverse health effects and fear future disease. They assert the need for
medical monitoring, diminution in the value of their properties in the case of residential and commercial property owners and commercial losses in the case of business owners.
Solutia believes that there are meritorious defenses to all these matters, including lack of any imminent or substantial endangerment to health or the environment caused by any activities at the Anniston plant, lack of any physical injury or property damage to plaintiffs caused by any activities at the Anniston plant, lack of any negligence or improper conduct on Monsanto's or Solutia's part, and the implementation of a remediation program under the oversight of the United States Environmental Protection Agency and the Alabama Department of Environmental Management. We are vigorously defending these actions.
Solutia has insurance coverage that is available to mitigate potential damages in these cases. The applicable insurance coverage is bound by a confidential claim administrative agreement that precludes Solutia from disclosing the insurance carriers' names and limits of coverage. The security of the insurers is better than A.M. Best's "A" rated companies. Solutia is receiving contribution from these insurers for defense costs, and there are currently no disputed coverage issues. However, there is no assurance that our available insurance will cover all claims, that our insurers will not challenge coverage for certain claims or that the final damage awards will not exceed our available insurance coverage.
ANNISTON PARTIAL CONSENT DECREE
In October 2000 Solutia entered into an Administrative Order on Consent ("AOC") with the EPA providing for sampling of certain residential properties and removal of soils found on those properties if PCBs were found at a level of 10 parts per million (ppm) or above. That order was amended in October 2001 to encompass additional areas for sampling and possible soil removal. Following entry of the October 2000 AOC Solutia and the EPA commenced negotiations on a comprehensive agreement that would address the steps leading to a final remedy. On March 25, 2002, in an action captioned United States of America v. Pharmacia Corporation (p/k/a Monsanto Company) and Solutia, the EPA lodged a Partial Consent Decree with the United States District Court for the Northern District of Alabama. Pursuant to that decree Solutia and Pharmacia agreed to conduct a Remedial Investigation and Feasibility Study to provide information for the selection by the EPA of a cleanup remedy for the Anniston PCB site. The decree also provided for the creation of an educational trust fund of $3.2 million to be funded over a 12-year period to provide supplemental educational services for school children in west Anniston. The Partial Consent Decree was submitted for a public comment period, which closed on June 3, 2002. On October 23, 2002, the EPA filed a revised Partial Consent Decree with the court. The revised decree contains a new provision, added in response to public comment, for addressing cleanup of residential properties sooner than would have been the case under the original proposed decree. The EPA has asked the court to approve the revised Partial Consent Decree.
PENNDOT CASE
Old Monsanto is one of several defendants added on February 7, 1997, to a case then pending in the Commonwealth Court of Pennsylvania. This action was originally filed against United States Mineral Products Company in 1990 by the Commonwealth, seeking damages caused by the presence of asbestos fireproofing in the Transportation and Safety Building ("T & S Building") in Harrisburg, Pennsylvania. In June 1994 a fire broke out in the T & S Building. Testing following the fire revealed the presence of low levels of PCBs at various locations in the building. The Commonwealth claims that PCBs used in fluorescent light ballasts, in adhesives in fiberglass ductboard that was part of the heating and ventilation system and in caulking used on the exterior of the building contaminated the building and necessitated its demolition. The Commonwealth seeks recovery of costs it allegedly incurred in testing, monitoring, cleanup, demolition and temporary relocation of Commonwealth employees caused by the alleged contamination. In addition, the Commonwealth seeks the cost of constructing a new building on the site of the T & S Building. Trial of this action commenced with the selection of a jury in April 1999. On August 23, 2000, the jury returned a verdict of $90 million against Old Monsanto. The verdict was reduced to $45 million by the trial court because the manufacturer of the fiberglass ductboard reached a settlement with the Commonwealth during trial. We filed extensive post-trial motions, seeking judgment notwithstanding the jury's verdict or a new trial. The trial court denied these motions in orders filed on October 16, 2002. On November 15, 2002, we filed an appeal as of right to the Supreme Court of Pennsylvania.
On November 15, 2002, Solutia, Pharmacia and Monsanto entered into an agreement (the "Penndot Protocol") pursuant to which Monsanto posted an appeal bond and the collateral required to secure that bond. We provided a $20 million letter of credit to secure a portion of Monsanto's obligations with respect to the bond. In addition, we paid all of Monsanto's out-of-pocket expenses incurred in obtaining the bond. As a result of Monsanto's providing the collateral required to secure the appeal bond, Monsanto assumed control of any settlement decision, but agreed to consult with Solutia and Pharmacia before agreeing to any settlement. The Penndot Protocol required us to release Monsanto from its obligations with respect to the appeal bond, and to either secure a replacement bond or settle the litigation within 15 business days following an asset sale having an aggregate value of $100 million or more (the "Release Conditions"). The Release Conditions were triggered on January 31, 2003, when we closed the sale of our resins, additives and adhesives businesses. On March 3, 2003, Solutia, Pharmacia and Monsanto entered into an amendment to the Penndot Protocol pursuant to which the appeal bond obtained by Monsanto will remain in effect and Monsanto will extend the time frame for satisfying the Release Conditions until November 30, 2003 (the
"Extension Period"). Under this amendment, Solutia will provide Monsanto with an additional letter of credit in the amount of $39.9 million, and Monsanto will return control of any settlement decision to Solutia during the Extension Period (with Solutia agreeing to consult with Monsanto and Pharmacia before entering into any settlement).
We believe that there are meritorious defenses, including lack of any hazard or danger to occupants of or visitors to the T & S Building caused by the presence of PCBs; a determination by the Pennsylvania Department of Health that the building was safe for use and occupancy; the failure of the Commonwealth to act prudently following the fire to mitigate its alleged damages; the impropriety of using replacement cost as a measure of damages; and the fact that most of plaintiffs' damages would have been incurred during the removal of asbestos fireproofing and the installation of fire suppression sprinklers required to comply with the 1987 Harrisburg Fire Safety Code, and thus cannot be attributed to the presence of PCBs. We are defending this matter vigorously.
Solutia has insurance coverage that is available to mitigate potential damages in this case and is receiving contribution from its insurers for defense costs.
OTHER PCB LITIGATION
Excluding the Anniston, Alabama cases and the Penndot case discussed above, since 1971, Old Monsanto has been named as a defendant in approximately 482 cases in which plaintiffs have made claims of personal injuries or property damage resulting from alleged exposure to PCBs. Of those cases 467 have been resolved, including the claims of approximately 15,000 plaintiffs at a cost to Old Monsanto and Solutia of approximately $32 million. These cases have usually involved product-based claims in which plaintiffs have alleged that exposure to PCBs occurred in the course of their employment or as a result of an incident involving equipment which used PCBs as a dielectric, hydraulic or heat transfer fluid. The fifteen pending cases that involve claims of this nature are the following:
(1) Binghamton State Office Building Litigation: In January 1984, Old Monsanto was served in the first of five cases brought in state court in Broome County, New York, relating to claims of injury allegedly resulting from exposure to PCBs during and immediately after a fire which occurred on February 5, 1981, in a State office building in Binghamton, N.Y. Plaintiffs are 43 emergency responders or individuals involved in clean up activities immediately after the fire and their spouses, for a total of 81 plaintiffs. PCBs, dibenzofurans and dibenzodioxins were allegedly spread throughout the building when a transformer, located in an equipment room in the basement of the building, ruptured during the fire. The dielectric fluid in the transformer was composed, in part, of PCBs. Plaintiffs claim to have suffered various personal injuries, including in some cases death, and allege fear of future disease and the need for medical monitoring. They seek compensatory and punitive damages in an unspecified amount. Plaintiffs have selected ten of their number to participate in a "Phase I" trial. A trial date has not yet been set by the court. Solutia is defending these actions vigorously and believes that there are meritorious defenses, including lack of proximate cause and lack of negligence or other improper conduct on the part of Old Monsanto or Solutia.
(2) Crystal Springs, Mississippi Litigation: Old Monsanto is one of many defendants named in a suit filed on May 14, 2001, on behalf of one plaintiff in state court in Copiah County, Mississippi. Three nearly identical suits, brought on behalf of an additional 168 plaintiffs in state court in Hinds County, Mississippi were served on Old Monsanto on December 18, 2001. Plaintiffs are present or former employees of Kuhlman Electric Company's Crystal Springs, Mississippi transformer manufacturing facility. As to Old Monsanto, plaintiffs claim exposure to PCBs, allegedly resulting in unspecified physical injuries and emotional distress. Plaintiffs claim to fear the development of disease in the future and allege the need for medical monitoring. They seek compensatory and punitive damages in an unspecified amount. All four of these cases were removed to U.S. District Court for the Southern District of Mississippi on April 10, 2002. Plaintiffs filed motions to remand the cases to state court; those motions await decision by the District Court. Old Monsanto and Solutia were named as defendants in one additional action filed on behalf of a single plaintiff in state court in Copiah County, Mississippi on December 31, 2002. This case makes claims similar to those previously filed, and has also been removed to U.S. District Court for the Southern District of Mississippi. Solutia is vigorously defending these actions and believes that there are meritorious defenses, including lack of proximate cause and lack of negligence or other improper conduct on the part of Old Monsanto or Solutia.
(3) Other Pending PCB Cases: There are an additional five PCB cases brought against Old Monsanto, one in state court in Louisiana brought on behalf of ten plaintiffs, one in state court in West Virginia brought on behalf of two plaintiffs, two in state courts in New Jersey brought on behalf of a total of three plaintiffs and one in federal court in Pennsylvania brought on behalf of one plaintiff. These cases make a variety of allegations, including personal injury or property damage resulting from alleged exposure to PCBs, or seek recovery of environmental remediation expenses resulting from the claimants' improper disposal of PCBs. Plaintiffs seek compensatory and, in some cases, punitive damages in unspecified amounts. Solutia is vigorously defending all these actions and believes that there are meritorious defenses, including lack of proximate cause and lack of negligence or other improper conduct on the part of Old Monsanto or Solutia.
Solutia has insurance coverage that is available to mitigate potential damages in cases alleging personal injury or property damage, and is either receiving contribution from its insurers for defense costs, or expects to receive such contribution once self-insured retentions are exhausted. Cases which seek recovery of environmental remediation costs are not insured.
