ITEM 1. BUSINESS
OVERVIEW
Solutia Inc., together with its subsidiaries ("Solutia"), is a global manufacturer and marketer of a variety of high-performance chemical-based materials that are used in a broad range of consumer and industrial applications. As used herein, the "Company" and terms such as "we" and "our" refers to Solutia unless the context requires otherwise.
Solutia reports its business in two segments: Performance Products and Integrated Nylon.
Solutia's Performance Products segment is comprised of six product lines. The product lines are generally managed based on the markets into which these products are sold.
o Solutia's SAFLEX(R) plastic interlayers are used for laminated safety glass, primarily in automotive manufacturing and architectural applications. Solutia markets its plastic interlayers to the automotive industry for use in automobile windshields and side, rear and roof windows of vehicles. SAFLEX(R) markets its plastic interlayers to the commercial and residential architectural markets via several sub-brands.
o Solutia's LLUMAR(R), VISTA(R), GILA(R) and FORMULA ONE PERFORMANCE AUTOMOTIVE FILM(R) brands of window films are custom coated and used primarily for aftermarket automotive and architectural applications. LLUMAR(R) and GILA(R) window films are marketed for both automotive and architectural applications, with LLUMAR(R) marketed to the professional aftermarket, and GILA(R) marketed to the do-it-yourself retail market. VISTA(R) window films are marketed for professional architectural applications, and FORMULA ONE PERFORMANCE AUTOMOTIVE FILM(R) automotive window films are marketed to the professional automotive aftermarket.
o Solutia's DEQUEST(R) water treatment phosphonates are used to enhance water quality for industrial and domestic use.
o Solutia's THERMINOL(R) heat transfer fluids are used in systems that provide for indirect heating or cooling of industrial and chemical processes.
o Solutia's SKYDROL(R) brand aviation hydraulic fluids and SKYKLEEN(R) brand of aviation solvents are supplied across the aviation industry.
o Solutia's plastic products include entrance matting and automotive spray suppression flaps sold under the brands ASTROTURF(R), CLEAN MACHINE(R), and CLEAR PASS(TM).
Solutia's Integrated Nylon segment is comprised of an integrated family of nylon products.
o Solutia's chemical intermediates are used internally as feedstock for nylon polymer and fiber production and also are sold in the merchant market.
o Solutia's VYDYNE(R) and ASCEND(R) nylon polymers are sold to the engineered thermoplastic, apparel, textile and industrial fiber markets.
o Solutia's nylon fibers are sold in carpet and industrial markets. Carpet fibers are sold under the WEAR-DATED(R) brand for residential carpet and the ULTRON(R) brand for commercial carpet, as well as under private labels.
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, a wholly owned subsidiary of Pfizer Inc. ("Pharmacia"). On September 1, 1997, Pharmacia spun off Solutia (the "Solutia Spinoff") by distributing Solutia's shares as a dividend to its stockholders. Solutia became an independent publicly held company as a result of the Solutia Spinoff.
CHAPTER 11 PROCEEDINGS
On December 17, 2003, Solutia and its 14 U.S. subsidiaries (the "Debtors") filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Chapter 11 Cases") in the U.S. Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"). The cases were consolidated for the purpose of joint administration and were assigned case number 03-17949 (PCB). Solutia's subsidiaries outside the United States were not included in the Chapter 11 filing.
The filing was made to restructure Solutia's balance sheet, to streamline operations and to reduce costs, in order to allow Solutia to emerge from Chapter 11 as a viable going concern, and to obtain relief from the negative financial impact of liabilities for litigation, environmental remediation and certain post-retirement benefits (the "Legacy Liabilities"), and liabilities under operating contracts, all of which were assumed at the time of the Solutia Spinoff. These factors, combined with the weakened state of the chemical manufacturing sector, general economic conditions and continuing high, volatile energy and crude oil costs were an obstacle to Solutia's financial stability and success.
Under Chapter 11, Solutia is operating its businesses as a debtor-in-possession ("DIP") under court protection from creditors and claimants. Since the Chapter 11 filing, orders sufficient to enable Solutia to conduct normal business activities, including the approval of Solutia's DIP financing, have been entered by the Bankruptcy Court. While Solutia is subject to Chapter 11, all transactions not in the ordinary course of business require the prior approval of the Bankruptcy Court. Under the U.S. Bankruptcy Code, Solutia had the exclusive right to propose a plan of reorganization for 120 days following the Chapter 11 filing date. The Bankruptcy Court has subsequently approved extensions of this exclusivity period. The exclusivity period continues until the order disposing of the current motion is entered on the Bankruptcy Court's docket.
On January 16, 2004, pursuant to authorization from the Bankruptcy Court, Solutia entered into a DIP credit facility. The DIP credit facility has subsequently been amended from time to time, with Bankruptcy Court approval. The DIP credit facility, as amended, currently consists of: (a) a $975 million fully-drawn term loan; and (b) a $250 million borrowing-based revolving credit facility, which includes a $150 million letter of credit subfacility. Of the $1,225 million facility, $150 million must be utilized to acquire Akzo Nobel's 50% interest in the Flexsys joint venture between Solutia and Akzo Nobel. For additional information regarding the DIP financing and the Flexsys acquisition, see "Management's Discussion and Analysis" in Item 7 below and Note 14 to the accompanying consolidated financial statements.
As a consequence of the Chapter 11 filing, pending litigation against Solutia is generally stayed, and no party may take any action to collect its pre-petition claims except pursuant to an order of the Bankruptcy Court. November 30, 2004 was the last date by which holders of pre-petition date claims against the Debtors could file such claims. Any holder of a claim that was required to file such claim by November 30, 2004 and did not do so may be barred from asserting such claim against the Debtors and, accordingly, may not be able to participate in any distribution on account of such claim. Differences between claim amounts identified by the Debtors and claims filed by claimants will be investigated and resolved in connection with the Debtors' claims resolution process, and only holders of claims that are ultimately allowed for purposes of the Chapter 11 case will be entitled to distributions. Solutia has not yet completed its analysis of all the proofs of claim. Since the settlement terms of allowed claims are subject to a confirmed plan of reorganization, the ultimate distribution with respect to allowed claims is not presently ascertainable.
On February 14, 2006, the Debtors filed with the Bankruptcy Court a Plan of Reorganization (the "Plan") and Disclosure Statement (the "Disclosure Statement"). The Plan and Disclosure Statement along with the Relationship Agreement (as defined below) and the Retiree Settlement Agreement, entered into among Solutia, the Official Committee of Unsecured Creditors (the "Unsecured Creditor's Committee") and Official Committee of Retirees appointed in the Chapter 11 Cases (the "Retirees' Committee"), Monsanto Company ("Monsanto"), certain retirees and the other parties thereto (the "Retiree Settlement"), set forth the terms of a global settlement (the "Global Settlement") between Solutia, the Unsecured Creditors' Committee, the Retirees' Committee, Monsanto and Pharmacia. The Global Settlement provides for, among other things, a reallocation of certain Legacy Liabilities among Solutia, Monsanto and Pharmacia and the treatment that various constituencies in the Chapter 11 Cases would receive under the Plan. The reallocation of liabilities between Solutia and Monsanto is set forth in a Relationship Agreement (the "Relationship Agreement") which would be entered into between Solutia and Monsanto upon confirmation of the Plan. Since the February 14, 2006 filing, the Bankruptcy Court has not moved forward with the process to approve the Disclosure Statement and confirm the Plan.
There are two adversary proceedings ongoing in our Chapter 11 case. JPMorgan, as indenture trustee of Solutia's debentures due 2027 and 2037, filed litigation against Solutia claiming that such debentures are entitled to secured status as
opposed to general unsecured status as set forth in the Plan. In addition, the Official Committee of Equity Security Holders ("Equity Committee") in Solutia's bankruptcy case has filed litigation against Pharmacia and Monsanto, arguing that holders of Solutia's existing equity are entitled to a distribution in the Chapter 11 case. For additional information regarding these litigation matters, see "Legal Proceedings" in Item 3 below.
Solutia is in discussions with the major stakeholders in our Chapter 11 case in an effort to modify the Global Settlement and Plan and achieve a confirmable Plan. In addition, Solutia continues to evaluate and explore all other reasonable alternatives to reorganize the Company, such as a sale of the reorganized Company's equity or a sale of certain of its businesses or assets, that may present a means of maximizing the value of the estate for stakeholders.
RECENT DEVELOPMENTS
On January 25, 2007, Solutia completed the extension and upsizing of its debtor-in-possession ("DIP") financing. This amendment increased the size of the DIP credit facility to $1,225 million, representing a $400 million increase, and extended the facility one year to March 31, 2008. The increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments that are coming due in 2007, as well as funds to partially facilitate the acquisition of Akzo Nobel's stake in the Flexsys joint venture. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties. The Bankruptcy Court entered an order approving this DIP amendment on January 23, 2007.
On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo Nobel N.V.'s ("Akzo Nobel") stake in Flexsys, the 50/50 rubber chemical joint venture between Solutia and Akzo Nobel (the "Flexsys joint venture"). Solutia and Akzo Nobel have entered into a letter agreement committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives. The proposed transaction is subject to approval by the United States Bankruptcy Court, receipt of required regulatory approvals, finalizing the definitive purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase via $150 million of funding under the amended DIP credit facility and additional funding through Flexsys.
SEGMENTS; PRINCIPAL PRODUCTS
Solutia's reportable segments are:
o Performance Products; and
o Integrated Nylon.
The tabular and narrative information contained in Note 22 to the accompanying consolidated financial statements appearing on pages 94-96 is incorporated by reference into this section.
PRINCIPAL EQUITY AFFILIATES
As of December 31, 2006, Solutia participated in one principal joint venture, its Flexsys joint venture with Akzo Nobel. The Flexsys joint venture is comprised of interests in Flexsys Holding B.V., Flexsys America L.P. and Flexsys Rubber Chemicals Ltd.
Flexsys, headquartered in Brussels, Belgium, is a leading global supplier of a broad range of rubber processing chemicals to the rubber industry used in the production of tires and other general rubber products such as automotive belts, hoses, bumpers and window seals and in mining, agriculture and oil refining applications. Its product line includes a number of performance-enhancing products, including branded accelerators (SANTOCURE(R), THIOFIDE(TM) and THIOTAX(TM)), pre-vulcanization inhibitors (SANTOGARD(R) PVI), antidegradants (SANTOFLEX(R)), antioxidants (FLECTOL(R)) and insoluble sulphur (CRYSTEX(TM)). In February 2007, Solutia and Akzo Nobel reached a definitive agreement for Solutia to purchase Akzo Nobel's interest in the Flexsys joint venture.
Prior to November 4, 2005, Solutia participated in another joint venture, Astaris. Astaris was formed in April 2000 as a joint venture between Solutia and FMC Corporation ("FMC"). Solutia and FMC each held 50 percent of the equity interests in Astaris. On November 4, 2005, Solutia, FMC and Astaris sold substantially all of Astaris' assets to Israel Chemicals Limited ("ICL") for $255 million in cash (subject to certain purchase price adjustments) and the assumption by ICL of certain related liabilities. Certain of the assets and liabilities of Astaris that were not included in the sale to ICL were transferred to Solutia and FMC. Generally, these assets and liabilities consist of property originally contributed to the joint venture by Solutia and FMC, as well as certain pre-closing liabilities relating to Astaris, including certain pre-closing environmental liabilities. In addition, certain non-operating assets and liabilities remained in the Astaris joint venture as part of the transaction. Further, the name of the joint venture which holds these remaining assets and liabilities was changed from Astaris LLC to Siratsa LLC.
Solutia's equity earnings (loss) from affiliates were $38 million in 2006, $96 million in 2005 and $(26) million in 2004. For additional information about the Flexsys joint venture and Siratsa, see "Management's Discussion and Analysis" in Item 7 below and Note 9 to the accompanying consolidated financial statements.
SALE OF PRODUCTS
Solutia sells its products directly to end users in various industries, principally by using its own sales force, and, to a lesser extent, by using distributors.
Solutia's marketing and distribution practices do not result in unusual working capital requirements on a consolidated basis. Solutia maintains inventories of finished goods, goods in process and raw materials to meet customer requirements and Solutia's scheduled production. In general, Solutia does not manufacture its products against a backlog of firm orders; it schedules production to meet the level of incoming orders and the projections of future demand. However, in the Performance Products segment, a large portion of sales for 2007 will be pursuant to volume commitments. Solutia does not have material contracts with the government of the United States or any state, local or foreign government, however, sales to the carpet mill industry represent a significant portion of Solutia's net sales. In 2006, no single customer or customer group accounted for 10 percent or more of Solutia's net sales. However, for the year ended December 31, 2005, Shaw Industries, Inc., a customer of the Integrated Nylon segment, accounted for approximately 11 percent of Solutia's consolidated net sales. Mohawk Industries, Inc. was a significant customer of the Integrated Nylon segment in 2006 and 2005, accounting for approximately 9 percent and 8 percent of Solutia's consolidated net sales respectively.
Solutia's second and third quarters are typically stronger than its first and fourth quarters because sales of carpet and window films are stronger in the spring and fall.
COMPETITION
The global markets in which Solutia's businesses operate are highly competitive. Solutia expects competition from other manufacturers of the same products and from manufacturers of different products designed for the same uses as Solutia's products to continue in both U.S. and international markets. Depending on the product involved, Solutia encounters various types of competition, including price, delivery, service, performance, product innovation, product recognition and quality. Overall, Solutia regards its principal product groups as competitive with many other products of other producers and
believes that Solutia is 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
Solutia buys large amounts of commodity raw materials and energy resources, including propylene, cyclohexane, benzene, vinyl acetate, polyvinyl alcohol, 2-ethyl hexanol and natural gas. Solutia typically buys major requirements for key raw materials pursuant to contracts with average contractual periods of one to four years. Solutia obtains certain important raw materials from a few major suppliers. In general, in those cases where Solutia has limited sources of raw materials, it has developed contingency plans to the extent practicable to minimize the effect of any interruption or reduction in supply. However, Solutia also purchases raw materials from some single source suppliers in the industry and in the event of an interruption or reduction in supply, might not be able to mitigate any negative effects.
While temporary shortages of raw materials and energy resources may occasionally occur, these items are generally sufficiently available to cover Solutia's 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. Due to the significant quantity of some of these raw materials and energy resources used by Solutia, a minor shift in the underlying prices for these items can result in a significant impact on Solutia's consolidated financial position and results of operations.
PATENTS AND TRADEMARKS
Solutia owns a large number of patents that relate to a wide variety of products and processes and has pending a substantial number of patent applications. In addition, Solutia is licensed under a small number of patents owned by others. Solutia owns a considerable number of established trademarks in many countries under which Solutia markets its products. These patents and trademarks in the aggregate are of material importance to Solutia's operations and to Solutia's Performance Products and Integrated Nylon segments. Patents and trademarks owned by Solutia and its domestic subsidiary CPFilms Inc. have been pledged as part of the collateral for the DIP credit facility. The holders of Solutia's 11.25 percent Senior Secured Notes due 2009 have a junior security interest in these patents and trademarks. Solutia Europe S.A./N.V.'s ("SESA") patents and trademarks of have been pledged to the holders of SESA's (euro)200 million Facility Agreement. For additional information on the (euro)200 million Facility Agreement, please see "Management's Discussion and Analysis" in Item 7 below.
RESEARCH AND DEVELOPMENT
Research and development constitute an important part of Solutia's activities. Solutia's expenses for research and development amounted to $38 million in 2006, $41 million in 2005 and $40 million in 2004, or about 1.4 percent of sales on average. Solutia focuses its expenditures for research and development on process improvements and selected product development.
Solutia's research and development programs in the Performance Products segment include new products and processes for the window glazing and specialty chemicals markets. Significant progress was achieved in developing a new acoustic safety interlayer, improved window films that mitigate or enhance the reception of electronic signals through windows, a new aviation fluid and environmentally friendly water treatment products. Several process technologies were developed to support the construction of SAFLEX(R) plants. Solutia's Integrated Nylon segment continues to focus on internal process improvements to mitigate increasing raw material prices and to commercialize new products to address customer needs and improve product mix.
ENVIRONMENTAL MATTERS
The narrative information appearing under "Environmental Matters" beginning on page 41 below is incorporated here by reference.
EMPLOYEE RELATIONS
On December 31, 2006, Solutia had approximately 5,100 employees worldwide, 632 of whom work in Europe. Approximately 450 of the European employees are represented by the union delegation. Approximately 14 percent of Solutia's U.S. workforce is currently represented by various labor unions with local agreements that expire between November 23, 2007 and March 31, 2010, at the following Solutia sites: Anniston, Alabama; Sauget, Illinois; Springfield, Massachusetts; and Trenton, Michigan. In the U.S., local agreements cover wages and working conditions. Each of Solutia's U.S. labor unions ratified new five-year collective bargaining agreements in 2005 which set pension and health and welfare benefits for Solutia's employees who are represented by labor unions. These agreements expire on December 31, 2010.
INTERNATIONAL OPERATIONS
Solutia and its subsidiaries are engaged in manufacturing, sales and research and development in areas outside the United States. Approximately 46 percent of Solutia's consolidated sales from continuing operations in 2006 were made into markets outside the United States, including Europe, Canada, Latin America and Asia. Solutia's Performance Products segment is increasingly dependent on its international operations as Solutia is currently building a plant for the manufacturing of SAFLEX(R) in Suzhou, China to provide more exposure in Asia for Performance Products. The plant in China will also expose the Performance Products segment to more competition. Approximately 69 percent of the 2006 sales of the Performance Products 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 Solutia's non-United States operations is generally 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, Solutia generates 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
Solutia's Internet address is www.solutia.com. Solutia makes available free of charge through Solutia's Internet website its annual report on Form 10-K, its 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 ("SEC"). All of these materials may be accessed from the "Investors" section of Solutia's website, www.solutia.com. These materials may also be accessed through the SEC's website (www.sec.gov) or in the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330.
ITEM 1A.
ITEM 1A. RISK FACTORS
IN EVALUATING SOLUTIA, CAREFUL CONSIDERATION SHOULD BE GIVEN TO THE RISK FACTORS SET FORTH BELOW, AS WELL AS THE OTHER INFORMATION SET FORTH IN THIS ANNUAL REPORT ON FORM 10-K. ALTHOUGH THESE RISK FACTORS ARE MANY, THESE FACTORS SHOULD NOT BE REGARDED AS CONSTITUTING THE ONLY RISKS ASSOCIATED WITH OUR BUSINESSES. EACH OF THESE RISK FACTORS COULD ADVERSELY AFFECT OUR BUSINESS, OPERATING RESULTS AND/OR FINANCIAL CONDITION. IN ADDITION TO THE FOLLOWING DISCLOSURES, PLEASE REFER TO THE OTHER INFORMATION CONTAINED IN THIS REPORT INCLUDING THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES.
CERTAIN BANKRUPTCY CONSIDERATIONS
PROLONGED CONTINUATION OF THE CHAPTER 11 CASES MAY HARM THE DEBTORS' BUSINESSES
The prolonged continuation of the Chapter 11 Cases could adversely affect our businesses and operations. So long as the Chapter 11 Cases continue, our senior management will be required to spend a significant amount of time and effort dealing with our reorganization instead of focusing exclusively on business operations. Prolonged continuation of the Chapter 11 Cases may also make it more difficult to attract and retain management and other key personnel necessary to the success and growth of our businesses. In addition, the longer the Chapter 11 Cases continue, the more likely it is that our customers, suppliers, distributors and agents will lose confidence in our ability to successfully reorganize our businesses and seek to establish alternative commercial relationships. Furthermore, so long as the Chapter 11 Cases continue, we will be required to incur substantial costs for professional fees and other expenses associated with the proceedings. The prolonged continuation of the Chapter 11 Cases may also require us to seek additional financing, either as part of the DIP credit facility or otherwise, in order to service our debt and other obligations. We may not be able to obtain additional financing during the pendency of the Chapter 11 Cases on commercially favorable terms or at all. If we were to require additional financing during the Chapter 11 Cases and were unable to obtain the financing on favorable terms or at all, it is unlikely that we could successfully reorganize.
WE MAY NOT BE ABLE TO OBTAIN CONFIRMATION OF THE PLAN
To successfully emerge from Chapter 11 bankruptcy protection as a viable entity, Solutia, like any debtor, must obtain approval of a plan of reorganization from its creditors, confirmation of the plan through the Bankruptcy Court and successfully implement this confirmed plan. The foregoing process requires Solutia to (i) meet certain statutory requirements with respect to the adequacy of disclosure with respect to any proposed plan, (ii) solicit and obtain creditor acceptances of the proposed plan, and (iii) fulfill other statutory conditions with respect to plan confirmation.
With regard to any proposed plan of reorganization we may not receive the requisite acceptances to confirm a plan. Even if the requisite acceptances of a proposed plan are received, the Bankruptcy Court may not confirm the plan as proposed. A dissenting holder of a claim against us could challenge the balloting procedures and results as not being in compliance with the Bankruptcy Code. Finally, even if the Bankruptcy Court determined that the balloting procedures and results were appropriate, the Bankruptcy Court could still decline to confirm a proposed plan if it found that any of the statutory requirements for confirmation had not been met. Specifically, section 1129 of the Bankruptcy Code sets forth the requirements for confirmation and requires, among other things, a finding by the Bankruptcy Court that (i) the debtor's plan "does not unfairly discriminate" and is "fair and equitable" with respect to any non-accepting classes, (ii) confirmation of the debtor's plan is not likely to be followed by a liquidation or a need for further financial reorganization, and (iii) the value of distributions to non-accepting holders of claims within a particular class under the debtor's plan will not be less than the value of distributions such holders would receive if the debtor was liquidated under Chapter 7 of the Bankruptcy Code. The Bankruptcy Court may determine that a proposed plan does not satisfy one or more of these requirements, in which case the proposed plan would not be confirmed by the Bankruptcy Court.
If Solutia's Plan filed on February 14, 2006, or an amended version of that plan is not confirmed by the Bankruptcy Court, it is unclear whether Solutia would be able to reorganize its businesses and what, if any, distributions holders of claims against or equity interests in Solutia ultimately would receive with respect to their claims or equity interests. There also can be no assurance that Solutia will be able to successfully develop, prosecute, confirm, and consummate an alternative plan of reorganization with respect to the chapter 11 cases that is acceptable to the Bankruptcy Court and Solutia's creditors, equity holders and other parties in interest. There can be no assurance that such an alternative plan of reorganization would preserve
the reallocation of the Legacy Liabilities that is achieved in the Plan, which eliminates legacy tort liability exposure, reduces environmental obligations, and significantly reduces Solutia's exposure with regard to retiree obligations. Additionally, it is possible that third parties may seek and obtain approval to terminate or shorten the exclusivity period during which only Solutia may propose and confirm a plan of reorganization. Finally, Solutia's emergence from bankruptcy is not assured. While we expect to emerge from bankruptcy in the future, there can be no assurance that we will successfully reorganize, or when this reorganization will occur.
THE CHANGE OF CONTROL PRODUCED BY OUR RESTRUCTURING MAY RESULT IN A LIMITATION ON OR LOSS OF NET OPERATING LOSSES FOR FEDERAL INCOME TAX PURPOSES
Our issuance of common stock in a reorganized Solutia, along with the cancellation of existing equity interests may cause us to undergo an ownership change upon emergence from Chapter 11. As a result, Section 382 of the Internal Revenue Code ("IRC") may apply to limit our use of consolidated net operating losses upon emergence. Additionally, our ability to use any remaining capital loss carryforwards and tax credits may be limited. The annual limitation imposed by the particular provision of Section 382 of the IRC that reorganized Solutia expects to apply to its ownership change generally equals the product of (i) the fair market value of the net equity value of our stock at the time of the ownership change, taking into account the increase in value of the corporation as a result of the surrender or cancellation of creditor's claims in the transaction (rather than the value without taking into account such increases, as is the case under the general rule for non-bankruptcy ownership changes) multiplied by (ii) the long-term tax-exempt rate in effect for the month in which the ownership change occurs. The long-term tax-exempt rate is published monthly by the IRS and is intended to reflect current interest rates on long-term tax-exempt debt obligations. Accordingly, under this rule the Section 382 limitation would generally reflect the increase in the value of reorganized Solutia's stock resulting from the conversion of debt to equity in the proceeding. Section 383 of the IRC applies a similar limitation to a capital loss carryforward and tax credits. Although it is impossible to predict with absolute certainty the net equity value of reorganized Solutia immediately upon emergence from Chapter 11, reorganized Solutia's use of its net operating losses is expected to be substantially limited after an ownership change.
RISKS RELATED TO OUR BUSINESS AND INDUSTRY
THE PRICES OF RAW MATERIALS AND ENERGY REQUIRED FOR US TO PRODUCE OUR PRODUCTS ARE VOLATILE AND CANNOT ALWAYS BE PASSED ON TO CUSTOMERS
We purchase large amounts of commodity raw materials, including natural gas, propylene, cyclohexane and benzene. Temporary shortages of these raw materials and energy sources may occasionally occur. In addition, we typically purchase major requirements for key raw materials under medium-term contracts. Pricing under these contracts may fluctuate as a result of unscheduled plant interruptions, United States and worldwide market conditions and government regulation. Given our competitive markets, it is not always possible to pass all of these increased costs on to our customers. In addition, natural gas prices and other raw material and energy costs are currently more than double the average ten-year levels. Elevated raw material and energy costs could significantly reduce our operating margins in the future.
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY THAT INCLUDES COMPETITORS WITH GREATER RESOURCES THAN OURS
The markets in which we compete are highly competitive. Competition in these markets is based on a number of factors, such as price, product quality and service. Some of our competitors may have greater financial, technological and other resources than we do and may be better able to withstand changes in market conditions. In addition, some of our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than us. Consolidation of our competitors or customers may also adversely affect our businesses. Furthermore, global competition and customer demands for efficiency will continue to make price increases difficult.
WE OPERATE IN CYCLICAL BUSINESS SEGMENTS AND OUR FINANCIAL RESULTS ARE LIKELY TO FLUCTUATE ACCORDINGLY
We operate in cyclical business segments. Specifically, a substantial portion of our sales are to customers involved, directly or indirectly, in the housing and automotive industries, both of which are, by their nature, cyclical industries. A downturn in either or both of these industries would result in lower demand for our products among customers involved in those industries and a reduced ability to pass on cost increases to those customers.
TURNOVER IN THE SENIOR MANAGEMENT TEAM AND LOSSES OF OTHER KEY PERSONNEL COULD HAVE A SIGNIFICANT ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS AND ABILITY TO EMERGE FROM CHAPTER 11
The services of our senior management team, as well as other key personnel, have been integral in our improving results during the Chapter 11 Cases and will be critical to the implementation of our business strategies going forward and our success. If our emergence from the Chapter 11 Cases is delayed, our financial results diminish, the terms of incentive compensation programs are not adequate or any other adverse events occur in the Chapter 11 Cases, we may have difficulty retaining current senior management and other key personnel and be unable to hire qualified personnel to fill any resulting vacancies, which could have a significant adverse effect on our results of operations and ability to emerge from Chapter 11.
OUR OPERATIONS ARE RESTRICTED BY THE TERMS OF OUR CURRENT CREDIT FACILITIES
Our current credit facilities include a number of significant restrictive covenants. These covenants could impair our financing and operational flexibility and make it difficult for us to react to market conditions and satisfy our ongoing capital needs and unanticipated cash requirements. Specifically, such covenants restrict our ability and, if applicable, the ability of our subsidiaries to, among other things:
o incur additional debt;
o make certain investments;
o enter into certain types of transactions with affiliates;
o limit dividends or other payments by Solutia and certain subsidiaries;
o use assets as security in other transactions;
o pay dividends on our common stock or repurchase our equity interests;
o sell certain assets or merge with or into other companies;
o guarantee the debts of others;
o enter into new lines of business;
o make capital expenditures;
o prepay, redeem or exchange our debt;
o form any joint ventures or subsidiary investments.
In addition, our current DIP credit facility requires us to periodically meet minimum capital expenditures on a consolidated bases and minimum EBITDA levels on a consolidated basis and for a certain business segment. Our (euro)200 million Facility Agreement requires us to periodically meet leverage ratios, interest coverage ratios, capital expenditures, and cash flow to debt service ratios on a SESA stand alone basis. These financial covenants and tests could limit our ability to react to market conditions or satisfy extraordinary capital needs and could otherwise restrict our financing and operations.
Our ability to comply with the covenants and other terms of our debt obligations will depend on our future operating performance. If we fail to comply with such covenants and terms, we would be required to obtain waivers from our lenders to maintain compliance with our debt obligations. If we are unable to obtain any necessary waivers and the debt is accelerated, it would have a material adverse effect on our financial condition and future operating performance.
WE HAVE AND WILL CONTINUE TO HAVE SIGNIFICANT INDEBTEDNESS
We have and will continue to have a significant amount of indebtedness. Solutia's significant indebtedness could have important consequences, including the following:
o We will have to dedicate a significant portion of our cash flow to making interest and principal payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions or other general corporate purposes.
o Levels of indebtedness may make us less attractive to potential acquirors or acquisition targets.
o Levels of indebtedness may limit our flexibility to adjust to changing business and market conditions, and make us more vulnerable to downturns in general economic conditions as compared to competitors that may be less leveraged.
o As described in more detail above, the documents providing for our indebtedness contain restrictive covenants that may limit our financing and operational flexibility.
Furthermore, our ability to satisfy our debt service obligations will depend, among other things, upon our future operating performance and ability to refinance indebtedness when necessary. These factors depend partly on economic, financial, competitive and other factors beyond our control. We may not be able to generate sufficient cash from operations to meet our debt service obligations as well as fund necessary capital expenditures, pension funding obligations and investments in research and development. In addition, if we need to refinance our debt, obtain additional financing or sell assets or equity, we may not be able to do so on commercially reasonable terms, if at all.
LEGAL PROCEEDINGS, INCLUDING PROCEEDINGS RELATED TO ENVIRONMENTAL OBLIGATIONS, COULD IMPOSE SUBSTANTIAL COSTS ON US
As a manufacturer of chemical-based materials, we have been subject to various lawsuits involving environmental, hazardous waste, personal injury and product liability claims. We are named in a number of legal proceedings primarily relating to former operations, including claims for personal injury and property damage arising out of releases of or alleged exposure to materials that are classified as hazardous substances under federal environmental law or alleged to be hazardous by plaintiffs. Adverse judgments in these legal proceedings, or the filing of additional environmental or other damage claims against us, may have a negative impact on our future results of operations. Additionally, administrative and legal costs associated with defending or settling large claims, or large numbers of claims, could have a negative impact on our future results of operations. It is possible that the Bankruptcy Court could disagree with our treatment of those claims. It is also possible that third parties, including the U.S. federal government, state regulatory agencies, or others, may challenge the dischargeability of these claims. If these litigation matters or claims are not treated as contemplated in our Plan, as filed, or if the actual costs are materially greater than estimates associated with those claims, it could have a material adverse effect on our financial condition and future operating performance.
THE APPLICABILITY OF NUMEROUS ENVIRONMENTAL LAWS TO OUR MANUFACTURING FACILITIES COULD CAUSE US TO INCUR MATERIAL COSTS AND LIABILITIES
We are subject to extensive federal, state, local and foreign environmental, safety and health laws and regulations concerning, among other things, emissions to the air, discharges to land and water and the generation, handling, treatment and disposal of hazardous waste and other materials. Under certain environmental laws, we can be held strictly liable for hazardous substance contamination of any real property we have ever owned, operated or used as a disposal site or for natural resource damages associated with such contamination. We are also required to maintain various environmental permits and licenses, many of which require periodic modification and renewal. Our operations entail the risk of violations of those laws and regulations, many of which provide for substantial fines and criminal sanctions for violations.
In addition, these requirements and their enforcement may become more stringent in the future. Non-compliance could subject us to material liabilities, such as government fines, third-party lawsuits or the suspension of non-compliant operations. We may also be required to make significant site or operational modifications at substantial cost. Future developments could also restrict or eliminate our ability to continue to manufacture certain products or could require us to make modifications to our products.
At any given time, we are involved in litigation, administrative proceedings and investigations of various types in a number of jurisdictions involving potential environmental liabilities, including clean-up costs associated with hazardous waste disposal sites, natural resource damages, property damages and personal injury. We may be required to spend substantial sums to defend or settle these actions, to pay any fines levied against us or satisfy any judgments or other rulings rendered against us.
Liability under environmental laws relating to contaminated sites can be imposed retroactively and on a joint and several basis. One liable party could be held responsible for all costs at a site, regardless of fault, percentage of contribution to the site or the legality of the original disposal. We may also face liability for violations under environmental laws occurring prior to the date of our acquisition of properties subject thereto. We could incur significant costs, including cleanup costs, natural resources damages, civil or criminal fines and sanctions and third-party claims as a result of past or future violations of, or liabilities under, environmental laws.
WE HAVE SUBSTANTIAL ENVIRONMENTAL AND REGULATORY COMPLIANCE COSTS
Due to the nature of our business, we make substantial expenditures for environmental and regulatory compliance. During 2006, we spent approximately $9 million on capital projects for various environmental matters, $60 million for the management of environmental programs, including the operation and maintenance of facilities for environmental control, and $10 million for remediation activities. Monsanto currently funds a number of the environmental remediation sites as required under the Plan. However, if the Plan or any other plan is not approved, we could become responsible for some of the sites previously funded by Monsanto and these unexpected expenses could affect our results of operations and financial condition.
The substantial amounts that we may be required to spend on environmental capital projects and programs could cause substantial cash outlays and, accordingly, may limit our financial and operating flexibility. In addition, although we believe that we have correctly budgeted and, to the extent appropriate under applicable accounting principles, reserved for these amounts, factors beyond our control may render these budgeted and reserved amounts inadequate. These factors include changing governmental policies and regulations, the commencement of new governmental proceedings or third party litigation regarding environmental remediation, hazardous waste or personal or property damage resulting from environmentally harmful activity, the discovery of unknown conditions and unforeseen problems encountered in environmental remediation programs.
PROBLEMS ENCOUNTERED IN OPERATING OUR PRODUCTION FACILITIES COULD ADVERSELY IMPACT OUR BUSINESS
Our production facilities are subject to hazards associated with the manufacture, handling, storage and transportation of chemical materials and products, including leaks and ruptures, explosions, fires, inclement weather and natural disasters, unscheduled down time and environmental hazards. From time to time in the past, we have had incidents that have temporarily shut down or otherwise disrupted our manufacturing, causing production delays and resulting in liability for workplace injuries and fatalities. We are dependent upon the continued safe operation of our production facilities.
