ITEM 1. BUSINESS
Company Overview
Solutia Inc., together with its subsidiaries, is a global manufacturer of performance materials and specialty chemicals used in a broad range of consumer and industrial applications including interlayers and aftermarket film for automotive and architectural glass; chemicals that promote safety and durability in tires; and encapsulants, coatings and specialty chemicals used in a variety of electronic, industrial and energy solutions. To serve our customers, we utilize a global infrastructure consisting of 22 manufacturing facilities, 7 technical centers and over 30 sales offices globally, collectively staffed by 3,300 employees located in the United States, Europe, Latin America and Asia Pacific.
We were formed in April 1997 by Pharmacia Corporation (“Pharmacia”), which was then known as Monsanto Company (“Old Monsanto”) to hold and operate substantially all of the assets, and assume all of the liabilities of Old Monsanto’s historical chemicals business. Pharmacia spun us off to Pharmacia’s shareholders and we became an independent company in September 1997 (the “Solutia Spinoff”). On December 17, 2003, we and our U.S. subsidiaries filed voluntary petitions for Chapter 11 to obtain relief from the negative financial impact of liabilities for litigation, environmental remediation and certain postretirement benefits (the "Legacy Liabilities") and liabilities under operating contracts, all of which were assumed at the time of the Solutia Spinoff. On February 28, 2008 (the “Effective Date”), we consummated our reorganization and emerged from bankruptcy. See the accompanying consolidated financial statements for additional discussion of our changes in capitalization relating to this event.
Beginning with the period in which we entered bankruptcy through the present, we have transformed our product portfolio into businesses that are leaders in their respective markets with sustainable competitive advantage. Meaningful steps in this evolution include the exit from various commodity or noncore businesses coupled with the strategic acquisition or expansion of specialty chemicals and performance materials businesses. Specifically, divestitures include our phosphorus and phosphate salts joint venture in 2005; our pharmaceutical services business in 2006; our water treatment phosphonates business in 2007; and our nylon plastics, fibers and basic chemicals business in 2009. Significant acquisitions or expansions include the 2007 acquisition of Flexsys, the world’s leading supplier of chemicals to the tire industry; the acquisition of the remaining 51 percent of our polyvinyl butyral (“PVB”) interlayer plant in Santo Toribio, Mexico and the subsequent expansion of our advanced acoustic PVB sheet capacity at this plant and Belgium; expansion of our presence in China by construction of a manufacturing plant in Suzhou; and, most recently, the acquisitions of Vistasolar, a leading manufacturer of ethylene vinyl acetate (“EVA”) encapsulants to the photovoltaic market and Novomatrix, a leader in branding, marketing and distributing performance window films catering to the premium segment in the automotive and architectural markets. Throughout this time period, we have also shut down unprofitable businesses which were subject to over-capacity and unlikely to recover.
The cumulative effect of these activities has been the transformation of Solutia into a company that provides specialty materials for products used by consumers all around the world.
Segments: Principle Products
We manage our business in three segments: Advanced Interlayers; Performance Films; and Technical Specialties. The tabular and narrative information contained in Note 18 - Segment and Geographic Data - to the accompanying consolidated financial statements is incorporated by reference into this section. A description of our segments follow:
Advanced Interlayers
Our Advanced Interlayers segment is a leading producer of PVB and EVA sheet. PVB sheet, a plastic interlayer used in the manufacture of laminated glass for automotive and architectural applications and as an encapsulant used in photovoltaic applications, is primarily marketed under the SAFLEX® brand. EVA sheet, marketed under the VISTASOLAR® brand, is used exclusively as an encapsulant in photovoltaic solar modules. We also manufacture specialty intermediate PVB resin products, sold under the BUTVAR® brand, optical grade PVB resin and plasticizer.
PVB is a specialty resin used in the production of laminated safety glass sheet, an adhesive interlayer with high tensile strength, impact resistance, transparency and elasticity that makes it particularly useful in the production of safety glass. Laminated safety glass is predominately produced with PVB sheet and is legislated in all industrialized countries for automobile windshields. Developing countries also use laminated safety glass in automotive windshields although it is not formally legislated. Approximately 40 percent of sales to the automotive sector are for aftermarket replacement windows.
Architectural laminated safety glass is widely used in the construction of modern office buildings, airports and residential homes. PVB sheet is also used as an encapsulant in the growing thin film solar cell market. Other applications for PVB resin include non-sheet applications such as wash primers and other surface coatings, specialty adhesive formulations and inks.
EVA sheet is a key component in the construction of solar modules that protects the solar cell from moisture and preserves the life of the solar module against harsh, extreme heat situations. In addition, reliability and consistent quality in the EVA sheet increases the ease of use of the material and can improve the speed of solar module production.