PREMISES BASED ASBESTOS LITIGATION
Like a great number of other companies that used high temperature manufacturing processes, Old Monsanto historically used asbestos insulating materials in piping and other equipment at its chemicals plants. As a result, Old Monsanto and Solutia have been named as defendants along with numerous other premises owners in actions brought by employees of contractors who claim that they were exposed to asbestos at our facilities and at the facilities of these other owners. Solutia has no product-based asbestos litigation. Historically, we have resolved these premises-related actions without a material effect on our results of operation, liquidity or financial position. Settlements in cases resolved in 2002 totaled approximately $6 million, a portion of which we expect to recover from our insurers. Although we have recently experienced an increase in the number of asbestos-related premises liability claims, we do not expect them to have a material effect. We now have pending approximately 450 such actions in Texas, West Virginia, Illinois, Missouri, Michigan and Florida involving an estimated 2,500 to 3,500 plaintiffs. More than 80% of these plaintiffs do not suffer from any manifest illness but may exhibit non-symptomatic pleural or pulmonary changes on x-ray screening, and, if not dismissed, such claims are typically settled for nominal amounts. Solutia believes that there are meritorious defenses, including the lack of injury or proximate causation and the responsible actions taken by Old Monsanto and Solutia to prevent asbestos exposures in the workplace, and is vigorously defending these actions.
ROCK SPRINGS CASE
On December 4, 1998, the EPA issued a notice of violation to Solutia, Old Monsanto and P4 Production, L.L.C., alleging violations of the Wyoming Environmental Quality Act, the Wyoming Air Quality Standards & Regulations and a permit issued in 1994 by the Wyoming Department of Environmental Quality to Sweetwater Resources, Inc., a former subsidiary of Old Monsanto, for a coal coking facility in Rock Springs, Wyoming. This facility is currently owned by P4 Production, a joint venture which the new Monsanto Company now both operates and controls. We remain a party to this litigation despite the sale of substantially all of our interest in this joint venture. On November 22, 1999, the United States, on behalf of the EPA, demanded $2.5 million from the parties as well as injunctive relief ensuring compliance with the permit requirements. On August 9, 2002, the United States filed a motion for summary judgment on the issue of liability. The motion is pending while the parties attempt to resolve the amount of the penalty through mediation.
OTHER
Authorities in the United States, Europe and Canada are investigating past commercial practices in the rubber chemicals industry. Flexsys, our 50/50 joint venture with Akzo Nobel N.V., has been fully cooperating with the authorities and will continue to do so. In addition, Solutia is aware of 20 purported class actions that have been filed against Flexsys and other producers of rubber chemicals in various state courts in the United States. Each seeks actual and treble damages under the law of the state in which it was filed on behalf of all retail purchasers of tires in that state since 1994.
For information about certain environmental proceedings involving Solutia, see "Environmental Matters" on page 29.
RISK MANAGEMENT
We have evaluated risk retention and insurance levels for product liability, property damage and other potential areas of risk. We will continue to devote significant effort to maintaining and improving safety and internal control programs, which reduce our exposure to certain risks. We actively participate in the safety and health Voluntary Protection Program ("VPP") administered by the Occupational Safety and Health Administration ("OSHA") for sites in the United States, and implemented by Solutia for sites outside the United States. Currently, ten of our U.S. sites have received the OSHA VPP "Star" designation, a rating signifying full compliance. Three of our ex-U.S. sites, two in Europe and one in Canada, have achieved the Solutia "Star" designation, which is an internal equivalent to the OSHA designation.
Our management determines the amount of insurance coverage to buy from unaffiliated companies and the appropriate amount of risk to retain and/or co-insure based on the cost and availability of insurance and the likelihood of a loss. Management believes that the levels of risk that Solutia has retained are consistent with those of other companies in the chemical industry. There can be no assurance that we will not incur losses beyond the limits, or outside the coverage, of our insurance. For additional information, see "Self-Insurance" on page 30.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We did not submit any matters to our security holders during the fourth quarter of 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our stock is traded principally on the New York Stock Exchange under the Symbol "SOI."
The following table shows the high and low sales prices for each quarter during 2002 and 2001 as reported in the New York Stock Exchange Composite Transactions.
On February 24, 2003, we had 32,878 registered shareholders.
The declaration and payment of dividends is made at the discretion of our board of directors. The board's current policy is to pay cash dividends on an annual basis in December. The annual dividend paid in 2002 and 2001 was $0.04 per share. Our credit facility and our senior secured notes restrict our ability to increase our dividend. We anticipate that the current four-cent annual dividend will remain unchanged for the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
FINANCIAL SUMMARY (Dollars in millions, except per share amounts)
See Management's Discussion and Analysis of Financial Condition and Results of Operations and Financial Condition and Liquidity under Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes thereto included in Item 8
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
FINANCIAL SECTION--TABLE OF CONTENTS
Page Number ------
Management Report........................................... 35
Report of Independent Auditors.............................. 35
Statement of Consolidated Income (Loss)..................... 36
Statement of Consolidated Comprehensive Loss................ 36
Statement of Consolidated Financial Position................ 37
Statement of Consolidated Cash Flows........................ 38
Statement of Consolidated Shareholders' Deficit............. 39
Notes to Consolidated Financial Statements.................. 40
MANAGEMENT REPORT
Management is responsible for the integrity, objectivity and preparation of Solutia Inc.'s consolidated financial statements and all of the related information appearing in this annual report. The statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Where necessary, this information reflects estimates that are based upon currently available information and management's judgments.
Management is also responsible for maintaining a system of internal accounting controls designed to provide reasonable assurance that Solutia's assets are safeguarded against material loss from unauthorized use or disposition and that authorized transactions are properly recorded to permit the preparation of accurate financial information. Cost/benefit judgments are an important consideration in this regard. The effectiveness of internal controls is maintained by careful personnel selection and thorough training, division of responsibilities, establishment and communication of policies and ongoing internal review programs and audits.
Management believes that Solutia's system of internal accounting controls as of and for the period ended December 31, 2002, was effective and adequate to accomplish the objectives described above.
/s/ JOHN C. HUNTER III /s/ ROBERT A. CLAUSEN
John C. Hunter III Robert A. Clausen Chairman, President and Vice Chairman, Chief Executive Officer Chief Financial Officer and Chief Administrative Officer
February 28, 2003
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of Solutia Inc.:
We have audited the accompanying statements of consolidated financial position of Solutia Inc. and subsidiaries (the Company) as of December 31, 2002 and 2001, and the related statements of consolidated income (loss), comprehensive loss, cash flows, and shareholders' deficit for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule in the Index at Item 15. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in the notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" effective January 1, 2002 and January 1, 2001, respectively.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP St. Louis, Missouri
February 28, 2003
The effect of exchange rate changes on cash and cash equivalents was not material. Cash payments for interest (net of amounts capitalized) were $84 million in 2002, $90 million in 2001 and $88 million in 2000. Cash refunds, net of payments for income taxes were $37 million in 2002. Cash payments for income taxes were $24 million in 2001 and $17 million in 2000. Cash payments for the management of environmental programs which were charged against recorded environmental liabilities were $26 million in 2002, $40 million in 2001 and $29 million in 2000.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
1. SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Solutia Inc. and its subsidiaries make and sell a variety of high-performance chemical-based materials. Solutia is a world leader in performance films for laminated safety glass and after-market applications; process development and scale-up services for pharmaceutical fine chemicals; specialties such as water treatment chemicals, heat transfer fluids and aviation hydraulic fluid and an integrated family of nylon products including high-performance polymers and fibers.
Prior to September 1, 1997, Solutia was a wholly-owned subsidiary of the former Monsanto Company (now known as Pharmacia Corporation). On September 1, 1997, Monsanto distributed all of the outstanding shares of common stock of the Company as a dividend to Monsanto stockholders (the spinoff). As a result of the spinoff, on September 1, 1997, Solutia became an independent publicly-held company listed on the New York Stock Exchange and its operations ceased to be owned by Monsanto. Net deficiency of assets of $113 million resulted from the spinoff.
Basis of Consolidation
The consolidated financial statements include the accounts of Solutia and its majority-owned subsidiaries. Other companies in which Solutia has a significant interest (20 to 50 percent) are included in "Investments in Affiliates" in the Statement of Consolidated Financial Position. Solutia's share of these companies' net earnings or losses is reflected in "Equity Earnings (Loss) from Affiliates" in the Statement of Consolidated Income (Loss).
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and that affect revenues and expenses during the period reported. Estimates are adjusted when necessary to reflect actual experience. Significant estimates were used to account for restructuring reserves, environmental reserves, self-insurance reserves, employee benefit plans, asset impairments and contingencies.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and temporary investments with maturities of three months or less when purchased.
Inventory Valuation
Inventories are stated at cost or market, whichever is less. Actual cost is used to value raw materials and supplies. Standard cost, which approximates actual cost, is used to value finished goods and goods in process. Standard cost includes direct labor and raw materials, and manufacturing overhead based on practical capacity. The cost of certain inventories (67 percent as of December 31, 2002) is determined by the last-in, first-out (LIFO) method, which generally reflects the effects of inflation or deflation on cost of goods sold sooner than other inventory cost methods. The cost of other inventories generally is determined by the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. The cost of plant and equipment is depreciated over weighted average periods of 20 years for buildings and 12 years for machinery and equipment, by the straight-line method.
Intangible Assets
Solutia discontinued the amortization of goodwill and identifiable intangible assets that have indefinite useful lives in accordance with SFAS No. 142. Intangible assets that have finite useful lives are amortized on a straight-line basis over their useful lives, generally periods ranging from 5 to 20 years. Goodwill is assessed annually for impairment. Fair value measurements of the reporting units are estimated by a third-party specialist utilizing both an income and market multiple approach.
Impairment of Long-Lived Assets
Impairment tests of long-lived assets are made when conditions indicate a possible loss. Impairment tests are based on a comparison of undiscounted cash flows to the recorded value of the asset. If an impairment is indicated, the asset value is written down to its fair value based upon market prices or, if not available, upon discounted cash value, at an appropriate discount rate.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Environmental Remediation
Costs for remediation of waste disposal sites are accrued in the accounting period in which the obligation is probable and when the cost is reasonably estimable. Postclosure costs for hazardous and other waste facilities at certain U.S. operating locations are accrued over the estimated life of the facility as part of its anticipated closure cost. Environmental liabilities are not discounted, and they have not been reduced for any claims for recoveries from insurance or third parties. In those cases where insurance carriers or third-party indemnitors have agreed to pay any amounts and management believes that collectability of such amounts is probable, the amounts are reflected as receivables in the consolidated financial statements.
Self-Insurance
Solutia has purchased commercial insurance in order to reduce its exposure to future legal costs, settlements and judgments related to workers' compensation, product, general, auto and operations liability claims from continuing operations. Because some of these claims are for amounts lower than policy deductible amounts or are not covered by insurance, Solutia maintains self-insurance reserves to reflect its estimates of such future uninsured costs. Self-insured losses are accrued based upon estimates of the aggregate liability for uninsured claims incurred using certain actuarial assumptions followed in the insurance industry and the Company's historical experience.
Revenue Recognition
The Company's primary revenue-earning activities involve delivering or producing goods, and revenues are considered to be earned when the Company has completed the process by which it is entitled to such revenues. The following criteria are used for revenue recognition: persuasive evidence of an arrangement exists, delivery has occurred, selling price is fixed or determinable and collection is reasonably assured.