In addition, some of our products involve the manufacture or handling of a variety of reactive, explosive and flammable materials. Use of these products by our employees, customers and contractors could result in liability to us if an explosion, fire, spill or other accident were to occur.
LABOR DISRUPTIONS WITH THE UNIONIZED PORTION OF OUR WORKFORCE COULD HAVE A NEGATIVE EFFECT
As of December 31, 2006, approximately 14 percent of our U.S. employees located in the Performance Products business segment were unionized. They are represented by various labor unions with local agreements set to expire between November 2007 and March 2010. While we believe that our relations with our employees are good, we may not be able to negotiate these or other collective bargaining agreements on the same or more favorable terms as the current agreements, or at all, and without production interruptions, including labor stoppages. A prolonged labor dispute, which could include a work stoppage, could impact our ability to satisfy our customers' requirements and negatively affect our financial condition.
WE FACE CURRENCY AND OTHER RISKS ASSOCIATED WITH INTERNATIONAL SALES
We generate revenue from export sales, as well as from operations conducted outside the United States. For example, approximately 46 percent of our consolidated sales in 2006 were made into markets outside the United States, including Europe, Canada, Latin America and Asia. Approximately 69 percent of the sales of the Performance Products segment were made into markets outside the United States. Operations outside the United States expose us to risks which would adversely affect our results of operations and financial conditions including fluctuations in currency values, trade restrictions, tariff and trade regulations, foreign tax laws, shipping delays, and economic and political instability.
The functional currency of each of our non-United States operations is generally the local currency. Exchange rates between some of these currencies and U.S. dollars have fluctuated significantly in recent years and may do so in the future. It is possible that fluctuations in foreign exchange rates will have a negative effect on our results of operations.
MANY OF OUR PRODUCTS AND MANUFACTURING PROCESSES ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND OUR BUSINESS WILL SUFFER IF WE FAIL TO KEEP PACE
Many of our products (and their corresponding manufacturing processes) participate in markets that are subject to rapid technological change and new product introductions and enhancements. We must continue to enhance our existing products and to develop and manufacture new products with improved capabilities to continue to be a market leader. We must also continue to make improvements in our manufacturing processes and productivity to maintain our competitive position. When we invest in new technologies, processes or production facilities, we will face risks related to construction delays, cost over-runs and unanticipated technical difficulties related to start-up. Our inability to anticipate, respond to, capitalize on or utilize changing technologies could have an adverse effect on our consolidated results of operations, financial condition and cash flows in any given period.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR SALES AND FINANCIAL PERFORMANCE COULD BE ADVERSELY AFFECTED
We own a large number of patents that relate to a wide variety of products and processes and have a substantial number of patent applications pending. 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 Integrated Nylon segments. Our performance may depend in part on our ability to establish, protect and enforce such intellectual property and to defend against any claims of infringement, which involve complex legal, scientific and factual questions and uncertainties.
In the future, we may have to rely on litigation to enforce our intellectual property rights and contractual rights. In addition, we may face claims of infringement that could interfere with our ability to use technology or other intellectual property rights that are material to our business operations. If litigation that we initiate is unsuccessful, we may not be able to protect the value of some of our intellectual property. In the event a claim of infringement against us is successful, we may be required to pay royalties or license fees to continue to use technology or other intellectual property rights that we had been using or we may be unable to obtain necessary licenses from third parties at a reasonable cost or within a reasonable period of time. If we are unable to obtain licenses on reasonable terms, we may be forced to cease selling or using any of our products that incorporate the challenged intellectual property, or to redesign or, in the case of trademark claims, rename our products to avoid infringing the intellectual property rights of third parties, which may not be possible and may be time-consuming. Any litigation of this type, whether successful or unsuccessful, could result in substantial costs to us and diversions of some of our resources. Our intellectual property rights may not have the value that we believe them to have, which could result in a competitive disadvantage or adversely affect our business and financial performance.
SIGNIFICANT PAYMENTS MAY BE REQUIRED TO MAINTAIN THE FUNDING OF SOLUTIA'S DOMESTIC QUALIFIED PENSION PLAN
We maintain a qualified pension plan under which certain of our employees and retirees are entitled to receive benefits. Although we have frozen future benefit accruals under the U.S. pension plan, significant liabilities still remain. In order to fund the pension plan, we have made significant contributions to the pension plan in 2006 amounting to approximately $179 million and will have to fund more going forward. We may be unable to obtain financing to make these pension plan contributions. In addition, even if financing for these contributions is obtained, the funding obligations and the carrying costs of debt incurred to fund the obligations could have a significant adverse effect on our results of operations.
In addition, we are party to certain litigation with respect to our domestic pension plan as more fully described in Part I, Item 3 - Legal Proceedings. It is not known what funding liabilities may be required of Solutia under the Employee Retirement Income Security Act (ERISA) 26 U.S.C. ss. 412, 29 U.S.C. ss. 1082 and any other applicable law if a judgment is entered against our pension plan in this litigation, given that we are the sponsor of the Solutia Pension Plan. If a final judgment is entered against the Solutia pension plan, the liability resulting from such judgment could have a material adverse effect on our financial results and continuing operations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Solutia's general offices are located in St. Louis County, Missouri, on land owned by Solutia in a facility which is the subject of a synthetic lease (see Note 11 to the accompanying consolidated financial statements). Solutia's principal European offices are located in Louvain-la-Neuve, Belgium, on land leased from the University of Louvain. Information about Solutia's major manufacturing locations worldwide and segments that used these locations on February 1, 2007, appears under "Segments; Principal Products" in Item 1 of this report and is incorporated here by reference.
Solutia's principal plants are suitable and adequate for their use. Utilization of these facilities varies with seasonal, economic and other business conditions. None of Solutia's principal plants is substantially idle. Solutia's facilities generally have sufficient capacity for existing needs and expected near-term growth.
Solutia owns most of its principal plants. However, at Antwerp, Belgium and Sao Jose dos Campos, Brazil, both of which are sites belonging to the current Monsanto Company, Solutia owns certain buildings and production equipment and leases the underlying land.
Monsanto and Solutia have operating agreements with respect to each of the two Monsanto facilities listed above and with respect to Solutia's Chocolate Bayou facility in Alvin, Texas and its facility in Ghent, Belgium. Under these operating agreements, Solutia is the guest at the facility and Monsanto is the operator of the facility, except at the Alvin, Texas and Ghent facilities at which Monsanto is the guest and Solutia is the operator. The initial term of each of the operating agreements has 11 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. Solutia operates several facilities for other third parties on its sites, principally within the Alvin, Texas; Sauget, Illinois; Pensacola, Florida; Newport, Wales (U.K.); and Springfield, Massachusetts sites under long-term lease and operating agreements.
Mortgages on Solutia's plants at the following locations constitute a portion of the collateral securing Solutia's DIP credit facility: Decatur, Alabama; Springfield, Massachusetts; Trenton, Michigan; Greenwood, South Carolina; Alvin (Chocolate Bayou), Texas; Pensacola, Florida; and Martinsville, Virginia. The holders of Solutia's 11.25 percent Senior Secured Notes due 2009 hold second mortgages on each of these plants. Holders of SESA's (euro)200 million Facility Agreement hold mortgages on Solutia's facilities in Ghent, Belgium and Louvain-la-Neuve, Belgium.
As a result of the Chapter 11 filing, Solutia has received notices of mechanics' liens from a number of contractors seeking payment of pre-petition claims. While contractors are permitted to take certain actions required to perfect their liens after the commencement of the Chapter 11 case, such as filing written notice, the automatic stay under Section 362 of the U.S. Bankruptcy Code prevents them from taking any further action to enforce a lien against Solutia's property unless they obtain court approval to lift the stay for that purpose, and Solutia does not expect the filing of these mechanics' liens to have any adverse effect on the operation of Solutia's plants.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Because of the size and nature of Solutia's 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 of its spinoff from Pharmacia, Solutia assumed the defense of specified legal proceedings and agreed to indemnify Pharmacia for obligations arising in connection with those proceedings. Solutia has determined that these defense and indemnification obligations to Pharmacia are pre-petition obligations under the U.S. Bankruptcy Code that Solutia is prohibited from performing, except pursuant to a confirmed plan of reorganization. As a result, Solutia has ceased performance of these obligations. Solutia's cessation of performance may give rise to a pre-petition unsecured claim against Solutia which Pharmacia may assert in Solutia's Chapter 11 bankruptcy case. The estimated unsecured claim amount was classified as a liability subject to compromise as of December 31, 2006 and December 31, 2005 in the amount of $111 million and $136 million, respectively.
Monsanto also indemnified Pharmacia with respect to a number of legal proceedings described in Solutia's 2003 Form 10-K/A in which Solutia was a named defendant or was defending solely due to its Pharmacia related indemnification obligations referred to above. Solutia is prohibited from performing with respect to these obligations, and developments, if any, in these matters are currently managed by other named defendants. Accordingly, Solutia has ceased reporting on the status of those legal proceedings. The legal proceedings which are in this category are (i) Owens v. Monsanto; (ii) ----------------- Payton v. Monsanto; (iii) other Anniston cases; and (iv) premises based - ------------------ asbestos litigation. Legal proceeding activities are currently being funded by Monsanto for these matters. Monsanto's funding of these legal activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's bankruptcy case.
Following is a summary of legal proceedings that Solutia or its equity affiliate continue to manage that, if resolved unfavorably, could have a material adverse effect on Solutia's results of operation and financial position.
LEGAL PROCEEDINGS IN SOLUTIA'S BANKRUPTCY CASE - ----------------------------------------------
JPMORGAN ADVERSARY PROCEEDING
On May 27, 2005, JPMorgan, as indenture trustee for Solutia's debentures due 2027 and 2037 (the "Prepetition Indenture"), filed an adversary proceeding against Solutia in Solutia's bankruptcy case. In the proceeding, JPMorgan asserted five causes of action seeking declaratory judgments to establish the validity and priority of the purported security interest of the holders of the 2027 and 2037 debentures, and one cause of action pursuant to section 363 of the Bankruptcy Code asserting that the alleged security interests lacked adequate protection. The proceeding relates to Solutia's 2002 and 2003 refinancings of its credit facilities. When Solutia refinanced its credit facilities in 2002, the 2027 and 2037 Debentures obtained a pro rata secured interest in certain of Solutia's assets as a result of the application of the "equal and ratable" provisions of the Prepetition Indenture. On October 8, 2003, Solutia restructured its credit facilities, reduced its outstanding secured indebtedness below the threshold level that initially triggered the "equal and ratable" provisions of the Prepetition Indenture and, as a result, the 2027 and 2037 Debentures returned to their original unsecured status. JPMorgan alleges that the October 8, 2003 refinancing had no effect on the security interests and liens that were created in 2002, and argues further that, even if it did, those liens should be reinstated as a matter of equity. The Unsecured Creditors' Committee and the Ad Hoc Solutia Trade Claims Committee have intervened in the proceeding in support of Solutia and the Ad Hoc Committee of Solutia Noteholders has intervened in the proceeding in support of JPMorgan.
Trial concluded on July 10, 2006. Post-trial briefs were submitted by the parties in August 2006. The Bankruptcy Court has not made a ruling.
EQUITY COMMITTEE ADVERSARY PROCEEDING AGAINST MONSANTO AND PHARMACIA
On March 7, 2005, the Equity Committee in Solutia's bankruptcy case filed a complaint against Pharmacia and Monsanto and objections to the proofs of claim filed by Pharmacia and Monsanto in Solutia's bankruptcy case. Solutia was not named as a defendant. In its complaint, the Equity Committee seeks to avoid certain obligations assumed by Solutia at the time of its spinoff from Pharmacia. The complaint alleges, among other things, that the Solutia Spinoff was a fraudulent transfer under the Bankruptcy Code because Pharmacia forced Solutia to assume excessive liabilities and insufficient assets such that Solutia was destined to fail from its inception. Pharmacia and Monsanto filed a motion to dismiss the complaint or, in the alternative, to stay the adversary proceeding. On August 4, 2005, the Debtors filed with the Bankruptcy Court their Statement and Reservation of Rights in Response to the complaint and Objection to Claims, in which the Debtors expressed
their view that the issues and disputes raised in the complaint would be resolved through the Plan confirmation process. During a hearing held on April 11, 2006, the Bankruptcy Court issued a bench ruling denying Pharmacia and Monsanto's motion to dismiss the complaint. The Ad Hoc Committee of Solutia Noteholders and the Ad Hoc Solutia Trade Claims Committee have intervened in this adversary proceeding in support of the Equity Committee. Solutia and the Unsecured Creditors' Committee have intervened in this adversary proceeding as neutral parties due to the importance of this proceeding with respect to Solutia's bankruptcy case. On September 14, 2006, the Court ruled that while the Equity Committee did not have standing to pursue these claims on behalf of the Debtors, it had standing to pursue its own objections to the claims of Monsanto and Pharmacia. This matter was submitted to mediation but the parties were unable to reach a consensual resolution. The adversary proceeding has been stayed indefinitely by the parties, subject to certain rights of the parties to recommence such proceeding.
LEGAL PROCEEDINGS OUTSIDE SOLUTIA'S BANKRUPTCY CASE - ---------------------------------------------------
ANNISTON PARTIAL CONSENT DECREE
On August 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Partial Consent Decree in an action captioned United States of America v. Pharmacia Corporation (p/k/a Monsanto Company) and Solutia. This Partial Consent Decree provides for Pharmacia and Solutia to sample certain residential properties and remove soils found on those properties if PCBs are at a level of 1 part per million (ppm) or above, to conduct a Remedial Investigation and Feasibility Study to provide information for the selection by the Environmental Protection Agency ("EPA") of a cleanup remedy for the Anniston, Alabama PCB site, and to pay EPA's past response costs and future oversight costs related to this work. The decree also provided for the creation of an educational trust fund of approximately $3 million to be funded over a 12-year period to provide supplemental educational services for school children in west Anniston.
A subsequent dispute arose between the EPA and Solutia regarding the scope and application of the automatic stay arising as a result of Solutia's Chapter 11 filing to the remaining obligations under the Partial Consent Decree. On April 19, 2004, the District Court held that the Partial Consent Decree enforces police and regulatory powers under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") and, as a result, the automatic stay provisions of the U.S. Bankruptcy Code are inapplicable to Solutia's obligations under the Partial Consent Decree. On April 30, 2004, the United States Bankruptcy Court for the Southern District of New York entered a Stipulation and Agreed Order in which the EPA and Solutia stipulated that the automatic stay is applicable to certain of the Partial Consent Decree's requirements. Solutia filed a motion asking the District Court to reconsider its order and to bring it into accord with the Stipulation and Agreed Order consented to by the EPA and entered by the Bankruptcy Court. On September 9, 2004, the District Court denied Solutia's motion and declared that the automatic stay is inapplicable to Solutia's obligations under the Consent Decree to perform site work. Solutia appealed this ruling to the Eleventh U.S. Circuit Court of Appeals, which dismissed the appeal for lack of jurisdiction.
On June 30, 2005, the United States District Court for the Northern District of Alabama issued an order (the "PCB Order") authorizing co-defendants Pharmacia and Solutia to "suspend" performance of the PCB clean-up at the Anniston site under the Anniston Consent Decree, upon the filing of a motion by either defendant requesting that relief. The PCB Order found that Solutia and Pharmacia entered into the Anniston Consent Decree, and that the court approved that Anniston Consent Decree, based on the understanding that the defendants' rights to pursue other liable parties for contribution would not be impaired by the EPA. The PCB Order further found that the EPA's planned settlements with certain Anniston foundries would thus deprive the defendants of one of the material considerations for entering into the Anniston Consent Decree.
In July 2006, Solutia and Pharmacia reached an agreement with EPA that clarifies the extent of remaining obligations under the Anniston Consent Decree and the coordination of that work with the lead site clean-up being performed by others, and by which Solutia and Pharmacia will forego the opportunity to suspend their obligations under the Anniston Consent Decree pursuant to the PCB Order. Solutia and Pharmacia preserved their rights under this agreement to continue to argue that the contribution protection afforded certain other potentially responsible parties performing lead site clean-up should not be effective as to Solutia and Pharmacia.
PENNDOT CASE
Solutia's Annual Report on Form 10-K/A for the year ended December 31, 2003 described a case then pending in the Commonwealth Court of Pennsylvania by the Commonwealth of Pennsylvania against Pharmacia seeking damages for PCB contamination in the Transportation and Safety Building ("T&S Building") in Harrisburg, Pennsylvania, that it claimed necessitated the demolition of the T&S Building. Solutia was not a named defendant in this litigation and therefore took no action to stay the litigation in connection with its Chapter 11 proceedings. Solutia assumed the defense of this litigation at the time of its spin-off from Pharmacia. Solutia determined that its obligation to defend and indemnify Pharmacia with regard to this litigation was a pre-petition obligation that Solutia was prohibited from performing, except pursuant to a confirmed plan of reorganization. Therefore, Solutia ceased defending Pharmacia with respect to this litigation. Solutia did, however, provide a $20 million letter of credit to secure a portion of Pharmacia's obligations with respect to an appeal bond issued with respect to the case.
On May 25, 2006 the Supreme Court of Pennsylvania issued its ruling on the appeal in this case, reversing in whole and remanding in part the decision of the trial court against Pharmacia. As a result of this ruling, the $20 million letter of credit that Solutia had committed to partially secure the appeal bond was released. With the release of the bond, Solutia recognized a gain in its Consolidated Statement of Operations during the second quarter 2006 from the reversal of a significant portion of the existing litigation reserve with respect to this matter.
FLEXSYS RELATED LITIGATION
Since 2002, antitrust authorities in the United States, Europe and Canada are continuing to investigate past commercial practices in the rubber chemicals industry including the practices of Flexsys, Solutia's joint venture with Akzo Nobel. The European Commission issued its findings from its investigation in 2005, without levying any fines against Flexsys. Investigations regarding the industry may still be on-going in the United States and Canada, but to date, no findings have been made against Flexsys in either country.
In addition, a number of purported civil class actions have been filed against Flexsys and other producers of rubber chemicals on behalf of indirect purchasers of rubber chemical products. Solutia is aware of a series of these purported class actions which had been filed against Flexsys in various state courts in the United States and in at least four courts in Canada. Except for two cases pending in the United States, all of the remaining cases have been dismissed, or are currently subject to tentative settlements.
CASH BALANCE PLAN LITIGATION
Davis v. Solutia Inc. Employees' Pension Plan; Hammond, et al. v. ----------------------------------------------------------------- Solutia Inc. Employees' Pension Plan. Since October 2005, current or former - ------------------------------------ participants in the Solutia Inc. Employees' Pension Plan (the "Pension Plan") have filed three class actions alleging that the Pension Plan is discriminatory based upon age and that the lump sum values of individual account balances in the Pension Plan have been, and continue to be, miscalculated. None of the Debtors, and no individual or entity other than the Pension Plan, has been named as a defendant in any of these cases. Two of these cases, captioned Davis, et al. v. Solutia, Inc. Employees' Pension Plan and Hammond, et al. v. Solutia, Inc. Employees' Pension Plan, are still pending in the Southern District of Illinois against Monsanto Company and Monsanto Company Pension Plan (Walker et al. v. The Monsanto Pension Plan, et al.) and Pharmacia Cash Balance Pension Plan, Pharmacia Corporation, Pharmacia and Upjohn, Inc., and Pfizer Inc. (Donaldson v. Pharmacia Cash Balance Pension Plan, et al.). The plaintiffs in the Pension Plan cases sought to obtain injunctive and other equitable relief (including money damages awarded by the creation of a common fund) on behalf of themselves and the nationwide putative class of similarly situated current and former participants in the Pension Plan.
A Consolidated Class Action Complaint (the "Complaint") was filed by all of the plaintiffs in the consolidated case on September 4, 2006. The plaintiffs in the Complaint alleged three separate causes of action against the Pension Plan: (1) the Pension Plan violates ERISA by terminating interest credits on prior plan accounts at the age of 55; (2) the Pension Plan is improperly backloaded in violation of ERISA; and (3) the Pension Plan is discriminatory on the basis of age.
Motions for class certification were filed in late 2006 by the plaintiffs against each of the defendants. With respect to the Pension Plan, plaintiffs moved to certify a class only on their first claim: i.e., that the Pension Plan discriminated against employees on the basis of their age by only providing interest credits on prior plan accounts through age 55. Briefing on the class certification motions was completed in January 2007 and the motion is still pending before the court.
OTHER LEGAL PROCEEDINGS - -----------------------
Dickerson V. Feldman. On October 7, 2004, a purported class action -------------------- captioned Dickerson v. Feldman; et al. was filed in the United States District Court for the Southern District of New York against a number of defendants, including former officers and employees of Solutia and Solutia's Employee Benefits Plans Committee and Pension and Savings Funds Committee. Solutia was not named as a defendant. The action alleged breach of fiduciary duty under ERISA and sought to recover alleged losses to the Solutia Inc. Savings and Investment Plan ("SIP Plan") during the period December 16, 1998 to the date the action was filed. The investment of SIP Plan assets in Solutia's common stock is alleged to have been imprudent because of the risks and liabilities related to Solutia's legacy environmental and litigation liabilities and because of Flexsys' alleged involvement in the matters described above under "Flexsys Related Litigation." The action sought monetary payment to the SIP Plan to recover the losses resulting from the alleged breach of fiduciary duties, as well as injunctive and other appropriate equitable relief, reasonable attorney's fees and expenses, costs and interest. In addition, the plaintiff in this action filed a proof of claim for $269 million against Solutia in the Bankruptcy Court.
On March 30, 2006, the District Court granted the defendants' motion to dismiss on grounds that the Dickerson plaintiffs lacked standing to sue and that the complaint failed to state a claim on which relief could be granted. The dismissal of Dickerson's cause of action resulted in dismissal of the entire purported class action, including claims asserted on behalf of the unnamed purported class members. On April 3, 2006, Dickerson filed an appeal of this dismissal with the United States Court of Appeals for the Second Circuit. The parties have fully briefed the appeal, and oral arguments are expected to be held in mid 2007.
Solutia Inc. v. FMC Corporation. On October 14, 2003, Solutia filed ------------------------------- an action captioned Solutia Inc. v. FMC Corporation ("FMC") in Circuit Court in St. Louis County, Missouri, against FMC over the failure of purified phosphoric acid technology provided by FMC to Astaris, the 50/50 joint venture formed by Solutia and FMC. On February 20, 2004, Solutia voluntarily dismissed the state court action and filed an adversary proceeding against FMC in the Bankruptcy Court. FMC filed with the Bankruptcy Court a motion to withdraw the reference. The motion was granted, and, as a result, the matter is now pending in the U.S. District Court for the Southern District of New York. FMC did not allege a counterclaim against Solutia or Astaris.
FMC filed a motion to dismiss Solutia's action based upon an alleged lack of standing. On March 29, 2005, the New York District Court granted in part and denied in part FMC's motion to dismiss. Specifically, the court dismissed with prejudice three of Solutia's causes of action for breach of contract. The New York District Court denied FMC's motion to dismiss Solutia's other causes of action for breach of warranty, breach of fiduciary duty, negligent misrepresentation, fraud and fraud in the inducement.
The parties have completed all fact discovery and submitted cross motions for Summary Judgment. On July 31, 2006, the District Court entered its Memorandum Opinion and Order on the Motions. It granted portions of FMC's Motion for Summary Judgment by ruling that Solutia cannot attempt to establish its breach of fiduciary duty claim by maintaining that the parties were in a joint venture or had a special relationship prior to April 2000. The District Court, however, denied FMC's Motion for Summary Judgment on the breach of fiduciary duty claim and held that Solutia will be permitted to prove at trial that FMC had special knowledge concerning its technology which can give rise to a fiduciary duty. The District Court further overruled the parties' Motion for Summary Judgment on the remaining claims. The District Court ruled Solutia may still be entitled to punitive damages in addition to its claims for out-of-pocket and lost profit damages.
A bench trial on the four claims noted above is scheduled to begin in April 2007.
Ferro Antitrust Investigation. Competition authorities in Belgium and ----------------------------- several other European countries are investigating past commercial practices of certain companies engaged in the production and sale of butyl benzyl phthalates ("BBP"). One of the BBP producers under investigation by the Belgian Competition Authority ("BCA") is Ferro Belgium sprl, a European subsidiary of Ferro Corporation ("Ferro"). Ferro's BBP business in Europe was purchased from Solutia in 2000. Solutia received an indemnification notice from Ferro and has exercised its right, pursuant to the purchase agreement relating to Ferro's acquisition of the BBP business from Solutia, to assume and control the defense of Ferro in proceedings relating to these investigations. On July 7, 2005, the BCA Examiner issued a Statement of Objections regarding its BBP investigation in which SESA, a European non-Debtor subsidiary of Solutia, along with Ferro Belgium sprl and two other producers of BBP, is identified as a party under investigation with respect to its ownership of the BBP business from 1997 until the business was sold to Ferro in 2000. SESA's written comments to the Statement of Objections were submitted on August 31, 2005 and presented at an oral hearing before the BCA on September 6, 2005. The Examiner submitted its
Reasoned Report to the BCA on December 22, 2005. Solutia is not named as a party under investigation in the Reasoned Report. SESA will have an opportunity to submit comments to the BCA on the Reasoned Report in writing and at a subsequent oral hearing on a date that has not yet been determined by the BCA. Solutia and SESA are fully cooperating with the BCA in this investigation.
Department of Labor Investigation of Solutia Inc. Savings and ------------------------------------------------------------- Investment Plan. Solutia was contacted in 2005 by the Department of Labor - --------------- ("DOL"), through the Employee Benefits Security Administration, informing Solutia that it wanted to conduct an investigation of Solutia's SIP Plan. Solutia fully cooperated with the DOL throughout the investigation.
On December 6, 2006, the DOL issued a letter stating that, based on facts gathered, it appeared that Solutia, through its fiduciaries, breached its fiduciary obligations and violated provisions of ERISA with respect to the SIP Plan. Specifically, the DOL stated that it found no evidence that: (1) the Pension and Savings Funds Committee ("PSFC") sufficiently monitored the Solutia Stock Fund option within the SIP Plan to determine if the Solutia Stock Fund continued to be a prudent investment for the SIP Plan prior to December 15, 2003; and (2) the Solutia Board of Directors, CEO, and PSFC, prior to December 15, 2003, adequately monitored the SIP Plan fiduciaries, including the PSFC, the Employee Benefits Plan Committee, and the Northern Trust Company of Connecticut. The DOL did not assert in its letter that the SIP Plan or its participants had been harmed by these alleged breaches. Further, the DOL did not find that the offering of the Solutia Stock Fund as an investment option in the SIP Plan was itself a violation of ERISA, or that it caused any participant to suffer investment losses. Further, the DOL did not assert any monetary fines or penalties against the Company based on its findings to date. The DOL stated in the letter that its findings were subject to the possibility that additional information could lead the DOL to revise its views.
The DOL did not choose to file suit against the Solutia fiduciaries, instead offering Solutia the opportunity to voluntarily discuss how the alleged violations may be corrected. Solutia has submitted additional information to the DOL to support the Company's request for reconsideration of the DOL's findings.
Solutia Canada Inc. v. INEOS Americas LLC. Solutia Canada Inc. ----------------------------------------- ("Solutia Canada") filed suit in Quebec Court in December 2006, alleging breach of contract by INEOS Americas LLC ("INEOS"). In late 2002, Solutia negotiated a Stock and Asset Sale Agreement for the sale of its Resimenes & Additives business to UCB S.A ("UCB"). As part of this agreement, Solutia agreed to exclude the LaSalle assets from the agreement and entered into the LaSalle Toll Agreement ("LTA") with UCB. The LTA passed through all the benefits and risks of ownership of the LaSalle operations to UCB, other than pre-closing environmental liabilities. In the LTA, Solutia Canada agreed to operate its LaSalle Plant for the benefit of UCB and to provide all the necessary services to convert UCB's raw materials on a cost-neutral basis. Thus, UCB would pay Solutia Canada for all of its actual, direct and indirect costs incurred in connection with the performance or supply of services under the LTA or in holding itself ready to perform or supply those services. In the years after its execution, the LTA was assigned by UCB to Cytec Industries, Inc., then to INEOS.
On January 31, 2006, INEOS notified Solutia Canada of its intention to terminate the LTA as of January 31, 2008, in compliance with the terms of the LTA. INEOS' decision to terminate the LTA will likely trigger the shutdown of all activities at the LaSalle Plant, resulting in termination costs recoverable by Solutia Canada against INEOS. Solutia Canada estimates that the overall termination costs associated with the termination of the LTA and the shutdown of the LaSalle Plant will total approximately $31 million (CAD). Solutia Canada provided INEOS with an estimate of the expected termination costs prior to the notice of termination. INEOS has disputed the overall amount of Solutia Canada's termination costs.
Under the detailed dispute resolution procedures in the LTA, Solutia Canada and INEOS were required to engage in negotiation and other means of dispute resolution prior to filing any litigation. In compliance with these obligations, Solutia Canada and INEOS negotiated extensively throughout 2006 to reach a resolution regarding the termination costs, but were unsuccessful. After the period for mandatory alternative dispute resolution expired, Solutia filed suit against INEOS in Quebec Court on December 8, 2006, for breach of the LTA with respect to termination costs. The case is pending.
Texas Commission on Environmental Quality Administrative Enforcement -------------------------------------------------------------------- Proceeding. On August 11, 2006, the Executive Director of the Texas Commission - ---------- on Environmental Quality commenced an administrative enforcement proceeding against Solutia by filing a petition with the Texas Commission on Environmental Quality. The petition alleges certain violations of the State of Texas air quality program. The Executive Director requests that an administrative penalty, the amount of which is immaterial, be assessed and that Solutia undertake corrective actions to ensure compliance with the Texas Health and Safety Code and the rules of the Commission in connection with alleged self-reported unauthorized emission events and deviations of air permits. Solutia answered the petition on September 1, 2006, asserted affirmative defenses and requested a contested enforcement case hearing. Solutia and the Commission have agreed to settle and are negotiating settlement terms. The hearing date has been continued pending settlement.
For information about certain environmental proceedings involving Solutia, see "Environmental Matters" on page 41.
RISK MANAGEMENT
Solutia has evaluated risk retention and insurance levels for product liability, workplace health and safety, property damage and other potential areas of risk. Solutia's management determines the amount of insurance coverage to acquire 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. Solutia shares certain of these policies with Pharmacia. There can be no assurance that Solutia will not incur losses beyond the limits, or outside the coverage, of its insurance. For additional information, see "Self-Insurance" on page 30.
Solutia will continue to devote significant effort to maintaining and improving safety and internal control programs, which reduce its exposure to certain risks. Solutia actively participates in the safety and health Voluntary Protection Program ("VPP") administered by the Occupational Safety and Health Administration ("OSHA") for most sites in the United States, and implements the program at most sites outside the United States.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Solutia did not submit any matters to its security holders during 2006.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER'S PURCHASES OF EQUITY SECURITIES
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On December 17, 2003, following Solutia's Chapter 11 bankruptcy filing, the New York Stock Exchange ("NYSE") halted trading in Solutia's common stock. On February 27, 2004, Solutia's common stock was delisted from the NYSE. Solutia's common stock is currently being quoted under the ticker symbol "SOLUQ" on the Pink Sheets Electronic Quotation Service maintained by The Pink Sheets LLC and on the OTC Bulletin Board.
Under the Plan, Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock, will be cancelled and holders of Solutia's common stock, including options and warrants to purchase Solutia's common stock, will not receive any consideration for that stock or those options and warrants.
The following table shows the high and low sales prices for Solutia's common stock for each quarter during 2006 and 2005 as quoted on the Pink Sheets Quotation Service or the OTC Bulletin Board, as applicable.
On February 28, 2007, Solutia had 28,890 registered shareholders.
No dividends were paid in 2006 or 2005. Solutia is currently prohibited by both the U.S. Bankruptcy Code and the DIP credit facility from paying dividends to shareholders.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
See Management's Discussion and Analysis of Financial Condition and Results of Operations 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 accompanying notes thereto included in Item 8 of this Form 10-K.
OVERVIEW
Solutia's reportable segments and their major products are as follows:
PERFORMANCE PRODUCTS - --------------------
SAFLEX(R) plastic interlayers
LLUMAR(R), VISTA(R), GILA(R) and FORMULA ONE PERFORMANCE AUTOMOTIVE FILM(R) professional and retail window films
THERMINOL(R) heat transfer fluids
DEQUEST(R) water treatment chemicals
SKYDROL(R) aviation hydraulic fluids and SKYKLEEN(R) brand of aviation solvents
ASTROTURF(R), CLEAN MACHINE(R) and CLEAR PASS(TM) entrance matting and automotive spray suppression flaps
INTEGRATED NYLON - ----------------
Nylon intermediate "building block" chemicals
Nylon polymers, including VYDYNE(R) and ASCEND(R)
Carpet fibers, including the WEAR-DATED(R) and ULTRON(R) brands
Industrial nylon fibers
Solutia evaluates the performance of its reportable segments based on segment profit, defined as earnings before interest expense and income taxes ("EBIT"), which includes marketing, administrative, technological and amortization expenses, gains and losses from asset dispositions and restructuring charges, and other income and expense items that can be directly attributable to the segment. Certain expenses and other items that are managed outside of the segments are excluded. These unallocated items consist primarily of corporate expenses, equity earnings from affiliates, other income and expense items, reorganization items, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the operating segment. There were no inter-segment sales in the periods presented below. See Note 22 to the consolidated financial statements for further information.
Summary of Significant 2006 Events
Senior Management Changes - -------------------------
Solutia has continued to restructure its senior management team during 2006. In January 2006, Kent Davies joined Solutia as Senior Vice President and President, CPFilms. Mr. Davies leads Solutia's CPFilms business with responsibility for all commercial, operational and strategic aspects of the business. On February 22, 2006, Jeffry N. Quinn, Solutia's President and Chief Executive Officer, was elected by the board of directors as Chairman of the Board of Solutia. In connection with Mr. Quinn's election as Chairman of the Board, Paul H. Hatfield was named as the lead non-employee director.
Reorganization Strategy - -----------------------
In 2006, Solutia continued its stated reorganization strategy with a focus on the principal objectives of (i) managing the businesses to enhance Solutia's performance; (ii) making changes to Solutia's asset portfolio to maximize the value of the estate; (iii) achieving reallocation of "legacy liabilities"; and (iv) negotiating an appropriate capital structure. Solutia took steps in 2006 to enhance its financial performance including using the tools of Chapter 11 and making changes to its asset portfolio, as explained below. Solutia also continues to pursue a reallocation of legacy liabilities in the Chapter 11 proceeding through negotiations with the other constituents in the Chapter 11 case. Solutia continues to work to establish a proper capital structure upon emergence from Chapter 11. However, as a result of the numerous uncertainties and complexities inherent in Solutia's Chapter 11 proceedings, its ability and timing of emergence from Chapter 11 are subject to significant uncertainty.