Principal Products
(1)
Major plants are comprised of those facilities at which each of the identified major products conclude their respective manufacturing processes. The major products may pass through other of our plants prior to the final sale to customers.
Performance Films
Our Performance Films segment is one of the world’s largest manufacturers of solar control, decorative, safety and security window films for aftermarket automotive and architectural applications. The films are marketed predominantly under the trademarks of LLUMAR®; V-KOOL®; HÜPER OPTIK®; VISTA®; GILA® and FORMULA ONE HIGH PERFORMANCE AUTOMOTIVE TINT®. Performance Films also manufactures advanced film components utilizing unique processes such as vacuum metalizing, sputter coating, deep dyeing and coating and laminating. These films, marketed under the FLEXVUE™ brand, are used in a wide variety of products including those within the growing industries of electronics and energy.
Principal Products
(1)
Major plants are comprised of those facilities at which each of the identified major products conclude their respective manufacturing processes. The major products may pass through other of our plants prior to the final sale to customers.
Technical Specialties
Technical Specialties is our specialty chemicals segment which includes the manufacture and sale of chemicals for the rubber, solar energy, process manufacturing and aviation industries.
Chemicals for the rubber industry help cure and protect rubber, impart desirable properties to cured rubber, increase durability and lengthen product life. These products play an important role in the manufacture of tires and other rubber products such as belts, hoses, seals and footwear. We manufacture different products for the rubber chemicals industry which are classified into two main product groups: vulcanizing agents, principally insoluble sulfur, and antidegradants. Insoluble sulfur is a key vulcanizing agent manufactured predominantly for the tire industry. We are the world's leading supplier of insoluble sulfur and market it under the trade name of CRYSTEX®. Antidegradant applications, principally marketed under the name SANTOFLEXâ, are used in pneumatic tire components, solid tires, belts, hoses, cables, automotive mounts, bushings and general mechanical products that are exposed to continuous and intermittent dynamic operating conditions and require protection from ozonation. SANTOFLEXâ also provides powerful antiozonant and antioxidant properties with excellent high temperature, fatigue and flex resistance to rubber compounds.
THERMINOL® heat transfer fluids are used for indirect heating or cooling of chemical processes in various types of industrial equipment and in solar energy power systems. The fluids provide enhanced heat transfer characteristics because they remain thermally stable at both high and low temperatures.
SKYDROL® brand aviation hydraulic fluids are supplied across the aviation industry, including airline airframe manufacturers, and aviation maintenance facilities. The SKYDROL® line includes fire-resistant aviation hydraulic fluids which are used in more than half of the world's commercial aircraft.
Principal Products
(1)
Major plants are comprised of those facilities at which each of the identified major products conclude their respective manufacturing processes. The major products may pass through other of our plants prior to the final sale to customers.
Sale of Products
We sell our products directly to end users in various industries, principally by using our own sales force, and, to a lesser extent, by using distributors and franchisees.
We maintain inventories of finished goods, goods in process and raw materials to meet customer requirements and our scheduled production. In general, we do not manufacture our products against a backlog of firm orders; we schedule production to meet the level of incoming orders and the projections of future demand. However, in the Advanced Interlayers segment, a large portion of sales for 2010 were pursuant to volume commitments. We do not have material contracts with the government of the United States or any state, local or foreign government. In 2010, no single customer or customer group accounted for 10 percent or more of our net sales.
Our second and third quarters are typically stronger than our first and fourth quarters because sales of window films are stronger in the spring and summer.
Competition
The global markets in which our businesses operate are highly competitive. We expect competition from other manufacturers of the same products and from manufacturers of different products designed for the same uses as our products to continue in both U.S. and international markets. Depending on the product involved, we encounter various types of competition, including price, delivery, service, performance, product innovation, product recognition and quality. Overall, we regard our principal product groups as competitive with many other products of other producers and believe that we are an important producer of many of these product groups. For additional information regarding competition in specific markets, see the charts under "Segments: Principal Products" above.
Raw Materials and Energy Resources
We buy significant amounts of commodity raw materials and energy resources, including benzene, vinyl acetate, polyvinyl alcohol, 2-ethyl hexanol, ethylene-vinyl-acetate resin, polyethylene film, napthenic processing oil and natural gas. We typically buy major requirements for key raw materials pursuant to contracts with average contractual periods of one to four years. We obtain certain important raw materials from a few major suppliers. In general, in those cases where we have limited sources of raw materials, we have developed contingency plans to the extent practicable to minimize the effect of any interruption or reduction in supply. However, we also purchase 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 our current and projected requirements. However, their continuing availability and price may be affected by unscheduled plant interruptions and domestic and world market conditions, political conditions and governmental regulatory actions. Due to the significant quantity of some of these raw materials and energy resources that we use, a minor shift in the underlying prices for these items can result in a significant impact on our cost profile and, potentially, our consolidated financial position and results of operations.