Derivative Financial Instruments
Currency forward contracts are used to manage currency exposures for financial instruments denominated in currencies other than the entity's functional currency. Natural gas contracts are used to manage some of the exposure for the cost of natural gas. Gains and losses on contracts that are designated and effective as hedges are included in net income (loss) and offset the exchange gain or loss of the transaction being hedged.
Major currencies affecting the Company's business are the U.S. dollar, the British pound sterling, the euro, the Canadian dollar, the Australian dollar and the Brazilian real. Currency restrictions are not expected to have a significant effect on Solutia's cash flow, liquidity or capital resources.
Income Taxes
Solutia accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities at enacted rates.
Currency Translation
The local currency has been used as the functional currency for nearly all worldwide locations. The financial statements for most of Solutia's ex-U.S. operations are translated into U.S. dollars at current or average exchange rates. Unrealized currency translation adjustments in the Statement of Consolidated Financial Position are accumulated as a component of Shareholders' Deficit.
Earnings (Loss) per Share
Basic earnings (loss) per share is a measure of operating performance that assumes no dilution from securities or contracts to issue common stock. Diluted earnings (loss) per share is a measure of operating performance by giving effect to the dilution that would occur if securities or contracts to issue common stock were exercised or converted.
New Accounting Pronouncements
Effective January 1, 2003, Solutia adopted SFAS No. 143, "Accounting for Asset Retirement Obligations." The statement addresses accounting and reporting requirements for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement obligations. The adoption of SFAS No. 143 did not have a material effect on the consolidated financial statements.
Effective January 1, 2003, Solutia adopted SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The statement addresses the financial accounting and reporting for a number of areas,
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
including gains and losses derived from the extinguishment of debt and the treatment of sale-leaseback transactions. The adoption of SFAS No. 145 did not have a material effect on the consolidated financial statements.
Effective January 1, 2003, Solutia adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The statement addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The adoption of SFAS No. 146 did not have a material effect on the consolidated financial statements.
Effective January 1, 2003, Solutia adopted SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure." The statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock options under APB Opinion No. 25, "Accounting for Stock Issued to Employees," based on their intrinsic value at the date of grant. As such, Solutia has adopted the additional disclosure requirements applicable under this standard for accounting for stock based compensation using the intrinsic value method.
Effective January 1, 2003, Solutia adopted FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This Interpretation also incorporates, without change, the guidance in FASB Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of Others," which is being superseded. The adoption of this Interpretation did not have a material effect on the consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities." This Interpretation provides guidance related to identifying variable interest entities and determining whether such entities should be consolidated. This Interpretation also provides guidance related to the initial and subsequent measurement of assets, liabilities, and noncontrolling interests of newly consolidated variable interest entities and requires disclosures for both the primary beneficiary of a variable interest entity and other beneficiaries of the entity. In addition, this Interpretation requires certain disclosures if it is reasonably possible that a company will consolidate or disclose information about a variable interest entity when it initially applies the guidance in this Interpretation. This Interpretation must be applied immediately to (a) variable interest entities created, or (b) interests in variable interest entities obtained, after January 31, 2003. For those variable interest entities created, or interests in variable interest entities obtained, on or before January 31, 2003, the guidance in this Interpretation must be applied in the first fiscal year or interim period beginning after June 15, 2003. Solutia is evaluating this Interpretation to determine the impact on its consolidated financial statements. However, as further discussed in Note 17, the Company expects to consolidate the assets and liabilities associated with leasing of the Company's corporate headquarters in the third quarter of 2003.
Reclassifications
Certain reclassifications to prior years' financial information have been made to conform to the 2002 presentation. These reclassifications include amounts related to resins, additives and adhesives businesses which have been presented as discontinued operations.
2. ACQUISITIONS AND DIVESTITURES
Discontinued Operations
On December 2, 2002, Solutia signed a definitive agreement to sell its resins, additives and adhesives businesses to UCB S.A. for $500 million in cash, plus an upfront payment of $10 million for a period of exclusivity. On January 31, 2003, the sale was completed resulting in a modest gain; accordingly, the assets and liabilities of the discontinued operations have been classified as current in the Statement of Consolidated Financial Position at December 31, 2002. In addition, as further described in Note 11, proceeds from this divestiture were used to pay down borrowings under the amended credit facility in accordance with bank agreements. As a result, all borrowings under this facility have been classified as short-term at December 31, 2002. The Company retained certain tax liabilities of approximately $40 million related
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
to the divested businesses and has excluded them from the liabilities identified below. The carrying amounts of assets and liabilities from discontinued operations at December 31, 2002, consisted of the following:
The operating results of the resins, additives and adhesives businesses have been reported separately as discontinued operations in the Consolidated Financial Statements for each year presented. The operating results exclude certain corporate expenses of $10 million in 2002, $12 million in 2001, and $11 million in 2000, which had previously been allocated to the resins, additives and adhesives businesses. In addition, interest expense of $26 million in 2002, $20 million in 2001, and $28 million in 2000, associated with debt that was repaid with the sales proceeds was allocated to discontinued operations. Net sales and income from discontinued operations are as follows:
Other Acquisitions and Divestitures
On May 31, 2002, Solutia acquired Axio Research Corporation (Axio) for approximately $5 million, which was financed with cash from operations. Axio is a contract research organization providing clinical trial design and data management to a wide range of clients including pharmaceutical, biotechnology and medical device companies as well as academic and government research groups. Axio will complement the Pharmaceutical service offering within the Performance Products and Services segment. The allocation of the purchase price to assets and liabilities acquired resulted in current assets of $1 million, non-current assets of $1 million, goodwill of $4 million and current liabilities of $1 million. Axio's results of operations were included in Solutia's results of operations from the acquisition date and were not material to Solutia's consolidated results of operations for the year ended December 31, 2002.
During the first quarter of 2002, Solutia sold its 50 percent interest in the Advanced Elastomer Systems joint venture to ExxonMobil Chemical Company, a division of Exxon Mobil Corporation and Exxon Chemical Asset Management Partnership, a subsidiary of Exxon Mobil Corporation for approximately $102 million. The sale resulted in a gain of $5 million.
During 2000, Solutia completed the sale of its Polymer Modifiers business and related manufacturing facilities to Ferro Corporation for approximately $130 million. As a result of this transaction, Solutia recognized a $73 million pretax gain. Solutia's continuing operations
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
results included net sales of approximately $90 million in 2000 and operating income of approximately $16 million in 2000 from the Polymer Modifiers business.
During 2000, Solutia recognized a $15 million pretax gain on the sale of substantially all of its minority interest in P4 Production L.L.C., a phosphorus manufacturing venture. The results of operations from Solutia's minority interest in P4 Production L.L.C. were not material to Solutia's consolidated results of operations.
During 2000, Solutia completed two acquisitions in the Performance Products and Services segment, which provide custom process and technology services to the global pharmaceutical industry. In the first acquisition, which closed on February 10, Solutia acquired CarboGen Holdings AG. CarboGen is a leading process research and development firm. In the second acquisition, which closed on March 24, Solutia purchased AMCIS AG. AMCIS serves the global pharmaceutical industry by developing production processes and by manufacturing active ingredients for clinical trials and small-volume commercial drugs. The combined purchase price for these acquisitions was approximately $118 million, which was financed with commercial paper and the assumption of debt. Both of the acquisitions have been accounted for using the purchase method. The allocations of the purchase price to the assets and liabilities acquired resulted in current assets of $17 million, non- current assets of $27 million, goodwill of $57 million, other intangible assets of $41 million, current liabilities of $21 million and non-current liabilities of $3 million. Other intangible assets are being amortized over their estimated useful lives, which average 18 years. Results of operations for CarboGen and AMCIS were included in Solutia's results of operations from the acquisition dates. The results of operations for the acquired businesses were not material to Solutia's consolidated results of operations for 2000.
3. EARNINGS (LOSS) PER SHARE
At December 31, 2002 and 2001, 0.2 million and 1.2 million common share equivalents, respectively, were excluded because the effect would be antidilutive.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. RESTRUCTURING RESERVES
During 2000, Solutia recorded restructuring charges of $53 million to cost of goods sold for costs associated with work force reductions and closure of certain non-strategic facilities. During 2001, Solutia reduced its workforce by approximately 700 positions. Additionally, Solutia eliminated more than 750 contractor positions during 2001. Approximately 90 percent of the workforce reductions affected North American business and manufacturing operations, and approximately 10 percent affected European, Asian and Latin American operations and sales offices. Management positions represented approximately one-third of the workforce reductions. During the fourth quarter of 2001, Solutia determined that the original provision taken for its 2001 restructuring program was insufficient to cover its total costs. Actual costs to terminate certain European and North American management employees and certain employee benefit costs for involuntary terminations were higher than the original estimates. As a result, Solutia recorded additional restructuring charges of $9 million to cost of goods sold to cover these higher costs. The restructuring actions contemplated by this reserve were completed by the end of 2001. Certain severance payments owed to individuals terminated late in the fourth quarter of 2001 were included in accrued liabilities at December 31, 2001, and were paid during the first quarter of 2002. The closure of non-strategic facilities is not anticipated to have a significant impact on future operations.
The following table summarizes the 2000 restructuring charge and amounts utilized to carry out those plans:
During 2000, Solutia identified excess production capacity for certain Solutia resins products that allowed for consolidation of production facilities. As a result, Solutia exited its operations at the Port Plastics site in Addyston, Ohio. An $8 million charge to cost of goods sold was recorded to carry out the exit plan. The charge included $2 million to write down plant assets to their fair value of approximately $1 million, $2 million of dismantling costs and $4 million of estimated costs for which Solutia was contractually obligated under an operating agreement. Fair value was determined by discounting future cash flows using an appropriate discount rate based on the Company's cost of capital. Under the operating agreement, Solutia is required to provide 24 months notice of intent to exit and is required to pay contractually obligated costs for an additional 18 months thereafter to a third-party operator. Solutia provided notice of intent to exit on June 30, 2000, and exited the site in June of 2002. The contractually obligated costs represent direct manufacturing, overhead, utilities and severance. The financial impact was not material to Solutia as production will be shifted to other production facilities.
The following table summarizes the restructuring charge, amounts utilized to carry out those plans and amount remaining at December 31, 2002:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. ASSET IMPAIRMENTS
During 2000, Solutia recorded a $76 million impairment charge to cost of goods sold primarily to write down certain non-performing and non-strategic fiber spinning, drawing and packaging equipment which supports several of Integrated Nylon's product lines. Solutia also recorded an impairment charge to cost of goods sold of $15 million to write down chlorobenzenes' production equipment in the Performance Products and Services segment. The impairments were indicated by 2000 operating losses and projections of continued losses primarily because of the noncompetitive cost positions these businesses have and the competitive market conditions that they face. The carrying values of the assets were written down as determined by discounting expected future cash flows, using an appropriate discount rate. The assumptions used in the cash flow projections approximated the market conditions experienced in 2000. These conditions are not expected to improve significantly in the foreseeable future. The cash flow assumptions included a declining demand and market share combined with decreased operating margins. Lower operating margins reflect the non-competitive cost position of these businesses and the impact of lower selling prices associated with an extremely competitive operating environment.