PERFORMANCE ENHANCEMENT
Solutia benefited in 2006 from several actions implemented earlier in the Chapter 11 reorganization process designed to enhance its performance. These included implementing significant general and administrative expense reductions; increasing performance-based compensation and benefits programs; making key senior management changes; initiating a cost reduction program at Solutia's operating sites focused on actions such as lean manufacturing techniques, yield improvement, maintenance savings and utilities optimization; and implementing an enterprise-wide procurement effort.
Solutia amended its DIP credit facility on March 17, 2006 with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP credit facility from $525 million to $825 million; (ii) extended the term of the DIP credit facility from June 19, 2006 to March 31, 2007; and (iii) decreased the interest rate on the term loan component of the DIP credit facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points.
On July 26, 2006, Solutia's indirect 100% owned subsidiary Solutia Services International S.C.A./Comm. V.A. ("SSI"), a subsidiary of SESA, entered into a (euro)200 million Facility Agreement (the "Facility Agreement") that closed on August 1, 2006. SESA used the proceeds from the Facility Agreement to refinance all of its (euro)200 million of 10 percent Euronotes due 2008 (the "Euronotes") on August 1, 2006. The refinancing significantly reduced the fixed interest rate of 10 percent to a lower adjustable rate structure of EURIBOR plus 275 basis points, which was 6.31 percent at December 31, 2006.
Solutia expects that both of these refinancings will provide greater flexibility in executing Solutia's reorganization strategy along with significant interest savings.
A key element of Solutia's reorganization strategy is a significantly more proactive commercial approach, one that recognizes that the long-term success of its customers requires a strong and dependable supplier. This new commercial perspective strives for a true partnership and is not based on the premise that the suppliers subsidize investments in materials, technology or people. Solutia's commercial approach has better managed with customers the risk of movements in the oil and energy markets, in some cases via formula pricing, to ensure the value chain remains connected to key raw material and energy cost inputs. Solutia intends to ensure the long term success of our customers by pricing its products adequately to fund customer-driven technology and innovation resulting in a stream of highly innovative and unique products and services. This commercial approach benefited the Company significantly in 2006, as the Company was able to expand operating margins, even though raw materials were approximately $91 million higher than 2005.
PORTFOLIO EVALUATION
Solutia's stated strategy is to build a portfolio of high-potential businesses that can consistently deliver returns in excess of Solutia's cost of capital. As part of this strategy, Solutia made several changes to re-shape its asset portfolio in 2006. On March 1, 2006, pursuant to a stock purchase agreement among Solutia, Vitro and Vitro Plan, a wholly-owned subsidiary of Vitro, Solutia acquired Vitro Plan's 51 percent stake in Quimica (originally formed in 1996 as a joint venture between Vitro, Vitro Plan, and Monsanto) for approximately $20 million in cash. As a result of this acquisition, Solutia became the sole owner of Quimica and its plastic interlayer plant located in Puebla, Mexico.
In addition, SESA sold its pharmaceutical services business to Dishman Pharmaceuticals and Chemicals Ltd. ("Dishman") pursuant to a Stock and Asset Purchase Agreement on August 22, 2006. Under the terms of the agreement, Dishman purchased 100 percent of the stock of the pharmaceutical services business, for $77 million.
On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo Nobel's stake in the Flexsys joint venture. Solutia and Akzo Nobel have entered into a letter agreement committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives. The proposed transaction is subject to approval by the United States Bankruptcy Court, receipt of required regulatory approvals, finalizing the definitive purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase via $150 million of funding under the January 2007 amended DIP credit facility and additional funding through Flexsys.
In addition, Solutia continues to evaluate its options, including potential sales, with respect to certain of its non-core businesses and assets in order to maximize the value of such non-core assets for stakeholders.
REALLOCATION OF LEGACY LIABILITIES
The Plan and Disclosure Statement provide for, among other things, the reallocation of certain Legacy Liabilities among Solutia, Monsanto and Pharmacia and sets forth the treatment that various constituencies in the Chapter 11 Cases would receive under the Plan. See Note 1 to the accompanying consolidated financial statements for further description of the Plan and Disclosure Statement, as well as a summary of developments in Solutia's ongoing Chapter 11 bankruptcy case.
Summary Results of Operations
The discussion below and accompanying consolidated financial statements have been prepared in accordance with Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code ("SOP 90-7"), and on a going concern basis, which assumes the continuity of operations and reflects the realization of assets and satisfaction of liabilities in the ordinary course of business. However, as a result of the Chapter 11 bankruptcy proceedings, such realization of assets and liquidation of liabilities are subject to a significant number of uncertainties.
Net sales and operating income (loss) of Solutia are as follows for the years ended December 31:
The $146 million, or 5 percent, increase in net sales in 2006 reflects higher average selling prices of approximately 6 percent, partially offset by lower sales volumes of approximately 1 percent. Solutia's net sales for 2005 increased by $122 million, or 5 percent, as compared to 2004. This increase in net sales reflected higher average selling prices of approximately 11 percent, partially offset by lower sales volumes of approximately 6 percent.
As indicated in the preceding table, operating results for each year were affected by various charges which are described in greater detail in the "Results of Operations" section below. Operating income improved by $54 million in 2006 as compared to 2005 primarily as a result of higher net sales and controlled spending, partially offset by higher overall raw
material and energy costs of $91 million. The 2005 results as compared to the 2004 results improved by $107 million, primarily as a result of higher net sales and controlled spending, partially offset by higher raw material and energy costs of $220 million.
Financial Information - ---------------------
Summarized financial information concerning Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of and for the year-ended December 31, 2006 is presented as follows:
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related footnotes. In preparing these consolidated financial statements, Solutia has made its best estimates of certain amounts included in these consolidated financial statements. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ materially from these estimates. Management has discussed the development, selection and disclosure of these critical accounting policies and estimates with the Audit and Finance Committee of Solutia's Board of Directors.
Solutia believes that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on the consolidated financial statements and require assumptions that can be highly uncertain at the time the estimate is made. Solutia considers the following items to be its critical accounting policies:
o Environmental Remediation o Self-Insurance o Income Taxes o Impairment of Long-Lived Assets o Impairment of Goodwill and Indefinite-Lived Intangible Assets o Pension and Other Postretirement Benefits
Solutia also has other significant accounting policies. Solutia believes that, compared to the critical accounting policies listed above, the other policies either do not generally require estimates and judgments that are as difficult or as subjective, or are less likely to have a material impact on the reported results of operations for a given period.
Environmental Remediation
With respect to environmental remediation obligations, Solutia's policy is to accrue costs for remediation of contaminated sites in the accounting period in which the obligation becomes probable and the cost is reasonably estimable. Cost estimates for remediation are developed by assessing, among other items, (i) the extent of Solutia's contribution to the environmental matter; (ii) the number and financial viability of other potentially responsible parties; (iii) the scope of the anticipated remediation and monitoring plan; (iv) settlements reached with governmental or private parties; and (v) Solutia's past experience with similar matters. Solutia's estimates of the environmental remediation reserve requirements typically fall within a range. If Solutia believes no best estimate exists within a range of possible outcomes, in accordance with existing
accounting guidance, the minimum loss is accrued. Environmental liabilities are not discounted, and they have not been reduced for any claims for recoveries from third parties.
These estimates are critical because Solutia must forecast environmental remediation activity into the future, which is highly uncertain and requires a large degree of judgment. Therefore, the environmental reserves may materially differ from the actual liabilities if Solutia's estimates prove to be inaccurate, which could materially affect results of operations in a given period. Uncertainties related to recorded environmental liabilities include changing governmental policy and regulations, judicial proceedings, the number and financial viability of other potentially responsible parties, the method and extent of remediation and future changes in technology. Because of these uncertainties, the potential liability for existing environmental remediation reserves not subject to compromise may range up to two times the amounts recorded. These valuations of future environmental costs do not contemplate the uncertainties inherent in Solutia's bankruptcy proceedings, as the potential impact of the Chapter 11 proceedings upon future environmental costs cannot be reasonably determined at this time. Due to these uncertainties, certain of the environmental liabilities have been classified as subject to compromise in the Consolidated Statement of Financial Position as of December 31, 2006, and have been excluded from the aforementioned range of possible outcomes of existing environmental remediation reserves. The potential liability for existing environmental remediation reserves classified as subject to compromise, if ultimately retained by Solutia as part of an accepted plan of reorganization, could be materially different than amounts recorded. The estimate for environmental liabilities is a critical accounting estimate for both reportable segments.
Self-Insurance
Solutia maintains self-insurance reserves to cover its estimated future legal costs, settlements and judgments related to workers' compensation, product, general, automobile and operations liability claims that are less than policy deductible amounts or not covered by insurance. Self-insured losses are accrued based upon estimates of the aggregate liability for claims incurred using certain actuarial assumptions followed in the insurance industry, Solutia's historical experience and certain case-specific reserves as required, including estimated legal costs. The maximum extent of the self-insurance provided by Solutia and related insurance recoveries are dependent upon a number of factors including the facts and circumstances of individual cases and the terms and conditions of the commercial policies. Solutia has purchased commercial insurance in order to reduce its exposure to workers' compensation, product, general, automobile and property liability claims. Policies for periods prior to the Solutia Spinoff are shared with Pharmacia. This insurance has varying policy limits and deductibles. When recovery from an insurance policy is considered probable, a receivable is recorded. Self-insurance reserve estimates are critical because changes to the actuarial assumptions used in the development of these reserves can materially affect earnings in a given period and Solutia must forecast loss activity into the distant future which is highly uncertain and requires a large degree of judgment.
Actuarial reserve indications are projections of the remaining future payments for workers' compensation, product, general, automobile and operations liability claims for which Solutia is legally responsible. These projections are made in the context of an uncertain future where variations between estimated and actual amounts are attributable to many factors, including changes in operations, changes in judicial environments, shifts in the types or timing of the reporting of claims, changes in the frequency or severity of losses and random chance. The actuarial estimates of the reserve requirements fall within a range. The actuary's best estimate of the liability is generally near the middle of the actuary's range; accordingly, Solutia has recorded the liability at this level. The range of outcomes is not material to the consolidated financial statements for losses that are not stayed by the Chapter 11 proceedings. These valuations of future self-insurance costs do not contemplate the uncertainties inherent in Solutia's bankruptcy proceedings, as the potential impact of the Chapter 11 proceedings upon future self-insurance costs cannot be reasonably determined at this time. Due to these uncertainties, certain of the self-insurance liabilities have been classified as subject to compromise in the Consolidated Statement of Financial Position as of December 31, 2006, and have been excluded from the range of possible outcomes of existing self-insurance reserves. The potential liability for existing self-insurance liabilities classified as subject to compromise, if ultimately retained by Solutia as part of an accepted plan of reorganization, could be materially different than amounts recorded. The estimate for self-insurance liabilities is a critical accounting estimate for both reportable segments.
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. Solutia bases its estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, business plans and other expectations about future outcomes. Solutia records a valuation
allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While Solutia has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event Solutia were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should Solutia determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. The consolidated financial statements include increases in valuation allowances as a result of uncertainty created by Solutia's Chapter 11 bankruptcy filing.
Solutia's accounting for deferred tax consequences represents management's best estimate of future events that can be appropriately reflected in the accounting estimates. Changes in existing tax laws, regulations, rates and future operating results may affect the amount of deferred tax liabilities or the valuation of deferred tax assets over time.
Impairment of Long-Lived Assets
Impairment tests of long-lived assets, including finite-lived intangible assets, are made when conditions indicate the carrying value may not be recoverable. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from such asset are separately identifiable and are less than its carrying value. Solutia's estimate of the cash flows is based on information available at that time including these and other factors: sales forecasts, customer trends, operating rates, raw material and energy prices and other global economic indicators and factors. 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 determined by Solutia to be commensurate with the risk inherent in the business model. These estimates are critical because changes to Solutia's assumptions used in the development of the impairment analyses can materially affect earnings in a given period and Solutia must forecast cash flows into the future which is highly uncertain and requires a significant degree of judgment. The consolidated financial statements do not reflect any adjustments for the impairment of long-lived assets that may result as part of the approval and implementation of a plan of reorganization to be submitted as part of the Chapter 11 bankruptcy process. The estimate for impairment of long-lived assets is a critical accounting estimate for both reportable segments.
Impairment of Goodwill and Indefinite-Lived Intangible Assets
Goodwill and indefinite-lived intangible assets are reviewed for impairment annually under the provisions of Statement of Financial Accounting Standard ("SFAS") No. 142, Goodwill and Other Intangible Assets. However, as required by SFAS No. 142, impairment analyses are performed more frequently if changes in circumstances indicate the carrying value may not be recoverable during the intervening period between annual impairment tests. Solutia performs the review for impairment at the reporting unit level. The impairment assessment is completed by determining the fair values of the reporting units using income and market multiple approaches and comparing those fair values to the carrying values of the reporting units. If the fair value of a reporting unit is less than its carrying value, Solutia then allocates the fair value of the reporting unit to all the assets and liabilities of that reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of the goodwill. If the carrying value of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized for this differential. This valuation process involves assumptions based upon management's best estimates and judgments that approximate the market conditions experienced at the time the impairment assessment is made. These assumptions include but are not limited to earnings and cash flow projections, discount rate and peer company comparability. Actual results may differ from these estimates due to the inherent uncertainty involved in such estimates. The consolidated financial statements do not reflect any adjustments for the impairment of goodwill and indefinite-lived intangible assets that may result as part of the approval and implementation of a plan of reorganization to be submitted as part of the Chapter 11 bankruptcy process. The estimate for impairment of goodwill and indefinite-lived intangible assets is a critical accounting estimate for the Performance Products reportable segment. The Integrated Nylon reportable segment does not have goodwill or indefinite-lived intangible assets.
Pension and Other Postretirement Benefits
Under the provisions of SFAS No. 87, Employers' Accounting for Pensions, and SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, measurement of the obligations under the defined benefit pension plans and the other postemployment benefit ("OPEB") plans are subject to several significant estimates. These estimates include the rate of return on plan assets, the rate at which the future obligations are discounted to value the liability and health care cost trend rates. Additionally, the cost of providing benefits depends on demographic assumptions including
retirements, mortality, turnover and plan participation. Solutia typically uses actuaries to assist it in preparing these calculations and determining these assumptions. Solutia's annual measurement date is December 31 for both the pension and OPEB plans.
The expected long-term rate of return on pension plan assets assumption was 8.75 percent and 9.00 percent in 2006 and 2005, respectively. The expected long-term rate of return on pension plan assets assumption is based on the target asset allocation policy and the expected future rates of return on these assets. A hypothetical 25 basis point change in the assumed long-term rate of return would result in a change of approximately $2 million to pension expense.
The discount rate used to remeasure the pension plans was 5.75 in 2006 and 5.50 percent in 2005, and the discount rates to remeasure the other postretirement benefit plans were 5.75 percent in 2006 and 5.50 percent in 2005. Solutia establishes its discount rate based upon the internal rate of return for a portfolio of high quality bonds with maturities consistent with the nature and timing of future cash flows for each specific plan. A hypothetical 25 basis point change in the discount rate for Solutia's pension plans results in a change of approximately $19 million in the projected benefit obligation and less than a $1 million change in pension expense. A hypothetical 25 basis point change in the discount rate for Solutia's OPEB plans results in a change of approximately $8 million in the accumulated benefit obligation and less than $1 million change to OPEB expense.
Solutia estimated the five-year assumed trend rate for healthcare costs in 2006 to be 9 percent with the ultimate trend rate for healthcare costs grading by 1 percent each year to 5 percent by 2010 and remaining at that level thereafter. A 1 percent change in the assumed health care cost trend rate would have changed the postretirement benefit obligation by $3 million as of December 31, 2006 and would have had a less than $1 million change to OPEB expense in 2006. Solutia's costs for postretirement medical benefits are capped for many current retirees and active employees; therefore, the impact of this hypothetical change in the assumed health care cost trend rate is limited.
These valuations of future pension and other postretirement costs do not include the uncertainties inherent in Solutia's Chapter 11 bankruptcy proceedings, as the potential impact of the Chapter 11 proceedings upon future spending for these items cannot be reasonably determined at this time. Due to these uncertainties, all pension and postretirement liabilities related to Solutia entities that have filed Chapter 11 bankruptcy have been classified as subject to compromise in the Consolidated Statement of Financial Position as of December 31, 2006.
The $57 million, or 5 percent, increase in 2006 net sales compared to 2005 resulted from higher selling prices of approximately 4 percent and increased sales volumes of approximately 1 percent. Higher average selling prices were experienced in SAFLEX(R) plastic interlayer products, LLUMAR(R) and VISTA(R) professional film products and THERMINOL(R) heat transfer fluids. Increased sales volumes were experienced in SAFLEX(R) plastic interlayer products, due to increasing demand and inclusion of sales from the Puebla, Mexico plant for ten months during 2006 as a result of the Quimica acquisition as further discussed in Note 4, and, LLUMAR(R) and VISTA(R) professional film products, partially offset by lower volumes in DEQUEST(R) water treatment chemicals and THERMINOL(R) heat transfer fluids.
The $68 million, or 6 percent, increase in 2005 net sales compared to 2004 resulted from higher selling prices of approximately 4 percent and increased sales volumes of approximately 2 percent. Higher average selling prices were experienced in SAFLEX(R) plastic interlayer products, LLUMAR(R) and Vista(R) professional window film products and THERMINOL(R) heat transfer fluids. Increased sales volumes were experienced in SAFLEX(R) plastic interlayer products and THERMINOL(R) heat transfer fluids, partially offset by lower volumes due to the cessation of Solutia's chlorobenzenes operations in 2004.
The $7 million, or 6 percent, improvement in 2006 segment profit in comparison to 2005 resulted principally from higher net sales, partially offset by higher raw material and energy costs of $22 million and higher charges. Segment profit in 2006 included $8 million of reorganization items, which consisted primarily of restructuring charges related to the shut down of operations at the Queeny Plant in St. Louis, Missouri and other non-strategic operations, as well as $4 million of restructuring charges consisting principally of severance costs for non-debtor entities that was not included within reorganization items. Segment profit in 2005 included $8 million of reorganization items, which consisted primarily of adjustments to record certain pre-petition claims at estimated amounts of the allowed claims, as well as $2 million of restructuring charges consisting principally of severance costs for non-debtor entities that was not included within reorganization items.
The $37 million improvement in 2005 segment profit in comparison to 2004 resulted principally from lower charges and higher net sales, partially offset by higher raw material and energy costs. Segment profit in 2005 included $8 million of reorganization items, which consisted primarily of adjustments to record certain pre-petition claims at estimated amounts of the allowed claims, as well as $2 million of restructuring charges consisting principally of severance costs for non-debtor entities that was not included within reorganization items. Segment profit in 2004 included $21 million of charges, including $18 million of restructuring costs related principally to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, and $3 million of asset write-offs and repairs and maintenance charges resulting from the impact of Hurricane Ivan at the Martinsville, Virginia plant. Segment profit in 2004 also included $2 million of reorganization items involving primarily severance related costs incurred as part of Solutia's overall reorganization process.
The $89 million, or 5 percent, increase in 2006 net sales as compared to 2005 resulted primarily from higher average selling prices of approximately 8 percent, partially offset by lower sales volumes of approximately 3 percent. Average selling prices increased in all businesses as a result of favorable market conditions and in response to the escalating cost of raw materials. Lower sales volumes were experienced within carpet fibers in 2006 and sales volumes were impacted by the exit from the unprofitable acrylic fibers operations in the second quarter 2005. These volume reductions were partially offset by higher sales volumes in intermediate chemicals and nylon plastics and polymers.
The $54 million, or 3 percent, increase in 2005 net sales as compared to 2004 resulted primarily from higher average selling prices of approximately 16 percent, partially offset by lower sales volume of approximately 13 percent. Average selling prices increased in all businesses in response to the escalating cost of raw materials. Sales volumes were negatively affected by Hurricanes Dennis, Katrina and Rita, which forced certain manufacturing facilities to reduce production rates due to the shortages of certain raw materials. Furthermore, Solutia declared force majeure in late September 2005 for certain products within its Integrated Nylon segment as a result of the these raw material and utility supply limitations some of which are a result of force majeure declarations by certain of Solutia's suppliers. The force majeure declaration was removed by Solutia in late November 2005. In addition, as a precaution for Hurricane Rita, the manufacturing facility in Alvin, Texas was forced to completely shut down its operations. This production slowdown did not allow Solutia to fully meet customer demand while certain customers were unable to take product due to their own operational issues resulting from the hurricanes. Sales volumes were also adversely affected as a result of Solutia's shutdown of the acrylic fibers operations in the second quarter 2005 but were partially offset because certain Solutia produced intermediate chemicals previously supplied to the acrylic fiber operations were sold into the intermediates merchant market. In addition, sales volumes were negatively impacted in 2005 as a result of contract rejections and terminations in the intermediate chemicals business in 2004.
Segment profit increased $35 million from a segment loss of $26 million in 2005 to a segment profit of $9 million in 2006 primarily as a result of higher net sales and lower charges, partially offset by higher raw material and energy costs of approximately $70 million and unfavorable manufacturing costs. The unfavorable manufacturing costs were precipitated by
a manufacturing interruption incurred at the Alvin, Texas facility, resulting in a significant turnaround being accelerated in its timing, as well as extended in its duration, during the first quarter of this year. Partially offsetting this impact is favorable manufacturing variances experienced in the second half of 2006 due to 2005 operations being negatively impacted by Hurricanes Katrina and Rita as discussed below.
Segment profit in 2006 also included reorganization items of $6 million comprised of $3 million of decommissioning and dismantling costs primarily due to the shut-down of the acrylic fibers business in 2005, $2 million of asset write-downs related to the exiting of various unprofitable businesses within the segment and $1 million of severance and retraining costs. The reorganization items in 2006 decreased by $8 million from 2005 due to lower shut-down costs as segment profit in 2005 consisted of $13 million principally to shut-down the acrylic fibers business as discussed below.
Segment losses decreased $33 million in 2005 as compared to 2004 primarily as a result of higher net sales, partially offset by higher raw material and energy costs of approximately $176 million. In addition, segment loss was affected by the aforementioned hurricanes experienced in 2005. Although Solutia's manufacturing facilities did not suffer significant physical damage, the manufacturing facility in Alvin, Texas was forced to completely shut down its operations ahead of Hurricane Rita as a precaution. Further, reduced availability of key raw material and energy sources affected the ability of certain plants to operate at normal production levels. As a result, Solutia experienced significant costs involved in shutting down and restarting these operations, significant unabsorbed fixed costs and lost sales volumes. Furthermore, the aforementioned declaration of force majeure by Solutia and certain of its customers as a result of the hurricanes had a negative impact on segment profit in 2005. In total, the amount of these aforementioned hurricane related costs was approximately $36 million in 2005. The hurricanes also resulted in a significant increase in raw material and energy prices during 2005. Solutia was successful in passing along a portion of these increases in raw materials and energy costs; however, approximately $19 million of these costs were directly absorbed by the Integrated Nylon segment. Further, it is anticipated segment profit in the first quarter 2006 will be negatively impacted by higher than expected costs experienced as part of a planned shut-down at the manufacturing facility in Alvin, Texas.
Segment profit in 2005 also included reorganization items of $14 million comprised of $13 million principally due to the shut-down of the acrylic fibers business and $1 million of other restructuring charges. The shut-down costs included $12 million of asset write-downs, $7 million of decontamination and dismantling costs and $4 million of severance and retraining costs, partially offset by a $7 million gain from the reversal of the LIFO reserve associated with the inventory sold and/or written off as part of the business shut-down and a $3 million gain from the sale of certain acrylic fibers assets. In addition, segment profit in 2004 was affected by $5 million of charges resulting from the impact of Hurricane Ivan at the Pensacola, Florida and Foley, Alabama manufacturing facilities involving primarily repairs and maintenance costs, as well as asset write-offs.
Corporate expenses decreased by $19 million, or 30 percent, in 2006 as compared to 2005 principally due to lower charges. After consideration of the net gains and charges recorded in 2006 and 2005, the change in corporate expenses was also impacted by a year over year increase in the Company's LIFO reserve, partially offset by controlled spending in the corporate function. Included in 2006 gains were a $20 million gain that resulted from the reversal of a litigation reserve with respect to a litigation matter that was decided favorably (as further described in Note 20 of the accompanying consolidated financial statements), partially offset by a $9 million environmental charge that was precipitated by the notification by a third-party of its intent to terminate a tolling agreement at one of Solutia's facilities outside the U.S. that will likely result in the cessation of operations at that site. The $13 million charge recorded in 2005 resulted from curtailment and settlement activities as a result of amendments to Solutia's pension and postretirement plans (as more fully described in Note 16 to the accompanying consolidated financial statements).
Corporate expenses decreased by $25 million, or 28 percent, in 2005 as compared to 2004 principally due to lower charges and other declines in corporate spending. Included in 2005 and 2004 corporate expenses were $13 million and $35 million, respectively, of net pension and other postretirement benefit plan curtailments and settlements (as more fully
described in Note 16 to the accompanying consolidated financial statements). In addition, Solutia experienced continued benefits in 2005 of cost reduction measures taken in the second half of 2004 as part of implementing its overall reorganization strategy, partially offset by a modest increase in legal costs.
Equity earnings (loss) from affiliates were affected by various items in both 2006 and 2005. During 2006, equity earnings from affiliates included $3 million in restructuring charges related to production asset rationalization and plant closures and $2 million related to asset impairment charges, partially offset by a non-operational gain of $1 million due to the reversal of a litigation reserve related to the Flexsys joint venture. During 2005, equity earnings from affiliates were impacted by a $50 million net gain realized in the Astaris joint venture from the sale of a majority of its assets to Israel Chemicals Limited ("ICL"), who purchased substantially all of the operating assets of Astaris for $255 million. Equity earnings in 2005 also included $2 million of net gains related to the Flexsys joint venture comprising a non-operational gain of $5 million, partially offset by $3 million of various restructuring charges. Flexsys earnings for 2006 were favorably impacted by a reduction in administrative expenses in comparison to 2005.
Equity earnings (loss) from affiliates were affected by various items in both 2005 and 2004. During 2005, equity earnings from affiliates were impacted by a $50 million net gain realized in the Astaris joint venture from the sale of a majority of its assets. Under the terms of the agreement, ICL purchased substantially all of the operating assets of Astaris for $255 million, subject to certain purchase price adjustments. Equity earnings in 2005 also included $2 million of net gains related to the Flexsys joint venture comprising a non-operational gain of $5 million, partially offset by $3 million of various restructuring charges. During 2004, equity loss from affiliates was negatively affected by $49 million in restructuring and litigation charges resulting from (i) restructuring charges related to production asset rationalization and certain plant closures at both the Flexsys and Astaris joint ventures; (ii) severance charges at both the Flexsys and Astaris joint ventures; and (iii) charges recorded by the Flexsys joint venture related to litigation contingencies. Also included in the 2005 results compared to 2004 were higher earnings from both Astaris and Flexsys. Astaris' earnings improved as a result of improved product mix due to the 2004 restructuring activities discussed above and higher average net selling prices. Flexsys' earnings improved primarily due to higher average net selling prices.
The $20 million, or 24 percent, increase in interest expense in 2006 in comparison to 2005 resulted principally from higher debt outstanding in 2006 than in 2005, partially offset by lower interest rates due to the March amendment of its DIP credit facility and the July refinancing of the Euronotes and subsequent partial pay down. In addition, results in 2006 included a $3 million charge related to SESA's Euronotes refinancing and a $1 million charge related to the amendment of the DIP credit facility. The amount of annual contractual interest not recorded was $32 million in both 2006 and 2005.
The $29 million, or 26 percent, decrease in interest expense in 2005 in comparison to 2004 resulted principally from the write-off of unamortized debt issuance costs of $25 million in 2004. In addition, Solutia amended its DIP financing agreement on June 1, 2005, which reduced the interest rate on the term loan component of the DIP credit facility to LIBOR
plus 4.25 percent from the previous interest rate of the greater of the prime rate plus 4.0 percent or 8.0 percent. The amount of annual contractual interest not recorded was $32 million in both 2005 and 2004.
Other income, net increased $6 million in 2006 as compared to 2005 primarily as a result of increased interest income due to higher cash balances on hand during 2006. The $8 million increase in other income, net in 2005 as compared to 2004 primarily resulted from the sale of various non-operating assets in 2005 coupled with lower currency losses.
Reorganization Items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain, or loss that are realized or incurred by Solutia because it is in reorganization under Chapter 11 of the U.S. Bankruptcy Code. Reorganization items incurred in 2006 included $58 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; $11 million of other reorganization charges primarily involving costs incurred with exiting certain non-strategic businesses; $4 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court; and a $2 million net gain from adjustments to record certain pre-petition claims at estimated amounts of the allowed claims.
Reorganization items incurred in 2005 included $49 million of professional fees for services provided by debtor and creditor professionals directly related to Solutia's reorganization proceedings; a $31 million net gain representing the difference between the settlement amount of certain pre-petition obligations and the corresponding amounts previously recorded; $12 million of expense provisions related to (i) employee severance costs incurred directly as part of the Chapter 11 reorganization process and (ii) a retention plan for certain Solutia employees approved by the Bankruptcy Court; $10 million of net charges for adjustments to record certain pre-petition claims at estimated amounts of the allowed claims; and $9 million of other reorganization charges primarily involving costs incurred with exiting the acrylic fibers operations.
Solutia's effective income tax expense (benefit) rate was approximately 64 percent in 2006 compared to approximately 63 percent in 2005. Decreases in valuation allowances in 2006 were $(7) million, of which $24 million was recorded in Income Tax Expense (Benefit) in the Consolidated Statement of Operations and $(31) million was recorded in Accumulated Other Comprehensive Loss in the Consolidated Statement of Comprehensive Income (Loss), as compared to increases in valuation allowances in 2005 of $21 million, of which $12 million was recorded in Income Tax Expense (Benefit) in the Consolidated Statement of Operations and $9 million was recorded in Other Comprehensive Loss in the Consolidated Statement of Comprehensive Income (Loss). The change in the valuation allowances in both 2006 and 2005 were provided principally
for the U.S. deferred tax assets as a result of Solutia's Chapter 11 bankruptcy filing (as more fully described in Note 13 to the accompanying consolidated financial statements).
Solutia's effective income tax expense (benefit) rate was approximately 63 percent in 2005 compared to approximately (1) percent in 2004. The above noted valuation allowance increases in 2005 and 2004 were the primary differences in comparing the 2005 and 2004 rates.
Income from discontinued operations consists of the results of Solutia's pharmaceutical services business. As described in Note 4 to the accompanying consolidated financial statements, on August 22, 2006, SESA sold its pharmaceutical services business to Dishman. Included in the results of discontinued operations for 2006 is a gain on the sale of $49 million as well as a tax gain of $5 million. The tax gain resulted from the reversal of a valuation allowance established as a result of the merger of CarboGen and AMCIS subsidiaries of the pharmaceutical services business into one legal entity.
Income from discontinued operations increased $36 million in 2005 as compared to 2004 primarily as a result of impairments in goodwill, long-lived assets and indefinite-lived intangible assets in the pharmaceutical services business in 2004 of $23 million, $12 million and $5 million, respectively. These charges were precipitated by the declining estimates of forecasted results given current economic and market conditions within the pharmaceutical services business environment.
Cumulative Effect of Change in Accounting Principle
Asset Retirement Obligations - ----------------------------
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143 ("FIN 47"). FIN 47 clarifies that the term "conditional asset retirement obligation" as used in Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations ("SFAS No. 143"), refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement, including those that may be conditional on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and (or) method of settlement should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when sufficient information to reasonably estimate the fair value of an asset retirement obligation is considered available.
Upon adoption of SFAS No. 143 as of January 1, 2003, Solutia identified certain conditional asset retirement obligations; however, these obligations were not recorded due to uncertainties involved with the determination of settlement timing. With the clarification outlined by FIN 47 for valuation of conditional asset retirement obligations, Solutia reevaluated the valuation concerns involving settlement timing for these conditional asset retirement obligations and accordingly reported an asset retirement obligation of $7 million as of December 31, 2005. These obligations involve various federal, state and local regulations and/or contractual obligations to decontaminate and/or dismantle certain machinery and equipment, buildings, and leasehold improvements at Solutia's various operating locations.
Asset retirement obligations were estimated for each of the Solutia's operating locations, where applicable, based upon Solutia's current and historical experience, adjusted for factors that a third-party would consider, such as overhead, profit and market risk premium. Estimated obligations were escalated based upon the anticipated timing of the related cash flows using an assumed inflation rate, and then were discounted using a credit-adjusted, risk-free interest rate. The impact of adoption resulted in a charge of $3 million recorded as a cumulative effect of change in accounting principle (net of tax) in the Consolidated Statement of Operations in 2005.
Summary of Events Affecting Comparability
Charges and gains recorded in 2006, 2005 and 2004 and other events affecting comparability have been summarized and described in the table and accompanying footnotes below (dollars in millions):
ENVIRONMENTAL MATTERS
Solutia is subject to numerous laws and government regulations concerning environmental, safety and health matters in the United States and other countries. U.S. environmental legislation that has a particular impact on Solutia includes the Toxic Substances Control Act; the Resource Conservation and Recovery Act; the Clean Air Act; the Clean Water Act; the Safe Drinking Water Act; and the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as Superfund). Solutia is also subject to the Occupational Safety and Health Act and regulations of the Occupational Safety and Health Administration ("OSHA") concerning employee safety and health matters. The EPA, OSHA and other federal agencies have the authority to promulgate regulations that have an impact on Solutia's operations. In addition to these federal activities, various states have been delegated certain authority under several of these federal statutes and have adopted environmental, safety and health laws and regulations. State or federal agencies having lead enforcement authority may seek fines and penalties for violation of these laws and regulations. Also, private parties have rights to seek recovery, under the above statutes or the common law, for civil damages arising from environmental conditions, including damages for personal injury and property damage.
Expenditures for environmental capital projects were approximately $9 million in 2006 and $8 million in both 2005 and 2004. Expenditures for the management of environmental programs and remediation activities were approximately $60 million, $62 million and $69 million in 2006, 2005 and 2004, respectively. Included in environmental program management is the operation and maintenance of current operating facilities for environmental control, which is expensed in the period incurred, and $10 million, $12 million and $19 million in 2006, 2005 and 2004, respectively, for remediation activity, which was charged against recorded environmental liabilities. Recoveries from third parties were less than $1 million for both 2006 and 2005 and $2 million in 2004.