Intellectual Property
We own a large number of patents that relate to a wide variety of products and processes and have pending a substantial number of patent applications. We also own and utilize across our business segments a significant amount of valuable technical and commercial information that is highly proprietary and maintained as a trade secret. In addition, we are licensed under a small number of patents owned by others. We own a considerable number of established trademarks in many countries as well as related internet domain names under which we market our products. This intellectual property in the aggregate is of material importance to our operations and to our various business segments.
Research and Development
Our investment in research and development creates new and innovative technology platforms, and/or results in new product development, providing higher-value solutions to existing customers or meeting new customers’ needs. Projects are coordinated globally through our network of research facilities. Our expenses for research and development amounted to $18 million in 2010, $14 million in 2009 and $19 million in 2008, or about 1 percent of net sales on average. We focus our expenditures for research and development on process improvements and selected product development.
In addition to the above, we actively invest into our existing products, production lines, manufacturing processes, and other ongoing operations in order to enhance product performance, differentiate our cost structure and fully leverage available raw materials. Although the effects of these investments often represent significant improvements, we typically expense these costs as incurred within cost of goods sold. These expenses amounted to $5 million in 2010, $4 million in 2009 and $1 million in 2008.
Environmental Matters
The narrative appearing under “Environmental Matters” in Item 7 below is incorporated by reference.
Employee Relations
On December 31, 2010, we had approximately 3,300 employees worldwide. The U.S., Europe, and Asia workforce constituted 53 percent, 26 percent and 14 percent of the total number of employees, respectively. Approximately 28 percent of our U.S. workforce is currently represented by various labor unions at the following sites: Anniston, Alabama; Sauget, Illinois; Monongahela, Pennsylvania; Springfield, Massachusetts; and Trenton, Michigan. Our local labor unions (except at the Monongahela, Pennsylvania site) engaged in coordinated bargaining with us with respect to benefits related to retirement and health and welfare (the “Welfare Agreement”), which Welfare Agreement expired on December 31, 2010. Prior to its expiration, we engaged in coordinated bargaining with the local labor unions governed by the Welfare Agreement and reached agreement to no longer engage in coordinated bargaining. Consequently, each union only has one agreement that incorporates retirement, health and welfare benefits, wages and working conditions. Nearly all of the European employees are represented by either a union delegation, works council or employee forum. Labor relations with our employees are good.
International Operations
We are engaged in manufacturing, sales and research and development in areas outside the United States. Approximately 75 percent of our consolidated sales from continuing operations for the year ended December 31, 2010 were made into markets outside the United States, including Europe, Asia, Latin America and Canada. Of our consolidated sales from continuing operations, 13 percent were made into China for the year ended December 31, 2010.
Operations outside the United States are potentially subject to a number of risks and limitations that are not present in domestic operations, including trade restrictions, investment regulations, governmental instability and other potentially detrimental governmental practices or policies affecting companies doing business abroad. Operations outside the United States are also subject to fluctuations in currency values. The functional currency of each of our non-U.S. 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, we generate revenue from export sales and operations conducted outside the United States that may be denominated in currencies other than the relevant functional currency.
Executive Officers
The following table shows information about our executive officers as of February 25, 2011:
The above listed individuals are elected or appointed 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.
Internet Access to Information
Our Internet address is www.solutia.com. We make available free of charge through our Internet website our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). All of these materials may be accessed from the "Investors" section of our 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 US, 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. UNLESS OTHERWISE NOTED, ALL RISK FACTORS LISTED BELOW SHOULD BE CONSIDERED ATTRIBUTABLE TO ALL OUR OPERATIONS INCLUDING ALL OPERATIONS CLASSIFIED AS DISCONTINUED.
Because our consolidated financial statements reflect fresh-start accounting adjustments made upon emergence from bankruptcy, and because of the effects of the transactions that became effective pursuant to the Plan of Reorganization, financial information in our future financial statements will not be comparable to our financial information from prior periods nor will our financial statements be comparable to those of our peers.