During 2000, Solutia recorded a $6 million impairment charge to administrative expenses for the write down of capitalized software costs related to the formation of the Astaris joint venture. The software had previously been fully dedicated to Solutia's Phosphorus Derivatives business. Impairment was indicated by a significant change in the extent and manner in which Astaris was expected to utilize the asset under a transition services agreement. The carrying value of the asset was written down to its estimated fair value, as determined by discounting expected future cash flows, using an appropriate discount rate.
6. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, Solutia adopted SFAS No. 142, "Goodwill and Other Intangible Assets." In accordance with SFAS No. 142, Solutia discontinued the amortization of goodwill and identifiable intangible assets that have indefinite useful lives. This statement also required certain intangible assets that did not meet the criteria for recognition apart from goodwill, to be subsumed into goodwill. During the quarter ended March 31, 2002, Solutia subsumed into goodwill $1 million of intangible assets net of related deferred tax liabilities representing assembled workforce that did not meet the separability criteria under SFAS No. 141, "Business Combinations."
In connection with the adoption of this standard, fair value measurements of the reporting units were estimated by a third-party specialist utilizing both an income and market multiple approach. Based on this analysis, Solutia recorded an impairment loss of $167 million during the first quarter of 2002 for the resins and additives businesses, which is presented as discontinued operations, due to declining estimates of future results given current economic and market conditions. The goodwill impairment charge is non-deductible for tax purposes and is reflected as the cumulative effect of change in accounting principle in the accompanying statement of consolidated income (loss).
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net income (loss) and earnings (loss) per share, excluding discontinued operations, for the years ended December 31, 2002, 2001 and 2000, adjusted to exclude the non-amortization provisions of SFAS No. 142, net of tax, are as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Identified intangible assets are as follows:
The Company's second quarter acquisition of Axio (see Note 2), resulted in goodwill of approximately $4 million. As a result of adoption of SFAS No. 142, there have been no changes to amortizable lives or methods, except for trademarks, which have indefinite lives as defined under the new standard. Trademarks are associated with products and tradenames of the Company and are expected to provide benefits beyond the foreseeable future. Amortization expense for the net carrying amount of intangible assets is $3 million in 2003, $3 million in 2004, $3 million in 2005, $3 million in 2006 and $3 million in 2007.
Goodwill as allocated by reportable segment is as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. RISK MANAGEMENT ACTIVITIES
Effective January 1, 2001, Solutia adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, which requires that all derivative instruments be reported on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. The cumulative effect of adopting SFAS No. 133 as of January 1, 2001, resulted in a cumulative addition to other comprehensive income of $2 million aftertax, principally attributable to unrealized gains in commodity cash flow hedges.
Solutia's business operations give rise to market risk exposures that result from changes in currency exchange rates, interest rates and certain commodity prices. To manage the volatility relating to these exposures, Solutia enters into various hedging transactions that enable it to alleviate the adverse effects of financial market risk. Designation is performed on a specific exposure basis to support hedge accounting. The changes in fair value of these hedging instruments are offset in part or in whole by corresponding changes in the fair value or cash flows of the underlying exposures being hedged. Solutia's hedging transactions are carried out under policies and procedures approved by the Audit and Finance Committee of the board of directors, which do not permit the purchase or holding of any derivative financial instruments for trading purposes.
Foreign Currency Exchange Rate Risk
Solutia manufactures and sells its products in a number of countries throughout the world and, as a result, is exposed to movements in foreign currency exchange rates. Solutia uses foreign currency hedging instruments to manage the volatility associated with foreign currency purchases of materials and other assets and liabilities created in the normal course of business. Solutia primarily uses forward exchange contracts and purchased options to hedge these risks with maturities of less than 18 months.
Solutia also enters into certain foreign currency derivative instruments primarily to protect against exposure related to intercompany financing transactions. Solutia has chosen not to designate these instruments as hedges and to allow the gains and losses that arise from marking the contracts to market to be recorded in other income (expense)--net in the period. The net impact of the related gains and losses was not material.
No cash flow hedges were discontinued during the year due to changes in expectations on the original forecasted transactions. Foreign currency hedging activity is not material to Solutia's financial statements.
Interest Rate Risk
Interest rate risk is primarily related to the changes in fair value of fixed-rate long-term debt and short-term, floating rate debt. Solutia believes its current debt structure appropriately protects the Company from changes in interest rates and is not actively using any contracts to manage interest rate risk.
Commodity Price Risk
Certain raw materials and energy sources used by Solutia are subject to price volatility caused by weather, crude oil prices, supply conditions, political and economic variables and other unpredictable factors. Solutia routinely uses forward and option contracts to manage a portion of the volatility related to anticipated energy purchases with maturities up to 6 months. These market instruments are designated as cash flow hedges. The mark-to-market gain or loss on qualifying hedges is included in other comprehensive income (loss) to the extent effective, and reclassified into cost of goods sold in the period during which the hedged transaction affects earnings. The mark-to-market gains or losses on ineffective portions of hedges are recognized in cost of goods sold immediately. For the year ended December 31, 2002, the net impact on other comprehensive income (loss) included approximately $1 million aftertax for realized losses on cash flow hedges. Solutia estimates that existing net unrealized losses of less than $1 million will be reclassified to cost of goods sold within 12 months.
Credit Risk
Credit risk arising from the inability of a counterparty to meet the terms of Solutia's financial instrument contracts is generally limited to the amounts, if any, by which the counterparty's obligations exceed the obligations of the Company. It is Solutia's policy to enter into financial instruments with a number of creditworthy counterparties. Therefore, Solutia does not expect to incur material credit losses on its risk management or other financial statement instruments.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INVESTMENTS IN AFFILIATES
During the first quarter of 2002, Solutia sold its 50 percent interest in the Advanced Elastomer Systems joint venture to ExxonMobil Chemical Company, a division of Exxon Mobil Corporation and Exxon Chemical Asset Management Partnership, a subsidiary of Exxon Mobil Corporation for approximately $102 million. The sale resulted in a gain of $5 million.
In April 2000, Astaris LLC, a joint venture between Solutia and FMC Corporation, started operations to manufacture and market phosphorus chemicals. Solutia contributed its Phosphorus Derivatives business to the joint venture in exchange for a 50 percent ownership share. Net assets contributed to the venture totaled approximately $87 million. During the third quarter of 2000, Solutia received $85 million from Astaris representing a cash distribution and repayment of working capital loans. In connection with the completion of the external financing agreement for Astaris, which expires in September of 2005, Solutia and FMC contractually agreed to provide Astaris with funding in the event the joint venture fails to meet certain financial benchmarks. The financial benchmarks were based on forecasted earnings that were developed when the joint venture was formed. Astaris' earnings have fallen short of the forecast underlying its external financing agreement due to numerous factors including significantly less than planned utilization of its purified wet acid technology, lower sales volumes and lower average selling prices due to the prolonged weak U.S. economy. As a result of these earnings shortfalls versus the original expectations developed at the time the venture was formed, Solutia has been required to make additional investments of $30 million in 2002 and $31 million in 2001 to the joint venture. These payments have largely been used to reduce debt outstanding within the venture. At December 31, 2002, net debt (total debt less cash) for Astaris totaled $160 million, $59 million lower than net debt at the end of the prior year. Solutia and FMC are evaluating other financing alternatives for the joint venture. However, if no new financing arrangements are in place for 2003, Solutia anticipates required contributions of approximately $50 million for 2003. Contributions are recorded in the Investments in Affiliates line on the Statement of Consolidated Financial Position.
At December 31, 2002, Solutia's investments in affiliates consisted principally of its 50 percent interests in the Flexsys and Astaris joint ventures for which Solutia uses the equity method of accounting. Solutia received dividends from affiliates of approximately $25 million in 2002, $30 million in 2001 and $45 million in 2000. Summarized combined financial information for 100 percent of the Flexsys and Astaris joint ventures and the results of operations for AES for the period up until the sale during the first quarter of 2002 is as follows:
9. INVENTORY VALUATION
The components of inventories were:
Inventories at FIFO approximate current cost. The effects of LIFO inventory liquidations were not significant.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
The components of income (loss) from continuing operations before income taxes were:
The components of income tax expense (benefit) charged to continuing operations were:
Factors causing Solutia's effective tax rate for continuing operations to differ from the U.S. federal statutory rate were:
Deferred income tax balances were related to:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 2002, foreign tax credit carryforwards available to reduce possible future U.S. income taxes amounted to approximately $7 million, all of which will expire in 2004 and 2005. At December 31, 2002, various federal, state and foreign net operating loss carryforwards are available to offset future taxable income. These net operating losses expire in years after 2004 or have an indefinite carryforward period. Valuation allowances have been provided for the foreign tax credit and net operating loss carryforwards that are not likely to be utilized. Income taxes and remittance taxes have not been recorded on $67 million in undistributed earnings of subsidiaries, either because any taxes on dividends would be offset substantially by foreign tax credits or because Solutia intends to reinvest those earnings indefinitely. It is not practicable to estimate the tax effect of remitting these earnings to the United States.
11. DEBT OBLIGATIONS
Solutia's debt obligations include borrowings against the amended revolving credit facility, notes and debentures. The weighted average interest rate on short-term debt outstanding at December 31, 2002, was 7.2 percent and 5.0 percent at December 31, 2001. The weighted average interest rate on total debt outstanding at December 31, 2002, was 7.8 percent and 6.1 percent at December 31, 2001.
On December 2, 2002, Solutia signed a definitive agreement to sell its resins, additives and adhesives businesses to UCB S.A. for $500 million in cash, plus an upfront payment of $10 million for a period of exclusivity. On January 31, 2003, the sale was completed. Proceeds from the divestiture were used to pay down all of the borrowings under the amended credit facility, provide $39 million cash collateral for certain outstanding letters of credit and purchase the co-generation facility at Pensacola, Florida in accordance with bank agreements. Accordingly, all of the borrowings under the amended credit facility are classified as short-term debt at December 31, 2002.
Amended Credit Facility
At December 31, 2002, the revolving credit facility had available capacity to borrow up to $140 million, after $78 million of letters of credit outstanding under the facility.
On July 25, 2002, Solutia and its bank syndicate amended Solutia's revolving credit facility. The amendment extended the maturity of the facility until August 2004. It also reduced the facility from $800 million to $600 million and separated the facility into a $300 million term loan and a $300 million revolving credit facility. The term loan has been paid off with proceeds from the sale of the resins, additives and adhesives businesses on January 31, 2003. The amended credit facility required the Company to cash collateralize certain outstanding letters of credit. Fees, expenses and other costs associated with the amended credit facility and cash collateralization of letters of credit totaled $33 million. The amended credit facility is available for working capital and other general corporate purposes.