Environmental compliance and remediation costs and other environmental liabilities incurred by Solutia generally fall into two broad categories: (a) those related to properties currently owned or operated by Solutia and (b) those related to properties that are not owned by Solutia, including non-owned properties adjacent to plant sites and certain owned offsite disposal locations. For the owned and operated sites, Solutia had an accrued liability of $78 million and $71 million as of December 31, 2006 and 2005, respectively, for solid and hazardous waste remediation, which represents Solutia's best estimate of the underlying obligation. In addition, this balance also includes post-closure costs at certain of Solutia's operating locations. This liability is not classified as subject to compromise in the Consolidated Statement of Financial Position because, irrespective of the bankruptcy proceedings, Solutia will be required to comply with environmental requirements in the conduct of its business, regardless of when the underlying environmental contamination occurred. However, Solutia ultimately expects to seek recovery against other potentially responsible parties at certain of these locations. Solutia spent $10 million in 2006 for remediation of these properties. In 2007, Solutia anticipates spending a similar amount related to these properties currently owned or operated by Solutia.
Solutia had an accrued liability of $81 million and $82 million as of December 31, 2006 and 2005, respectively, for properties not owned or operated by Solutia which was classified as subject to compromise in the Consolidated Statement of Financial Position. Under the Plan and the Relationship Agreement, as between Monsanto and Solutia, Monsanto would accept financial responsibility for environmental remediation obligations at all sites for which Solutia was required to assume responsibility at the Solutia Spinoff but which were never owned or operated by Solutia. This includes more than 50 sites with active remediation projects and approximately 200 additional known sites and off-site disposal facilities, as well as sites that have not yet been identified. Finally, Monsanto would share financial responsibility with Solutia for off-site remediation costs in Anniston, Alabama and Sauget, Illinois. Remediation activities are currently being funded by Monsanto for all of these properties not owned or operated by Solutia, with the exception of one off-site remediation project in Sauget, Illinois. Monsanto's funding of these remediation activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's Chapter 11 bankruptcy case. In addition, Solutia has only made minimal adjustments to its recorded environmental liabilities classified as subject to compromise for ongoing remediation activities since the inception of Solutia's bankruptcy
case to reflect actual cash expenditures incurred by the Company. Any other adjustments to this liability are not deemed appropriate by the Company at this time given the uncertainty regarding any potential claim amount to be asserted by Monsanto.
In addition to the bankruptcy proceedings, Solutia's environmental liabilities are also subject to changing governmental policy and regulations, discovery of unknown conditions, judicial proceedings, changes in method and extent of remediation, existence of other potentially responsible parties and changes in technology. Solutia believes that the known and unknown environmental matters, including matters classified as subject to compromise for which Solutia may ultimately assume responsibility, when ultimately resolved, which may be over an extended period of time, could have a material effect on the consolidated financial position, liquidity and profitability of Solutia.
SELF-INSURANCE
As discussed in Item 3 of this Annual 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 of Solutia's spinoff from Pharmacia, Solutia assumed the defense of specified legal proceedings and agreed to indemnify Pharmacia in connection with those proceedings. Solutia has determined that these defense and indemnification obligations to Pharmacia are pre-petition obligations under the U.S. Bankruptcy Code that Solutia is prohibited from performing, except pursuant to a confirmed plan of reorganization. As a result, Solutia has ceased performance of these obligations. Solutia's cessation of performance may give rise to a pre-petition unsecured claim against Solutia which Pharmacia may assert in Solutia's Chapter 11 bankruptcy case.
Since the spinoff, Solutia has been responsible for bearing the costs associated with various toxic tort lawsuits related to PCBs, premises-based asbestos and other chemical exposures from the conduct of the historic chemical business of Pharmacia. At the time of the Chapter 11 bankruptcy filing, Solutia was defending approximately 520 asbestos actions (involving an estimated 3,500 to 4,500 plaintiffs) brought against Pharmacia. In addition, notwithstanding the settlement of cases relating to the Anniston plant site, Solutia was defending approximately 30 cases involving alleged exposure from PCB's manufactured by Pharmacia prior to the spinoff. Solutia was also defending approximately 100 general and product liability claims brought against Pharmacia.
Claims for legal matters arising prior to Solutia's Chapter 11 bankruptcy filing will be addressed in the bankruptcy proceedings. As a result of the Chapter 11 petition, an automatic stay has been imposed against the commencement or continuation of legal proceedings against Solutia outside of the bankruptcy court process. Consequently, Solutia's pre-petition accrued liability for litigation of $111 million and $136 million as of December 31, 2006 and 2005, respectively, has been classified as subject to compromise in the Consolidated Statement of Financial Position. In general, all claims against Solutia that seek a recovery of assets of Solutia's estate will be addressed in the Chapter 11 bankruptcy process and paid only pursuant to the terms of a confirmed plan of reorganization. However, pursuant to a Bankruptcy Court order, Solutia made a $5 million payment with respect to pre-petition legal proceedings in both 2006 and 2005. Solutia cannot forecast the level of future pre-petition self-insurance spending and anticipated levels of recoveries based upon the inherent uncertainty underlying the bankruptcy proceedings.
Solutia had an accrued liability of $11 million and $9 million as of December 31, 2006 and 2005, respectively, for post-petition self-insurance liabilities including workers' compensation, product, general, automobile and operations liability claims. Self-insurance expense was $5 million in 2006 and $4 million in both 2005 and 2004. Cash payments for self-insurance matters were $9 million in 2006, $8 million in 2005, and $9 million in 2004, whereas recoveries from insurance carriers were less than $1 million in 2006, $1 million in 2005, and $7 million in 2004. Included in the 2006, 2005 and 2004 payments was a $5 million scheduled payment with respect to the 2003 Anniston PCB litigation settlement paid pursuant to a Bankruptcy Court order.
EMPLOYEE BENEFITS
Employee benefits include noncontributory defined benefit pension plans and OPEB that provide certain health care and life insurance benefits. Solutia also has stock option plans covering officers and employees and a non-employee director compensation plan for non-employee members of Solutia's board of directors.
Solutia amended its U.S. qualified pension plan in 2004 for non-union participants and in 2005 for union participants to cease future benefit accruals effective July 1, 2004 and January 1, 2006, respectively. Further, Solutia amended its U.S. postretirement plan in 2004 for non-union, active employees and in 2005 for union, active employees to discontinue all postretirement benefits after attaining age 65, make changes to certain eligibility requirements for pre-65 postretirement benefits with the eventual elimination of these benefits by 2016, and eliminate retiree life insurance benefits for future retirees. In addition, Solutia amended its U.S. postretirement plan in 2006 for retiree participants to terminate medical benefits for certain retirees who are Medicare eligible, and if not Medicare eligible, to terminate medical benefits on the earlier of (a) the date such retirees or participants become Medicare eligible if such date is on or after January 1, 2007 or (b) October 19, 2016.
Pension expense in accordance with SFAS No. 87 was $23 million in 2006 and $29 million in both 2005 and 2004, and expense for OPEB was $30 million in 2006, $42 million in 2005 and $44 million in 2004. In addition, Solutia did not record any charges resulting from pension and postretirement benefit plan curtailments and settlements in 2006, while the Company recorded charges of $13 million in 2005 and $35 million in 2004 (as more fully described in Note 16 to the accompanying consolidated financial statements).
Pension Plan Funded Status
The majority of Solutia's employees are covered under noncontributory defined benefit pension plans. The pension plans are 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. The amount of pension plan underfunding in the pension plans decreased to $353 million as of December 31, 2006 from $540 million as of December 31, 2005.
Solutia actively manages funding of its domestic qualified pension plan in order to meet the requirements of the IRS and the Pension Benefits Guarantee Corporation (a U.S. federal agency). Solutia contributed $179 million in 2006 to the qualified pension plan in accordance with IRS funding rules and made a discretionary contribution of $11 million in 2004 to the qualified pension plan in order to minimize future required contributions and to utilize available tax benefits. No contributions were made during 2005 to the qualified pension plan. According to current IRS funding rules, Solutia estimates that it will be required to make approximately $100 million in pension contributions to its U.S. qualified pension plan in 2007. In addition, Solutia contributed $6 million in 2006, $5 million in 2005 and $4 million in 2004, respectively, to fund its foreign pension plans. Moreover, Solutia expects to be required to fund a like amount in pension contributions for its foreign pension plans in 2007.
DERIVATIVE FINANCIAL INSTRUMENTS
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. Solutia's hedging transactions are carried out under policies and procedures approved by the Audit and Finance Committee of the Board of Directors, which does not permit the purchase or holding of any derivative financial instruments for trading purposes. Notes 2 and 8 to the accompanying consolidated financial statements include further discussion of Solutia's accounting policies for derivative financial instruments.
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 with maturities of less than 18 months to hedge these risks. Solutia also enters into certain foreign currency derivative instruments primarily to protect against exposure related to intercompany financing transactions. Corporate policy prescribes the range of allowable hedging activity and what hedging instruments Solutia is permitted to use. Because the counterparties to these contracts are major international financing institutions, credit risk arising from these contracts is not significant, and Solutia does not anticipate any counterparty losses. Currency restrictions are not expected to have a significant effect on Solutia's cash flows, liquidity or capital resources. Major currencies affecting Solutia's business are the U.S. dollar, British pound sterling, Euro, Canadian dollar, Swiss franc, Brazilian real, Chinese yuan and the Japanese yen.
At December 31, 2006, Solutia had currency forward contracts to purchase and sell $181 million of currencies, principally the Euro, Swiss franc, and U.S. dollar, with average remaining maturities of four months. Based on Solutia's
overall currency rate exposure at December 31, 2006, including derivatives and other foreign currency sensitive instruments, a 10 percent adverse change in quoted foreign currency rates of these instruments would result in a change in fair value of these instruments of $15 million. This is consistent with the overall foreign currency exchange rate exposure at December 31, 2005.
Interest Rate Risk
Interest rate risk is primarily related to changes in interest expense from floating rate debt. Solutia believes its current debt structure mitigates some of the risk associated with changes in interest rates due to the combination of fixed versus floating rate debt instruments. Further, periodically, the Company does enter into contracts to further mitigate interest rate risk. A 1 percent increase in the LIBOR and EURIBOR would have increased interest expense by approximately $9 million during 2006, assuming the debt composition at December 31, 2006 was consistent throughout the year. This is consistent with the overall interest rate exposure at December 31, 2005.
Commodity Price Risk
Certain raw materials and energy resources 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 uses forward and option contracts to manage a portion of the volatility related to anticipated energy purchases. Solutia had commodity forward contracts with notional amounts of $2 million associated with future natural gas purchases as of December 31, 2006. Based on Solutia's overall energy market rate exposure at December 31, 2006, including derivatives and other commodity sensitive instruments, a 10 percent adverse change in quoted market rates of these instruments would result in a less than $1 million decrease in fair value of these instruments. This is consistent with the overall commodity price exposure at December 31, 2005. In addition, Solutia mitigates some of its commodity price risks through formula based contractual pricing for certain products within the Integrated Nylon segment. The use of these types of arrangements has increased in 2006 compared to previous years.
RESTRUCTURING ACTIVITIES
During 2006, Solutia recorded $3 million of decommissioning and dismantling costs primarily as a result of the shut-down of its acrylic fibers business in 2005, and $3 million of asset write-downs. Solutia also recorded $3 million of future contractual payments related to the termination of a third party manufacturing agreement. These costs were all recorded within Reorganization Items, net with $4 million in the Integrated Nylon segment and $5 million in the Performance Products segment. In addition, Solutia recorded $8 million of severance and retraining costs in 2006 with $4 million recorded in Reorganization Items, net and $4 million in Marketing and Administrative expenses involving headcount reductions within the Integrated Nylon and Performance Products, as well as the corporate function. Cash outlays associated with the restructuring actions were funded from operations.
During 2005, Solutia recorded restructuring charges of $13 million in Reorganization Items, net involving the shut-down of its acrylic fiber operations and shut-down of its nylon industrial fiber manufacturing unit at its plant in Pensacola, Florida. This $13 million of net charges from the closure of these businesses included $12 million of asset write-downs, $7 million of decontamination and dismantling costs and $4 million of severance and retraining costs, partially offset by a $7 million gain from the reversal of the LIFO reserve associated with the inventory sold and/or written off as part of the business shut-down and a $3 million gain from the sale of certain acrylic fibers assets. In addition, Solutia recorded $5 million of severance and retraining costs in 2005 with $3 million recorded in Reorganization Items, net and $2 million in Cost of Goods Sold involving headcount reductions within the Integrated Nylon and Performance Products segments, as well as the corporate function. Cash outlays associated with the restructuring actions were funded from operations.
During 2004, Solutia recorded restructuring and severance charges of $18 million to Cost of Goods Sold principally related to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations, including $10 million for decommissioning and dismantling costs, $3 million of severance and retraining costs; $2 million related to operating leases where the underlying services and properties are no longer providing benefit; and $3 million of various other restructuring charges. In addition, Solutia recorded $4 million of severance and retraining costs during 2004 in Reorganization Items, net principally related to workforce reduction initiatives of management positions within the corporate function directly associated with the bankruptcy reorganization process. Cash outlays associated with the restructuring actions were funded from operations.
FINANCIAL CONDITION AND LIQUIDITY
As discussed in Note 1 to the accompanying consolidated financial statements, Solutia is operating as a debtor-in-possession under Chapter 11 of the U.S. Bankruptcy Code. As a result of the uncertainty surrounding Solutia's current circumstances, it is difficult to predict Solutia's actual liquidity needs and sources. However, based upon current and anticipated levels of operations during the continuation of the bankruptcy proceedings, Solutia believes that its liquidity and capital resources will be sufficient to maintain its normal operations at current levels. Solutia's access to additional financing while in the Chapter 11 bankruptcy process may be limited.
Financial Analysis
Solutia used its existing cash on-hand to finance operating needs and capital expenditures during 2006. Cash used in continuing operations was $186 million in 2006 compared to cash used by continuing operations of $34 million in 2005. The increase in 2006 as compared to 2005 in cash used in continuing operations was primarily attributable to higher pension contributions and increases in working capital items, including a significant increase in trade receivables resulting from higher net sales and an increase in days sales outstanding due to a shift in sales mix within the Integrated Nylon segment. Partially offsetting these uses was the receipt of a dividend from Flexsys in 2006 as compared to no dividend received in the prior year. In 2005, cash used by continuing operations was $34 million compared to cash provided by continuing operations of $35 million in 2004. The change in 2005 as compared to 2004 was primarily attributable to changes in working capital items including a significant change in accounts payable in 2005 due to the relative stabilization in accounts payable terms in 2005 compared to 2004 when terms significantly improved due to Solutia's filing of Chapter 11 bankruptcy in late 2003.
Solutia's working capital, defined as current assets less current liabilities, decreased by $314 million to ($276) million at December 31, 2006, compared to $38 million at December 31, 2005. The change was primarily a result of higher short-term debt from additional DIP credit facility borrowings as well as a decrease of $44 million related to the sale of the pharmaceutical services business, partially offset by higher cash on-hand and an increase in trade receivables.
Capital spending increased $29 million to $106 million in 2006 as compared to $77 million in 2005. The expenditures in 2006 were primarily to fund certain strategic initiatives in the Performance Products and Integrated Nylon segments, as well as various capital improvements and certain cost reduction projects. Capital spending increased by $26 million in 2005 as compared to $51 million in 2004. Expenditures during 2005 were used primarily to fund certain growth initiatives, as well as various capital improvements and certain cost reduction projects. In addition, included in 2004 was $5 million of capital spending incurred as a result of damage from Hurricane Ivan. In 2007, Solutia expects capital spending will be approximately $120 million and will focus on growth initiatives including the continued expenditures on the new SAFLEX(R) plastic interlayer plant in China expected to be completed in 2007, the addition of a third SAFLEX(R) line in the plant in Ghent, Belgium expected to be completed in 2008, and the transformation of staple carpet lines to plastic polymer lines. Approximately $16 million of estimated capital requirements were committed at December 31, 2006.
Solutia continued to divest certain non-strategic businesses in order to focus resources on core businesses. The proceeds from these and other asset sales generated $77 million in 2006 and $81 million in 2005. Proceeds from divestitures in 2004 were less than $1 million. During 2006, net proceeds were primarily comprised of $69 million received from the pharmaceutical services business divestiture. During 2005, net proceeds included $76 million received from the Astaris transaction with an additional approximately $20 million deposited into escrow accounts. Distributions, if any, from the escrow accounts are expected to be received in 2007, subject to certain terms and conditions of the asset purchase agreement and the escrow agreements. Solutia lenders under the DIP credit facility agreed to waive certain prepayment requirements and allowed Solutia to retain the entire proceeds of the Astaris sale. In addition, $3 million of proceeds were received in 2005 from the sale of assets associated with the closure of Solutia's acrylic fibers business in 2005.
Total debt of $1,528 million as of December 31, 2006, including $668 million subject to compromise and $860 million not subject to compromise, increased by $313 million as compared to $1,215 million at December 31, 2005, which included $668 million subject to compromise and $547 million not subject to compromise. This increase in total debt resulted primarily from $350 million of additional borrowings from Solutia's DIP credit facility in 2006, of which $300 million resulted from the March 2006 amendment to the DIP credit facility (as described below), partially offset by a $51 million payment on SESA's Facility Agreement (as described below).
The weighted average interest rate on Solutia's total debt outstanding at December 31, 2006 was 8.4 percent compared to 8.7 percent at December 31, 2005. Excluding debt subject to compromise, with the exception of the 11.25 percent notes due 2009 on which the Bankruptcy Court has permitted continued payments of the contractual interest, the weighted average interest rate on total debt was 8.9 percent at December 31, 2006 compared to 9.8 percent at December 31, 2005. The reductions in weighted average rates in 2006 are due to the refinancing of the Euronotes and the amendment to the DIP Financing Agreement. While operating as a debtor-in-possession during the Chapter 11 proceedings, Solutia has ceased paying interest on its 6.72 percent debentures due 2037 and its 7.375 percent debentures due 2027. The amount of annual contractual interest expense not recorded in each of 2006 and 2005 was approximately $32 million.
As a result of the Chapter 11 bankruptcy filing, Solutia was in default on all its debt agreements as of December 31, 2006, with the exception of its DIP credit facility and SESA's Facility Agreement. In addition, subsequent to Solutia's bankruptcy filing, Moody's Investors Ratings Services and Standard & Poor's withdrew all ratings for Solutia and its related debt securities.
Solutia had a shareholders' deficit of $1,417 million at December 31, 2006, compared to a shareholders' deficit of $1,454 million at December 31, 2005. Shareholders' deficit decreased principally due to a $24 million decrease in additional minimum pension liability and net income of $11 million.
At December 31, 2006, Solutia's total liquidity was $245 million in the form of $95 million of availability under the final DIP credit facility and approximately $150 million of cash on-hand, of which $112 million was cash of Solutia's subsidiaries that are not parties to the Chapter 11 bankruptcy proceedings. In comparison, at December 31, 2005 Solutia's total liquidity was $238 million in the form of $131 million of availability under the final DIP credit facility and approximately $107 million of cash on-hand, of which $89 million was cash of Solutia's subsidiaries that are not parties to the Chapter 11 bankruptcy proceedings.
Solutia contributed $179 million to its U.S. qualified domestic pension plan in 2006 in accordance with IRS funding rules. According to current IRS funding rules, Solutia will be required to make approximately $100 million in pension contributions to its U.S. qualified pension plan in 2007. In addition, Solutia contributed $6 million in 2006 to fund its foreign pension plans and expects to be required to fund a like amount in pension contributions for its foreign pension plans in 2007.
Astaris Financing Activities
On October 8, 2003 Solutia and Astaris, a 50/50 joint venture with FMC Corporation ("FMC"), amended Astaris' external financing agreement to release the Astaris lenders' security interests in certain Solutia assets in exchange for Solutia's posting of a $67 million letter of credit, representing fifty percent of the Astaris lenders' outstanding commitments to Astaris. Solutia used approximately $36 million in 2004 for investment payments ("keepwell payments") to keep the Astaris joint venture in compliance with its financial covenants. There were no keepwell payments made in 2005. The remaining commitment to Astaris was $10 million as of December 31, 2004, which was subsequently terminated as part of Astaris' refinancing of its credit facility on February 8, 2005.
Solutia and FMC had also agreed to allow Astaris to defer up to $27 million of payment obligations to each of Solutia and FMC under existing operating agreements and certain other agreements. The deferral amount outstanding from Astaris to Solutia was $16 million as of December 31, 2004. In February 2005, this deferral agreement was terminated and all amounts outstanding were paid in full in conjunction with the Astaris refinancing.
Amendments to DIP Financing Agreement
On March 17, 2006, Solutia amended its DIP credit facility with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP credit facility from $525 million to $825 million; (ii) extended the term of the DIP credit facility from June 19, 2006 to March 31, 2007; (iii) decreased the interest rate on the term loan component of the DIP credit facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points; (iv) increased certain thresholds allowing the Debtors to retain more of the proceeds from certain dispositions and other extraordinary receipts; (v) approved the disposition of certain assets of the Debtors; (vi) allowed refinancing of, and certain amendments to, SESA's outstanding Euronotes; and (vii) amended certain financial and other covenants. The amendment contained a number of other changes and other modifications required to make the remaining terms of the DIP credit facility consistent with the amendments set forth above.
On January 25, 2007, Solutia completed the extension and upsizing of its $1,225 million of DIP credit facility, maturing March 31, 2008 with Bankruptcy Court approval. This represents a $400 million increase and a one year extension over Solutia's current DIP credit facility. The increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments that are coming due in 2007, as well as funds to partially facilitate the acquisition of Akzo Nobel's stake in the 50/50 rubber chemical joint venture Flexsys Holding B.V. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties.
Euronotes Refinancing
On July 26, 2006, Solutia's indirect 100% owned subsidiary SSI, a subsidiary of SESA, entered into a Facility Agreement guaranteed by SESA and CPFilms Vertriebs GmbH, a subsidiary of SESA. Closing of the Facility Agreement occurred on August 1, 2006. SESA used the proceeds of the Facility Agreement to refinance all of the Euronotes on August 1, 2006, at a prepayment premium of 3 percent, as required pursuant to the Euronotes, for a total redemption amount of approximately (euro)215 million, including accrued interest. The Euronotes were refinanced to reduce the interest rate, extend the term of the indebtedness and facilitate certain dispositions by Solutia, including the sale of its pharmaceutical services business described below.
The Facility Agreement has a five-year term, with a termination date of July 31, 2011 and an adjustable rate structure of EURIBOR plus 275 basis points. The margin is subject to adjustment upon the occurrence of certain events specified in the Facility Agreement or upon SESA and its subsidiaries attaining certain financial benchmarks. The Facility Agreement consists of a (euro)160 million term loan and a (euro)40 million term loan. The (euro)40 million term loan was repaid from the proceeds of the sale of Solutia's pharmaceutical services business during the third quarter 2006 (as further described in Note 4 to the accompanying consolidated financial statements). The Facility Agreement is secured by substantially all of the assets of SESA and its subsidiaries. The Facility Agreement also contains other customary terms and conditions, including certain financial covenants relating to the performance of SESA and its subsidiaries.
PENNDOT Letter of Credit
As a result of the favorable ruling in the PENNDOT litigation matter described in Note 20 to the accompanying consolidated financial statements, in August 2006, Monsanto released the $20 million letter of credit that Solutia posted to secure a portion of Pharmacia's obligations with respect to an appeal bond issued in relation to this case.
Off-Balance Sheet Arrangements
See Note 20 to the accompanying consolidated financial statements for a summary of off-balance sheet arrangements.
Contingencies
See Note 20 to the accompanying consolidated financial statements for a summary of Solutia's contingencies as of December 31, 2006.
Commitments
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 associated products. The unamortized deferred credits were $91 million at December 31, 2006, and $100 million at December 31, 2005.
The obligations of Solutia and Solutia Business Enterprises, Inc., as borrowers under Solutia's DIP credit facility, are guaranteed by Solutia's other domestic subsidiaries which own substantially all of Solutia's domestic assets. These subsidiaries are Axio Research Corporation, Beamer Road Management Company, CPFilms Inc., Monchem, Inc., Monchem International, Inc., Solutia Greater China, Inc., Solutia Inter-America, Inc., Solutia International Holding, LLC, Solutia Investments, LLC, Solutia Management Company, Inc., Solutia Overseas, Inc., Solutia Systems, Inc. and Solutia Taiwan, Inc. The obligations also must be guaranteed by each of Solutia's subsequently acquired or organized domestic subsidiaries,
subject to certain exceptions. In addition, Solutia and Solutia Business Enterprises, Inc. are jointly and severally liable with respect to their obligations under the final DIP credit facility, thus in effect each guaranteeing the other's debt.
The following table summarizes Solutia's contractual obligations and commercial commitments that are not subject to compromise as of December 31, 2006. Payments associated with liabilities subject to compromise have been excluded from the table below, as Solutia cannot accurately forecast its future level and timing of spending given the inherent uncertainties associated with the ongoing Chapter 11 bankruptcy process. See Note 3 to the accompanying consolidated financial statements for further disclosure concerning liabilities subject to compromise.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 2 to the accompanying consolidated financial statements for a summary of recently issued accounting standards.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information appearing under "Derivative Financial Instruments" on page 43 is incorporated here by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL SECTION - TABLE OF CONTENTS
Page Number ---------------
Report of Independent Registered Public Accounting Firm - Deloitte & Touche LLP 50 Consolidated Statement of Operations 51 Consolidated Statement of Comprehensive Income (Loss) 51 Consolidated Statement of Financial Position 52 Consolidated Statement of Cash Flows 53 Consolidated Statement of Shareholders' Deficit 54 Notes to Consolidated Financial Statements 55
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Solutia Inc.:
We have audited the accompanying consolidated statements of financial position of Solutia Inc. and subsidiaries (Debtor-In-Possession) (the "Company") as of December 31, 2006 and 2005, and the related consolidated statements of operations, comprehensive income (loss), cash flows and shareholders' deficit for each of the three years in the period ended December 31, 2006. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, 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 Note 1 to the consolidated financial statements, the Company has filed for reorganization under Chapter 11 of the United States Bankruptcy Code. The accompanying financial statements do not purport to reflect or provide for the consequences of the bankruptcy proceedings. In particular, such financial statements do not purport to show (1) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (2) as to pre-petition liabilities, the amounts that may be allowed for claims or contingencies, or the status and priority thereof; (3) as to shareholder accounts, the effect of any changes that may be made in the capitalization of the Company; or (4) as to operations, the effect of any changes that may be made in its business.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company's recurring losses from operations, negative working capital, and shareholders' deficit raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also discussed in Note 1 to the financial statements. The financial statements do not include adjustments that might result from the outcome of this uncertainty.
As discussed in Note 2 and Note 12, respectively, to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, and Financial Accounting Standards Board Interpretation No. 47, Accounting for Conditional Retirement Obligations - an interpretation of FASB Statement No. 143, effective December 31, 2006 and December 31, 2005, respectively.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2006, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework and our report dated March 1, 2007 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
St. Louis, Missouri March 1, 2007
See accompanying Notes to Consolidated Financial Statements.
See accompanying Notes to Consolidated Financial Statements.
See accompanying Notes to Consolidated Financial Statements.
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
1. NATURE OF OPERATIONS AND BANKRUPTCY PROCEEDINGS
Nature of Operations
Solutia is a global manufacturer and marketer of a variety of high-performance chemical-based materials. Solutia is a world leader in performance films for laminated safety glass and after-market applications; specialties such as water treatment chemicals, heat transfer fluids and aviation hydraulic fluids; 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, a 100% owned subsidiary of Pfizer, Inc.). On September 1, 1997, Pharmacia distributed all of the outstanding shares of common stock of Solutia as a dividend to Pharmacia stockholders (the "Solutia Spinoff"). As a result of the Solutia Spinoff, on September 1, 1997, Solutia became an independent publicly held company and its operations ceased to be owned by Pharmacia. A net deficiency of assets of $113 resulted from the Solutia Spinoff.
Bankruptcy Proceedings
Overview --------
On December 17, 2003, Solutia and its 14 U.S. subsidiaries (the "Debtors") filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code (the "Chapter 11 Cases") in the U.S. Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"). The cases were consolidated for the purpose of joint administration and were assigned case number 03-17949 (PCB). Solutia's subsidiaries outside the United States were not included in the Chapter 11 filing.
The filing was made to restructure Solutia's balance sheet, to streamline operations and to reduce costs, in order to allow Solutia to emerge from Chapter 11 as a viable going concern. The filing was also made to obtain relief from the negative financial impact of liabilities for litigation, environmental remediation and certain post-retirement benefits (the "Legacy Liabilities"), and liabilities under operating contracts, all of which were assumed at the time of the Solutia Spinoff. These factors, combined with the weakened state of the chemical manufacturing sector, general economic conditions and continuing high, volatile energy and crude oil costs were an obstacle to Solutia's financial stability and success.
Under Chapter 11, Solutia is operating its businesses as a debtor-in-possession ("DIP") under court protection from creditors and claimants. Since the Chapter 11 filing, orders sufficient to enable Solutia to conduct normal business activities, including the approval of Solutia's DIP financing, have been entered by the Bankruptcy Court. While Solutia is subject to Chapter 11, all transactions not in the ordinary course of business require the prior approval of the Bankruptcy Court. Under the U.S. Bankruptcy Code, Solutia had the exclusive right to propose a plan of reorganization for 120 days following the Chapter 11 filing date. The Bankruptcy Court has subsequently approved extensions of this exclusivity period. The exclusivity period continues until the order disposing of the current motion is entered on the Bankruptcy Court's docket.
On January 16, 2004, pursuant to authorization from the Bankruptcy Court, Solutia entered into a DIP credit facility. The DIP credit facility has subsequently been amended from time to time, with Bankruptcy Court approval. The DIP credit facility, as amended, currently consists of: (a) a $975 million fully-drawn term loan; and (b) a $250 million borrowing-based revolving credit facility, which includes a $150 million letter of credit subfacility. Of the $1,225 million facility, $150 million must be utilized to acquire Akzo Nobel's 50% interest in the Flexsys joint venture between Solutia and Akzo Nobel. For additional information regarding the DIP financing and the Flexsys acquisition, see Note 14 to the accompanying consolidated financial statements.
As a consequence of the Chapter 11 filing, pending litigation against Solutia is generally stayed, and no party may take any action to collect its pre-petition claims except pursuant to an order of the Bankruptcy Court. November 30, 2004 was the last date by which holders of pre-petition date claims against the Debtors could file such claims. Any holder of a claim that was required to file such claim by November 30, 2004 and did not do so may be barred from asserting such claim against the Debtors and, accordingly, may not be able to participate in any distribution on account of such claim. Differences between claim amounts identified by the Debtors and claims filed by claimants will be investigated and resolved in
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
connection with the Debtors' claims resolution process, and only holders of claims that are ultimately allowed for purposes of the Chapter 11 case will be entitled to distributions. Solutia has not yet completed its analysis of all the proofs of claim. Since the settlement terms of allowed claims are subject to a confirmed plan of reorganization, the ultimate distribution with respect to allowed claims is not presently ascertainable.
On February 14, 2006, the Debtors filed with the Bankruptcy Court a Plan of Reorganization (the "Plan") and Disclosure Statement (the "Disclosure Statement"). The Plan and Disclosure Statement along with the Relationship Agreement (as defined below) and the Retiree Settlement Agreement, entered into among Solutia, the Official Committee of Unsecured Creditors (the "Unsecured Creditor's Committee") and Official Committee of Retirees appointed in the Chapter 11 Cases (the "Retirees' Committee"), Monsanto Company ("Monsanto"), certain retirees and the other parties thereto (the "Retiree Settlement"), set forth the terms of a global settlement (the "Global Settlement") between Solutia, the Unsecured Creditors' Committee, the Retirees' Committee, Monsanto and Pharmacia. The Global Settlement provides for, among other things, a reallocation of certain Legacy Liabilities among Solutia, Monsanto and Pharmacia and the treatment that various constituencies in the Chapter 11 Cases would receive under the Plan. The reallocation of liabilities between Solutia and Monsanto is set forth in a Relationship Agreement (the "Relationship Agreement") which would be entered into between Solutia and Monsanto upon confirmation of the Plan. Since the February 14, 2006 filing, the Bankruptcy Court has not moved forward with the process to approve the Disclosure Statement and confirm the Plan.
There are two adversary proceedings ongoing in our Chapter 11 case. JPMorgan, as indenture trustee of Solutia's debentures due 2027 and 2037, filed litigation against Solutia claiming that such debentures are entitled to secured status as opposed to general unsecured status as set forth in the Plan. In addition, the Official Committee of Equity Security Holders ("Equity Committee") in Solutia's bankruptcy case has filed litigation against Pharmacia and Monsanto, arguing that holders of Solutia's existing equity are entitled to a distribution in the Chapter 11 case. For additional information regarding these litigation matters, see Note 20 to the accompanying consolidated financial statements.
Solutia is in discussions with the major stakeholders in our Chapter 11 case in an effort to modify the Global Settlement and Plan and achieve a confirmable Plan. In addition, Solutia continues to evaluate and explore all other reasonable alternatives to reorganize the Company, such as a sale of the reorganized Company's equity or a sale of certain of its businesses or assets that may present a means of maximizing the value of the estate for stakeholders.
Going Concern - -------------
Solutia is currently operating under Chapter 11 of the U.S. Bankruptcy Code and continuation of Solutia as a going concern is contingent upon, among other things, Solutia's ability to (i) comply with the terms and conditions of its DIP financing; (ii) obtain confirmation of a plan of reorganization under the U.S. Bankruptcy Code; (iii) return to profitability; (iv) generate sufficient cash flow from operations; and (v) obtain financing sources to meet Solutia's future obligations. These matters create substantial doubt about Solutia's ability to continue as a going concern. The consolidated financial statements do not reflect any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of these uncertainties. Additionally, a plan of reorganization could materially change amounts reported in the consolidated financial statements, which do not give effect to all adjustments of the carrying value of assets and liabilities that are necessary as a consequence of reorganization under Chapter 11 bankruptcy.
Consolidating Financial Statements - ----------------------------------
Consolidating financial statements for Solutia and subsidiaries in reorganization and subsidiaries not in reorganization as of December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005 and 2004 are presented below. These consolidating financial statements include investments in subsidiaries carried under the equity method.
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with Statement of Position 90-7 ("SOP 90-7"), Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, and on a going concern basis, which assumes the continuity of operations and reflects the realization of assets and satisfaction of liabilities in the ordinary course of business. However, as a result of the Chapter 11 bankruptcy proceedings, such realization of assets and satisfaction of liabilities are subject to a significant number of uncertainties that have not been reflected in the consolidated financial statements.