Upon our emergence from Chapter 11 in February 2008, we adopted fresh-start accounting in accordance with Accounting Standards Codification (“ASC”) 852, Reorganizations, pursuant to which our reorganization value, which represents the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the reorganization, has been allocated to the fair value of assets in conformity with ASC 805, Business Combinations, using the purchase method of accounting for business combinations. We stated liabilities, other than deferred taxes, at a present value of amounts expected to be paid. The amount remaining after allocation of the reorganization value to the fair value of identified tangible and intangible assets is reflected as goodwill, which is subject to periodic evaluation for impairment. In addition, under fresh-start accounting the accumulated deficit has been eliminated. In addition to fresh-start accounting, our consolidated financial statements reflect all effects of the transactions contemplated by the Plan of Reorganization. Thus, our future statements of financial position and statements of operations data will not be comparable in many respects to our consolidated statements of financial position and consolidated statements of operations data for periods prior to our adoption of fresh-start accounting and prior to accounting for the effects of the reorganization. Additionally, when comparing our financial performance to that of our peers, the requirement to fair value our assets and liabilities on our balance sheet will generally result in our having a significantly higher amortization rate than our peers. Consequently, our financial statements may not be comparable to those of our peers. Moreover, stemming from our emergence from Chapter 11, the carrying amount of our goodwill and intangible assets was established at fair value as of February 28, 2008 and therefore is more susceptible to impairment if business operation results and/or macroeconomic conditions significantly deteriorate.
Negative or uncertain worldwide economic conditions may adversely impact our business.
Our operations and performance are materially affected by worldwide economic conditions. In periods with significant market turmoil and tightened credit availability, we may experience difficulty in collecting accounts receivable, pricing pressure on products and services and reduced global business activity. A global economic downturn may reduce demand for our products, which would decrease our revenues and could have a material adverse effect on our financial condition and cash flows.
Our operations are restricted by our credit facilities and could be impacted by the failure of our lenders to perform.
Our credit facilities and our indentures governing the 2017 and 2020 senior unsecured notes 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:
In addition, our current credit facilities require us to satisfy certain financial covenants. 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, a material adverse effect on our financial condition and future operating performance would result.
Our current revolving credit facility is a syndicated credit agreement in which each lender is severally liable for only its agreed part of the loan commitments. One or more lender’s failure to perform on their obligations could have a material adverse effect on the Company’s ability to fund its ongoing operations and other commitments.
We have significant indebtedness.
We have a significant amount of indebtedness. Our significant indebtedness could have important consequences, including the following:
Our ability to satisfy our debt service obligations will depend, among other things, upon fluctuations in interest rates, 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 have hedged a significant portion of our variable rate debt with derivative instruments. 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. Finally, counterparties to our derivative instruments may not be able to honor their contractual obligations.
However, in the first quarter of 2010 we entered into a new $1,150 million senior secured credit facility, which consists of an $850 million term loan maturing in 2017 and a $300 million revolving credit facility maturing in 2015. As of the date hereof, we have made $126 million in voluntary prepayments of the term loan.
Volatility in the prices of raw materials and energy or their reduced availability could significantly impact our operating margins.
Our manufacturing processes consume significant amounts of energy and large amounts of commodity raw materials, including benzene, vinyl acetate, sulfur, polyvinyl alcohol, 2-ethyl hexanol, ethylene-vinyl-acetate resin, polyethylene film and natural gas, the cost of which are subject to worldwide supply and demand as well as other factors beyond our control. Also, temporary shortages or over supply of these raw materials and energy sources may occasionally occur. 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, worldwide market conditions and government regulation. Volatile raw material and energy costs could impact our operating margins in the future. See also Business - Raw Materials and Energy Resources.
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. While we have had infrequent incidents in the past, there is no guarantee that we won’t experience temporarily shut down or otherwise other disruptions in our manufacturing, which could lead to production delays and result 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.
The utilization of our net deferred tax assets could be substantially limited if we experienced an ownership change as defined by the Internal Revenue Code.
As of December 31, 2010, we have deferred tax assets of $546 million related to our U.S. net operating loss (“NOL”) carryforward and $145 million related to our U.S. tax credit carryforward. We have recorded a valuation allowance of equal amount against each of these assets. Section 382 of the Internal Revenue Code contains rules that limit the ability of a company that undergoes an ownership change to utilize its NOL and tax credit carryforwards. Under the rules, such an ownership change is generally any change in ownership of more than 50 percent of its stock within a rolling three-year period, as calculated in accordance with the rules. The rules generally operate by focusing on changes in ownership among stockholders considered by the rules as owning directly or indirectly 5 percent or more of the stock of the company and any change in ownership arising from new issuances of stock by the company.
If we undergo an ownership change for purposes of Section 382 as a result of future transactions involving our common stock, our ability to use any of our NOL and tax credit carryforwards, at the time of the ownership change would be subject to the limitations of Section 382. The limitation could operate to cause the benefit of the assets to expire before they are utilized. Our inability to use the full benefits of our NOL and tax credit carryforwards could have a material effect on our financial position, results of operations and cash flow.