Borrowings under the amended credit facility bear interest at a floating rate based on LIBOR, plus an applicable margin. The margin for LIBOR loans is 5.75 percent and will increase by 50 basis points in July 2003 and an additional 50 basis points in January 2004. A premium in the amount of 2 percent of the principal repaid on the term loan will apply until July 25, 2003, and a premium of 1 percent will apply to such principal payments thereafter.
In September 2002, Solutia negotiated an amendment to its revolving credit facility which reduced the amount of debt outstanding as defined in the credit agreement for purposes of the leverage covenant ratio. Solutia deposited approximately $155 million from the proceeds of the Senior Secured Notes offering which occurred in July 2002 with the trustee for the $150 million of 6.5 percent notes due October 15, 2002, to pay the principal and interest at maturity. However, the principal amount of the 6.5 percent notes due October 15, 2002, was still considered outstanding debt under the amended credit facility. The amendment eliminated the $150 million of 6.5 percent notes due October 15, 2002, from consideration in the leverage covenant ratio. Without the amendment, Solutia would not have been in compliance with the leverage coverage ratio at September 30, 2002.
In order to facilitate the sale of the resins, additives and adhesives businesses to UCB S.A. and to be in compliance with the interest coverage ratio at December 31, 2002, the Company was required to obtain amendments to its revolving credit facility. Effective December 24, 2002, the facility was amended to modify certain financial covenants, release any collateral that is subject to the divestiture and release all liens upon the property of the European subsidiary borrowers upon the repayment in full of the principal and interest of all amounts outstanding in connection with the divestiture ("Amended Credit Facility"). Without the amendment, Solutia would not have been able to sell its resins, additives and adhesives businesses or been in compliance with the interest coverage ratio at December 31, 2002.
Senior Secured Notes
On July 9, 2002, Solutia completed a private placement of 223,000 units consisting of $223 million of 11.25 percent senior secured 7-year notes (the "Notes") and warrants to purchase 5,533,522 shares of common stock at an exercise price of $7.59 per share. The warrants are exercisable at any time after their separation from the Notes and before their expiration on July 15, 2009. The 7-year notes were issued by
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOI Funding Corp., a special purpose entity, and the offering resulted in cash proceeds, net of estimated fees, of $193 million, which were placed in escrow pending amendment of Solutia's credit facility, as described under "Amended Credit Facility" above and assumption of SOI Funding Corp.'s obligations under the notes. Both of these events occurred on July 25, 2002, at which time the net offering proceeds were released from escrow. Solutia deposited approximately $155 million of the proceeds with the trustee for the $150 million of 6.5 percent notes due October 15, 2002, to pay the principal and interest at maturity. The remaining proceeds were used to pay fees, expenses and other costs related to the Amended Credit Facility, cash collateralize existing letters of credit and repay a portion of borrowings under Solutia's Amended Credit Facility.
Solutia recorded the Notes and warrants based on their estimated relative fair value at the time of their issuance. Accordingly, Solutia recorded $182 million for the value of the Notes and $19 million for the value of the warrants. The discount associated with this offering, which includes the value given to the warrants, will be non-deductible for income tax purposes.
On November 18, 2002, Solutia completed an exchange offer for all of its outstanding 11.25% Senior Secured Notes due 2009 issued under Rule 144A for notes which are available to be traded freely.
Solutia's obligations and the obligations of its subsidiary borrowers under the Amended Credit Facility and the Notes are guaranteed by CPFilms Inc., Monchem International, Inc., Monchem, Inc., Solutia Systems, Inc. and each of Solutia's subsequently acquired or organized domestic subsidiaries, subject to certain exceptions. In addition, Solutia Inc. guarantees the payment of amounts due from subsidiary borrowers under the Amended Credit Facility. The Notes and the guarantees are secured by either first or second priority liens on all of the domestic collateral securing Solutia's bank obligations.
Long-Term Debt
Long-term debt consisted of the following:
Interest is payable semiannually, on January 15 and July 15 for the 11.25% notes and on April 15 and October 15 for the remaining maturities. The holders of the 2037 debentures have the right to require repayment on October 15, 2004. The notes and debentures contain provisions that, among other things, restrict Solutia's ability to create liens on assets and its ability to enter into sale and leaseback transactions.
12. FAIR VALUES OF FINANCIAL INSTRUMENTS
The estimated fair value of Solutia's long-term debt was $650 million as of December 31, 2002, and $553 million as of December 31, 2001. These estimates compare with the recorded amount of $839 million in 2002 and $626 million in 2001.
The recorded amounts of cash, trade receivables, third-party guarantees, accounts payable and short-term debt approximate their fair values at both December 31, 2002, and December 31, 2001. The estimated fair value of the Company's foreign currency forward contracts on intercompany financing transactions was approximately $16 million at December 31, 2002. Notional amounts for purchase contracts were $413 million at December 31, 2002, and $308 million at December 31, 2001, and for sell contracts the notional amounts were $413 million at December 31, 2002, and $301 million at December 31, 2001.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Fair values are estimated by the use of quoted market prices, estimates obtained from brokers and other appropriate valuation techniques and are based upon information available as of December 31, 2002, and December 31, 2001. The fair-value estimates do not necessarily reflect the values Solutia could realize in the current market.
13. POSTRETIREMENT BENEFITS
Pension benefits are based on the employee's age, years of service and/or compensation level. The qualified pension plan is funded in accordance with Solutia's long-range projections of the plan's financial conditions. These projections take into account benefits earned and expected to be earned, anticipated returns on pension plan assets and income tax and other regulations. Prior to the spinoff, the majority of Solutia's employees participated in Monsanto's noncontributory pension plans. In conjunction with the spinoff, Solutia assumed pension liabilities and received related assets from those plans for its applicable active employees and for certain former employees who left Monsanto in earlier years.
Certain employees also participate in benefit programs that provide certain health care and life insurance benefits for retired employees. All regular, full-time U.S. employees and certain employees in other countries, who were employed by the Company on or before December 31, 1998, may become eligible for these benefits if they reach retirement age while employed by Solutia and have the required years of service. These postretirement benefits are unfunded and are generally based on the employee's age, years of service and/or compensation level. The costs of postretirement benefits are accrued by the date the employees become eligible for the benefits. In connection with the spinoff, Solutia assumed retiree medical liabilities for its applicable active employees and for approximately two-thirds of the retired U.S. employees of Monsanto.
For 2002, 2001, and 2000, Solutia's pension and healthcare and other benefit costs were as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Components of the changes in fair value of plan assets, changes in the benefit obligation and the funding status of Solutia's postretirement plans were as follows:
Plan assets consist principally of common stocks and U.S. government and corporate obligations. As a result of the decline in the fair value of our plan assets, and, to a lesser extent, higher benefit obligations resulting from a lower discount rate, the amount of pension plan underfunding in the pension plans increased to $587 million as of December 31, 2002. As a result of the underfunded status of the pension plans and in accordance with SFAS No. 87, "Employers' Accounting for Pensions," Solutia recorded a non-cash minimum pension liability of $262 million, an intangible asset of $68 million, an aftertax charge to shareholders' deficit of $122 million and a related deferred tax asset of $72 million at its measurement date of December 31, 2002.
The Company is actively managing the funding of the pension plan in order to meet the requirements of the IRS and the Pension Benefits Guarantee Corporation (a U.S. federal agency). In the third quarter of 2002, Solutia made discretionary contributions of $17 million to the qualified pension plan to reduce the probability of larger contribution requirements in the future and to utilize available tax benefits. The Company also contributed $7 million in 2002 to fund its other benefit plans. According to IRS funding rules, Solutia does not expect to be required to make a pension contribution in 2003. However, future discretionary contributions will be considered based on actual market returns, pension cost projections and tax and other financial considerations.
The funded status of Solutia's postretirement benefit plans at December 31, 2002, and 2001 was as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The accrued net liability was included in:
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets were $1,601 million, $1,551 million and $1,017 million, respectively, as of December 31, 2002, and $1,643 million, $1,547 million and $1,313 million, respectively, as of December 31, 2001.
The significant actuarial assumptions used to estimate the projected benefit obligation for the Company's principal pension, healthcare and other benefit plans were as follows:
A 1 percent change in the assumed health care cost trend rates would have the following effect as of December 31, 2002:
14. EMPLOYEE SAVINGS PLANS
In connection with the spinoff, Monsanto common stock held by the Monsanto Employee Stock Ownership Plan (ESOP) and related Monsanto ESOP borrowings were allocated between Solutia and Monsanto. As a result of this allocation, Solutia received 2.4 million shares of Monsanto common stock and assumed $29 million of ESOP debt to third parties. Simultaneously, Solutia created its own ESOP, established a trust to hold the Monsanto shares, and issued a $29 million loan to the trust. The trust used the proceeds of the loan to repay the assumed third-party debt. Subsequent to the spinoff, the ESOP trust was required by government regulations to divest its holdings of Monsanto common stock and to use the proceeds to acquire Solutia common stock. The divestiture of Monsanto common stock and the purchase of Solutia common stock were completed in early 1998. At inception, the trust held 10,737,097 shares of Solutia common stock. As of December 31, 2002, there have been 10,737,097 shares allocated to participants. The ESOP loans to Solutia were repaid in 2002. The ESOP is no longer leveraged. During 2002, the ESOP purchased Solutia common stock on the open market to fund company match. The ESOP will fulfill future matching obligations with the use of treasury stock and open market purchases.
Substantially all U.S. employees of Solutia are eligible to participate in the Solutia Inc. Savings and Investment Plan, a 401(k) plan. Shares held in the ESOP were used to make Solutia's matching contribution to eligible participants' accounts under this plan. The number of shares released was computed on each pay date based on formula that considers the participant contribution, the Solutia matching rate, and Solutia's closing stock price. Shares allocated to participant accounts totaled 433,536 shares in 2002, 1,160,203 shares in 2001, and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1,314,341 shares in 2000. The value of these contributions was $4 million in 2002, $15 million in 2001 and $17 million in 2000. Company cash contributions during 2002 were used to repay ESOP loans of $2 million and to purchase Solutia common stock on the open market of $11 million. Compensation expense is equal to the cost of the shares allocated to participants and the cost to purchase Solutia's common stock on the open market.
Information regarding the ESOP follows:
15. STOCK OPTION PLANS
Solutia has two stock-based incentive plans under which awards are being granted to officers and employees, the Solutia Inc. 2000 Stock-Based Incentive Plan and the Solutia Inc. 1997 Stock-Based Incentive Plan. The 2000 plan authorizes up to 5,400,000, and the 1997 plan up to 7,800,000, shares of Solutia common stock for grants of non-qualified and incentive stock options, stock appreciation rights, restricted stock awards and bonus stock awards. The shares used may be newly issued shares, treasury shares or a combination. Under both plans, the exercise price of a stock option must be no less than the fair market value of Solutia's common stock on the option grant date. Additionally, the plans provide that the term of any stock option granted may not exceed 10 years. At December 31, 2002, approximately 2,036,196 shares from the 2000 plan and 146,772 shares from the 1997 plan remained available for grants.