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Basis of Consolidation
The consolidated financial statements include the accounts of Solutia and its majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Companies in which Solutia has a significant interest but not a controlling interest are accounted for under the equity method of accounting and included in Investments in Affiliates in the Consolidated Statement of Financial Position. Solutia's proportionate share of these companies' net earnings or losses is reflected in Equity Earnings (Loss) from Affiliates in the Consolidated Statement of Operations. In accordance with Financial Accounting Standards Board ("FASB") Interpretation No. 46, Consolidation of Variable Interest Entities, as amended, variable interest entities in which Solutia is the primary beneficiary are consolidated within the consolidated financial statements.
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 which 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, intangible assets, income taxes, asset impairments and contingencies. Actual results, particularly with respect to those matters affected by the Chapter 11 bankruptcy proceedings, could materially differ from those estimates.
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 inventories in the United States, excluding supplies and CPFilms' inventory in the United States (73 percent as of both December 31, 2006, and 2005) 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 inventories outside the United States, as well as supplies inventories in the United States, 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 5 to 35 years for buildings and improvements and 3 to 15 years for machinery and equipment, by the straight-line method. Periodically, Solutia conducts a complete shutdown of certain manufacturing units ("turnaround") to perform necessary inspections, repairs and maintenance. Costs associated with significant turnarounds, which include estimated costs for material, labor, supplies and contractor assistance, are accrued ratably during the period between each planned activity, which generally occurs every 2 to 3 years.
Intangible Assets
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 and indefinite-lived intangible assets are assessed annually for impairment in the fourth quarter, or more frequently if changes in the circumstances indicate they may not be recoverable.
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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.
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. Environmental liabilities are not discounted, and they have not been reduced for any claims for recoveries from third parties. In those cases where third-party indemnitors have agreed to pay any amounts and management believes that collection of such amounts is probable, the amounts are reflected as receivables in the consolidated financial statements.
Self-Insurance and Insurance Recoveries
Solutia maintains self-insurance reserves to reflect its estimate of uninsured losses. Self-insured losses are accrued based upon estimates of the aggregate liability for claims incurred using certain actuarial assumptions followed in the insurance industry, Solutia's historical experience and certain case specific reserves as required, including estimated legal costs. The maximum extent of the self-insurance provided by Solutia is dependent upon a number of factors including the facts and circumstances of individual cases and the terms and conditions of the commercial policies. Solutia has purchased commercial insurance in order to reduce its exposure to workers' compensation, product, general, automobile and property liability claims. Policies for periods prior to the spinoff are shared with Pharmacia. This insurance has varying policy limits and deductibles.
Insurance recoveries are estimated in consideration of expected losses, coverage limits and policy deductibles. When recovery from an insurance policy is considered probable, a receivable is recorded.
Revenue Recognition
Solutia's primary revenue-earning activities involve producing and delivering goods. Revenues are considered to be earned when Solutia has completed the process by which it is entitled to such revenues. The following criteria are used for revenue recognition: persuasive evidence that an arrangement exists, delivery has occurred, selling price is fixed or determinable and collection is reasonably assured.
Allowance for Doubtful Accounts
The provisions for losses on uncollectible trade receivables are determined primarily on the basis of past collection experience applied to ongoing evaluations of Solutia's receivables and evaluations of the risks of uncollectibility.
Distribution Costs
Solutia includes inbound freight charges, purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs and the other costs of its distribution network in Cost of Goods Sold in the Consolidated Statement of Operations.
Shipping and Handling Costs
Amounts billed for shipping and handling are included in Net Sales and the costs incurred for these activities are included in Cost of Goods Sold in the Consolidated Statement of Operations.
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Derivative Financial Instruments
In accordance with Statement of Financial Accounting Standard ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"), as amended, all derivatives, whether designated for hedging relationships or not, are recognized in the Consolidated Statement of Financial Position at their fair value.
Currency forward and option contracts are used to manage currency exposures for financial instruments denominated in currencies other than the entity's functional currency. 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 included in Other Income, net in the Consolidated Statement of Operations.
Natural gas forward and option contracts are used to manage some of the exposure for the cost of natural gas. These market instruments are designated as cash flow hedges. The mark-to-market gain or loss on qualifying hedges is included in Accumulated Other Comprehensive Loss in the Consolidated Statement of Financial Position to the extent effective, and reclassified into Cost of Goods Sold in the Consolidated Statement of Operations 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.
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. Solutia determines the appropriateness of valuation allowances in accordance with the "more likely than not" recognition criteria outlined in SFAS No. 109, Accounting for Income Taxes.
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 are included in Accumulated Other Comprehensive Loss in the Consolidated Statement of Financial Position.
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.
Stock Option Plans
As of January 1, 2006, Solutia adopted SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123, Accounting for Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation--Transition and Disclosure. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method under SFAS No. 123(R). The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. Additionally, Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options to purchase Solutia's common stock will receive any consideration in our Chapter 11 Cases for their equity based compensation.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Recently Issued Accounting Standards
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, ("FIN 48"). FIN 48 creates a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. In addition, FIN 48 eliminates income taxes from the scope of SFAS No. 5, Accounting for Contingencies.
FIN 48 is effective for fiscal years beginning after December 15, 2006. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative effect adjustment recorded to the beginning balance of retained earnings. The cumulative effect adjustment would not apply to those items that would not have been recognized in earnings, such as the effect of adopting FIN 48 on tax positions related to business combinations. Solutia is currently evaluating the impact of FIN 48 on the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurement. Where applicable, SFAS No. 157 simplifies and codifies fair value related guidance previously issued within generally accepted accounting principles (GAAP). Although, SFAS No. 157 does not require any new fair value measurements, its application may, for some entities, change current practice. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Solutia is currently evaluating the impact of SFAS No. 157 on the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans ("SFAS No. 158"). SFAS No. 158 requires the recognition of the funded status of pension and other postretirement benefit plans on the balance sheet. The overfunded or underfunded status would be recognized as an asset or liability on the balance sheet with changes occurring during the current year reflected through the comprehensive income portion of equity. Further, SFAS No. 158 requires the unrecognized transition asset or obligation, gains or losses, and prior service costs to be recognized as a component of other comprehensive income, net of tax. SFAS No. 158 will also require the measurement of the funded status of a plan to match that of the date of the Company's fiscal-year-end financial statements, eliminating the use of earlier measurement dates previously permissible. The portions of SFAS No. 158 relating to the recognition of the funded status of a plan and the unrecognized components of net periodic benefit cost are effective for fiscal years ending after December 15, 2006. See Note 16 for the impact of SFAS No. 158 on the consolidated financial statements.
In September 2006, the FASB issued FASB Staff Position AUG AIR-1, Accounting For Planned Major Maintenance Activities ("FSP AUG AIR-1"), that eliminates the acceptability of the accrue-in-advance method of accounting for planned major maintenance activities. This staff position is effective for fiscal years beginning after December 15, 2006 and requires retrospective application to all prior period results presented. The Company has been accruing for certain major maintenance activities associated with periodic major overhauls and maintenance of equipment under the accrue-in-advance method. The anticipated impact upon adoption of FSP AUG AIR-1 on Solutia's consolidated financial statements is estimated to be an approximate $13 increase in beginning retained earnings.
3. LIABILITIES SUBJECT TO COMPROMISE AND REORGANIZATION ITEMS, NET
Liabilities Subject to Compromise
Under Chapter 11 of the U.S. Bankruptcy Code, certain claims against Solutia in existence prior to the filing of the petitions for relief under the federal bankruptcy laws are stayed while Solutia continues business operations as debtor-in-possession. These estimated claims are reflected in the Consolidated Statement of Financial Position as Liabilities Subject to Compromise as of December 31, 2006 and 2005 and are summarized in the table below. Such claims remain subject to future adjustments. Adjustments may result from actions of the Bankruptcy Court, negotiations with claimants, rejection or acceptance of executory contracts, determination of value of any collateral securing claims, reconciliation of proofs of claim or other events.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Solutia has received approval from the Bankruptcy Court to pay or otherwise honor certain of its pre-petition obligations, including (i) certain pre-petition compensation to employees and employee-equivalent independent contractors; (ii) business expenses of employees; (iii) obligations under employee benefit plans; (iv) employee payroll deductions and withholdings; (v) costs and expenses incident to the foregoing payments (including payroll-related taxes and processing costs); (vi) certain pre-petition workers' compensation claims, premiums and related expenses; (vii) certain pre-petition trust fund and franchise taxes; (viii) pre-petition claims of certain contractors, freight carriers, processors, customs brokers and related parties; (ix) customer accommodation programs; and (x) pre-petition claims of critical vendors in the ordinary course of business. Accordingly, these pre-petition items have been excluded from Liabilities Subject to Compromise as of December 31, 2006 and 2005, as applicable.
The amounts subject to compromise consisted of the following items:
DECEMBER 31, ------------ 2006 2005 ---- ---- Postretirement benefits (a)........................... $ 800 $1,098 Litigation reserves (b)............................... 111 136 Accounts payable (c).................................. 116 118 Environmental reserves (d)............................ 81 82 Other miscellaneous liabilities....................... 73 74
6.72% debentures due 2037(e).......................... 150 150 7.375% debentures due 2027(e)......................... 300 300 11.25% notes due 2009 (f)............................. 223 223 Other (g)............................................. 43 43 ------ ------ 716 716 Unamortized debt discount and debt issuance costs..... (48) (48) ------ ------ TOTAL DEBT SUBJECT TO COMPROMISE................ 668 668 ------ ------ TOTAL LIABILITIES SUBJECT TO COMPROMISE............... $1,849 $2,176 ====== ======
(a) Postretirement benefits include Solutia's domestic (i) qualified pension plan of $305 and $501 as of December 31, 2006 and December 31, 2005, respectively; (ii) non-qualified pension plan of $19 as of both December 31, 2006 and 2005; and (iii) other postretirement benefits of $476 and $578 as of December 31, 2006 and December 31, 2005, respectively. Pursuant to a Bankruptcy Court order, Solutia made payments with respect to other postretirement obligations of $96 and $85 in 2006 and 2005, respectively. Solutia also made contributions of $179 to its qualified pension plan pursuant to IRS funding requirements in 2006. (b) An automatic stay has been imposed against the commencement or continuation of legal proceedings against Solutia outside of the bankruptcy court process. Consequently, Solutia's accrued liability with respect to pre-petition legal proceedings has been classified as subject to compromise as of December 31, 2006 and 2005. During the second quarter 2006, Solutia transferred out of liabilities subject to compromise $20 of litigation reserves related to the PENNDOT litigation matter that were no longer deemed uncertain as a result of a favorable court ruling (as further described in Note 20). Pursuant to a Bankruptcy Court order, Solutia made annual scheduled payments of $5 in both 2006 and 2005 with respect to the Anniston litigation settlement reached in 2003. (c) Pursuant to Bankruptcy Court orders, Solutia settled certain accounts payable liabilities subject to compromise in 2006 and 2005. (d) Represents remediation obligations related primarily to properties that are not owned or operated by Solutia, including non-owned properties adjacent to plant sites and certain owned offsite disposal locations. See Note 20 for further disclosure with respect to ongoing legal proceedings concerning environmental liabilities subject to compromise. (e) While operating during the Chapter 11 bankruptcy proceedings, Solutia has ceased recording interest on its 6.72% debentures due 2037 and its 7.375% debentures due 2027. The amount of annual contractual interest expense not recorded was approximately $32 in both 2006 and 2005. (f) Pursuant to a Bankruptcy Court order, Solutia is required to continue payments of the contractual interest on its 11.25% notes due 2009 as a form of adequate protection under the U.S. Bankruptcy Code; provided, however, that Solutia's official committee of unsecured creditors (the "Creditors' Committee") has the right at any time, and Solutia has the right at any time after the payment of the contractual interest made in July 2005, to seek to terminate Solutia's obligation to continue making the interest payments. Solutia or the Creditors' Committee could successfully terminate all or part of Solutia's interest payment obligations only after a showing that the noteholders are not entitled to adequate protection, which would depend, among other things, on the value of the collateral securing the notes as of December 17, 2003, and whether that value is decreasing during the course of Solutia's
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
bankruptcy case. The amount of annual contractual interest paid with respect to these notes was approximately $25 in both years ended December 31, 2006 and 2005, and the accrued interest related to these notes was included in Accrued Liabilities classified as not subject to compromise as of December 31, 2006 and 2005. (g) Represents the debt obligation incurred upon the consolidation of the assets and liabilities of a synthetic lease structure consolidated as part of the adoption of FASB Interpretation No. 46, Consolidation of Variable Interest Entities. The obligation represents the synthetic lease arrangement with respect to Solutia's headquarters building.
Reorganization Items, net
Reorganization items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain or loss that are realized or incurred by Solutia because it is in reorganization under Chapter 11 of the U.S. Bankruptcy Code.
Reorganization items, net consisted of the following items:
4. ACQUISITIONS AND DIVESTITURES
On March 1, 2006, pursuant to a stock purchase agreement among Solutia, Vitro S.A. de C.V. ("Vitro") and Vitro Plan S.A. de C.V. ("Vitro Plan"), a 100% owned subsidiary of Vitro, Solutia acquired Vitro Plan's 51 percent stake in Quimica M, S.A. de C.V. ("Quimica") (originally formed in 1996 as a joint venture between Vitro, Vitro Plan, and Monsanto) for approximately $20 in cash. As a result of this acquisition, Solutia became the sole owner of Quimica and its plastic interlayer plant located in Puebla, Mexico. Pursuant to the purchase agreement, Solutia also entered into supply agreements with Vitro Flex S.A. de C.V. and Vitro Automotriz S.A. de C.V. to provide their requirements for most SAFLEX(R) plastic interlayer products for up to five years. This acquisition reflects Solutia's commitment to meet the growing global demand for its SAFLEX(R) plastic interlayer products.
The allocation of purchase price to the assets acquired and liabilities assumed resulted in Solutia's acquisition or assumption of total current assets of $18, non-current assets of $32, goodwill of $5, amortizable contract-based intangible assets of $4, current liabilities of $11 and non-current liabilities of $7. The contract-based intangible assets are being amortized over their estimated useful lives of 5 years. Results of operations for Quimica were included in Solutia's results of operations from the acquisition date in the Performance Products segment. The results of operations for the acquired business were not material to Solutia's consolidated results of operations.
Astaris, a 50/50 joint venture with FMC Corporation ("FMC"), divested substantially all of its operating assets in the fourth quarter 2005. Under the terms of the agreement, Israel Chemicals Limited ("ICL") purchased substantially all of the operating assets of Astaris for $255, subject to certain purchase price adjustments. As a result of this divestiture of assets,
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Solutia realized a $50 net gain on sale recorded in Equity Earnings (Loss) from Affiliates in the Consolidated Statement of Operations. In addition, certain of the assets and liabilities of Astaris that were not included in the sale to ICL were transferred to Solutia and FMC. Generally, these assets and liabilities consist of property originally contributed to the joint venture by Solutia and FMC, as well as associated liabilities.
In December 2004, Solutia sold the assets of Axio Research Corporation ("Axio") for less than $1, resulting in a loss on sale of $1.
Discontinued Operations
On August 22, 2006, Solutia's 100% owned subsidiary Solutia Europe S.A./N.V. ("SESA"), sold its pharmaceutical services business to Dishman Pharmaceuticals & Chemicals Ltd. ("Dishman"). Under the terms of the sale, Dishman purchased 100 percent of the stock of the pharmaceutical services business, as well as certain other assets used in the pharmaceutical services business, for $77, subject to certain purchase price adjustments. Dishman also assumed substantially all of the liabilities relating to the pharmaceutical services business, other than certain liabilities that arose prior to the closing of the transaction and liabilities under certain employment agreements. SESA agreed, subject to certain exceptions, that for a period of three years after the closing of the transaction neither it nor its affiliates will compete with the pharmaceutical services business or solicit for employment certain employees of the pharmaceutical services business and their current affiliates.
The pharmaceutical services business was a component of the Performance Products segment prior to the classification as discontinued operations. Solutia recorded a gain on the sale of the pharmaceutical services business of $49. Further, Solutia used $51 of the proceeds from the sale to pay down SESA's (euro)200 million credit facility (as described in Note 14).
The carrying amounts of assets and liabilities from discontinued operations have been classified as current in the Consolidated Statement of Financial Position and consisted of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The operating results of the pharmaceutical services business have been reported separately as discontinued operations, net of tax, in the Consolidated Statement of Operations for each period presented. Net sales and income from discontinued operations are as follows:
Solutia recorded a gain on the sale of the pharmaceutical services business of $49. The gain on sale was exempt from tax outside the United States and no gain was realized for United States tax purposes.
6. RESTRUCTURING RESERVES
During 2006, Solutia recorded $3 of decommissioning and dismantling costs primarily as a result of the 2005 shut-down of its acrylic fibers business, and $3 of asset write-downs. Solutia also recorded $3 of future contractual payments related to the termination of a third party manufacturing agreement. These costs were all recorded within Reorganization Items, net with $4 in the Integrated Nylon segment and $5 in the Performance Products segment. In addition, Solutia recorded $8 of severance and retraining costs in 2006 with $4 recorded in Reorganization Items, net and $3 in Marketing and Administrative expenses and $1 in Cost of Goods Sold involving headcount reductions within the Integrated Nylon and Performance Products segments. Cash outlays associated with the restructuring actions were funded from operations.
During 2005, Solutia recorded restructuring charges of $13 in Reorganization Items, net involving the shut-down of its acrylic fiber operations at its plant in Decatur, Alabama and the shut-down of its nylon industrial fiber manufacturing unit at its plant in Pensacola, Florida. This $13 of net charges from the closure of these businesses included $12 of asset write-downs, $7 of decontamination and dismantling costs and $4 of severance and retraining costs, partially offset by a $7 gain from the reversal of the LIFO reserve associated with the inventory sold and/or written off as part of the business shut-down
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
and a $3 gain from the sale of certain acrylic fibers assets. In addition, Solutia recorded $4 of severance and retraining costs in 2005 with $2 recorded in Reorganization Items, net and $2 in Cost of Goods Sold involving headcount reductions within the Integrated Nylon and Performance Products segments, as well as the corporate function. Cash outlays associated with the restructuring actions were funded from operations.
The following table summarizes the above noted restructuring charges, amounts utilized to carry out those plans and amount remaining at December 31, 2006:
Restructuring reserves of less than $1 as of December 31, 2006 were included in Liabilities Subject to Compromise in the Consolidated Statement of Financial Position. See Note 3 for further description of Solutia's Liabilities Subject to Compromise. In addition, Solutia expects the majority of the $5 of restructuring liabilities classified as not subject to compromise as of December 31, 2006 to be utilized within the next twelve months. Given the inherent uncertainties associated with the bankruptcy process, Solutia cannot forecast its level of future spending for restructuring reserves classified as subject to compromise.
7. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Goodwill of $89 and $76 at December 31, 2006 and 2005, respectively, was allocated to the Performance Products segment. This $13 increase in goodwill was a result of the Quimica acquisition (as further described in Note 4), of which $5 resulted from the 2006 acquisition and $8 resulted from the original acquisition in 1996 that was previously accounted for under the equity method of accounting. There were no impairments to the net carrying amount of goodwill during the year ended December 31, 2006.
Identified Intangible Assets
Identified intangible assets generally are comprised of (i) amortizable contract-based intangible assets with finite useful lives, and (ii) indefinite-lived trademarks not subject to amortization. These intangible assets are summarized in aggregate as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
There were no changes to amortizable lives or methods during the year ended December 31, 2006. In addition, amortization expense for the net carrying amount of finite-lived intangible assets is estimated to be $1 annually from 2007 through 2010 and less than $1 in 2011.
8. RISK MANAGEMENT ACTIVITIES
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 does 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, net in the period. There was a net loss of $3, $1, and $3 recorded in the years ended December 31, 2006, 2005 and 2004. Solutia had currency forward and option contracts to purchase and sell $181 and $365 of currencies as of December 31, 2006 and 2005, respectively, comprised principally of the Euro, British Pound-Sterling, Swiss Franc and U.S. Dollar.
Interest Rate Risk
Interest rate risk is primarily related to changes in interest expense from floating rate debt. Solutia believes its current debt structure mitigates some of the risk associated with changes in interest rates due to the combination of fixed versus floating rate debt instruments. Further, periodically, the Company does enter into contracts to further mitigate interest rate risk.
Commodity Price Risk
Certain raw materials and energy resources 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 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 Accumulated Other Comprehensive Loss to the extent effective, and reclassified into Cost of Goods Sold in the period during which the hedged transaction is settled. The mark-to-market gains or losses on ineffective portions of hedges are recognized in Cost of Goods Sold immediately.
As of December 31, 2006, less than $1 of after-tax unrealized net losses on derivative instruments was recorded in Accumulated Other Comprehensive Loss and is expected to be reclassified into Cost of Goods Sold in the first quarter of 2007. The actual purchases of energy, which are expected to occur during the next 3 months, will necessitate the reclassification of the derivative losses into Cost of Goods Sold. There were no gains or losses recorded in Cost of Goods Sold as a result of the ineffectiveness of any hedging contacts, and no cash flow hedges were discontinued during 2006 or 2005 due to changes in expectations on the original forecasted transactions. Solutia had commodity forward contracts with notional amounts of $2 and $9 as of December 31, 2006 and 2005, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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 Solutia. 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.
9. INVESTMENTS IN AFFILIATES
As further described in Note 4, Astaris divested substantially all of its operating assets in the fourth quarter 2005. Pursuant to this transaction, there were certain assets and liabilities of Astaris that were not included in the sale to ICL which were transferred to Solutia and FMC. Generally, these assets and liabilities consisted of property originally contributed to the joint venture by Solutia and FMC, as well as certain pre-closing liabilities relating to Astaris, including certain pre-closing environmental liabilities. In addition, certain non-operating assets and liabilities remained in the Astaris joint venture as part of the transaction. Further, the name of the joint venture which holds these remaining assets and liabilities was changed from Astaris LLC to Siratsa LLC.
At December 31, 2006, Solutia's investments in affiliates consisted principally of its 50 percent interests in the Flexsys and Siratsa joint ventures for which Solutia applies the equity method of accounting. Summarized combined financial information for 100 percent of the Flexsys and Siratsa joint ventures is as follows:
Solutia's investment in Flexsys as of December 31, 2006 and 2005 exceeded Solutia's proportionate share of the underlying equity of Flexsys by $5 and $1, respectively, primarily due to goodwill recorded by Solutia at inception of the joint venture. Solutia received a $25 dividend from Flexsys during the third quarter 2006, while there were no dividends from either Flexsys or Siratsa during 2005.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
11. VARIABLE INTEREST ENTITIES
Solutia has a synthetic lease related to its corporate headquarters in St. Louis, Missouri, entered into in 1999, that qualifies as a variable interest entity ("VIE"). Based on the terms of the lease agreement and the residual value guarantee Solutia provides to the lessor, Solutia concluded it is the primary beneficiary of the VIE and is consolidated in accordance with FASB Interpretation No. 46, Consolidation of Variable Interest Entities. As a result, the property, plant and equipment of $32 and long-term debt of $43 held by the VIE are included in the Consolidated Statement of Financial Position.
12. ASSET RETIREMENT OBLIGATIONS
In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143 ("FIN 47"). FIN 47 clarifies that the term "conditional asset retirement obligation" as used in SFAS No. 143, Accounting for Asset Retirement Obligations ("SFAS No. 143"), refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement, including those that may be conditional on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and (or) method of settlement should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when sufficient information to reasonably estimate the fair value of an asset retirement obligation is considered available.
Upon adoption of SFAS No. 143 as of January 1, 2003, Solutia identified certain conditional asset retirement obligations; however, these obligations were not recorded due to uncertainties involved with the determination of settlement timing. With the clarification outlined by FIN 47 for valuation of conditional asset retirement obligations, Solutia reevaluated the valuation concerns involving settlement timing for these conditional asset retirement obligations and accordingly reported an asset retirement obligation of $7 as of December 31, 2005. These obligations involve various federal, state and local regulations and/or contractual obligations to decontaminate and/or dismantle certain machinery and equipment, buildings, and leasehold improvements at Solutia's various operating locations.
Asset retirement obligations were estimated for each of Solutia's operating locations, where applicable, based upon Solutia's current and historical experience, adjusted for factors that a third-party would consider, such as overhead, profit and market risk premium. Estimated obligations were escalated based upon the anticipated timing of the related cash flows using an assumed inflation rate, and then were discounted using a credit-adjusted, risk-free interest rate. The impact of adoption resulted in a charge of $3 recorded as a cumulative effect of change in accounting principle (net of tax of $1) in the Consolidated Statement of Operations in 2005.
The pro-forma effects of the application of FIN 47 for the years ended December 31, 2005 and 2004 for these specific conditional asset retirement obligations are presented below:
At December 31, 2006 and 2005, the Company had a liability pertaining to the asset retirement obligation in Other Liabilities on the Consolidated Statement of Financial Position. The following is a reconciliation of the beginning and ending carrying amount of the Company's asset retirement obligation and the related assets:
The net book value of the related long-lived assets is less than $1 for both 2006 and 2005.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
13. INCOME TAXES
The components of income (loss) from continuing operations before income taxes were:
The components of income tax expense (benefit) recorded in continuing operations were:
Income tax (benefit) expense differed from the amounts computed by applying the U.S. Federal income tax rate of 35% to income from continuing operations before income taxes as a result of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Deferred income tax balances were related to:
At December 31, 2006, research and development tax credit carryforwards available to reduce possible future U.S. income taxes amounted to approximately $5, all of which will expire in 2019 through 2022. At December 31, 2006, various federal, state and foreign net operating loss carryforwards are available to offset future taxable income. These net operating losses expire from 2007 through 2026 or have an indefinite carryforward period. Valuation allowances have been provided for the tax credit and net operating loss carryforwards that are not likely to be utilized. Income taxes and remittance taxes have not been recorded on $87 of undistributed earnings of subsidiaries because Solutia intends to reinvest those earnings indefinitely.
Solutia reduced the valuation allowances by $(7) in 2006 of which $24 was recorded in Income Tax Expense (Benefit) in the Consolidated Statement of Operations and $(31) was recorded in Accumulated Other Comprehensive Loss in the Consolidated Statement of Comprehensive Income (Loss). The valuation allowances are principally provided for the U.S. deferred tax assets as Solutia continues to no longer believe that the "more likely than not" recognition criteria outlined in SFAS No. 109, Accounting for Income Taxes, were appropriate given a combination of factors surrounding Solutia's Chapter 11 bankruptcy filing including: (i) the possibility that all or a substantial portion of the loss and credit carryforwards and tax bases of assets could be reduced to the extent of cancellation of indebtedness occurring as part of a reorganization plan; (ii) the possibility that all or a substantial portion of the loss and credit carryforwards could become limited if a change in ownership occurs as a result of a reorganization plan; and (iii) updated expectations regarding near-term taxable income.
As of December 31, 2006, the Internal Revenue Service ("IRS") had completed its examination of the income tax returns of Solutia through 2001. No other years are currently being examined by the IRS. In addition, Solutia is subject to audits in several state and foreign jurisdictions. Solutia believes that it has adequate contingency reserves established for probable adjustments resulting from these audits. During 2006, Solutia increased its tax contingency reserves by $8 based on expected outcomes of income tax audits in various jurisdictions. The tax contingency reserves were adjusted by less than $(1) in 2005.
14. DEBT OBLIGATIONS
As of December 31, 2006, Solutia's debt obligations include borrowings from its DIP credit facility, notes and debentures. The weighted average interest rate on Solutia's total debt outstanding at December 31, 2006 was 8.4 percent compared to 8.7 percent at December 31, 2005. Excluding debt subject to compromise, with the exception of the 11.25 percent notes due 2009 on which the Bankruptcy Court has permitted continued payments of the contractual interest (see
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Note 3 for further description of these notes due 2009), the weighted average interest rate on total debt was 8.9 percent at December 31, 2006, compared to 9.8 percent at December 31, 2005. The weighted average interest rate on Solutia's short-term debt outstanding at December 31, 2006, was 9.0 percent as compared to 8.5 percent at December 31, 2005. As a result of the Chapter 11 filing, Solutia was in default on all its debt agreements as of December 31, 2006, with the exception of its DIP credit facility and SESA's (euro)200 million Facility Agreement ("Facility Agreement"). While operating as a debtor-in-possession during the Chapter 11 bankruptcy proceedings, Solutia has ceased recording interest on all unsecured pre-petition indebtedness in accordance with SOP 90-7, with the exception of the 11.25 percent notes due 2009. The amount of contractual interest not recorded was $32 in 2006, 2005 and 2004. Contractual interest is payable semiannually in January and July for the 11.25 percent notes due 2009. The DIP credit facility had $650 of borrowings at December 31, 2006 and $300 at December 31, 2005 and was classified as a current liability at both reporting dates. At both December 31, 2006 and 2005, Solutia had $95 and $131, respectively, of availability under the DIP credit facility due to borrowings and amounts outstanding under letter of credit facilities.
Long-term debt consisted of the following as of December 31,
2006 2005 ---- ----
6.72% debentures due 2037........................ 150 150 10.00% Euro notes due 2008 ...................... -- 247 Facility Agreement due 2011 ..................... 210 -- 11.25% notes due 2009............................ 223 223 7.375% debentures due 2027....................... 300 300 Other............................................ 43 43 ------ ------ Total principal amount..................... 926 963 Unamortized net discount (a)..................... -- -- ------ ------ 926 963 Less amounts subject to compromise (Note 3)...... (716) (716) ------ ------ TOTAL............................................ $ 210 $ 247 ====== ======
(a) Unamortized net discount of $48 as of both December 31, 2006 and December 31, 2005 is included in liabilities subject to compromise, as further described in Note 3.
Amendments to DIP Financing Agreement
Solutia amended its DIP credit facility on March 17, 2006 with Bankruptcy Court approval. This amendment, among other things, (i) increased the DIP credit facility from $525 to $825; (ii) extended the term of the DIP credit facility from June 19, 2006 to March 31, 2007; (iii) decreased the interest rate on the term loan component of the DIP credit facility from LIBOR plus 425 basis points to LIBOR plus 350 basis points; (iv) increased certain thresholds allowing the Debtors to retain more of the proceeds from certain dispositions and other extraordinary receipts; (v) approved the disposition of certain assets of the Debtors; (vi) allowed refinancing of, and certain amendments to, SESA's outstanding Euronotes; and (vii) amended certain financial and other covenants. Note 23 describes an additional amendment to the DIP financing agreement made subsequent to December 31, 2006.
Solutia analyzed the modifications of the DIP credit facility in March 2006 in accordance with the provisions of Emerging Issues Task Force ("EITF") No. 02-04, Determining Whether a Debtor's Modification or Exchange of Debt Instruments is within the Scope of FASB Statement No. 15, and EITF No. 96-19, Debtor's Accounting for a Modification or Exchange of Debt Instruments, and recorded a charge of approximately $8 to record the write-off of debt issuance costs and to record the DIP credit facility as modified at its fair value. In addition, $1 of unamortized debt issuance costs associated with the DIP credit facility were written off at the time of modification in March 2006.
Solutia amended its DIP financing agreement on June 1, 2005 and received Bankruptcy Court approval on July 25, 2005. The amendment reduced the interest rate on the term loan component of the DIP credit facility to LIBOR plus 4.25 percent from the previous interest rate of the greater of the prime rate plus 4.0 percent or 8.0 percent, extended the maturity date of the current facility to June 19, 2006 from the previous December 19, 2005 maturity date, and made other minor
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
modifications. No changes were made to the financial covenants contained in the DIP agreement aside from extending the financial covenant requirements to be commensurate with the new maturity date of the DIP agreement.
Euronotes Refinancing
On July 26, 2006, Solutia's indirect 100% owned subsidiary Solutia Services International S.C.A./Comm. V.A ("SSI"), a subsidiary of SESA, entered into a Facility Agreement guaranteed by SESA and CPFilms Vertriebs GmbH, a subsidiary of SESA. Closing of the Facility Agreement occurred on August 1, 2006. SESA used the proceeds of the Facility Agreement to refinance all of its (euro)200 million of 10 percent Senior Secured Notes (the "Euronotes") on August 1, 2006 at a prepayment premium of 3 percent, as required pursuant to the Euronotes, for a total redemption amount of approximately (euro)215 million, including accrued interest. The Euronotes were refinanced to reduce the interest rate, extend the term of the indebtedness and facilitate certain dispositions by Solutia, including the sale of its pharmaceutical services business as described in Note 4.
The Facility Agreement has a five-year term, with a termination date of July 31, 2011 and an adjustable rate structure which is EURIBOR plus 275 basis points. The margin is subject to adjustment upon the occurrence of certain events specified in the Facility Agreement or upon SESA and its subsidiaries attaining certain financial benchmarks. The Facility Agreement consists of a (euro)160 million term loan and a (euro)40 million term loan. The (euro)40 million term loan was repaid from the proceeds of the sale of Solutia's pharmaceutical services business (as further described in Note 4). The Facility Agreement is secured by substantially all of the assets of SESA and its subsidiaries. The Facility Agreement also contains other customary terms and conditions, including certain financial covenants relating to the performance of SESA and its subsidiaries.
15. FAIR VALUES OF FINANCIAL INSTRUMENTS
The recorded amounts of cash, trade receivables, third-party guarantees, accounts payable and short-term debt approximate their fair values at both December 31, 2006 and 2005, respectively.
The estimated fair value of Solutia's long-term debt not subject to compromise was $214 at December 31, 2006 and $248 as of December 31, 2005. These estimates compare with the recorded amount of $210 in 2006 and $247 in 2005. Fair value of the debt subject to compromise cannot be fairly determined due to the inherent uncertainties underlying the valuation assumptions affected by the Chapter 11 bankruptcy proceedings.
The estimated fair value of Solutia's foreign currency forward and option contracts on intercompany financing transactions was $1 at December 31, 2006 and less than $1 at December 31, 2005. Notional amounts for these forward and option contracts to purchase and sell foreign currencies were $181 at December 31, 2006, and $365 at December 31, 2005.
The estimated fair value of Solutia's commodity forward contracts was less than a $1 and an approximate $1 loss at December 31, 2006 and 2005, respectively. Notional amounts for these commodity forward contracts were $2 and $9 at December 31, 2006 and 2005, respectively.
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 both December 31, 2006, and December 31, 2005. The fair-value estimates do not necessarily reflect the values Solutia could realize in the current market.
16. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
Pension benefits generally are based on the employee's age, years of service and/or compensation level. The domestic 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. Solutia amended its U.S. qualified pension plan in 2005 for union participants and in 2004 for non-union participants to cease future benefit accruals effective January 1, 2006 and July 1, 2004, respectively (as further described below). Prior to the spinoff, the majority of Solutia's employees participated in
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Pharmacia'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 Pharmacia in earlier years. Further, Solutia terminated certain domestic, non-qualified pension plans in 2005.