We believe we have not experienced a subsequent ownership change since we experienced an initial ownership change on February 28, 2008, the date we emerged from Chapter 11 bankruptcy. However, the amount by which our ownership may change in the future could be affected by purchases and sales of common stock by 5 percent stockholders over which we have no control, and new issuances of common stock by us, should we choose to do so. In July 2009, our Board of Directors adopted a Section 382 rights agreement as a measure intended to deter such an ownership change in order to preserve our deferred tax assets. The Section 382 rights agreement, however, may not prevent an ownership change. In addition, while the Section 382 rights agreement is in effect, it could discourage or prevent a merger, tender offer, proxy contest or accumulations of substantial blocks of shares for which some stockholders might receive a premium above market value. It could also adversely affect the liquidity of the market for our shares.
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 and may be better able to withstand changes in market conditions. In addition, some of our competitors may be able to respond more quickly than us to new or emerging technologies and changes in customer requirements. 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 commercial and residential real estate and automotive industries, all of which are, by their nature, cyclical industries. A downturn in either or both of these industries would and has in the past, and may again in the future, result in lower demand for our products among customers involved in those industries and a reduced ability to pass on cost increases to these customers.
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 the operations of our businesses. 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 could 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. See also Business - Intellectual Property.
Legal proceedings may have a materially negative impact on our future results of operations.
We are, and may in the future be, subject to various lawsuits and other legal proceedings, including proceedings related to contract, environmental and other regulatory matters. We may also become subject to lawsuits by our customers, distributors and employees alleging personal injury or product liability associated with our products and businesses. Adverse judgments or rulings against us in these legal proceedings, or the filing of additional environmental or other damage claims against us, may have a materially negative impact on our future results of operations, cash flows and financial condition. Additionally, we may incur significant administrative and legal costs associated with defending or settling litigation.
As more fully described under “Item 3 - Legal Proceedings,” we are currently involved in various “Legacy Tort Claims,” which include claims for property damage, personal injury, products liability or premises liability or other damages arising out of or related to exposure to asbestos, PCB, dioxin, benzene, vinyl chloride, silica, butadiene, pentachlorophenol, styrene tars and other chemicals manufactured before our spinoff from Pharmacia Corporation. Monsanto is responsible to defend and indemnify us for any Legacy Tort Claims under the settlement agreement entered into between us and Monsanto in connection with our emergence from Chapter 11. To the extent that Monsanto averts responsibility for any Legacy Tort Claims, Pharmacia will bear financial responsibility for such claims. However, if any purported Legacy Tort Claim relates to exposure arising from our conduct occurring after our spinoff from Pharmacia Corporation or does not otherwise qualify as a Legacy Tort Claim, we could be liable for any adverse rulings, judgments or settlements relating thereto, which could have a material adverse effect on our results of operations, cash flows and financial condition.
The applicability of numerous environmental laws to our manufacturing facilities and other locations 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 the distribution of chemical substances. We are also required to maintain various environmental permits and licenses, many of which require periodic modification and renewal and related governmental approvals. Our operations entail the risk of violations of these 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 with such future requirements could subject us to material liabilities, such as government fines, third-party lawsuits or the suspension of non-compliant operations. Future requirements may also result in our making significant site or operational modifications at substantial cost. Future regulatory and enforcement 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 contaminated sites, natural resource damages, property damages and personal injury. We may be required to spend substantial sums to defend or settle these and other actions, to pay any fines levied against us or satisfy any judgments or other rulings rendered against us and such sums may be material.
Under certain environmental laws, we can be held strictly liable for hazardous substance contamination at real property we have owned, operated or used as a disposal site or for natural resource damages associated with such contamination. Liability under environmental laws relating to contaminated sites can be imposed retroactively and on a joint and several basis. One liable party can 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. As described in more detail above and in the following paragraph, 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 hazardous substance contamination.
We have made and will continue to make substantial expenditures for environmental and regulatory compliance and remediation projects. The substantial amounts that we may be required to spend on environmental capital projects and programs could cause substantial cash outlays and, accordingly, could have a material effect on our consolidated financial position, liquidity and profitability or 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; new releases of hazardous substances that result in personal injury, property damage or harm to the environment; and the discovery of unknown conditions of contamination or unforeseen problems encountered in the environmental remediation programs.