During 2002, non-qualified options to purchase 393,000 shares of Solutia common stock were granted under the plans to current executive officers and other senior executives as a group, and non-qualified stock options to purchase 1,179,800 shares were granted to other employees at an average exercise price of $10.28 per share. Total shares covered by options granted under the plans to current executive officers and other senior executives as a group totaled 2,960,000 and other employees totaled 9,080,318, through December 31, 2002. The options granted to Solutia's executive officers and other senior executives are primarily performance options that become exercisable upon the earlier of achievement of specified share price targets or the ninth anniversary of the option grant. The options granted to the other management employees are time-based. They generally become exercisable in thirds, one-third on each of the first three anniversaries of the option grant date.
The Solutia Inc. Non-Employee Director Compensation Plan provides incentives to non-employee members of Solutia's board of directors. This plan authorizes up to 400,000 shares for grants of non-qualified stock options and for grants of deferred shares in payment of all or a portion of the annual retainer for the non-employee directors. Only treasury shares may be used. Under this plan, the exercise price of a stock option must be no less than the fair market value of Solutia's common stock on the grant date and the term of any stock option granted under the plan may not exceed 10 years. At December 31, 2002, 65,650 shares of Solutia's common stock remained available for grants under the plan. Shares covered by options granted to non-employee directors totaled 24,833 in 2002, 25,167 in 2001 and 25,167 in 2000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," Solutia has elected to continue following the guidance of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," for measurement and recognition of stock-based transactions with employees. Accordingly, no compensation cost has been recognized for Solutia's option plans in net income (loss), as all options granted under the plans had an exercise price equal to the market value of the Company's stock on the date of the grant. Had the determination of compensation cost for these plans been based on the fair value at the grant dates for awards under these plans, consistent with the method of SFAS No. 123, Solutia's net income (loss) would have been reduced (increased) to the pro forma amounts indicated below:
Compensation expense resulting from the fair value method of SFAS No. 123 may not be representative of compensation expense to be incurred on a pro forma basis in future years. The fair value of each option grant is estimated on the date of grant by use of the Black-Scholes option-pricing model.
The following weighted-average assumptions were used for grants of Solutia options in 2002, 2001 and 2000:
The weighted-average fair values of options granted were $5.08 in 2002, $5.57 in 2001 and $5.30 in 2000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the status of Solutia's stock option plans for years ended December 31, 2002, 2001 and 2000 follows:
The following table summarizes information about stock options outstanding at December 31, 2002:
OPTIONS OUTSTANDING:
OPTIONS EXERCISABLE:
16. CAPITAL STOCK
Solutia's board of directors declared a dividend of one preferred stock purchase right for each share of Solutia's common stock issued in the distribution of shares by Monsanto to its shareholders on the effective date of the spinoff and authorized the issuance of one right for each share of common stock issued after the effective date of the spinoff until the earlier of the date the rights become exercisable and the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
termination date of the rights plan. If a person or group acquires beneficial ownership of 20 percent or more, or announces a tender offer that would result in beneficial ownership of 20 percent or more, of Solutia's outstanding common stock, the rights become exercisable. Then, for every right held, the owner will be entitled to purchase one one-hundredth of a share of a series of preferred stock for $125. If Solutia is acquired in a business combination transaction while the rights are outstanding, for every right held, the holder will be entitled to purchase, for $125, common shares of the acquiring company having a market value of $250. In addition, if a person or group acquires beneficial ownership of 20 percent or more of Solutia's outstanding common stock, for every right held, the holder (other than such person or members of such group) will be entitled to purchase, for $125, a number of shares of Solutia's common stock having a market value of $250. Furthermore, at any time after a person or group acquires beneficial ownership of 20 percent or more (but less than 50 percent) of Solutia's outstanding common stock, Solutia's board of directors may, at its option, exchange part or all of the rights (other than rights held by the acquiring person or group) for shares of Solutia's common stock on a one-share-for-every-one-right basis. At any time prior to the acquisition of such a 20 percent position, Solutia can redeem each right for $0.01. The board of directors is also authorized to reduce the aforementioned 20 percent thresholds to not less than 10 percent. The rights expire in the year 2007.
The Company has 10 million shares of preferred stock, par value $0.01 per share, authorized. As of December 31, 2002, there were no preferred shares issued or outstanding.
17. COMMITMENTS AND CONTINGENCIES
Commitments, principally in connection with uncompleted additions to property, were approximately $7 million at December 31, 2002. Solutia was contingently liable as a guarantor principally in connection with bank loans totaling approximately $9 million in 2001. In addition, as of December 31, 2002, the Company was contingently liable under letters of credit, primarily related to environmental remediation, totaling $128 million, $11 million of which were cash collaterized. Solutia collaterized an additional $39 million of letters of credit on January 31, 2003, with proceeds from the divestiture of the resins, additives and adhesives businesses. Solutia's future minimum payments under noncancelable operating leases and unconditional purchase obligations are $25 million for 2003, $26 million for 2004, $20 million for 2005, $17 million for 2006, $50 million for 2007, and $66 million thereafter.
Solutia has entered into agreements with certain customers to supply a guaranteed quantity of certain products annually at prices specified in the agreements. In return, the customers have advanced funds to Solutia to cover the costs of expanding capacity to provide the guaranteed supply. Solutia has recorded the advances as deferred credits and amortizes the amounts to income as the customers purchase the products. The unamortized deferred credits were approximately $161 million at December 31, 2002, and approximately $175 million at December 31, 2001.
The more significant concentrations in Solutia's trade receivables at year-end were:
Management does not anticipate losses on its trade receivables in excess of established allowances.
Off-Balance Sheet Arrangements
In 1993, a co-generation facility was constructed at the Pensacola, Florida manufacturing site to provide the plant with electricity and steam. Solutia financed the construction by placing the co-generation facility in a trust that was funded by a syndicate of commercial banks. This arrangement enabled the Company to lease the facility rather than acquire it. Solutia makes operating lease payments of approximately $2 million annually and the lease term is co-terminous with the Amended Credit Facility. As required by the Amended Credit
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Facility, Solutia used a portion of the expected proceeds from the sale of the resins, additives and adhesives businesses to purchase the co- generation facility from the trust for approximately $32 million during the first quarter of 2003.
In 1999, the Company's corporate headquarters office building was constructed in St. Louis, Missouri. Solutia financed the construction of the building by placing the facility in a trust that was funded by a syndicate of financial institutions. This arrangement enabled the Company to lease the facility rather than acquire it. Solutia makes operating lease payments of approximately $3 million annually. The lease term expires in August 2007 at which time the Company has the option to refinance the building through a similar lease arrangement, purchase the building from the trust for the lease balance of approximately $43 million or sell the building on behalf of the trust and deliver the proceeds to the trust. Solutia has provided the trust a residual value guaranty of approximately $35 million in the event that the building is sold for less than the lease balance or cannot be sold. Although current commercial real estate values in St. Louis, Missouri metropolitan area have declined recently because of the general weakening of the economy in the United States, the Company estimates that the fair value of the building exceeds the residual value guaranty and will continue to do so in the foreseeable future. As a result, the Company does not expect this guarantee to have a financial statement impact. The Company intends to refinance the building with a similar leasing arrangement when the current lease expires. Based on the terms of the lease agreements and the residual value guarantee Solutia provides to the trust, the Company expects to be the primary beneficiary. As a result, Solutia would be required to consolidate the assets and liabilities held by the trust in the third quarter of 2003.
Contingencies
In connection with the completion of the external financing agreement for Astaris, which expires in September of 2005, Solutia and its equal partner in the venture, FMC Corporation, contractually agreed to provide Astaris with funding in the event the joint venture fails to meet certain financial benchmarks. The financial benchmarks were based on forecasted earnings that were developed when the joint venture was formed in April 2000. Astaris' earnings have fallen short of the forecast underlying its external financing agreement due to numerous factors including significantly less than planned utilization of its purified wet acid technology, lower sales volumes and lower average selling prices due to the prolonged weak U.S. economy. As a result of these earnings shortfalls versus the original expectations developed at the time the venture was formed, Solutia has been required to make additional investments of $30 million in 2002 and $31 million in 2001 to the joint venture. These payments have largely been used to reduce debt outstanding within the venture. At December 31, 2002, net debt (total debt less cash) for Astaris totaled $160 million, $59 million lower than net debt at the end of the prior year. Solutia and FMC are evaluating other financing alternatives for the joint venture. However, if no new financing arrangements are in place for 2003, Solutia anticipates required contributions of approximately $50 million for 2003. Contributions are recorded in the Investments in Affiliates line on the Statement of Consolidated Financial Position.
The Statement of Consolidated Financial Position included accrued liabilities of $146 million at December 31, 2002, and $165 million at December 31, 2001, for the remediation of identified waste disposal sites. Expenditures related to remediation activities were $26 million in 2002, $40 million in 2001, and $26 million in 2000. Solutia expects to incur expenditures in the range of $30 million to $40 million annually for remediation activities for the foreseeable future.
Uncertainties related to recorded environmental liabilities include changing governmental policy and regulations, judicial proceedings, the method and extent of remediation and future changes in technology. The Company believes that these matters, when ultimately resolved, which may be over an extended period of time, will not have a material adverse effect on the consolidated financial position or liquidity, but could have a material adverse effect on net income in any given period.
Mortgages on the plants located in Decatur, Alabama; Springfield, Massachusetts; Trenton, Michigan; Greenwood, South Carolina; Alvin (Chocolate Bayou), Texas; Pensacola, Florida; and Martinsville, Virginia constitute a portion of the collateral securing the Amended Credit Facility, publicly issued debt, and obligations under certain other financing facilities. In addition, there is a mechanics' lien filed by Fluor Daniel, a division of Fluor Enterprises, Inc., against the Chocolate Bayou facility, currently in the amount of $10 million, securing the remaining payments the Company has agreed to make to Fluor Daniel over a three-year period in settlement of litigation arising out of the construction of an acrylonitrile facility at the Chocolate Bayou plant.