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 Solutia 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. Solutia amended its U.S. postretirement plan in 2005 for union, active employees and in 2004 for non-union, active employees (as further described below). In connection with the Solutia Spinoff, Solutia assumed retiree medical liabilities for its applicable active employees and for approximately two-thirds of the retired U.S. employees of Pharmacia.
Solutia uses a measurement date of December 31 for the majority of its pension and other postretirement benefit plans. The amounts disclosed below do not reflect the impact of any changes to the benefit plans that might be contemplated as a result of the bankruptcy filing. In addition, the accrued liabilities for domestic pension and other postretirement obligations have been classified as liabilities subject to compromise as of December 31, 2006 and 2005 (see Note 3).
Net Periodic Cost
For the years ended December 31, 2006, 2005, and 2004, Solutia's pension and healthcare and other benefit costs were as follows:
Curtailments and Settlements ----------------------------
Solutia amended its U.S. postretirement plan in 2006 for retiree participants to be effective January 1, 2007. The changes terminate medical benefits for certain retirees who are Medicare eligible, and if not Medicare eligible, to terminate medical benefits on the earlier of (a) the date such retirees or participants become Medicare eligible if such date is on or after January 1, 2007 or (b) October 19, 2016. This action resulted in a curtailment of the U.S. postretirement plan, as defined by SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, due to the termination of medical benefits provided to retiree participants in Solutia's U.S. postretirement plan. The net result of this action in 2006 was a $40 gain due primarily to the required recognition of prior service gains that were expected to be amortized into earnings over the estimated future service period of the plan participants.
Solutia amended its U.S. qualified pension plan in 2005 to cease benefit accruals for domestic union participants to be effective January 1, 2006. This action resulted in a curtailment of the U.S. qualified pension plan, as defined by SFAS No. 88, Employees Accounting for Settlements and Curtailments of Defined Pension Plans and for Termination Benefits, due to the reduction in anticipated future service of union participants in Solutia's U.S. qualified pension plan. The net result of this action in 2005 was a $7 loss due primarily to the required recognition of unrecognized losses that were expected to be amortized into earnings over the estimated future service period of the plan participants.
Solutia also amended in 2005 its U.S. postretirement plan for union, active employees to be effective January 1, 2006. These changes included discontinuation of all postretirement benefits after attaining age 65, changes to certain
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
eligibility requirements for pre-65 postretirement benefits with the eventual elimination of these benefits by 2016, and significant reduction of retiree life insurance benefits for future retirees. This action resulted in a curtailment of the U.S. postretirement plan, as defined by SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, due to the reduction in anticipated future service of union participants in Solutia's U.S. postretirement plan. The net result of this action in 2005 was a $4 gain due primarily to the required recognition of unrecognized gains that were expected to be amortized into earnings over the estimated future service period of the plan participants.
Solutia terminated certain domestic, non-qualified pension plans in 2005, which were effectively frozen since Solutia's bankruptcy filing on December 17, 2003. The termination of these plans resulted in a pension settlement in accordance with SFAS No. 88. However, no adjustments were made to the recorded amount of $19 for these plans since this amount represents the best proxy for the allowed claim amount in accordance with SOP 90-7. An adjustment to this amount will be made if the allowed claim is deemed to be different through the claims resolution process. The amount has been presented as a reduction to the overall pension obligation in 2005, as the amount no longer represent a pension obligation, but instead general unsecured claims against Solutia.
Solutia amended its U.S. qualified and non-qualified pension plans in 2004 to cease future benefit accruals effective July 1, 2004 for non-union participants in these plans. As a result, Solutia recorded a pension curtailment net loss of $63 in 2004 due to the reduction in anticipated future service of participants in Solutia's U.S. qualified and non-qualified pension plans. In addition, Solutia recorded a pension settlement net gain of $1 resulting from the significant reduction in the number of participants in Solutia's non-qualified pension plan principally resulting from workforce reduction initiatives.
Solutia amended its U.S. postretirement plan for non-union, active employees during 2004. These changes, effective September 1, 2004, include discontinuation of all postretirement benefits after attaining age 65, changes to certain eligibility requirements for pre-65 postretirement benefits with the eventual elimination of these benefits by 2016, and elimination of retiree life insurance benefits for future retirees. As a result, Solutia recorded a curtailment gain of $38 in 2004 due to the reduction in anticipated future service of non-union participants in Solutia's U.S. postretirement plan.
Solutia recorded pension settlement charges of $10 in both 2005 and 2004 resulting principally from the significant amount of lump sum distributions from Solutia's U.S. qualified pension plan during each of those years relating primarily to headcount reductions. In addition, Solutia recorded a curtailment loss of $1 during 2004 due to the reduction in anticipated future service of participants in Solutia's Canadian pension plan resulting from headcount reductions.
Actuarial Assumptions ---------------------
The significant actuarial assumptions used to determine net periodic cost for Solutia's principal pension, healthcare and other benefit plans were as follows:
Solutia establishes its discount rate based upon the internal rate of return for a portfolio of high quality bonds with maturities consistent with the nature and timing of future cash flows for each specific plan. The expected long-term rate of return on pension plan assets assumption is based on the target asset allocation policy and the expected future rates of return on these assets.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
A 1 percent change in the assumed health care cost trend rates would have the following effect as of December 31, 2006:
Solutia's costs for postretirement medical benefits are capped for many current retirees and for active employees; therefore, the impact of this hypothetical change in the assumed health care cost trend rate is limited.
Benefit Obligations
Components of the changes in the benefit obligation of Solutia's principal pension, healthcare and other benefit plans were as follows:
The accumulated benefit obligation was $1,157 and $1,217 as of December 31, 2006 and 2005, respectively.
The significant actuarial assumptions used to estimate the projected benefit obligation for Solutia's principal pension, healthcare and other benefit plans were as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Plan Assets
Components of the changes in fair value of plan assets of Solutia's pension plans were as follows:
The other postretirement benefits plans are unfunded as of December 31, 2006 and 2005.
The asset allocation for Solutia's pension plans as of December 31, 2006 and 2005, and the target allocation for 2007, by asset category, follows.
The Solutia defined benefit plan investment strategy is to maintain an asset allocation that is diversified among multiple asset classes, and among multiple managers within each asset class, in order to minimize the risk of large losses and to maximize the long-term risk-adjusted rate of return.
Funded Status
The funded status of Solutia's principal pension, healthcare and other benefit plans at December 31, 2006, and 2005 and the related amounts recognized in the Consolidated Statement of Financial Position was as follows:
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the pension plans with projected benefit obligation in excess of plan assets and for the pension plans with accumulated benefit obligations in excess of plan assets were as follows as of December 31:
The accumulated postretirement benefit obligation exceeds plan assets for all of Solutia's other postretirement benefit plans.
Solutia actively manages funding of its domestic qualified pension plan in order to meet the requirements of the IRS and the Pension Benefits Guarantee Corporation (a U.S. federal agency). Solutia contributed $179 in 2006 to the qualified pension plan in accordance with IRS funding rules and made a discretionary contribution of $11 in 2004 to the qualified pension plan in order to minimize future required contributions and to utilize available tax benefits. No contributions were made during 2005 to the qualified pension plan. According to current IRS funding rules, Solutia estimates that it will be required to make approximately $100 in pension contributions to its U.S. qualified pension plan in 2007. In addition, Solutia contributed $6 in 2006, $5 in 2005 and $4 in 2004, respectively, to fund its foreign pension plans. Moreover, Solutia expects to be required to fund a like amount in pension contributions for its foreign pension plans in 2007.
Effects of Adopting SFAS No. 158
The following table illustrates the incremental effect of applying SFAS No. 158 on individual line items in the Consolidated Statement of Financial Position at December 31, 2006:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Estimated Future Benefit Payments
Estimated benefit payments expected to be made over the next five years and the cumulative five year period thereafter are as follows:
PENSION HEALTHCARE AND BENEFITS OTHER BENEFITS -------- --------------
2007............................. $ 114 $ 71 2008............................. 112 65 2009............................. 107 61 2010............................. 107 58 2011............................. 101 55 2012-2016........................ 455 203
17. EMPLOYEE SAVINGS PLANS
Substantially all U.S. employees of Solutia are eligible to participate in the Solutia Savings and Investment Plan ("SIP"), a 401(k) plan. Effective December 15, 2003, all matching contributions are invested in the same manner as participants' personal SIP contributions. Company cash contributions related to the employer match were $15 in 2006 and 2005, respectively, and $10 in 2004, and were invested in accordance with participants' personal investment elections. In addition, effective January 1, 2005, Solutia increased its SIP matching contribution percentage to 100 percent on the first 7 percent of a participant's qualified contributions from 60 percent on the first 8 percent, previously.
18. STOCK OPTION PLANS
Solutia has two stock-based incentive plans under which awards are available for grants to officers and employees; the Solutia Inc. 2000 Stock-Based Incentive Plan ("2000 Plan") and the Solutia Inc. 1997 Stock-Based Incentive Plan ("1997 Plan"). The 2000 Plan authorizes up to 5,400,000 shares 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, 2006, approximately 2,240,193 shares from the 2000 Plan and 2,414,464 shares from the 1997 Plan remained available for grants.
During 2006, no options were granted to named executive officers and other senior executives as a group, or to other employees. Total shares covered by options granted under the plans to current executive officers and other senior executives as a group totaled 3,011,000, and those to other employees totaled 10,016,592, through December 31, 2006. 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, 2006 and 2005, 25,174 shares of Solutia's common stock remained available for grants under the plan. There were no options or deferred shares granted in 2006 as all non-employee director compensation is paid in cash.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
As of January 1, 2006, Solutia adopted SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123, Accounting for Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation--Transition and Disclosure. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method under SFAS No. 123(R). The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. Additionally, Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options to purchase Solutia's common stock will receive any consideration in our Chapter 11 Cases for their equity based compensation.
There were no options granted or exercised during 2006. Accordingly, no compensation cost with respect to such activities was recognized in the Consolidated Statement of Operations. However, to the extent that the remaining service periods of unvested options granted prior to January 1, 2006 extend past the adoption date of SFAS No. 123(R), the residual unamortized fair value originally calculated for footnote disclosures required under SFAS No. 123, net of estimated forfeitures, is now recognized on a straight-line basis over such remaining periods. Compensation cost and all related effects within the Consolidated Statement of Operations and Consolidated Statement of Cash Flows associated with these unvested options was less than $1 during 2006. Additionally, there was less than $1 of total unrecognized compensation cost related to these unvested options as of December 31, 2006 to be recognized over a weighted-average recognition period of less than one year.
Prior to January 1, 2006, Solutia applied SFAS No. 123 as amended by SFAS No. 148, which allowed Solutia 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 was recognized for Solutia's option plans in the Consolidated Statement of Operations during such periods, as all options granted under the plans had an exercise price equal to the market value of Solutia's stock on the date of the grant. The effect would have been less than $1 on net income and no change on income per share 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 SFAS No. 123, for 2006.
A summary of the status of Solutia's stock option plans for years ended December 31, 2006, 2005 and 2004 follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The following table summarizes information about stock options outstanding at December 31, 2006:
19. CAPITAL STOCK
On December 17, 2003, following the announcement that Solutia had filed for Chapter 11 bankruptcy protection, the New York Stock Exchange ("NYSE") halted trading in Solutia's common stock. Solutia's common stock was delisted from the NYSE on February 24, 2004. Solutia's common stock is currently being quoted under the ticker symbol SOLUQ on the Pink Sheets Electronic Quotation Service maintained by The Pink Sheets LLC and on the OTC Bulletin Board.
No dividends were paid in 2006 or 2005. Solutia is currently prohibited by both the U.S. Bankruptcy Code and the DIP credit facility from paying dividends to shareholders.
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 Pharmacia 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 or the 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 $.000125. 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 $.000125, common shares of the acquiring company having a market value of $.000250. 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 $.000125, a number of shares of Solutia's common stock having a market value of $.000250. 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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
of such a 20 percent position, Solutia can redeem each right for $.00000001. The board of directors is also authorized to reduce the 20 percent thresholds described above to not less than 10 percent. The rights expire in the year 2007. However, Solutia believes that its plan of reorganization will result in cancellation of its existing shares of common stock, as well as options and warrants to purchase its common stock and that it is unlikely that holders of Solutia's common stock, including options and warrants to purchase Solutia's common stock, will receive any consideration for that stock or those options and warrants in such a plan of reorganization. Consequently, this preferred stock purchase right plan would be cancelled if the underlying common stock were to be cancelled.
Solutia has 10 million shares of preferred stock, par value $0.01 per share, authorized. As of December 31, 2006, there were no preferred shares issued or outstanding.
20. COMMITMENTS AND CONTINGENCIES
Commitments
Commitments, principally in connection with uncompleted additions to property, were approximately $16 at December 31, 2006 and 2005. In addition, as of December 31, 2006 and 2005, Solutia was contingently liable under letters of credit totaling $76 and $98, respectively, of which $2 and $1, respectively, were cash collaterized, primarily related to environmental remediation and various insurance related activities. The cash underlying these collateralized letters of credit is contractually restricted and accordingly is excluded from cash and cash equivalents and recorded in Other Assets within the Consolidated Statement of Financial Position as of December 31, 2006 and 2005.
Solutia's future minimum payments under operating leases and various unconditional purchase obligations are $10 for 2007, $6 for 2008, $3 for 2009, $2 for 2010, and $0 for 2011 and thereafter. The amounts of these commitments have not been adjusted to reflect any potential impact that the bankruptcy proceedings may have upon the timing and valuation of such commitments.
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 $91 at December 31, 2006 and $100 at December 31, 2005.
No single customer or customer group accounted for 10 percent or more of Solutia's net sales for the years ended December 31, 2006 and 2004. For the year ended December 31, 2005, Shaw Industries, Inc., a single customer within the Integrated Nylon segment, accounted for approximately 11 percent of Solutia's consolidated net sales.
The more significant concentrations in Solutia's trade receivables at December 31, 2006 and 2005 were:
Management does not anticipate losses on its trade receivables in excess of established allowances.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Contingencies
Litigation ----------
Because of the size and nature of Solutia's 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 of its spinoff from Pharmacia, Solutia assumed the defense of specified legal proceedings and agreed to indemnify Pharmacia for obligations arising in connection with those proceedings. Solutia has determined that these defense and indemnification obligations to Pharmacia are pre-petition obligations under the U.S. Bankruptcy Code that Solutia is prohibited from performing, except pursuant to a confirmed plan of reorganization. As a result, Solutia has ceased performance of these obligations. Solutia's cessation of performance may give rise to a pre-petition unsecured claim against Solutia which Pharmacia may assert in Solutia's Chapter 11 bankruptcy case. The estimated unsecured claim amount was classified as a liability subject to compromise as of December 31, 2006 and December 31, 2005 in the amount of $111 and $136, respectively.
Monsanto also indemnified Pharmacia with respect to a number of legal proceedings described in Solutia's 2003 Form 10-K/A in which Solutia was a named defendant or was defending solely due to its Pharmacia related indemnification obligations referred to above. Solutia is prohibited from performing with respect to these obligations, and developments, if any, in these matters are currently managed by other named defendants. Accordingly, Solutia has ceased reporting on the status of those legal proceedings. The legal proceedings which are in this category are (i) Owens v. Monsanto; (ii) Payton v. Monsanto; (iii) other Anniston cases; and (iv) premises based asbestos litigation. Legal proceeding activities are currently being funded by Monsanto for these matters. Monsanto's funding of these legal activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's bankruptcy case.
Following is a summary of legal proceedings that Solutia or its equity affiliate continue to manage that, if resolved unfavorably, could have a material adverse effect on Solutia's results of operation and financial position.
LEGAL PROCEEDINGS IN SOLUTIA'S BANKRUPTCY CASE - ----------------------------------------------
JP MORGAN ADVERSARY PROCEEDING
On May 27, 2005, JPMorgan, as indenture trustee for Solutia's debentures due 2027 and 2037 (the "Prepetition Indenture"), filed an adversary proceeding against Solutia in Solutia's bankruptcy case. In the proceeding, JPMorgan asserted five causes of action seeking declaratory judgments to establish the validity and priority of the purported security interest of the holders of the 2027 and 2037 debentures, and one cause of action pursuant to section 363 of the Bankruptcy Code asserting that the alleged security interests lacked adequate protection. The proceeding relates to Solutia's 2002 and 2003 refinancings of its credit facilities. When Solutia refinanced its credit facilities in 2002, the 2027 and 2037 Debentures obtained a pro rata secured interest in certain of Solutia's assets as a result of the application of the "equal and ratable" provisions of the Prepetition Indenture. On October 8, 2003, Solutia restructured its credit facilities, reduced its outstanding secured indebtedness below the threshold level that initially triggered the "equal and ratable" provisions of the Prepetition Indenture and, as a result, the 2027 and 2037 Debentures returned to their original unsecured status. JPMorgan alleges that the October 8, 2003 refinancing had no effect on the security interests and liens that were created in 2002, and argues further that, even if it did, those liens should be reinstated as a matter of equity. The Unsecured Creditors' Committee and the Ad Hoc Solutia Trade Claims Committee have intervened in the proceeding in support of Solutia and the Ad Hoc Committee of Solutia Noteholders has intervened in the proceeding in support of JPMorgan.
Trial concluded on July 10, 2006. Post-trial briefs were submitted by the parties in August 2006. The Bankruptcy Court has not made a ruling.
EQUITY COMMITTEE ADVERSARY PROCEEDING AGAINST MONSANTO AND PHARMACIA
On March 7, 2005, the Equity Committee in Solutia's bankruptcy case filed a complaint against Pharmacia and Monsanto and objections to the proofs of claim filed by Pharmacia and Monsanto in Solutia's bankruptcy case. Solutia was not named as a defendant in its complaint, the Equity Committee seeks to avoid certain obligations assumed by Solutia at the
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time of its spinoff from Pharmacia. The complaint alleges, among other things, that the Solutia Spinoff was a fraudulent transfer under the Bankruptcy Code because Pharmacia forced Solutia to assume excessive liabilities and insufficient assets such that Solutia was destined to fail from its inception. Pharmacia and Monsanto filed a motion to dismiss the complaint or, in the alternative, to stay the adversary proceeding. On August 4, 2005, the Debtors filed with the Bankruptcy Court their Statement and Reservation of Rights in Response to the complaint and Objection to Claims, in which the Debtors expressed their view that the issues and disputes raised in the complaint would be resolved through the Plan confirmation process. During a hearing held on April 11, 2006, the Bankruptcy Court issued a bench ruling denying Pharmacia and Monsanto's motion to dismiss the complaint. The Ad Hoc Committee of Solutia Noteholders and the Ad Hoc Solutia Trade Claims Committee have intervened in this adversary proceeding in support of the Equity Committee. Solutia and the Unsecured Creditors' Committee have intervened in this adversary proceeding as neutral parties due to the importance of this proceeding with respect to Solutia's bankruptcy case. On September 14, 2006, the Court ruled that while the Equity Committee did not have standing to pursue these claims on behalf of the Debtors, it had standing to pursue its own objections to the claims of Monsanto and Pharmacia. This matter was submitted to mediation but the parties were unable to reach a consensual resolution. The adversary proceeding has been stayed indefinitely by the parties, subject to certain rights of the parties to recommence such proceeding.
LEGAL PROCEEDINGS OUTSIDE SOLUTIA'S BANKRUPTCY CASE - ---------------------------------------------------
ANNISTON PARTIAL CONSENT DECREE
On August 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Partial Consent Decree in an action captioned United States of America v. Pharmacia Corporation (p/k/a Monsanto Company) and Solutia. This Partial Consent Decree provides for Pharmacia and Solutia to sample certain residential properties and remove soils found on those properties if PCBs are at a level of 1 part per million (ppm) or above, to conduct a Remedial Investigation and Feasibility Study to provide information for the selection by the Environmental Protection Agency ("EPA") of a cleanup remedy for the Anniston, Alabama PCB site, and to pay EPA's past response costs and future oversight costs related to this work. The decree also provided for the creation of an educational trust fund of approximately $3 to be funded over a 12-year period to provide supplemental educational services for school children in west Anniston.
A subsequent dispute arose between the EPA and Solutia regarding the scope and application of the automatic stay arising as a result of Solutia's Chapter 11 filing to the remaining obligations under the Partial Consent Decree. On April 19, 2004, the District Court held that the Partial Consent Decree enforces police and regulatory powers under the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") and, as a result, the automatic stay provisions of the U.S. Bankruptcy Code are inapplicable to Solutia's obligations under the Partial Consent Decree. On April 30, 2004, the United States Bankruptcy Court for the Southern District of New York entered a Stipulation and Agreed Order in which the EPA and Solutia stipulated that the automatic stay is applicable to certain of the Partial Consent Decree's requirements. Solutia filed a motion asking the District Court to reconsider its order and to bring it into accord with the Stipulation and Agreed Order consented to by the EPA and entered by the Bankruptcy Court. On September 9, 2004, the District Court denied Solutia's motion and declared that the automatic stay is inapplicable to Solutia's obligations under the Consent Decree to perform site work. Solutia appealed this ruling to the Eleventh U.S. Circuit Court of Appeals, which dismissed the appeal for lack of jurisdiction.
On June 30, 2005, the United States District Court for the Northern District of Alabama issued an order (the "PCB Order") authorizing co-defendants Pharmacia and Solutia to "suspend" performance of the PCB clean-up at the Anniston site under the Anniston Consent Decree, upon the filing of a motion by either defendant requesting that relief. The PCB Order found that Solutia and Pharmacia entered into the Anniston Consent Decree, and that the court approved that Anniston Consent Decree, based on the understanding that the defendants' rights to pursue other liable parties for contribution would not be impaired by the EPA. The PCB Order further found that the EPA's planned settlements with certain Anniston foundries would thus deprive the defendants of one of the material considerations for entering into the Anniston Consent Decree.
In July 2006, Solutia and Pharmacia reached an agreement with EPA that clarifies the extent of remaining obligations under the Anniston Consent Decree and the coordination of that work with the lead site clean-up being performed by others, and by which Solutia and Pharmacia will forego the opportunity to suspend their obligations under the Anniston Consent Decree pursuant to the PCB Order. Solutia and Pharmacia preserved their rights under this agreement to continue to
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argue that the contribution protection afforded certain other potentially responsible parties performing lead site clean-up should not be effective as to Solutia and Pharmacia.
PENNDOT CASE
Solutia's Annual Report on Form 10-K/A for the year ended December 31, 2003 described a case then pending in the Commonwealth Court of Pennsylvania by the Commonwealth of Pennsylvania against Pharmacia seeking damages for PCB contamination in the Transportation and Safety Building ("T&S Building") in Harrisburg, Pennsylvania, that it claimed necessitated the demolition of the T&S Building. Solutia was not a named defendant in this litigation and therefore took no action to stay the litigation in connection with its Chapter 11 proceedings. Solutia assumed the defense of this litigation at the time of its spin-off from Pharmacia. Solutia determined that its obligation to defend and indemnify Pharmacia with regard to this litigation was a pre-petition obligation that Solutia was prohibited from performing, except pursuant to a confirmed plan of reorganization. Therefore, Solutia ceased defending Pharmacia with respect to this litigation. Solutia did, however, provide a $20 letter of credit to secure a portion of Pharmacia's obligations with respect to an appeal bond issued with respect to the case.
On May 25, 2006 the Supreme Court of Pennsylvania issued its ruling on the appeal in this case, reversing in whole and remanding in part the decision of the trial court against Pharmacia. As a result of this ruling, the $20 letter of credit that Solutia had committed to partially secure the appeal bond was released. With the release of the bond, Solutia recognized a gain in its Consolidated Statement of Operations during the second quarter 2006 from the reversal of a significant portion of the existing litigation reserve with respect to this matter.
FLEXSYS RELATED LITIGATION
Since 2002, antitrust authorities in the United States, Europe and Canada are continuing to investigate past commercial practices in the rubber chemicals industry including the practices of Flexsys, Solutia's joint venture with Akzo Nobel. The European Commission issued its findings from its investigation in 2005, without levying any fines against Flexsys. Investigations regarding the industry may still be on-going in the United States and Canada, but to date, no findings have been made against Flexsys in either country.
In addition, a number of purported civil class actions have been filed against Flexsys and other producers of rubber chemicals on behalf of indirect purchasers of rubber chemical products. Solutia is aware of a series of these purported class actions which had been filed against Flexsys in various state courts in the United States and in at least four courts in Canada. Except for two cases pending in the United States, all of the remaining cases have been dismissed, or are currently subject to tentative settlements.
CASH BALANCE PLAN LITIGATION
Davis v. Solutia Inc. Employees' Pension Plan; Hammond, et al. v. ----------------------------------------------------------------- Solutia Inc. Employees' Pension Plan. Since October 2005, current or former - ------------------------------------ participants in the Solutia Inc. Employees' Pension Plan (the "Pension Plan") have filed three class actions alleging that the Pension Plan is discriminatory based upon age and that the lump sum values of individual account balances in the Pension Plan have been, and continue to be, miscalculated. None of the Debtors, and no individual or entity other than the Pension Plan, has been named as a defendant in any of these cases. Two of these cases, captioned Davis, et al. v. Solutia, Inc. Employees' Pension Plan and Hammond, et al. v. Solutia, Inc. Employees' Pension Plan, are still pending in the Southern District of Illinois against Monsanto Company and Monsanto Company Pension Plan (Walker et al. v. The Monsanto Pension Plan, et al.) and Pharmacia Cash Balance Pension Plan, Pharmacia Corporation, Pharmacia and Upjohn, Inc., and Pfizer Inc. (Donaldson v. Pharmacia Cash Balance Pension Plan, et al.). The plaintiffs in the Pension Plan cases sought to obtain injunctive and other equitable relief (including money damages awarded by the creation of a common fund) on behalf of themselves and the nationwide putative class of similarly situated current and former participants in the Pension Plan.
A Consolidated Class Action Complaint (the "Complaint") was filed by all of the plaintiffs in the consolidated case on September 4, 2006. The plaintiffs in the Complaint alleged three separate causes of action against the Pension Plan: (1) the Pension Plan violates ERISA by terminating interest credits on prior plan accounts at the age of 55; (2) the Pension Plan is improperly backloaded in violation of ERISA; and (3) the Pension Plan is discriminatory on the basis of age.
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Motions for class certification were filed in late 2006 by the plaintiffs against each of the defendants. With respect to the Pension Plan, plaintiffs moved to certify a class only on their first claim: i.e., that the Pension Plan discriminated against employees on the basis of their age by only providing interest credits on prior plan accounts through age 55. Briefing on the class certification motions was completed in January 2007 and the motion is still pending before the court.
OTHER LEGAL PROCEEDINGS - -----------------------
Dickerson V. Feldman. On October 7, 2004, a purported class action -------------------- captioned Dickerson v. Feldman; et al. was filed in the United States District Court for the Southern District of New York against a number of defendants, including former officers and employees of Solutia and Solutia's Employee Benefits Plans Committee and Pension and Savings Funds Committee. Solutia was not named as a defendant. The action alleged breach of fiduciary duty under ERISA and sought to recover alleged losses to the Solutia Inc. Savings and Investment Plan ("SIP Plan") during the period December 16, 1998 to the date the action was filed. The investment of SIP Plan assets in Solutia's common stock is alleged to have been imprudent because of the risks and liabilities related to Solutia's legacy environmental and litigation liabilities and because of Flexsys' alleged involvement in the matters described above under "Flexsys Related Litigation." The action sought monetary payment to the SIP Plan to recover the losses resulting from the alleged breach of fiduciary duties, as well as injunctive and other appropriate equitable relief, reasonable attorney's fees and expenses, costs and interest. In addition, the plaintiff in this action filed a proof of claim for $269 against Solutia in the Bankruptcy Court.
On March 30, 2006, the District Court granted the defendants' motion to dismiss on grounds that the Dickerson plaintiffs lacked standing to sue and that the complaint failed to state a claim on which relief could be granted. The dismissal of Dickerson's cause of action resulted in dismissal of the entire purported class action, including claims asserted on behalf of the unnamed purported class members. On April 3, 2006, Dickerson filed an appeal of this dismissal with the United States Court of Appeals for the Second Circuit. The parties have fully briefed the appeal, and oral argument will be held on February 12, 2007.
Solutia Inc. v. FMC Corporation. On October 14, 2003, Solutia filed ------------------------------- an action captioned Solutia Inc. v. FMC Corporation ("FMC") in Circuit Court in St. Louis County, Missouri, against FMC over the failure of purified phosphoric acid technology provided by FMC to Astaris, the 50/50 joint venture formed by Solutia and FMC. On February 20, 2004, Solutia voluntarily dismissed the state court action and filed an adversary proceeding against FMC in the Bankruptcy Court. FMC filed with the Bankruptcy Court a motion to withdraw the reference. The motion was granted, and, as a result, the matter is now pending in the U.S. District Court for the Southern District of New York. FMC did not allege a counterclaim against Solutia or Astaris.
FMC filed a motion to dismiss Solutia's action based upon an alleged lack of standing. On March 29, 2005, the New York District Court granted in part and denied in part FMC's motion to dismiss. Specifically, the court dismissed with prejudice three of Solutia's causes of action for breach of contract. The New York District Court denied FMC's motion to dismiss Solutia's other causes of action for breach of warranty, breach of fiduciary duty, negligent misrepresentation, fraud and fraud in the inducement.
The parties have completed all fact discovery and submitted cross motions for Summary Judgment. On July 31, 2006, the District Court entered its Memorandum Opinion and Order on the Motions. It granted portions of FMC's Motion for Summary Judgment by ruling that Solutia cannot attempt to establish its breach of fiduciary duty claim by maintaining that the parties were in a joint venture or had a special relationship prior to April 2000. The District Court, however, denied FMC's Motion for Summary Judgment on the breach of fiduciary duty claim and held that Solutia will be permitted to prove at trial that FMC had special knowledge concerning its technology which can give rise to a fiduciary duty. The District Court further overruled the parties' Motion for Summary Judgment on the remaining claims. The District Court ruled Solutia may still be entitled to punitive damages in addition to its claims for out-of-pocket and lost profit damages.
A bench trial on the four claims noted above is scheduled to begin in April 2007.
Ferro Antitrust Investigation. Competition authorities in Belgium and ----------------------------- several other European countries are investigating past commercial practices of certain companies engaged in the production and sale of butyl benzyl phthalates ("BBP"). One of the BBP producers under investigation by the Belgian Competition Authority ("BCA") is Ferro Belgium sprl, a European subsidiary of Ferro Corporation ("Ferro"). Ferro's BBP business in Europe was purchased from Solutia in
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2000. Solutia received an indemnification notice from Ferro and has exercised its right, pursuant to the purchase agreement relating to Ferro's acquisition of the BBP business from Solutia, to assume and control the defense of Ferro in proceedings relating to these investigations. On July 7, 2005, the BCA Examiner issued a Statement of Objections regarding its BBP investigation in which SESA, a European non-Debtor subsidiary of Solutia, along with Ferro Belgium sprl and two other producers of BBP, is identified as a party under investigation with respect to its ownership of the BBP business from 1997 until the business was sold to Ferro in 2000. SESA's written comments to the Statement of Objections were submitted on August 31, 2005 and presented at an oral hearing before the BCA on September 6, 2005. The Examiner submitted its Reasoned Report to the BCA on December 22, 2005. Solutia is not named as a party under investigation in the Reasoned Report. SESA will have an opportunity to submit comments to the BCA on the Reasoned Report in writing and at a subsequent oral hearing on a date that has not yet been determined by the BCA. Solutia and SESA are fully cooperating with the BCA in this investigation.
Department of Labor Investigation of Solutia Inc. Savings and ------------------------------------------------------------- Investment Plan. Solutia was contacted in 2005 by the Department of Labor - --------------- ("DOL"), through the Employee Benefits Security Administration, informing Solutia that it wanted to conduct an investigation of Solutia's SIP Plan. Solutia fully cooperated with the DOL throughout the investigation.
On December 6, 2006, the DOL issued a letter stating that, based on facts gathered, it appeared that Solutia, through its fiduciaries, breached its fiduciary obligations and violated provisions of ERISA with respect to the SIP Plan. Specifically, the DOL stated that it found no evidence that: (1) the Pension and Savings Funds Committee ("PSFC") sufficiently monitored the Solutia Stock Fund option within the SIP Plan to determine if the Solutia Stock Fund continued to be a prudent investment for the SIP Plan prior to December 15, 2003; and (2) the Solutia Board of Directors, CEO, and PSFC, prior to December 15, 2003, adequately monitored the SIP Plan fiduciaries, including the PSFC, the Employee Benefits Plan Committee, and the Northern Trust Company of Connecticut. The DOL did not assert in its letter that the SIP Plan or its participants had been harmed by these alleged breaches. Further, the DOL did not find that the offering of the Solutia Stock Fund as an investment option in the SIP Plan was itself a violation of ERISA, or that it caused any participant to suffer investment losses. Further, the DOL did not assert any monetary fines against the Company based on its findings to date. The DOL stated in the letter that its findings were subject to the possibility that additional information could lead the DOL to revise its views.
The DOL did not choose to file suit against the Solutia fiduciaries, instead offering Solutia the opportunity to voluntarily discuss how the alleged violations may be corrected. Solutia has submitted additional information to the DOL to support the Company's request for reconsideration of the DOL's findings.
Solutia Canada Inc. v. INEOS Americas LLC. Solutia Canada Inc. ----------------------------------------- ("Solutia Canada") filed suit in Quebec Court in December 2006, alleging breach of contract by INEOS Americas LLC ("INEOS"). In late 2002, Solutia negotiated a Stock and Asset Sale Agreement for the sale of its Resimenes & Additives business to UCB S.A ("UCB"). As part of this agreement, Solutia agreed to exclude the LaSalle assets from the agreement and entered into the LaSalle Toll Agreement ("LTA") with UCB. The LTA passed through all the benefits and risks of ownership of the LaSalle operations to UCB, other than pre-closing environmental liabilities. In the LTA, Solutia Canada agreed to operate its LaSalle Plant for the benefit of UCB and to provide all the necessary services to convert UCB's raw materials on a cost-neutral basis. Thus, UCB would pay Solutia Canada for all of its actual, direct and indirect costs incurred in connection with the performance or supply of services under the LTA or in holding itself ready to perform or supply those services. In the years after its execution, the LTA was assigned by UCB to Cytec Industries, Inc., then to INEOS.