Our Chapter 11 case was caused, in significant part, by an accumulation of legacy liabilities, including, among others, “legacy environmental liability” arising from historical operations of Pharmacia prior to the Solutia Spinoff. In the course of the Chapter 11 case we achieved a substantial reallocation of the risk from these legacy liabilities. In particular, pursuant to the settlement agreement entered into between Monsanto and us, Monsanto agreed to be financially responsible for remediation costs and other environmental liabilities for sites owned, operated or used by Pharmacia but never owned, operated or used by us after the Solutia Spinoff; to share liabilities with respect to offsite areas at the Sauget and Anniston plant sites; and to be financially responsible for personal injury and property damage claims associated with exposures to hazardous substances arising from legacy Pharmacia operations (so-called “Legacy Toxic Tort Claims”). If Monsanto and/or Pharmacia fail to honor their respective obligation with respect to such remediation costs or Legacy Toxic Tort Claims, we could become responsible for some or all of such liabilities except for the remediation costs and other environmental liabilities for sites owned, operated or used by Pharmacia but never owned, operated or used by us for which Solutia received a discharge under the Plan which liabilities could be material. See also Management’s Discussion and Analysis - Environmental Matters.
We face currency and other risks associated with international sales.
Sales and operations outside the United States constituted a majority of our revenues in fiscal 2010. Our operations outside the United States expose us to risks including fluctuations in currency values, trade restrictions, tariff and trade regulations, U.S. export controls, reduced protection of intellectual property rights; foreign tax laws, shipping delays, economic and political instability; the effect of global health, safety and environmental matters on economic conditions and market opportunities and changes in financial policy.
The functional currency of each of our non-U.S. 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 technological change and our business will suffer if we fail to keep pace.
Many of the markets in which our products (and their corresponding manufacturing processes) compete are subject to 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. 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.
We may engage in acquisitions that could disrupt our business and harm our operating results or financial condition.
We expect to make selective domestic and international acquisitions of and investments in businesses that represent synergistic bolt-ons to our existing businesses or represent one or more businesses in the performance material and specialty chemical sector that would be new platforms for the Company. We may not be able to identify suitable acquisition, investment, alliance, or joint venture opportunities or consummate any such transactions or relationships on terms and conditions acceptable to us. Further, notwithstanding thorough pre-acquisition due diligence and careful analysis performed by the Company, we may not have identified all possible issues that might arise with respect to such acquired assets and such transaction that we enter into may not be as successful as the Company’s premises as of the acquisition date.
These transactions or any other acquisitions or dispositions involve risks and uncertainties, which may have a material adverse effect on our business. A critical component of the success of certain acquisitions is the Company’s ability to quickly and effectively integrate the acquired business or businesses into Solutia. Also, these integration efforts could result in disruption to other parts of our business and the diversion of management’s attention from daily operations.
Any acquisition may also cause us to assume liabilities, record goodwill and indefinite-lived intangible assets that will be subject to impairment testing and potential impairment charges, incur significant restructuring charges and increased working capital and capital expenditure requirements, which would reduce our return on invested capital.
Changes in supply-demand balance in the regions and the industries in which we operate may adversely affect our financial results.
Our key markets are shifting from mature markets such as North America and Western Europe to emerging regions such as Asia, in particular China and India. Although we are responding to meet these market demand conditions, we cannot be certain that we will be successful in expanding capacity in emerging regions (which depends in part on economic and political conditions in these regions and, in some cases, on our ability to acquire or form strategic business alliances) or in reducing capacity in mature regions commensurate with industry demand.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We lease office space in a multi-tenant building in which our headquarters is located in St. Louis County, Missouri. Our principal European offices are located in Louvain-la-Neuve, Belgium, in a building which we own but on land leased from the University of Louvain. In 2011, we will be moving our principal European offices from Louvain-la-Neuve to office space in a multi-tenant building that is being leased in Zaventem, Belgium. For our Asia Pacific operations, we lease office space in multi-tenant buildings in Shanghai, China and other locations in the region. Information about our major manufacturing locations worldwide and segments that used these locations as of February 1, 2011, appears under "Segments; Principal Products" in Item 1 of this report and is incorporated herein by reference.
Our principal plants are suitable and adequate for their use. Utilization of these facilities varies with seasonal, economic and other business conditions. None of our principal plants are substantially idle. Our facilities generally have sufficient capacity for existing needs and expected near-term growth.