As discussed in Item 3 to this report, because of the size and nature of its business, Solutia is a party to numerous legal proceedings. Most of these proceedings have arisen in the ordinary course of business and involve claims for money damages. In addition, at the time we became an independent company, we assumed liabilities related to specified legal proceedings from the former Monsanto Company (now known as Pharmacia Corporation), under an agreement known as the Distribution Agreement. As a result, although Monsanto remains the named defendant, the Company is required to manage the litigation and indemnify Monsanto for costs, expenses and judgments arising from the litigation. While the results of litigation cannot be predicted with certainty, the Company does not believe, based on currently available facts, that the ultimate resolution of any of these preceding matters will have a material adverse effect on our financial position or
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
liquidity in any one year. However, resolution in those cases described below involving the alleged discharge of polychlorinated biphenyls ("PCBs") from the Anniston, Alabama plant site and the Penndot case, also described below, may have a material adverse effect on net income in a given year, although it is impossible at this time to estimate the range or amount of any such liability. In addition, there cannot be any assurance that any final judgment against the Company in the Anniston, Alabama cases, if upheld on appeal, will not have a material adverse effect on financial position and liquidity.
Monsanto manufactured PCBs at the Anniston, Alabama plant from 1935 to 1971. Solutia is defending a number of actions in state and federal court in Alabama relating to the alleged emission of PCBs and other allegedly hazardous materials from that plant. Plaintiffs claim to suffer from various personal injuries and are allegedly fearful of future illness. Some claim property damage. To date we have settled approximately 5,900 PCB claims relating to Anniston. Four cases originally filed on behalf of approximately 3,500 plaintiffs were consolidated and a trial of the claims of 16 individuals and one business from that group of plaintiffs is in progress. Plaintiffs in the current trial are claiming property damage and mental anguish and are seeking compensatory and punitive damages and injunctive relief. The jury in that case has returned a verdict finding Solutia liable to plaintiffs on theories of negligence, wantonness, suppression of the truth, nuisance, trespass and outrage. The issue of damages has not yet been submitted to the jury. The jury also determined that the circumstances in Anniston constitute a public nuisance. The Alabama Attorney General and the District Attorneys in four counties around Anniston intervened in this matter as plaintiffs for the public nuisance count. They seek an order compelling Solutia to pay for a study of the impact of PCBs in the area, and formulating a plan and setting a schedule for cleanup. In addition, the Alabama Department of Environmental Management intervened in this matter to assure that any decision reached has a sound scientific basis. Another Anniston case pending in federal court in Birmingham, Alabama, filed on behalf of 1,116 minor plaintiffs, now involves approximately 17,000 adult and minor plaintiffs. Those plaintiffs claim to suffer unspecified injuries and assert their right to medical monitoring and testing, and seek compensatory and punitive damages in unspecified amounts. The case will proceed in phases, with trial of the claims of 8 Phase I plaintiffs scheduled to begin after July 31, 2003. These cases are being vigorously defended.
Solutia is also defending an action brought against Monsanto in the Commonwealth Court of Pennsylvania relating to the discovery of low levels of PCBs in the Transportation & Safety Building owned by the Commonwealth in Harrisburg, Pennsylvania. The Commonwealth sought recovery of costs it allegedly incurred in testing, monitoring, cleanup, demolition and temporary relocation of Commonwealth employees allegedly caused by the PCBs found in the building. In addition the Commonwealth sought the cost of constructing a new building on the site of the T&S Building. After trial a judgment was entered against Monsanto in the amount of $59.5 million, and Solutia filed an appeal with the Pennsylvania Supreme Court. This matter is being vigorously defended. Liability, if any, that may result from litigation against Solutia is not determinable. Management does not believe that the ultimate resolution of these cases will have a material adverse impact on its consolidated financial position or liquidity. However, it is possible that a resolution of these cases may have a material adverse impact on Solutia's net income in a given year, although it is impossible at this time to estimate the range or amount of any such liability.
18. SUPPLEMENTAL DATA
Supplemental income statement data from continuing operations were:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. SEGMENT AND GEOGRAPHIC DATA
In anticipation of the divestiture of the resins, additives and adhesives businesses, Solutia reorganized its management structure and realigned its reportable segments during the fourth quarter of 2002. Solutia's new reportable segments and their major products are as follows:
Solutia evaluates the performance of its operating segments based on segment earnings before interest expense and income taxes (EBIT), which includes marketing, administrative, technological, and amortization expenses and other restructuring and asset impairment charges that can be directly attributable to the segment profit/(loss). Certain expenses and other items that are managed outside of the segments are excluded. These unallocated items consist primarily of corporate expenses, equity earnings (loss) from affiliates, interest expense, other income--net and expense items, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the operating segment.
Solutia's 2002, 2001 and 2000 segment information follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Solutia's geographic information for 2002, 2001 and 2000 follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. QUARTERLY DATA--UNAUDITED
Net loss in the first quarter of 2002 includes an aftertax gain of $3 million from the sale of the Company's 50 percent interest in the Advanced Elastomer Systems joint venture. Net income in the third quarter of 2002 includes aftertax charges of $3 million related to the resolution of a construction dispute with the contractor of the acrylonitrile plant in Alvin, (Chocolate Bayou) Texas and an aftertax charge of $8 million for a non-cash pension settlement loss because of the significant amount of lump sum distributions from the pension plan. Net loss in the fourth quarter of 2002 includes $4 million of charges for the Flexsys joint venture related to the write-down of production assets to fair market value at its Nitro, West Virginia, facility, and an aftertax charge of $3 million for a non-cash pension settlement loss because of the significant amount of lump sum distributions from the pension plan.
Net loss in the fourth quarter of 2001 includes aftertax charges of $96 million to cover Solutia's share of restructuring costs at its Astaris and Flexsys joint ventures, increases to environmental and self-insurance reserves, additional severance costs and the write down of certain non-performing assets.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Under SFAS No. 128, "Earnings per Share," the quarterly and total year calculations of basic and diluted earnings (loss) per share are based on weighted average shares outstanding for that quarterly or total year period, respectively. As a result, the sum of diluted earnings (loss) per share for the quarterly periods may not equal total year earnings (loss) per share.
21. CONSOLIDATING CONDENSED FINANCIAL STATEMENTS
CPFilms, Inc., Monchem International, Inc., Monchem, Inc., and Solutia Systems, Inc., wholly-owned subsidiaries of the Company (the "Guarantors"), are guarantors of the Amended Credit Facility and the Notes (see Note 11). The Guarantors fully and unconditionally guarantee the Notes on a joint and several basis. The following consolidating condensed financial statements present, in separate columns, financial information for: Solutia Inc. on a parent only basis carrying its investment in subsidiaries under the equity method; Guarantors on a combined, or where appropriate, consolidated basis, carrying investments in subsidiaries who do not guarantee the debt (the "Non-Guarantors") under the equity method; Non-Guarantors on a combined, or where appropriate, consolidated basis; eliminating adjustments; and consolidated totals as of December 31, 2002 and December 31, 2001, and for the years ended December 31, 2002, 2001 and 2000. The eliminating adjustments primarily reflect intercompany transactions, such as interest income and expense, accounts receivable and payable, advances, short and long-term debt, royalties and profit in inventory eliminations. The Company has not presented separate financial statements and other disclosures concerning the Guarantors as such information is not material and would substantially duplicate disclosures included elsewhere in this report.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
* * * * *
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information about directors and executive officers appearing under "Election of Directors" on pages 5 through 7 of Solutia's definitive Proxy Statement for its 2003 Annual Meeting of Stockholders, to be filed with the SEC, is incorporated by reference. The following information about Solutia's executive officers on March 6, 2003, is included pursuant to Instruction 3 of Item 401(b) of Regulation S-K:
The above listed individuals are elected to the offices set opposite their names to hold office until their successors are duly elected and have qualified, or until their earlier death, resignation or removal.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Information appearing under "Compensation of Directors" on page 9 and under "Summary Compensation Table," "Option Grants in 2002," "Aggregated Option Exercises in 2002 and Year-End Option Values," "Long-Term Incentive Plan--Awards in Last Fiscal Year," "Pension Plans," and "Agreements with Named Executive Officers" on pages 15 through 19 of Solutia's 2003 Proxy Statement is incorporated here by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information appearing under "Ownership of Company Common Stock" on pages 10 through 12 of Solutia's 2003 Proxy Statement is incorporated here by reference.
EQUITY COMPENSATION PLAN INFORMATION
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES.
Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information that is required to be included in our filings under the Securities Exchange Act of 1934.
There have not been any significant changes in our internal controls or in other factors that could significantly affect these controls, including any corrective actions with regard to significant deficiencies or material weaknesses, since the date of our evaluation.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
1. Financial Statements--See the Index to Consolidated Financial Statements and Financial Statement Schedule at page 34 of this report.
2. The following supplemental schedule for the years ended December 31, 2002, 2001 and 2000
II--Valuation and Qualifying Accounts
All other supplemental schedules are omitted because of the absence of the conditions under which they are required.
3. Exhibits--See the Exhibit Index beginning at page 81 of this report. For a listing of all management contracts and compensatory plans or arrangements required to be filed as exhibits to this report, see the exhibits listed under Exhibit Nos. 10(a), 10(b), 10(d) through 10(n) on pages 82 and 83 of the Exhibit Index. The following exhibits listed in the Exhibit Index are filed with this report:
3(b) By-Laws of Solutia Inc., as amended February 26, 2003
10(k) Solutia Inc. Deferred Compensation Plan, as amended in 2002
10(r) Amendment No. 2, dated as of December 24, 2002, to Second Amended and Restated Credit Agreement dated as of July 25, 2002, between Solutia Inc., as Borrower, the initial lenders named therein, Bank of America, N.A., as Syndication Agent and Citibank, N.A., as Administrative Agent
10(t) Amendment to Protocol Agreement, dated as of March 3, 2003, by and among Pharmacia Corporation, Solutia Inc. and Monsanto Company
12 Computation of the Ratio of Earnings to Fixed Charges
21 Subsidiaries of the Registrant
23 Independent Auditors' Consent
24(a) Powers of Attorney submitted by John C. Hunter III, Robert A. Clausen, James M. Sullivan, Paul Donovan, Paul H. Hatfield, Robert H. Jenkins, Philip R. Lochner, Jr., Frank A. Metz, Jr., J. Patrick Mulcahy, Sally G. Narodick, William D. Ruckelshaus and John B. Slaughter
24(b) Certified copy of board resolution authorizing Form 10-K filing using powers of attorney
(b) Reports on Form 8-K during the quarter ended December 31, 2002:
Solutia filed a Form 8-K on November 18, 2002, to incorporate certain audited financial statements into its filings under the Securities Act of 1933.
Solutia filed a Form 8-K on December 3, 2002, to announce the agreement to sell its resins, additives and adhesives businesses to UCB S.A.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SOLUTIA INC.
By: /s/ J. M. SULLIVAN ------------------------------ James M. Sullivan Vice President and Controller (Principal Accounting Officer)
Date: March 6, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ JEFFRY N. QUINN --------------------------------- Jeffry N. Quinn, Attorney-in-Fact
I, John C. Hunter III, certify that:
1. I have reviewed this annual report on Form 10-K of Solutia Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ JOHN C. HUNTER III ----------------------------------------------- John C. Hunter III Chairman, President and Chief Executive Officer
I, Robert A. Clausen, certify that:
1. I have reviewed this annual report on Form 10-K of Solutia Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 6, 2003
/s/ ROBERT A. CLAUSEN ------------------------------------------ Robert A. Clausen Vice Chairman, Chief Financial Officer and Chief Administrative Officer
EXHIBIT INDEX
These exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K.