On January 31, 2006, INEOS notified Solutia Canada of its intention to terminate the LTA as of January 31, 2008, in compliance with the terms of the LTA. INEOS' decision to terminate the LTA will likely trigger the shutdown of all activities at the LaSalle Plant, resulting in termination costs recoverable by Solutia Canada against INEOS. Solutia Canada estimates that the overall termination costs associated with the termination of the LTA and the shutdown of the LaSalle Plant will total approximately $31 (CAD). Solutia Canada provided INEOS with an estimate of the expected termination costs prior to the notice of termination. INEOS has disputed the overall amount of Solutia Canada's termination costs.
Under the detailed dispute resolution procedures in the LTA, Solutia Canada and INEOS were required to engage in negotiation and other means of dispute resolution prior to filing any litigation. In compliance with these obligations, Solutia
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Canada and INEOS negotiated extensively throughout 2006 to reach a resolution regarding the termination costs, but were unsuccessful. After the period for mandatory alternative dispute resolution expired, Solutia filed suit against INEOS in Quebec Court on December 8, 2006, for breach of the LTA with respect to termination costs. The case is pending.
Texas Commission on Environmental Quality Administrative Enforcement -------------------------------------------------------------------- Proceeding. On August 11, 2006, the Executive Director of the Texas Commission - ---------- on Environmental Quality commenced an administrative enforcement proceeding against Solutia by filing a petition with the Texas Commission on Environmental Quality. The petition alleges certain violations of the State of Texas air quality program. The Executive Director requests that an administrative penalty, the amount of which is immaterial, be assessed and that Solutia undertake corrective actions to ensure compliance with the Texas Health and Safety Code and the rules of the Commission in connection with alleged self-reported unauthorized emission events and deviations of air permits. Solutia answered the petition on September 1, 2006, asserted affirmative defenses and requested a contested enforcement case hearing. Solutia is pursuing settlement discussions with the Commission. No date has yet been set for a hearing.
Environmental Liabilities - -------------------------
Environmental compliance and remediation costs and other environmental liabilities incurred by Solutia generally fall into two broad categories: (a) those related to properties currently owned or operated by Solutia and (b) those related to properties that are not owned by Solutia, including non-owned properties adjacent to plant sites and certain owned offsite disposal locations. For the owned and operated sites, Solutia had an accrued liability of $78 and $71 as of December 31, 2006 and 2005, respectively, for solid and hazardous waste remediation, which represents Solutia's best estimate of the underlying obligation. In addition, this balance also includes post-closure costs at certain of Solutia's operating locations. This liability is not classified as subject to compromise in the Consolidated Statement of Financial Position because, irrespective of the bankruptcy proceedings, Solutia will be required to comply with environmental requirements in the conduct of its business, regardless of when the underlying environmental contamination occurred. However, Solutia ultimately intends to seek recovery against other potentially responsible parties at certain of these locations.
Solutia had an accrued liability of $81 and $82 as of December 31, 2006 and 2005, respectively, for properties not owned or operated by Solutia which was classified as subject to compromise in the Consolidated Statement of Financial Position. Under the Plan and the Relationship Agreement, as between Monsanto and Solutia, Monsanto will accept financial responsibility for environmental remediation obligations at all sites for which Solutia was required to assume responsibility at the Solutia Spinoff but which were never owned or operated by Solutia. This includes more than 50 sites with active remediation projects and approximately 200 additional known sites and off-site disposal facilities, as well as sites that have not yet been identified. Finally, Monsanto will share financial responsibility with Solutia for off-site remediation costs in Anniston, Alabama and Sauget, Illinois. Remediation activities are currently being funded by Monsanto for all of these properties not owned or operated by Solutia, with the exception of one off-site remediation project in Sauget, Illinois. Monsanto's funding of these remediation activities may give rise to a claim against Solutia which Monsanto may assert in Solutia's Chapter 11 bankruptcy case. In addition, Solutia has only made minimal adjustments to its recorded environmental liabilities classified as subject to compromise for ongoing remediation activities since the inception of Solutia's bankruptcy case to reflect actual cash expenditures incurred by the Company. Any other adjustments to this liability are not deemed appropriate by the Company at this time given the uncertainty regarding any potential claim amount to be asserted by Monsanto.
In addition to the bankruptcy proceedings, Solutia's environmental liabilities are also subject to changing governmental policy and regulations, discovery of unknown conditions, judicial proceedings, method and extent of remediation, existence of other potentially responsible parties and future changes in technology. Solutia believes that the known and unknown environmental matters, including matters classified as subject to compromise for which Solutia may ultimately assume responsibility, when ultimately resolved, which may be over an extended period of time, could have a material effect on the consolidated financial position, liquidity and profitability of Solutia.
Astaris Joint Venture - ---------------------
On October 8, 2003 Solutia and Astaris, a 50/50 joint venture with FMC, amended Astaris' external financing agreement to release the Astaris lenders' security interests in certain Solutia assets in exchange for Solutia's posting of a $67 letter of credit, representing fifty percent of the Astaris lenders' outstanding commitments to Astaris. Solutia used
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approximately $36 in 2004 for investment payments ("keepwell payments") to keep the Astaris joint venture in compliance with its financial covenants. There were no keepwell payments made in 2005. The remaining commitment to Astaris was $10 as of December 31, 2004, which was subsequently terminated as part of Astaris' refinancing of its credit facility on February 8, 2005.
Solutia and FMC had also agreed to allow Astaris to defer up to $27 of payment obligations to each of Solutia and FMC under existing operating agreements and certain other agreements. The deferral amount outstanding from Astaris to Solutia was $16 as of December 31, 2004. In February 2005, this deferral agreement was terminated and all amounts outstanding were paid in full in conjunction with the Astaris refinancing.
Impact of Chapter 11 Proceedings - --------------------------------
During the reorganization process, substantially all pending litigation against Solutia and its subsidiaries that filed for reorganization under Chapter 11 ("Debtors") is stayed, as well as the majority of all other pre-petition claims. Exceptions would generally include pre-petition claims addressed by the Bankruptcy Court, as well as fully secured claims. Such claims may be subject to future adjustments. Adjustments may result from actions of the Bankruptcy Court, negotiations, assumption or rejection of executory contracts, determination as to the value of any collateral securing claims, proofs of claims or other events. Additional pre-petition claims not currently reflected in the consolidated financial statements may be identified through the proof of claim reconciliation process. The amount of pre-petition claims ultimately allowed by the Bankruptcy Court with respect to contingent claims may be materially different from the amounts reflected in the consolidated financial statements. Generally, claims against Debtors arising from actions or omissions prior to their filing date may be subject to compromise in connection with the plan of reorganization. The ultimate resolution of all of these claims may be settled through negotiation as compared to court proceedings, with the result being that Solutia may retain certain obligations currently classified as subject to compromise in the Consolidated Statement of Financial Position.
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21. SUPPLEMENTAL DATA
Supplemental income statement and cash flow data from continuing operations were:
22. SEGMENT AND GEOGRAPHIC DATA
Solutia, together with its subsidiaries, is a global manufacturer and marketer of a variety of high-performance chemical-based materials, which are used in a broad range of consumer and industrial applications. Solutia manages its business in three operating segments: CPFilms, Other Performance Products ("OPP") and Integrated Nylon. The CPFilms and OPP operating segments are aggregated into the Performance Products reportable segment pursuant to SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Performance Products reportable segment is a world leader in performance films for laminated safety glass and after-market applications, and specialties such as water treatment chemicals, heat transfer fluids and aviation hydraulic fluid. The Integrated Nylon reportable segment consists of an integrated family of nylon products including high-performance polymers and fibers. The major products and services by reportable segment are as follows:
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PERFORMANCE PRODUCTS --------------------
SAFLEX(R) plastic interlayer
LLUMAR(R), VISTA(R), GILA(R) and FORMULA ONE PERFORMANCE AUTOMOTIVE FILMS(R) professional and retail window films
THERMINOL(R) heat transfer fluids
DEQUEST(R) water treatment chemicals
SKYDROL(R) aviation hydraulic fluids and SKYKLEEN(R) brand of aviation solvents
ASTROTURF(R), CLEAN MACHINE(R), and CLEAR PASS(TM). entrance matting and automotive spray suppression flaps
INTEGRATED NYLON ----------------
Nylon intermediate "building block" chemicals
Nylon polymers, including VYDYNE(R) and ASCEND(R)
Carpet fibers, including the WEAR-DATED(R) and ULTRON(R) brands
Industrial nylon fibers
Solutia evaluates the performance of its operating segments based on segment profit, defined as earnings before interest expense and income taxes ("EBIT"), which includes marketing, administrative, technological and amortization expenses, gains and losses from asset dispositions and restructuring charges, and other income and expense items that can be directly attributable to the segment. Certain expenses and other items that are managed outside the segments are excluded. These unallocated items consist primarily of corporate expenses, equity earnings (losses) from affiliates, other income and expense items, reorganization items, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the operating segment. There were no inter-segment sales in the periods presented below. Solutia's 2006, 2005 and 2004 segment information follows:
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Solutia's geographic information for the year ended December 31, 2006, 2005 and 2004 follows:
23. SUBSEQUENT EVENTS
On January 25, 2007, Solutia completed the extension and upsizing of its $1,225 of debtor-in-possession ("DIP") financing, maturing March 31, 2008. This represents a $400 increase and a one year extension over Solutia's current DIP credit facility. The increased availability under the DIP credit facility provides Solutia with additional liquidity for operations and the ability to fund mandatory pension payments that are coming due in 2007, as well as funds to partially facilitate the acquisition of Akzo Nobel's stake in the 50/50 rubber chemical joint venture Flexsys Holding B.V. The DIP credit facility can be repaid by Solutia at any time without prepayment penalties. The Bankruptcy Court entered an order approving this amendment on January 23, 2007.
On February 27, 2007, Solutia reached a definitive agreement to purchase Akzo Nobel's stake in the Flexsys joint venture. Solutia and Akzo Nobel have entered into a letter agreement committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives. The proposed transaction is subject to approval by the United States Bankruptcy Court, receipt of required regulatory approvals, finalizing the definitive purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase via $150 of funding under the January 2007 amended DIP credit facility (as described above) and additional funding through Flexsys.
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
24. QUARTERLY DATA -- UNAUDITED
In 2006 and 2005 certain events affecting comparability were recorded in Reorganization Items, net in the Consolidated Statement of Operations. A comparison of reorganization items for these periods respectively is provided in Note 3. Charges and gains recorded in 2006 and 2005 and other events affecting comparability recorded outside of reorganization items have been summarized below.
SOLUTIA INC. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Net loss in the first quarter of 2006 included charges of $9 for an environmental charge at one of Solutia's facilities outside the U.S. and $9 for the write-off of debt issuance costs and recording of the DIP credit facility as modified at its fair value. Net income in the second quarter of 2006 included a gain of $20 resulting from the reversal of a litigation reserve; charges of $1 related principally to severance and retraining costs and $1 for restructuring charges at the Flexsys joint venture. Net income in the third quarter of 2006 included charges of $3 from early extinguishment costs for the refinancing of SESA's Euronotes, $1 related principally to severance and retraining costs and $1 for restructuring charges at the Flexsys joint venture. Net loss in the fourth quarter of 2006 included $2 for restructuring charges related principally to severance and retraining costs. The Flexsys joint venture had net charges comprised of $2 for asset impairments and $1 for restructuring, partially offset by a $1 non-operational gain related to the reversal of a litigation reserve.
In the first quarter of 2005, there were no events, other than those recorded in Reorganization Items, net within the Consolidated Statement of Operations that significantly affected comparability. Net income in the second quarter of 2005 included charges of $1 for various restructuring charges principally related to the closure of Solutia's chlorobenzenes operations as well as certain other non-strategic operations; and $5 for a non-operational gain incurred by the Flexsys joint venture. Net loss in the third quarter of 2005 included a $3 loss from the net pension and other postretirement benefit plan curtailments and settlements. Net loss in the fourth quarter of 2005 included $1 for restructuring charges related principally to severance and retraining costs; $3 for restructuring charges at the Astaris and Flexsys joint ventures; a $50 net gain on sale as a result of the Astaris joint venture divestiture of assets; and $10 of net pension settlement charges.
Under SFAS No. 128, Earnings per Share, the quarterly and total year calculations of basic and diluted loss per share are based on weighted average shares outstanding for that quarterly or total year period, respectively. As a result, the sum of basic and diluted income (loss) per share for the quarterly periods may not equal total year income (loss) per share.
25. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
CPFilms, Inc., Monchem International, Inc., Monchem, Inc., Solutia Systems, Inc., Solutia Investments, LLC and Solutia Business Enterprises, Inc., 100% owned subsidiaries of Solutia (the "Guarantors"), are guarantors of Solutia's 11.25% Senior Secured Notes due 2009 (the "Notes"). In connection with the completion of the October 2003 credit facility, Solutia Investments, LLC and Solutia Business Enterprises, Inc. became guarantors of the Notes through cross-guarantor provisions. Solutia's obligations under the October 2003 facility were paid in full with the proceeds of the DIP credit facility dated January 16, 2004, which payment did not affect the Guarantors' obligations in respect of the Notes. Certain other 100% owned subsidiaries of Solutia (the "DIP Guarantors") guaranteed the final DIP credit facility (as well as a smaller, interim DIP credit facility put in place as of December 19, 2003), but the DIP Guarantors were not required by the cross-guarantor provisions to guarantee the Notes.
The Guarantors fully and unconditionally guarantee the Notes on a joint and several basis. The following condensed consolidating financial statements present, in separate columns, financial information for: Solutia 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 which 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, 2006 and December 31, 2005, and for the years ended December 31, 2006, 2005 and 2004. 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. Solutia 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. (DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of December 31, 2006, Solutia carried out an evaluation, under the supervision and with the participation of Solutia's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Solutia's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 ("Exchange Act")). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2006, Solutia's disclosure controls and procedures are effective in timely alerting them to material information relating to Solutia and its consolidated subsidiaries that is required to be included in Solutia's periodic SEC filings. The Chief Executive Officer and Chief Financial Officer also concluded that, as of December 31, 2006, Solutia's disclosure controls and procedures are effective to provide reasonable assurance that Solutia records, processes, summarizes, and reports the required disclosure information within the specified time periods. Further, there were no changes in Solutia's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
MANAGEMENT REPORT
Management of Solutia Inc. and its subsidiaries (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Solutia's internal control over financial reporting is a process designed by, or under the supervision of, Solutia's principal executive and principal financial officers and effected by Solutia's board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Solutia's internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Solutia;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Solutia are being made only in accordance with authorizations of management and directors of Solutia; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Solutia's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of Solutia's internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. Based on our assessment and those criteria, management believes that Solutia maintained effective internal control over financial reporting as of December 31, 2006.
Solutia's independent auditors have issued an attestation report on management's assessment of Solutia's internal control over financial reporting. This report appears on page 108.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Solutia Inc.:
We have audited management's assessment, included in the accompanying Management Report, that Solutia Inc. and subsidiaries (Debtor-In-Possession) (the "Company") maintained effective internal control over financial reporting as of December 31, 2006, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2006 of the Company and our report dated March 1, 2007, expressed an unqualified opinion on those financial statements and financial statement schedule, and included explanatory paragraphs regarding the Company's filing for reorganization under Chapter 11 of the United States Bankruptcy Code, substantial doubt about the Company's ability to continue as a going concern, and change in accounting principle for the adoption of Statement of Financial Accounting Standard No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, effective December 31, 2006.
St. Louis, Missouri March 1, 2007
ITEM 9B.
ITEM 9B. OTHER INFORMATION
On February 27, 2007, Solutia announced that it had reached a definitive agreement (the "Transaction Agreement") to purchase Akzo Nobel's stake in Flexsys, the 50%/50% rubber chemicals joint venture between Akzo Nobel and Solutia. Solutia and Akzo Nobel have entered into a letter agreement, attached hereto as Exhibit 10(ss), committing the parties to execute the definitive agreement upon completion of consultation with Dutch employee works council representatives.
The following description of the Transaction Agreement sets forth a brief summary of certain material terms of that agreement. However, this description does not purport to be complete and is qualified in its entirety by reference to the specific terms of the Transaction Agreement, attached to this Annual Report on Form 10-K as Exhibit 10(rr).
The Transaction Agreement provides for the sale by Akzo Nobel of its interest in the Flexsys joint venture to Solutia for an initial purchase price of $212.5 million subject to various adjustments. The purchase will make Solutia the sole owner of Flexsys.
This transaction is subject to approval by the Bankruptcy Court, receipt of required regulatory approvals, finalizing the purchase agreement for Akzo Nobel's Crystex manufacturing operations in Japan and the fulfillment of other customary closing conditions. Solutia will fund the purchase through a combination of sources, including a portion of its DIP financing package as described in "Management's Discussion and Analysis" in Item 7 above.
Pursuant to the Transaction Agreement, Akzo Nobel has agreed, subject to certain limitations and exclusions, to indemnify, defend and hold harmless Flexsys, Solutia, their affiliates and representatives from and in respect of any losses and liabilities arising out of any breaches of the representations, warranties or covenants contained in the Transaction Agreement. Solutia and Flexsys have agreed, subject to certain limitations and exclusions, to indemnify, defend and hold harmless Akzo Nobel and its affiliates from and in respect of any losses and liabilities arising out of any breaches of the representations, warranties or covenants contained in the Transaction Agreement.
Akzo Nobel has agreed, subject to certain exceptions, that for a period of five years after the closing of the Transaction Agreement, neither it nor its affiliates will compete with the Flexsys business and for a period of three years after the closing of the Transaction Agreement, Akzo Nobel will not solicit for employment certain employees of Flexsys.
In addition to customary termination rights, the Transaction Agreement may be terminated prior to closing by Akzo Nobel or Solutia if the closing has not occurred on or before May 25, 2007.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
DIRECTORS
The following table shows information about Solutia's directors on March 1, 2007:
Philip R. Lochner resigned from our board of directors effective January 31, 2007 and as a result, his information is not included above. His resignation was not due to any disagreement with Solutia with respect to its operations, policies or practices. All the directors were elected prior to Solutia's Chapter 11 filing. Solutia has not held an annual shareholders' meeting during its Chapter 11 case.
OFFICERS
The following table shows information about Solutia's executive officers on March 1, 2007:
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.
AUDIT AND FINANCE COMMITTEE; AUDIT COMMITTEE FINANCIAL EXPERT
The members of Solutia's Audit and Finance Committee, which met nine times in 2006, are Mr. Metz, chairman; Mr. Mulcahy, Mrs. Narodick and Dr. Slaughter. Solutia's board of directors has concluded that each member of the committee is independent within the meaning of Rule 10A-3 of the Exchange Act of 1934 and the New York Stock Exchange's listing standards. The board has also concluded that Mr. Metz is an audit committee financial expert, as that term is defined in the rules issued under the Sarbanes-Oxley Act of 2002.
The purpose of the committee is to assist the board in overseeing the integrity of Solutia's financial statements, Solutia's compliance with legal and regulatory requirements, the qualifications and independence of the independent auditor, the performance of the independent auditor and Solutia's internal audit function, and Solutia's systems of disclosure controls and internal controls over financial reporting, and to prepare the report required by the rules of the U.S. Securities and Exchange Commission.
Among the committee's responsibilities is the selection of Solutia's independent auditor.
The committee's written charter sets out the functions the committee is to perform, in light of the Sarbanes-Oxley Act of 2002 and the rules of the New York Stock Exchange.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 requires Solutia's directors and executive officers to file reports of holdings and transactions in Solutia's common stock with the Securities and Exchange Commission. During 2006, all reports required by Solutia's directors and executive officers under Section 16(a) of the Securities Exchange Act of 1934 were made in a timely manner.
CODE OF ETHICS
Solutia's board of directors has adopted a Code of Ethics for Senior Financial Officers. This code applies to Solutia's chief executive officer and the other senior officers who have financial responsibilities, including Solutia's chief financial officer, treasurer, controller and general counsel. This code is filed as an exhibit to this Annual Report on Form 10-K. Any person who wishes to obtain a copy of our Code of Ethics may do so by writing to Investor Relations, Solutia Inc., 575 Maryville Centre Drive, St. Louis, Missouri 63141.
LEGAL PROCEEDINGS
For a description of litigation pending against certain former officers of Solutia see the first paragraph under "Other Legal Proceedings" on page 21 above.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
COMPENSATION PHILOSOPHY AND OBJECTIVES
The Executive Compensation and Development Committee of our Board of Directors (the "ECDC") establishes our compensation philosophy and enacts and administers programs consistent with that philosophy. The ECDC does this in consultation with our Chief Executive Officer and our senior-level human resources personnel. The ECDC functions pursuant to a designation of authority from the full Board of Directors and in accordance with a written charter which was approved by the ECDC and the full Board of Directors.
The ECDC has endorsed a pay-for-performance philosophy for our executives, including our Chief Executive Officer, designed to support our efforts to create a high performance culture within the Company. The key objectives of this philosophy are to:
o Attract, retain and motivate executive officers by maintaining programs which offer competitive total compensation opportunities ( as compared to similarly situated companies) but which provide the potential for recognition of outstanding performance and penalties for performance that is not competitive;
o Promote and incent the achievement of short-term and long-term operating and financial objectives that will maximize the value of Solutia's bankruptcy estate for our constituents; and
o Avoid creation of an entitlement mentality by sufficiently differentiating between high-performers who drive the Company's performance and those who do not.
The ECDC believes that the programs in place are well-designed to achieve the above stated compensation philosophy; however, certain of its decisions with respect to executive compensation matters are subject to Bankruptcy Court approval. As part of the court approval process, these ECDC determinations are subject to objections by constituents in our Chapter 11 case. In the opinion of the ECDC often the perspectives of these various constituents may be motivated by their own pecuniary interest, which in some cases, may not be consistent with the Board's obligations to maximize the value of our estate for the benefit of all constituents.
In addition, as a result of being in Chapter 11, the Company has been unable to offer effective broad-based long-term compensation programs. The absence of the ability to offer any equity-based long term compensation has been especially troubling in effecting the above stated compensation philosophy.
Due to these dynamics, during our bankruptcy case, the ECDC has not been able to, and in the future, may not be able to, fully implement executive compensation changes to meet the objectives stated above. The ECDC believes that the current aggregate compensation opportunities for many of the Company's executives, including its senior executives, may fall short of the objectives stated above. As a result, the Company may experience difficulty attracting or retaining executive officers, which could have the effect of delaying or preventing our emergence from Chapter 11 or our failure to achieve operating and financial objectives.
To mitigate this issue, to the extent possible, the Company has requested bankruptcy court approval to make certain changes in its compensation programs with respect to the terms and conditions of employment for its senior executives. Specifically the company has requested approval of changes to the employment contracts of the CEO and certain other senior executives, a change in the base compensation of the CEO, and the approval of the 2007 annual incentive plan. These matters are scheduled for hearing before the Bankruptcy Court on March 12, 2007.
ESTABLISHING COMPENSATION PROGRAMS AND COMPENSATION LEVELS
Our Chief Executive Officer, Jeffry N. Quinn (the "CEO"), plays a significant role in the compensation process, other than with respect to his own compensation. Our CEO participates in ECDC meetings at the ECDC's request to provide:
o Background information regarding our operating and financial objectives;
o His evaluation of the performance of the senior executive officers; and
o Compensation and professional development recommendations as to senior executive officers (other than himself).
The ECDC evaluates the performance of the CEO and, subject to Bankruptcy Court approval, makes all compensation decisions related to the CEO and other members of the executive leadership team.
To assist the ECDC in making decisions regarding compensation program design and appropriate compensation levels, the ECDC employs Mercer HR Consulting, an internationally recognized compensation consulting firm. Mercer provides the ECDC with company specific compensation market data from their review of the public filings of certain peer companies. They advise the ECDC on program design and competitive compensation levels. The ECDC established two peer groups to be used in evaluating the overall competitiveness of our compensation program (the "Peer Groups"). The Peer Groups were chosen based on a number of factors, including similar lines of business and the overall size and value of the peer companies. One of the Peer Groups consists of chemical companies while the second peer group includes similarly situated companies currently in Chapter 11. The Peer Groups are evaluated and updated at least once a year and more often if necessary.
The ECDC annually compares the compensation program for our executive officers, including our CEO, Chief Financial Officer ("CFO"), and our three other most highly paid executive officers named in the Summary Compensation Table (collectively, the "Named Executive Officers"), to programs of companies in the Peer Groups.
COMPONENTS OF EXECUTIVE COMPENSATION
The principal components of our current executive compensation program, including our Named Executive Officers, are:
o Base salary;
o Annual bonus; and
o For certain of our senior executives, including our Named Executive Officers, a bonus related to emergence from Chapter 11.
Each of these elements is discussed more fully below.
Currently our executive compensation program does not include any long-term compensation. Our equity based incentive plan was suspended upon our Chapter 11 filing. Without such a plan, our executives do not have the opportunity to be rewarded for the achievement of long term performance goals. Consequently, the total compensation our executives can earn is significantly impaired as compared to executives at companies within Solutia's Peer Groups, that have long term incentive plans. Long term incentive compensation, particularly in the form of equity based compensation creates an ownership mentality, encourages retention and helps balance longer term strategic goals with shorter-term operating and financial goals. The absence of such incentives is a significant shortcoming in our current programs, especially with respect to our senior executives for whom, under competitive market practices, long term compensation would normally constitute a significant part of total compensation.
ANNUAL COMPENSATION
Mix of Compensation Components
Annual cash compensation for our employees and executives, including our Named Executive Officers, is comprised of a mixture of base salary and an annual performance-based bonus. The exact mix between fixed compensation (base pay) and variable compensation (annual bonuses) varies based upon an employee's role in the organization. In allocating annual compensation opportunity between base salary and annual bonus, our ECDC believes that the compensation of our most senior management personnel - those levels of management having the greatest ability to influence our performance - should be weighted more heavily to variable compensation tied to the Company's performance. As position and responsibility increase, the ECDC believes that an increasing portion of an employee's total compensation should be performance based, and contingent upon the achievement of the company's financial and operating objectives.
As a result, while almost all of our employees have an annual bonus opportunity, those at senior management levels receive a greater percentage of their annual cash compensation opportunity in the form of a bonus and therefore a greater amount of their total annual compensation is at risk. The ECDC believes that such structure creates a strong incentive for our senior executives to drive high levels of performance.
Base Salary
Base salary is a critical element of executive compensation as it is the only element of compensation that provides our executives with an assured annual cash compensation amount. We generally attempt to maintain base salaries for senior executives at approximately the 50th percentile of companies in our Peer Groups. In determining the appropriate base salary level, the ECDC considers a number of factors including:
o the executive's qualifications, past performance and experience;
o the scope of the executive's responsibilities;
o salary practices at other companies within our Peer Group for similar positions;
o our internal equity considerations; and
o our overall performance.
Base salaries are reviewed on an annual basis, and may be adjusted from time to time based on the above criteria. See the Summary Compensation Table on page 119 for more information about the 2006 base salaries of our Named Executive Officers.
Annual Bonus
Our annual bonus plan, which was approved for 2006 by the Bankruptcy Court on September 25, 2006, is the Solutia Annual Incentive Program (the "AIP"). The AIP is a broad-based plan that applies to almost all of our employees. The AIP serves as an integral component of annual compensation for employees and fosters our pay-for-performance philosophy. The AIP is designed to deliver a significant portion of the executive's annual overall compensation opportunity in the form of a cash bonus based on achievement of key financial and operating objectives. The ECDC administers the AIP. The following is a discussion of the principal concepts embedded in the AIP.
TARGET BONUSES
Each participant in the AIP has a set target bonus. Target bonuses are based upon both external and internal considerations. The ECDC's philosophy is that from an external perspective, target bonuses are set such that median performance will result in median annual compensation and that performance above or below median levels will result in compensation above or below median levels. From an internal perspective, target bonuses are determined primarily by salary grade level within the organization. Salary grade levels are reflective of an individual's job and level of responsibility. In general, those with direct profit-and-loss responsibility have a higher target bonus opportunity than another participant at the same salary grade level that does not have direct profit-and-loss responsibility.
BONUS POOLS
The AIP is based upon a bonus pool concept. There are separate bonus pools determined for enterprise-level participants and the participants in each business unit in the following manner. Each year the ECDC establishes financial and operating performance metrics for the enterprise and for each business unit and a weighting for each metric. These determinations are based on the advice and recommendation of management. For each metric, a threshold (0.50x), target (1.0x), and maximum (3.0x) funding level is determined by the ECDC. Under the AIP these funding levels are referred to as funding factors. If the threshold performance level is not met with respect to any particular performance metric there is no funding of the bonus pool with respect to that metric. The target level funding or a 1.0x funding factor is the aggregate of all target bonuses for participants in the AIP.
These determinations by the ECDC in effect establish a correlation between performance and funding for bonuses. For example, if only threshold level performance was achieved for all metrics, the funding factor would be 0.50x and total bonus pool would be only 50% of the sum of all participants' target bonuses. Conversely, if maximum performance levels were achieved for all metrics the funding factor would be 3.0x and the total bonus pool would be 300% of the sum of all participants' target bonuses. At the end of the year, the performance of the Company and its business units against the pre-established metrics is measured and the ECDC determines the funding factor for each bonus pool.
FUNDING HISTORY OF BONUS POOLS
The enterprise and each business unit achieved at least the threshold level of performance during the previous three years and during that period, the average overall annual funding of the bonus pools has been 42.6% of the maximum. Overall funding of the AIP for 2006 was approved by the ECDC at 47.3% of maximum.
2006 PERFORMANCE METRICS
The performance metrics for 2006 for each incentive pool are as set forth in the following chart:
BONUS DETERMINATIONS
Once the bonus pools are established, individual bonuses are determined as part of our performance management process. Individual bonuses are comprised of an objective portion and a subjective portion.
Forty-five percent (45%) of each bonus pool is paid out on a straight objective basis to participants in that pool. This is the objective portion of a participant's bonus. Forty-five percent (45%) of each bonus pool is allocated to individual participants within the pool based upon on individual performance versus set goals and individual performance versus peer performance. The remaining ten percent (10%) of each bonus pool are aggregated to constitute an enterprise discretionary pool which can be allocated to any participant in the AIP. Allocations from these discretionary funds constitute the discretionary portion of a participant's bonus.
Each participant's target bonus is multiplied by the relevant funding factor (the same funding factor that was used to determine the size of the bonus pool from which the participant's bonus is paid). By definition, the sum of all performance adjusted target bonuses for all participants in one of the bonus pools equals the total bonus pool. As a result, an individual is in effect guaranteed 45% of their target adjusted performance bonus except in cases of extreme individual performance issues. The discretionary portion of an individual's bonus can range from zero upward, which is limited only by the total funding of the relevant bonus pool. However, the ECDC has determined, as an administrative policy matter, that except in extreme cases, the maximum bonus an individual can receive under the AIP is 200% of their performance adjusted target bonus.
The aggregate of all bonuses paid from each of the bonus pools can not exceed the amount of the pool except, any discretionary bonus paid to the CEO in excess of 50% of his performance adjusted target bonus, does not, at the discretion of the ECDC, diminish the pool available for bonus to other participants.
BONUS RANGES
The concepts described above in effect determine the range of potential bonus for a participant in any given year. If threshold performance levels are not met, there would be no bonus pool, and there would be no bonuses. If a bonus pool is funded, except in extreme performance situations, a participant would be eligible to receive a minimum bonus of 45% of their performance adjusted target bonus to a maximum bonus of two times their performance adjusted target bonus. Since the maximum funding factor that can be achieved is 3.0x (if the maximum performance is achieved) a participant's maximum performance adjusted bonus would be three times their target bonus and the maximum bonus they could receive is two times this amount or six times their target bonus.
BONUSES OF NAMED EXECUTIVE OFFICERS
The bonuses of our CEO and other Named Executive Officers are determined in accordance with the above plan concepts. The ECDC determines the bonus for our CEO. The ECDC also reviews and approves our CEO's recommendations for bonus awards to our executive leadership team including the other Named Executive Officers.
For 2006 Our Named Executive Officers were eligible to receive awards from the following incentive pools, in addition to the enterprise discretionary bonus pool:
The target annual bonus for the Named Executive Officer is in accordance with the Named Executive Officer's employment agreement with the Company as described in "Employment Agreements with Named Executive Officers" on page 122.
Based upon the performance achieved by the Company in 2006 and the funding of the incentive pools, among other factors, the following items were considered by the ECDC in determining the amount of the discretionary bonus for our CEO and in approving the recommendations made by the CEO regarding senior executives.
o The significant improvement in the Company's financial performance despite such challenges as continuously escalating raw material costs, unplanned downtime at our Alvin, Texas plant and managing the competing demands of the Chapter 11 process.
o The improved safety performance of the Company;
o The continued growth in our Saflex business and completion of, or progress towards, such strategic initiatives in Saflex as the acquisition of our joint venture partner's 51% stake in Quimica resulting in our sole ownership of Quimica's plant located in Puebla, Mexico, the construction of our PVB plant in China and a third extrusion line at our Ghent plant;
o The continued transformation of our Nylon business as evidenced by the conversion of carpet fiber lines at the Company's Pensacola facility to produce nylon plastics;
o The development and implementation of a new business model in our CP Films business;
o The successful launch of an operations excellence initiative;
o The significant progress in our Chapter 11 case including the filing of a plan of reorganization in February 2006 and completing a trial on the JPMorgan litigation matter;
o The exploration of all possible avenues to reach a confirmable plan of reorganization, including the possibility of selling the equity of the reorganized company or certain of the Company's businesses or assets;
o The successful amendment and upsizing of our debtor-in-possession financing;
o The continued upgrading of the Company portfolio as evidenced by the disposition of the Company's pharmaceutical services business at an attractive valuation, and the agreement to acquire the remainder of the Flexsys joint venture; and
o The strong leadership of the executive team that has been successful in retaining management talent for the Company, kept morale high and the organization focused notwithstanding the challenges of the Chapter 11 proceeding.
Please see the "Grants of Plan Based Awards Table" on page 120 for estimated payouts under the AIP at threshold, target and maximum payout levels for each Named Executive Officer for the fiscal year ended December 31, 2006. The actual bonus amount paid under the AIP to each Named Executive Officer can be found in the Summary Compensation Table on page 119.
Long Term Incentives and Emergence Bonus
EQUITY BASED INCENTIVES
Use of our long-term equity based incentive plan was suspended upon our Chapter 11 filing and no awards have been made under it since that time. Although suspended, our long-term incentive plan previously included a stock incentive plan under which stock options, restricted stock or other awards of stock-based compensation could be granted. Certain of our Named Executive Officers hold fully-vested stock options that were granted prior to the suspension of our long-term incentive plan. Solutia's existing shares of common stock, as well as options and warrants to purchase common stock, will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options, including the Named Executive Officers, will receive any consideration in our Chapter 11 case for their equity based compensation. See the "Outstanding Equity Awards at Fiscal Year-End Table" on page 120 for more information regarding the stock options owned by our Named Executive Officers.