We own most of our principal plants. However, we lease and operate as a guest, but own certain buildings and production equipment, at manufacturing facilities in Antwerp, Belgium; Sao Jose dos Campos, Brazil; Itupeva, Brazil; and Lemoyne, Alabama. The Antwerp and Sao Jose dos Campos facilities, where we manufacture certain Advanced Interlayers’ products and Technical Specialties products, belong to and are staffed by Monsanto under terms of master operating agreements. For facilities used in the manufacture of Advanced Interlayers’ products, the master operating agreement has an initial term that expires in 2020. For facilities used to manufacture rubber chemical products, the master operating agreement has an initial term that expires at the end of 2014. The Itupeva and Lemoyne facilities, where we manufacture certain Technical Specialties products, belong to and are staffed by Akzo Nobel under terms of master operating agreements. The initial term of these master operating agreements run until 2027. After the initial term, both agreements continue indefinitely unless either party terminates on at least 24 months' prior written notice. All agreements may be terminated by either party upon 24 months notice, which notice shall not be effective before the expiration of the initial term. These agreements also provide that, under certain circumstances, either the operator or the guest may terminate before the expiration of the applicable term, subject to early termination penalties.
We operate several facilities for other third parties on our sites, principally within the Nienburg, Germany; Wrexham, U.K.; Sauget, Illinois; Newport, Wales (U.K.); and Springfield, Massachusetts sites under long-term lease and operating agreements.
Mortgages on our plants at the following locations constitute a portion of the collateral securing our Term Loan and Revolver credit facilities: Springfield, Massachusetts; Trenton, Michigan; and Martinsville, Virginia.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Litigation
We are a party to legal proceedings, which have arisen in the ordinary course of business and involve claims for money damages.
Except for the potential effect of an unfavorable outcome with respect to our Legacy Tort Claims litigation, it is our opinion that the aggregate of all claims and lawsuits will not have a material adverse impact on our business, operating results or financial condition.
Legacy Tort Claims Litigation
Pursuant to the Amended and Restated Settlement Agreement effective February 28, 2008, entered into by us and Monsanto in connection with our emergence from Chapter 11 (the “Monsanto Settlement Agreement”), Monsanto is responsible to defend and indemnify us for any Legacy Tort Claims as that term is defined in the Monsanto Settlement Agreement, while we retain responsibility for certain tort claims, if any, which may arise out of our conduct after our spinoff from Pharmacia Corporation (“Pharmacia”) (the former Monsanto Company which is now a 100 percent owned subsidiary of Pfizer, Inc.), which occurred on September 1, 1997 (the “Solutia Spinoff”). We or our 100 percent owned subsidiary, Flexsys, have been named as defendants in the following actions, and have submitted the matters to Monsanto as Legacy Tort Claims. However, to the extent these matters relate to post Solutia Spinoff conduct or such matters are not within the meaning of Legacy Tort Claims as defined in the Monsanto Settlement Agreement, we could potentially be liable.
Putnam County, West Virginia Litigation. On December 17, 2004, a purported class action lawsuit was filed in the Circuit Court of Putnam County, West Virginia against Flexsys, Pharmacia, Monsanto and Akzo Nobel (we are not a named defendant) alleging exposure to dioxin from Flexsys’ Nitro, West Virginia facility, which is now closed. The relevant production activities at the facility occurred during Pharmacia’s ownership and operation of the facility and well prior to the creation of the Flexsys joint venture between Pharmacia (whose interest was subsequently transferred to us in the Solutia Spinoff) and Akzo Nobel. The plaintiffs are seeking damages for loss of property value, medical monitoring and other equitable relief.
Beginning in February 2008, Flexsys, Monsanto, Pharmacia, Akzo Nobel and another third party were named as defendants in approximately seventy-five individual lawsuits, and we were named in two individual lawsuits, filed in various state court jurisdictions by residents or former residents of Putnam County, West Virginia. The largely identical complaints allege that the residents were exposed to potentially harmful levels of dioxin particles from the Nitro facility. Plaintiffs did not specify the amount of their alleged damages in their complaints. In 2009, over fifty additional nearly identical complaints were filed by individual plaintiffs in the Putnam County area, which named us and Flexsys as defendants, and one additional complaint was filed in January 2011.
The claims in this matter concern alleged conduct occurring while Flexsys was a joint venture between us and Akzo Nobel, and any potential damages in these cases would be evenly apportioned between us and Akzo Nobel to the extent such claims are determined not to be Legacy Tort Claims.
Escambia County, Florida Litigation. On June 6, 2008, a group of approximately fifty property owners and business owners in the Pensacola, Florida area filed a lawsuit in the Circuit Court for Escambia County, Florida against Monsanto, Pharmacia, Solutia and the plant manager at our former Pensacola plant, an Integrated Nylon asset that was included in the divestiture of our Integrated Nylon business. The lawsuit alleges that the defendants are responsible for elevated levels of PCBs in the Escambia River and Escambia Bay due to past and continuing releases of PCBs from the Pensacola plant. The plaintiffs seek: (1) damages associated with alleged decreased property values caused by the alleged contamination and (2) remediation of the alleged contamination in the waterways. Plaintiffs did not specify the amount of their alleged damages in their complaint. Plaintiffs have subsequently amended their complaint to add additional plaintiffs to the litigation, such that 111 property and business owners are now named as plaintiffs.