Exhibit No. Description - ----------- -----------
2(a) Distribution Agreement (incorporated by reference to Exhibit 2 of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997)
2(b) Amendment to Distribution Agreement, dated as of July 1, 2002, by and among Pharmacia Corporation, Solutia Inc., and Monsanto Company (incorporated by reference to Exhibit 2 of Solutia's Form 10-Q for the quarter ended June 30, 2002)
2(c) Joint Venture Agreement between Solutia Inc. and FMC Corporation* (incorporated by reference to Exhibit 2(i) of Solutia's Form 8-K filed on April 27, 2000)
2(d) First Amendment to Joint Venture Agreement between Solutia Inc. and FMC Corporation (incorporated by reference to Exhibit 2(ii) of Solutia's Form 8-K filed on April 27, 2000)
2(e) Second Amendment to Joint Venture Agreement between Solutia Inc. and FMC Corporation (incorporated by reference to Exhibit 2(iii) of Solutia's Form 8-K filed on April 27, 2000)
2(f) Third Amendment to Joint Venture Agreement between Solutia Inc. and FMC Corporation (incorporated by reference to Exhibit 2(iv) of Solutia's Form 8-K filed on April 27, 2000)
2(g) Stock and Asset Purchase Agreement by and between UCB S.A. and Solutia Inc., dated as of December 2, 2002 (incorporated by reference to Exhibit 2 of Solutia's Form 8-K filed on February 18, 2003)
3(a) Restated Certificate of Incorporation of Solutia (incorporated by reference to Exhibit 3(a) of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997)
3(b) By-Laws of Solutia Inc., as amended February 26, 2003
4(a) Rights Agreement (incorporated by reference to Exhibit 4 of Solutia's Registration Statement on Form 10 filed on August 7, 1997)
4(b) Amendment to the Rights Agreement (incorporated by reference to Exhibit 4.4, of Solutia's Registration Statement on Form S-3 (333-75812) filed December 21, 2001)
4(c) Indenture dated as of October 1, 1997, between Solutia Inc. and The Chase Manhattan Bank, as Trustee (incorporated by reference to Exhibit 4.1 of Solutia's Form 10-Q for the quarter ended September 30, 1997)
4(d) 7.375% Debentures due 2027 in the principal amount of $200,000,000 (incorporated by reference to Exhibit 4.3 of Solutia's Form 10-Q for the quarter ended September 30, 1997)
4(e) 7.375% Debentures due 2027 in the principal amount of $100,000,000 (incorporated by reference to Exhibit 4.4 of Solutia's Form 10-Q for the quarter ended September 30, 1997)
4(f) 6.72% Debentures due 2037 in the principal amount of $150,000,000 (incorporated by reference to Exhibit 4.5 of Solutia's Form 10-Q for the quarter ended September 30, 1997)
4(g) Registrant agrees to furnish to the Securities and Exchange Commission upon request copies of instruments defining the rights of holders of certain unregistered long-term debt of the registrant and its consolidated subsidiaries.
4(h) Warrant Agreement between Solutia Inc. and HSBC Bank USA as Warrant Agent, dated as of July 9, 2002 (incorporated by reference to Exhibit 4 of Solutia's Form 10-Q for the quarter ended June 30, 2002)
4(i) Indenture dated as of July 9, 2002, between SOI Funding Corp. and HSBC Bank USA, as Trustee (incorporated by reference to Exhibit 4.2 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
- ------------ *Confidential treatment has been granted for a portion of this exhibit.
EXHIBIT INDEX (CONTINUED)
Exhibit No. Description - ----------- -----------
4(j) First Supplemental Indenture, dated as if July 25, 2002, among Solutia Inc., SOI Funding Corp., the Subsidiary Guarantors and HSBC Bank USA, as Trustee (incorporated by reference to Exhibit 4.3 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
4(k) Second Supplemental Indenture, dated as of October 24, 2002, among Solutia Inc., the subsidiary guarantors named therein and HSBC Bank USA (incorporated by reference to Exhibit 4 of Solutia's Form 10-Q for the quarter ended September 30, 2002)
4(l) Restated Intercreditor and Collateral Agency Agreement, dated as of July 25, 2002, between Solutia Inc., the subsidiary guarantors named therein, and Citibank, N.A. (incorporated by reference to Exhibit 4.8 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
4(m) Restated Security and Guarantee Agreement, dated as of July 25, 2002, between Solutia Inc., the subsidiary guarantors named therein, and Citibank, N.A. (incorporated by reference to Exhibit 4.9 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
4(n) Intercreditor and Collateral Trust Agreement, dated as of July 25, 2002, between Solutia Inc., the subsidiary guarantors named therein, and Citibank, N.A. (incorporated by reference to Exhibit 4.10 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
4(o) Sharing Security Agreement, dated as of July 25, 2002, between Solutia Inc., the subsidiary guarantors named therein, and HSBC Bank USA (incorporated by reference to Exhibit 4.11 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
4(p) Junior Intercreditor Agreement, dated as of July 25, 2002, between Solutia Inc., the subsidiary guarantors named therein, and Citibank, N.A. (incorporated by reference to Exhibit 4.12 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
4(q) Junior Security Agreement, dated as of July 25, 2002, between Solutia Inc., the subsidiary guarantors named therein, and Citibank, N.A. (incorporated by reference to Exhibit 4.13 of Solutia's Form S-4 (333-99699) filed September 17, 2002)
9 Omitted--Inapplicable
10(a) Financial Planning and Tax Preparation Services Program for the Executive Leadership Team (incorporated by reference to Exhibit 10(a) of Solutia's Form 10-K for the year ended December 31, 1997)
10(b) Employee Benefits Allocation Agreement (incorporated by reference to Exhibit 10(a) of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997)
10(c) Tax Sharing and Indemnification Agreement (incorporated by reference to Exhibit 10(b) of Solutia's Registration Statement on Form S-1 (333-36355) filed September 25, 1997)
10(d) Solutia Inc. Management Incentive Replacement Plan as amended in 1999 (incorporated by reference to Exhibit 10(2) of Solutia's Form 10-Q for the quarter ended June 30, 1999)
10(e) Solutia Inc. 1997 Stock-Based Incentive Plan as amended in 1999 and 2000 (incorporated by reference to Exhibit 10(1) of Solutia's Form 10-Q for the quarter ended June 30, 2000)
10(f) Solutia Inc. Non-Employee Director Compensation Plan, as amended in 1999, 2000, and 2001 (incorporated by reference to Exhibit 10 of Solutia's Form 10-Q for the quarter ended June 30, 2001)
10(g) Form of Employment Agreement with certain Named Executive Officers (incorporated by reference to Exhibit 10(1) of Solutia's Form 10-Q for the quarter ended March 31, 1998)
10(h) Form of Employment Agreement with other executive officers (incorporated by reference to Exhibit 10(2) of Solutia's Form 10-Q for the quarter ended March 31, 1998)
10(i) Solutia Inc. Annual Incentive Plan (incorporated by reference to Appendix B of the Solutia Inc. Notice of Annual Meeting and Proxy Statement dated March 9, 2000)
EXHIBIT INDEX (CONTINUED)
Exhibit No. Description - ----------- -----------
10(j) Solutia Inc. Long-Term Incentive Plan (incorporated by reference to Appendix C of the Solutia Inc. Notice of Annual Meeting and Proxy Statement dated March 9, 2000)
10(k) Solutia Inc. Deferred Compensation Plan, as amended in 2002
10(l) Solutia Inc. 2000 Stock-Based Incentive Plan (incorporated by reference to Appendix A of the Solutia Inc. Notice of Annual Meeting and Proxy Statement dated March 9, 2000)
10(m) Solutia Inc. 2002-2006 Long-Term Incentive Plan (incorporated by reference to Appendix A of the Solutia Inc. Notice of Annual Meeting and Proxy Statement dated March 14, 2002)
10(n) Letter Agreement between Solutia Inc. and Russell J. Belle dated January 14, 2002 (incorporated by reference to Exhibit 10 of Solutia's Form 10-Q for the quarter ended March 31, 2002)
10(o) Protocol Agreement, dated as of July 1, 2002, by and among Pharmacia Corporation, Solutia Inc., and Monsanto Company (incorporated by reference to Exhibit 10(b) of Solutia's Form 10-Q for the quarter ended June 30, 2002)
10(p) Second Amended and Restated Credit Agreement, dated as of July 25, 2002, between Solutia Inc., as Borrower, the initial lenders named therein, Bank of America, N.A., as Syndication Agent and Citibank, N.A. as Administrative Agent (incorporated by reference to Exhibit 10(c) of Solutia's Form 10-Q for the quarter ended June 30, 2002)
10(q) Amendment No. 1, dated as of September 26, 2002, to Second Amended and Restated Credit Agreement dated as of July 25, 2002, between Solutia Inc., as Borrower, the initial lenders named therein, Bank of America, N.A. as Syndication Agent and Citibank, N.A., as Administrative Agent (incorporated by reference to Exhibit 10 of Solutia's Form 10-Q for the quarter ended September 30, 2002)
10(r) Amendment No. 2, dated as of December 24, 2002, to Second Amended and Restated Credit Agreement dated as of July 25, 2002, between Solutia Inc., as Borrower, the initial lenders named therein, Bank of America, N.A., as Syndication Agent and Citibank, N.A., as Administrative Agent
10(s) Protocol Agreement, dated as of November 15, 2002, by and among Pharmacia Corporation, Solutia Inc. and Monsanto Company (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed November 18, 2002)
10(t) Amendment to Protocol Agreement, dated as of March 3, 2003, by and among Pharmacia Corporation, Solutia Inc. and Monsanto Company
11 Omitted--Inapplicable; see "Statement of Consolidated Income (Loss)" on page 36
12 Computation of the Ratio of Earnings to Fixed Charges (see page 84)
16 Omitted--Inapplicable
18 Omitted--Inapplicable
21 Subsidiaries of the Registrant (see page 85)
22 Omitted--Inapplicable
23 Independent Auditors' Consent (see page 86)
24(a) Powers of Attorney submitted by John C. Hunter III, Robert A. Clausen, James M. Sullivan, Paul Donovan, Paul H. Hatfield, Robert H. Jenkins, Philip R. Lochner, Jr., Frank A. Metz, Jr., J. Patrick Mulcahy, Sally G. Narodick, William D. Ruckelshaus and John B. Slaughter
24(b) Certified copy of Board resolution authorizing Form 10-K filing utilizing powers of attorney
- -------- Only Exhibit Nos. 12, 21 and 23 have been included in the printed copy of this report.