EMERGENCE BONUS
Pursuant to their employment agreements and under certain circumstances, each of our Named Executive Officers is entitled to receive an emergence bonus when we emerge from Chapter 11. When we entered into these employment agreements in 2004 and 2005, the ECDC believed that the inclusion of an emergence bonus would provide a strong incentive for our Named Executive Officers to achieve our emergence from Chapter 11 as soon as reasonably practicable and provide long-term compensation that would serve as a reasonable substitute for the lack of any other long-term compensation program. However, the delay in our emergence from Chapter 11, which has been caused by factors outside the control of senior management, and other program design issues, have diminished the annualized value of potential awards under this plan. See "Employment Agreements with Named Executive Officers" on page 122 for a description of the emergence bonuses that each Named Executive Officer may be entitled to receive.
TERMINATION/SEVERANCE AGREEMENTS
All executives, including our Named Executive Officers, are parties to employment agreements with us which specify payments upon termination for various causes. In the event of a "not for cause" termination (as defined in the respective employment agreements), our Named Executive Officers are entitled to receive various amounts based on multiples of their base salaries. Executives are also entitled to four months continuation of health insurance at active employee contribution rates and executive outplacement services. No specific "change in control" provisions or tax gross-up provisions are provided in the agreements. See "Employment Agreements with Named Executive Officers" on page 122 and the "Potential Payments Under Employment Agreements" on page 124 for a description of the terms of the employment agreements and an estimate of the benefits that our Named Executive Officers would be entitled to receive pursuant to their respective employment agreements under various employment termination scenarios.
BENEFITS AND OTHER PERQUISITES
Executives participate in the same benefit programs provided for other Solutia employees. There are no supplemental retirement programs. The only additional perquisite the executives are provided is company paid financial and tax preparation services not to exceed $7,000.00 per year. This benefit is provided for the executive given our belief that good financial planning and tax preparation by a professional reduces the time and attention the executive would otherwise spend on their personal financial affairs and affords them more time to focus on their executive responsibilities with Solutia.
RETIREMENT PLANS
We froze our pension plan as of June 30, 2004 in connection with our Chapter 11 reorganization and, as a result, only interest credits are being applied to the accounts. See "Pension Plans" on page 121 for more information about our retirement plan and the benefits that our Named Executive Officers would be entitled to receive thereunder.
COMPENSATION COMMITTEE REPORT
The Executive Compensation and Development Committee has reviewed and discussed the Compensation Discussion and Analysis with management and based on the review and discussions, the ECDC recommended to the Board of Directors that the Compensation Discussion and Analysis be included in Solutia's annual report on Form 10-K for 2006.
J. PATRICK MULCAHY (CHAIR) ROBERT H. JENKINS FRANK A. METZ, JR.
SUMMARY COMPENSATION TABLE
The following table shows information about the compensation of Solutia's chief executive officer, chief financial officer and the three most highly compensated executive officers other than the chief executive officer and chief financial officer who were serving as executive officers at December 31, 2006. Certain columns have been omitted where inapplicable.
GRANTS OF PLAN-BASED AWARDS TABLE
The amounts indicated below are non-equity incentive payouts under Solutia's 2006 Annual Incentive Plan. For a complete discussion of the 2006 AIP, please see "Annual Bonus" in the Compensation Discussion and Analysis above.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE
The following table sets forth information for each of the Named Executive Officers regarding the number of shares subject to both exercisable and unexercisable stock options as of December 31, 2006.
For purposes of the vesting of performance options, "Fair Market Value" means, as of any given date, the average of the highest and lowest sales prices of Solutia common stock reported as the New York Stock Exchange-Composite Transactions for such day, or if the Common Stock was not traded on the New York Stock Exchange on such day, then on the next preceding day on which the Common Stock was traded, all as reported by The Wall Street Journal under the heading New York Stock Exchange-Composite Transactions or by such other source as the Executive Compensation and Development Committee may select. For each stock option reported above, the "Fair Market Value" at the date of grant is equal to the exercise price.
AGGREGATED OPTION EXERCISES IN 2006 AND STOCK VESTED
There were no options exercised by the Named Executive Officers during 2006, and none of the options held by them at the end of 2006 were "in the money." Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock, will be cancelled upon our emergence from Chapter 11. It is highly unlikely that holders of options to purchase Solutia's common stock, including the Named Executive Officers, will receive any consideration in our Chapter 11 case for their equity based compensation.
PENSION PLANS
We froze our pension plan as of June 30, 2004 in connection with our Chapter 11 reorganization and as a result, only interest credits are being applied to accounts. To the extent Named Executive Officers participated in the pension plan prior to the freezing of the plan, they are eligible for benefits payable under the defined benefit pension plans applicable to Solutia's regular full-time employees. An executive's benefits are based on his service, if any, with Pharmacia prior to the spinoff of Solutia and service with Solutia since the spinoff. Solutia's defined benefit pension plans for its U.S. employees consist of two accounts: a "Prior Plan Account" (for those employees who earned benefits under Pharmacia's pension plan before the spinoff) and a "Cash Balance Account." The opening balance of the Prior Plan Account was the December 31, 1996 present value of the executive's lump sum retirement benefit earned prior to January 1, 1997, under Pharmacia's defined benefit pension plans, calculated using the assumption that the monthly benefit would be
payable at age 55 with no reduction for early payment. The formula used to calculate the opening balance was based on average final compensation (as defined in the pension plan) multiplied by years of service (as defined in the pension plan). Until June 30, 2004, for each year of the executive's continued employment with Solutia (including all of 1997), the executive's Prior Plan Account increased by 4% to recognize that prior plan benefits would have grown as a result of pay increases. As a result of the plan freeze, the 4% annual increases to the Prior Plan Account were eliminated for service after June 30, 2004. The Prior Plan Account is credited with 8.5% interest each year until the executive reaches age 55.
Until June 30, 2004, for each year during which the executive was employed by Solutia, 3% of annual compensation (salary and annual bonus) in excess of the Social Security wage base and a percentage, ranging from 3% to 7% based on age, of annual compensation were credited to the Cash Balance Account. In addition, the Cash Balance Account of executives who earned benefits under Pharmacia's defined benefit pension plans before 1997 was credited each year (for up to ten years based on prior years of service with Pharmacia before 1997) during which the executive was employed by Solutia (including all of 1997) with an amount equal to a percentage, ranging from 2% to 6% based on age, of annual compensation. As a result of the plan freeze, all credits to the Cash Balance Account that are based on annual compensation were eliminated for compensation earned after June 30, 2004. The Cash Balance Account was credited with interest each year based on the 30-year treasury rate. In light of the discontinuance of the 30-year treasury rate, the Cash Balance Account is currently credited with an interest rate determined and published by the Internal Revenue Service to serve as a proxy for the 30-year treasury rate.
U.S. Pension
The December 31, 2006 account balances were projected to age 65. The Prior Plan account was projected at 8.5% interest to age 55, and 0% from age 55 to age 65, according to the plan rules. The Cash Balance Account was projected to age 65 using the current interest crediting rate in effect for 2006 and 2007, which is 5%. The balances were then discounted back from age 65 to December 31, 2006 using the discount rate of 5.75% to determine the present value.
Because the U.S. Pension Plan is frozen as of June 30, 2004, compensation earned by the Named Executive Officers after this date is not considered in the calculation of pension benefits. Prior to June 30, 2004, the pensionable pay included base pay and annual incentive bonus payments. The account balances in the U.S. Pension Plan are payable upon termination of employment, or the executive can choose to defer the receipt of benefits to a later date and earn interest on the Cash Balance Account and Prior Plan Account as described above.
Belgian Retirement Plan
Mr. De Temmerman is a Belgian employee and as such, participates in Solutia's Belgian Retirement Plan. His accrued benefit was calculated as of December 31, 2006 based on the final average earnings, the credited service, and the average social security ceiling as of December 31, 2006. The accrued benefit is equal to a lump sum payable at age 60 based on final average earnings (as defined in the plan) and credited service (as defined in the plan). The present value of the accrued benefit as of December 31, 2006 was determined by discounting the accrued benefit from age 60 to December 31, 2006 using a discount rate of 4.50%. This amount was converted to U.S. dollars using a conversion rate of $1.31470 per Euro as of December 31, 2006.
Only base salary is used in calculating earnings under the Belgian Retirement Plan. The Belgian Pension benefit is payable at age 60 with an actuarial reduction applied to the benefit for earlier retirement or termination. The Chapter 11 filing does not impact the operation of the Belgian Retirement Plan in any respect.
NONQUALIFIED DEFERRED COMPENSATION
Solutia does not offer nonqualified deferred compensation to any employees at this time.
EMPLOYMENT AGREEMENTS WITH NAMED EXECUTIVE OFFICERS
The descriptions below are only summaries of the agreements that Solutia has with its Named Executive Officers and are qualified in their entirety by the actual agreements, copies of which have been filed with the Securities and Exchange Commission and are identified in the Exhibit Index to this Annual Report on Form 10-K.
Effective July 19, 2004, Solutia entered into Senior Executive Agreements with Mr. Quinn, Mr. De Temmerman and Mr. Sullivan which were approved by our Board and the Bankruptcy Court. On April 21, 2005, upon Bankruptcy Court approval, we entered into amended and restated employment agreements with Mr. Quinn and Mr. Sullivan, each dated July 19, 2004. Subsequently the Company entered similar agreements with Mr. Voss and Mr. Wright which were approved by the Bankruptcy Court on August 1, 2005. Each of these agreements has a term beginning on the date such agreement was effective and expiring on the date which is six-months from the date on which Solutia emerges from bankruptcy. These agreement as amended and restated are collectively referred to as the "Senior Executive Agreements".
BASE SALARY
The Senior Executive Agreements provide for a minimum annual base salary for each of the executives until the six month anniversary of the Emergence Date (as described below) as follows:
Mr. Quinn $500,000 Mr. De Temmerman $350,000 Mr. Sullivan $325,000 Mr. Voss $300,000 Mr. Wright $350,000
Mr. De Temmerman's minimum salary is actually expressed as 289,519 Euros. The above dollar figure represents the U.S. Dollar equivalent at an exchange rate of 1.2089.
TARGET BONUS OPPORTUNITY AND OTHER BENEFITS
Each of these executives is entitled to participate in Solutia's annual incentive program with each having a target annual bonus opportunity of a percentage of his annual base salary as follows:
Mr. Quinn 150% Mr. De Temmerman 100% Mr. Wright 100% Mr. Sullivan 75% Mr. Voss 75%
Each of the executives is also entitled to participate in all long-term and other incentive plans or programs applicable to senior executive officers of Solutia and its subsidiaries and in the applicable savings, retirement, welfare benefit and vacation plans.
EMERGENCE INCENTIVE PROGRAM
Pursuant to the Senior Executive Agreements each of the Named Executive Officers participates in the Solutia Inc. Emergence Incentive Bonus Program ("Emergence Incentive Bonus Program") under which the executives would be entitled to a bonus on such date that the Bankruptcy Court shall have confirmed a plan of reorganization of Solutia Inc. under Chapter 11 of the U.S. Bankruptcy Code and such plan shall have become effective (the "Emergence Date"). Eligibility for such bonus is dependent upon the Named Executives being employed by Solutia (or any of our subsidiaries) on the Emergence Date.
If the executives are employed on the six-month anniversary of the Emergence Date, or shall have been terminated without Cause (as defined in the Senior Executive Agreements), or shall have resigned for Good Reason (as defined in the Senior Executive Agreements), or shall have died or been terminated for Disability (as defined in the Senior Executive Agreements), they shall be entitled to receive a special emergence bonus to be paid from a pool. If the executive voluntarily terminates his employment other than for Good Reason or is terminated for Cause between the Emergence Date and the six-month anniversary thereof, then he shall forfeit his right to receive the special emergence bonus.
Funding of the bonus pool will depend upon the achievement of three performance measures: EBITDA, Enterprise Value and Unsecured Creditor Recoveries (all as defined and described in the Emergence Incentive Bonus Program). Our Board, in its discretion, may elect to pay the bonuses in shares of Reorganized Solutia common stock in lieu of cash. The maximum pool that can be achieved under the Emergence Incentive Bonus Program is $10,000,000 with the Named Executive Officers being entitled to receive a fixed percentage of such pool as follows:
Mr. Quinn 37.5% Mr. Sullivan 15.0% Mr. De Temmerman 22.5% Mr. Wright 15.0% Mr Voss 10.0%
SEVERANCE AND NON-COMPETE PROVISIONS
If, during the Employment Period, any of the Named Executives is terminated other than for Cause, or any of these executives terminates his employment for Good Reason, we will pay such executive: (a) any unpaid but accrued base salary through the Date of Termination (as defined in the Senior Executive Agreements), (b) any unpaid annual bonus earned with respect to the previous year, and
(c) any unpaid accrued vacation pay (collectively, "Accrued Obligations"). In addition, if the Date of Termination occurs before the Emergence Date, Mr. De Temmerman, would receive an amount equal to 125% of his annual base salary immediately prior to his Date of Termination, and Mr. Quinn, Mr. Sullivan, Mr. Wright or Mr. Voss would receive an amount equal to 200% of his respective annual base salary immediately prior to his respective Date of Termination, provided that they waive any and all claims against Solutia and its subsidiaries. The executives will also be entitled to any other benefits or amounts, excluding severance or separation pay or benefits, for which they are eligible under any plan, program, or policy of Solutia and its subsidiaries, such as any vested benefit under any qualified defined benefit or defined contribution retirement plan in which they participate (collectively, "Other Benefits"). If employment terminates because of death or Disability, the executive or his estate, as applicable, will receive Accrued Obligations and Other Benefits.
The Senior Executive Agreements also contain provisions relating to non-competition, protection of Solutia's confidential information and non-solicitation of Solutia employees.
POTENTIAL PAYMENTS UPON TERMINATION
The table below sets forth estimates of the amounts to which each Named Executive Officer would be entitled, other than accrued but unpaid base salary and benefits payable under broad-based employee benefit plans and programs, in the event of a termination of the officer's employment other than for Cause, or by the executive for Good Reason, on December 31, 2006. The amounts would be payable under the Senior Executive Agreements are as follows:
COMPENSATION OF DIRECTORS
The following table describes the compensation arrangements with our non-employee directors for the 2006 fiscal year.
Solutia's existing shares of common stock, as well as options and warrants to purchase its common stock, together with deferred stock units, will be canceled upon our emergence from Chapter 11. It is highly unlikely that its directors and executive officers will receive any consideration in our Chapter 11 case for their equity based compensation.
(3) Philip R. Lochner resigned from our Board of Directors effective January 31, 2007. His resignation was not due to any disagreement with Solutia with respect to its operations, policies or practices.
The following table displays all components of compensation for non-employee directors in fiscal year 2006. In June 2006, the board of directors approved an increase in compensation based on the recommendation of the Governance Committee.
Directors who are Solutia employees do not receive payment for their services as directors. Jeffry N. Quinn, the current Chairman of the Board is also our President and Chief Executive Officer. The Lead Director retainer is paid to the lead non-employee director if the Chairman of the Board is an employee of Solutia. The current Lead Director is Paul Hatfield and he receives the Lead Director retainer.
Non-employee directors do not have a retirement plan, nor do they participate in Solutia's benefit plans.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Executive Compensation and Development Committee is comprised of three directors: Mr. Mulcahy, Chair, and Messrs. Metz and Jenkins. None of these individuals is a current or former officer or employee of Solutia or any of its subsidiaries, nor did any of these individuals have any reportable transactions with Solutia or any of its subsidiaries during 2006. During 2006, none of Solutia's executive officers served as a director or member of the compensation committee (or equivalent thereof) of another entity, any of whose executive officers served as a director of Solutia.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
OWNERSHIP BY DIRECTORS AND NAMED EXECUTIVE OFFICERS
The following table shows Solutia common stock owned beneficially by Solutia's directors and executive officers as of December 31, 2006, including those deferred stock units credited to the account of each non-employee director that are payable in stock. Solutia's existing shares of common stock as well as options and warrants to purchase its common stock as well as deferred stock units will be cancelled upon our emergence from Chapter 11. It is highly unlikely that our directors and executive officers will receive any consideration in our Chapter 11 case for their equity based compensation. In general, "beneficial ownership" includes those shares a person has the power to vote, or the power to transfer, and stock options that are exercisable currently or become exercisable within 60 days. Except as otherwise noted, each person has sole voting and investment power over his or her shares.
The total share holdings reported above for all directors and executive officers as a group equal less than 1% of the number of shares of Solutia common stock outstanding on December 31, 2006. No director or executive officer holds more than 1% of these shares.
OWNERSHIP BY CERTAIN BENEFICIAL OWNERS
The following table shows all persons or entities that Solutia knows were "beneficial owners" of more than five percent of Solutia common stock on February 23, 2007.
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes information about Solutia's equity compensation plans as of December 31, 2006. Solutia's existing shares of common stock as well as options and warrants to purchase its common stock will be cancelled upon our emergence from Chapter 11. It is highly unlikely that its directors or executive officers will receive any consideration in our chapter 11 case for their equity based compensation.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
RELATED PARTY TRANSACTION POLICY AND PROCEDURES
Solutia has a written related party transaction policy and procedures. The Audit and Finance Committee of the Board of Directors is responsible for approving and ratifying related party transactions under the Company's policy and procedures. The Audit and Finance Committee reviews the material facts of all Interested Transactions (as defined in the Policy) that require the Audit and Finance Committee's approval and either approves or disapproves of the entry into the Interested Transaction. If advance pre-approval of an Interested Transaction is not feasible, the Audit and Finance Committee considers the Interested Transaction at its next regularly scheduled meeting and if appropriate, the Interested Transaction is ratified.
Under the policy, certain Interested Transactions have standing pre-approval including (i) employment of executive officers, (ii) director compensation, (iii) transactions where all shareholders receive proportional benefits, (iv) transactions involving competitive bids, (v) certain transactions with other companies where the related party's only relationship is as an employee (other than an executive officer), director, or beneficial owner of less than 10% of that company's shares, if the aggregate amount involved does not exceed $1,000,000 or 2% of that company's total annual revenues, (vi) regulated transactions and (vii) certain banking related services.
The Chair of the Audit and Finance Committee also has authority to pre-approve or ratify any Interested Transaction with a related party in which the aggregate amount involved is expected to be less than $250,000. No director may participate in the approval of an Interested Transaction for which he or she is a related party. If an Interested Transaction will be ongoing, the Audit and Finance Committee may establish guidelines for Solutia to follow in its ongoing dealings with the related party. Thereafter, the Audit and Finance Committee, on a regular basis, will review and assess ongoing relationships with the related party to assess whether they are in compliance with the Committee's guidelines, if any, and that the Interested Transaction remains appropriate.
Mr. Sullivan and one other executive officer, who is not a "named executive officer" for reporting purposes, have unsecured claims as creditors in Solutia's Chapter 11 case by virtue of their participation in Solutia's 401(k) excess benefit plan and/or non-qualified defined benefit pension plan. Vested amounts owed to them under these plans at the time that Solutia filed for Chapter 11 are as follows:
In addition, each non-employee director is an unsecured creditor of Solutia with respect to deferred compensation that was payable in cash in the following amounts: Mr. Hatfield, $37,500; each other current director, $18,750.
Each director and executive officer has also filed a proof of claim for benefits under Solutia's director and officer and fidelity insurance and for any right he or she may have to corporate indemnification. Each director and executive officer also has, by virtue of Solutia's Chapter 11 filing, a claim for shares of Solutia common stock held by the director and for the value of deferred stock units that were payable in shares of Solutia's common stock.
DIRECTOR INDEPENDENCE
Solutia's board of directors has determined that all its non-employee directors as of December 31, 2006 - Messrs. Hatfield, Jenkins, Metz, Mulcahy, Mrs. Narodick and Dr. Slaughter - are independent under the board's categorical independence standards. Mr. Phillip R. Lochner, who resigned from the board on January 31, 2007, was also determined by the board to be independent. A copy of these standards is attached to this report as Exhibit 99.1.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
FEES PAID TO INDEPENDENT AUDITOR
The Audit and Finance Committee of Solutia's board of directors appointed Deloitte & Touche LLP as principal independent auditors to examine the consolidated financial statements of Solutia and its subsidiaries for 2006 and 2005. The following table displays the aggregate fees billed to Solutia for the fiscal years ended December 31, 2006 and 2005, by Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates.
- ------------------------------------------------------------------------------ TYPE OF FEE 2006 2005 - ------------------------------------------------------------------------------ Audit Fees $2,294,000 $2,266,000 - ------------------------------------------------------------------------------ Audit-Related Fees (1) 62,000 77,000 - ------------------------------------------------------------------------------ Tax Fees (2) 398,000 606,000 - ------------------------------------------------------------------------------ All Other Fees (3) 188,000 203,000 - ------------------------------------------------------------------------------
(1) Audit-Related Fees include fees for audits of employee benefit plans; agreed-upon or expanded audit procedures related to accounting records required to respond to or comply with financial, accounting or regulatory reporting matters; consultations on the accounting or disclosure treatment of transactions or events and/or the actual or potential impact of final or proposed rules, standards or interpretations by the Securities and Exchange Commission, FASB or other regulatory or standard-setting bodies; and attest services not required by statute or regulation.
(2) Tax Fees include fees for domestic tax planning and advice; domestic tax compliance; international tax planning and advice; international tax compliance; and review of federal, state, local and international income, franchise and other tax returns.
(3) All Other Fees include fees for expatriate tax return preparation, international assignment services and various other permitted services.
PRE-APPROVAL POLICIES AND PROCEDURES
Consistent with the Sarbanes-Oxley Act of 2002 and the SEC's rules relating to auditor independence, the Audit and Finance Committee has adopted a policy to pre-approve all audit and permissible non-audit services provided by Solutia's independent auditor, Deloitte & Touche LLP. Under this policy, the committee or its designated member must pre-approve services before a specified service is begun. Each approval includes a specified range of fees for the approved service. If approval is by the designated member, the decision is reported to the committee at its next meeting. Requests for pre-approval are submitted to the committee or its designated member by both the independent auditor and either the chief financial officer, treasurer or controller, with a joint statement as to whether, in their view, the request is consistent with the Securities and Exchange Commission's rules on auditor independence.
The Audit and Finance Committee pre-approved all services for which the fees shown above were paid.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
(a) Documents filed as part of this Form 10-K:
1. Financial Statements--See the Index to Consolidated Financial Statements and Financial Statement Schedule at page 49 of this report.
2. The following supplemental schedule for the years ended December 31, 2006, 2005 and 2004
II--Valuation and Qualifying Accounts
3. Exhibits--See the Exhibit Index beginning at page 133 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) and 10(d) through 10 (v) on page 133 and 134 of the Exhibit Index. The following exhibits listed in the Exhibit Index are filed with this Form 10-K:
10(rr) Transaction agreement by and among Akzo Nobel Chemicals International B.V., Akzo Nobel Chemicals Inc., Akzo Nobel N.V., Flexsys Holding B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc. 10(ss) Works council side letter by and among Akzo Nobel N.V., Akzo Nobel Chemicals International B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc., dated as of February 27, 2007. 12 Computation of the Ratio of Earnings to Fixed Charges 14 Solutia Inc. Code of Ethics for Senior Financial Officers 21 Subsidiaries of the Registrant 23 Consent of Independent Registered Public Accounting Firm 24(a) Powers of Attorney 24(b) Certified copy of board resolution authorizing Form 10-K filing using powers of attorney 31(a) Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31(b) Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32(a) Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32(b) Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Solutia's Categorical Independence Standards for Non-Employee Directors
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/ Timothy J. Spihlman ------------------------------ Timothy J. Spihlman Vice President and Controller (Principal Accounting Officer)
Dated: March 6, 2007
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.
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(1) (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)
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 (incorporated by reference to Exhibit 3(b) of Solutia's Form 10-K for the year ended December 31, 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) 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)
4(h) First Supplemental Indenture, dated as of 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(i) 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(j) Third Supplemental Indenture, dated as of October 8, 2003, among Solutia Inc., the subsidiary guarantors named therein and HSBC Bank USA (incorporated by reference to Exhibit 4(c) of Solutia's Form 10-Q for the quarter ended September 30, 2003)
4(k) Amended, Restated and Novated Junior Intercreditor Agreement, dated as of October 8, 2003, among Solutia Inc., Solutia Business Enterprises, Inc., each of the subsidiary guarantors named therein, Ableco Finance LLC and HSBC Bank USA (incorporated by reference to Exhibit 4(a) of Solutia's Form 10-Q for the quarter ended September 30, 2003)
4(l) Amended, Restated and Novated Junior Security Agreement, dated as of October 8, 2003, among Solutia Inc., Solutia Business Enterprises, Inc., each of the subsidiary guarantors named therein, Ableco Finance LLC and HSBC Bank USA (incorporated by reference to Exhibit 4(b) of Solutia's Form 10-Q for the quarter ended September 30, 2003)
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. 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(g) 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(h) Solutia Inc. 2003 Non-Employee Director Compensation Plan (incorporated by reference to Exhibit 10(a) of Solutia's Form 10-Q for the quarter ended June 30, 2003)
10(i) 2006 Solutia Annual Incentive Plan (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K, filed September 28, 2006)
10(j) Solutia Inc. Deferred Compensation Plan, as amended in 2002 (incorporated by reference to Exhibit 10(l) of Solutia's Form 10-K for the year ended December 31, 2002)
10(k) 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(l) Form of Retention Agreement between Solutia Inc. and other named Executive Officers (incorporated by reference to Exhibit 10(q) of Solutia's Form 10-K for the year ended December 31, 2003, filed March 15, 2004)
10(m) Agreement by and between Solutia Inc. and Rosemary L. Klein (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed April 27, 2005)
10(n) Amended and Restated Agreement by and between Solutia Inc. and Jeffry N. Quinn (incorporated by reference to Exhibit 99.3 of Solutia's Form 8-K filed April 27, 2005)
10(o) Amended and Restated Agreement by and between Solutia Inc. and James M. Sullivan (incorporated by reference to Exhibit 99.4 of Solutia's Form 8-K filed April 27, 2005)
10(p) Agreement by and between Solutia Inc. and Luc De Temmerman dated as of July 19, 2004 (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed January 18, 2005)
10(q) Letter Agreement between Solutia Inc. and Luc De Temmerman effective as of July 19, 2004 (incorporated by reference to Exhibit 99.3 of Solutia's Form 8-K filed January 18, 2005)
10(r) Retention Agreement, dated as of June 17, 2004, by and between Solutia Inc. and Rosemary L. Klein (incorporated by reference to Exhibit 10(aa) of Solutia's Form 10-K for the year ended December 31, 2004)
10(s) Agreement by and between Solutia Inc. and James R. Voss, dated as of August 1, 2005 (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended June 30, 2005)
10(t) Agreement by and between Solutia Inc. and Jonathon P. Wright, dated as of August 1, 2005 (incorporated by reference to Exhibit 10.2 of Solutia's Form 10-Q for the quarter ended June 30, 2005)
10(u) Form of Retention Agreement between Solutia Inc. and Key Employees (incorporated by reference to Exhibit 10(bb) of Solutia's Form 10-K for the year ended December 31, 2004)
10(v) Form of Agreement by and between Solutia Inc., CPFilms, Inc. and Kent J. Davies (incorporated by reference to Exhibit 10(y) of Solutia's Form 10-K for the year ended December 31, 2005)
10(w) 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(x) 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(y) Amendment to Protocol Agreement, dated as of March 3, 2003, by and among Pharmacia Corporation, Solutia Inc. and Monsanto Company (incorporated by reference to Exhibit 10(t) of Solutia's Form10-K for the year ended December 31, 2003)
10(z) Amendment to Protocol Agreement, dated August 4, 2003, by and among Pharmacia Corporation, Monsanto Company and Solutia Inc. (incorporated by reference to Exhibit 10(e) of Solutia's Form 10-Q for the quarter ended June 30, 2003)
10(aa) Financing Agreement, dated as of January 16, 2004, by and among Solutia Inc. and Solutia Business Enterprises, Inc., as debtors and debtors-in-possession, as Borrowers, certain subsidiaries of Solutia Inc. listed as a Guarantor, as debtors and debtors-in-possession, as Guarantors, the lenders from time to time party thereto, as Lenders, Citicorp USA, Inc., as Collateral Agent, Administrative Agent and Documentation Agent (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed January, 23, 2004)
10(bb) Amendment No. 1 to Financing Agreement and Waiver, dated as of March 1, 2004, by and among Solutia Inc. and Solutia Business Enterprises, Inc., as debtors, debtors-in-possession and as Borrowers; certain subsidiaries of Solutia Inc., as debtors, debtors-in-possession and as Guarantors; the lenders from time to time party thereto, as Lenders; Citicorp USA, Inc., as Collateral Agent, Administrative Agent and Co-Documentation Agent and Wells Fargo Foothill, LLC, as Co-Documentation Agent (incorporated by reference to Exhibit 10(y) of Solutia's Form 10-K for the year ended December 31, 2004)
10(cc) Amendment No. 2 to Financing Agreement and Waiver dated as of July 20, 2004 by and among Solutia Inc. and Solutia Business Enterprises, Inc., as debtors, debtors-in-possession and as Borrowers; certain subsidiaries of Solutia Inc. as debtors, debtors-in-possession and as Guarantors; the lenders from time to time party thereto, as Lenders; Citicorp USA, Inc., as Collateral Agent, Administrative agent and Co-Documentation Agent and Wells Fargo Foothill, LLC, as Co-Documentation Agent (incorporated by reference to Exhibit 10(f) of Solutia's Form 10-Q for the quarter ended June 30, 2004)
10(dd) Amendment No. 3 to the $525,000,000 Debtor-in-Possession Financing Agreement dated January 16, 2004 (as amended) between Solutia Inc., Solutia Business Enterprises, Inc. and the other parties thereto (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed July 27, 2005)
10(ee) Amendment No. 4 to Financing Agreement and Waiver dated as of March 17, 2006 amending the Debtor-in-Possession Financing Agreement dated January 16, 2005 (as amended) between Solutia Inc., Solutia Business Enterprises, Inc. and the other parties thereto (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed March 17, 2006)
10(ff) Waiver and Consent dated as of October 31, 2005 by and among Solutia, Solutia Business Enterprises, Inc., each subsidiary of Solutia listed on the signature pages thereto, the lenders party thereto, Citicorp USA, Inc. and Wells Fargo Foothill, LLC (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed December 5, 2005)
10(gg) Asset Purchase Agreement by and among FMC Corporation, Solutia Inc., Astaris LLC, Israel Chemicals Limited and ICL Performance Products Holding Inc. dated as of September 1, 2005 (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended September 30, 2005)
10(hh) Toll Manufacturing Agreement by and between Solutia Inc. and Phosphorus Derivatives Inc. dated November 4, 2005 (incorporated by reference to Exhibit 10.2 of Solutia's Form 10-Q for the quarter ended September 30, 2005)
10(ii) Owners Agreement by and between Solutia Inc. and FMC Corporation dated as of September 1, 2005 (incorporated by reference to Exhibit 10.3 of Solutia's Form 10-Q for the quarter ended September 30, 2005)
10(jj) Stock Purchase Agreement, dated as November 23, 2005 by and between Solutia Inc., Vitro S.A. de C.V., and Vitro Plan S.A. de C.V. (incorporated by reference to Exhibit 10.1 of Solutia's Form 8-K filed on December 21, 2005)
10(kk) Debtors' Joint Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code (incorporated by reference to Exhibit 99.1 of Solutia's Form 8-K filed on February 21, 2006)
10(ll) Debtors' Disclosure Statement Pursuant to Section 1125 of the Bankruptcy Code (incorporated by reference to Exhibit 99.2 of Solutia's Form 8-K filed on February 21, 2006)
10(mm) Revised Exhibit D to Debtors' Disclosure Statement Pursuant to Section 1125 of the Bankruptcy Code (incorporated by reference to Exhibit 99.1 of Solutia's Form 8-K filed on February 27, 2006)
10(nn) Share and Asset Purchase Agreement entered into on May 23, 2006 between Solutia Europe S.A./N.V. and Dishman Pharmaceuticals & Chemicals Ltd. (incorporated by reference to Exhibit 10.2 of Solutia's Form 10-Q for the quarter ended June 30, 2006)
10(oo) Amendment to Share and Asset Purchase Agreement entered into on August 22, 2006 between Solutia Europe S.A./N.V. and Dishman Pharmaceuticals & Chemicals Ltd.(1) (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended September 30, 2006)
10(pp) (euro)200,000,000 Facility Agreement dated July 26, 2006 between Solutia Europe S.A./N.V., Solutia Services International S.C.A./Comm. V.A., the guarantors listed therein, Citigroup Global Markets Limited, as mandated lead arranger, the financial institutions listed therein, as the original lenders, Citibank International plc as agent for the finance parties and Citibank N.A. as security agent for the secured parties (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended June 30, 2006)
10(qq) (euro)200,000,000 Facility Agreement dated July 26, 2006 between Solutia Europe S.A./N.V., Solutia Services International S.C.A./Comm. V.A., the guarantors listed therein, Citigroup Global Markets Limited, as mandated lead arranger, the financial institutions listed therein, as the original lenders, Citibank International plc as agent for the finance parties and Citibank N.A. as security agent for the secured parties (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended June 30, 2006) and amendment and restatement thereof dated September 15, 2006 filed herewith (incorporated by reference to Exhibit 10.1 of Solutia's Form 10-Q for the quarter ended September 30, 2006)
10(rr) Transaction agreement by and among Akzo Nobel Chemicals International B.V., Akzo Nobel Chemicals Inc., Akzo Nobel N.V., Flexsys Holding B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc.
10(ss) Works council side letter by and among Akzo Nobel N.V., Akzo Nobel Chemicals International B.V., Flexsys America LP, Flexsys Rubber Chemicals Ltd. and Solutia Inc., dated as of February 27, 2007.
11 Omitted--Inapplicable; see "Consolidated Statement of Operations" on page 51.
12 Computation of the Ratio of Earnings to Fixed Charges (see page 137)
14 Solutia Inc. Code of Ethics for Senior Financial Officers
16 Omitted--Inapplicable
18 Omitted--Inapplicable
21 Subsidiaries of the Registrant
22 Omitted--Inapplicable
23 Consent of Independent Registered Public Accounting Firm
24(a) Powers of Attorney
24(b) Certified copy of board resolution authorizing Form 10-K filing utilizing powers of attorney
31(a) Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31(b) Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32(a) Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32(b) Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1 Solutia's Categorical Independence Standards for Non-Employee Directors
(1) Confidential treatment has been granted for a portion of this exhibit.