St. Clair County, Illinois and Related Litigation. On February 10, 2009, a purported class action lawsuit was filed in the Circuit Court of St. Clair County, Illinois against us, Pharmacia, Monsanto and two other unrelated defendants alleging the contamination of the plaintiff’s property from PCBs, dioxins, furans and other hazardous substances emanating from the defendants’ facilities in Sauget, Illinois (including our W.G. Krummrich site in Sauget, Illinois). The proposed class action is comprised of residents who live within a two-mile radius of the Sauget facilities. The plaintiffs are seeking damages for medical monitoring and the costs associated with remediation and removal of alleged contaminants from their property. This action is one of several lawsuits (primarily filed by the same plaintiffs’ counsel) filed in 2009 and 2010 regarding alleged historical contamination from the W.G. Krummrich site.
In addition to the purported class action lawsuit, twenty additional individual lawsuits have been filed since February 2009 against the same defendants (including us) comprised of claims from over one thousand individual residents of Illinois who claim they suffered illnesses and/or injuries as well as property damages as a result of the same PCBs, dioxins, furans and other hazardous substances allegedly emanating from the defendants’ facilities in Sauget. In June 2010, a group of approximately 1,200 plaintiffs also filed wrongful death claims in a lawsuit in the Circuit Court of St. Clair County arising out of contamination from the defendants’ facilities. Moreover, four additional individual lawsuits comprised of claims from twelve plaintiffs were filed between January and April 2010 in the Circuit Court of Madison County, Illinois, alleging that plaintiffs suffered illnesses resulting from exposure to benzene, PCBs, dioxins, furans and other hazardous substances. Lastly, on June 14, 2010, a second purported class action lawsuit was filed in the Circuit Court of St. Louis City, Missouri against the same defendants alleging the contamination of the plaintiffs’ property from PCBs, dioxins, furans and other hazardous substances emanating from the defendants’ facilities in Sauget, Illinois and from our now-closed Queeny plant in St. Louis. The plaintiffs are seeking damages for medical monitoring and the costs associated with remediation and removal of alleged contaminants from their property. The proposed class members include residents exclusively within the state of Missouri.
Solutia Inc. Employees’ Pension Plan Litigation
Starting in October 2005, separate purported class action lawsuits were filed by current or former participants in our U.S. pension plan (“U.S. Plan”), which were ultimately consolidated into a single case on September 1, 2006 with similar lawsuits against the pension plans of Monsanto and Pharmacia. The Consolidated Class Action Complaint alleged three separate causes of action against the U.S. Plan: (1) the U.S. Plan violates ERISA by terminating interest credits on prior plan accounts at the age of 55; (2) the U.S. Plan is improperly backloaded in violation of ERISA; and (3) the U.S. Plan is discriminatory on the basis of age. In September 2007, the court dismissed the plaintiffs’ second and third claims, and by consent of the parties, certified a class action against the U.S. Plan only with respect to plaintiffs’ claim that the U.S. Plan violates ERISA by allegedly terminating interest credits on prior plan accounts at the age of 55. On June 11, 2009, the United States District Court for the Southern District of Illinois entered a summary judgment in favor of the U.S. Plan on the sole remaining claim against the U.S. Plan. The district court entered its final appealable judgment in the case on September 29, 2009, and plaintiffs appealed the decision to the Seventh Circuit Court of Appeals. The Seventh Circuit affirmed the decision of the district court in favor of the defendants on July 30, 2010. The plaintiffs have subsequently filed with the United States Supreme Court a petition for a writ of certiorari, and that request remains pending.
Medicare Reimbursement Litigation
On December 1, 2009, the Department of Justice (“DOJ”), on behalf of the United States government, filed suit in the United States District Court, Northern District of Alabama (in a case captioned United States of America v. Stricker, et al.), against us, Monsanto, Pharmacia and the attorneys and law firms who represented the plaintiffs in the Abernathy v. Solutia Inc., et al. (“Abernathy”) lawsuit arising out of PCB contamination in Anniston, Alabama. The DOJ alleges the defendants failed to reimburse Medicare for medical expenses paid to Abernathy settlement recipients who were Medicare beneficiaries. Specifically, the DOJ claims that approximately 907 claimants who received payments for medical treatment under the Abernathy settlement were Medicare beneficiaries who received “conditional” payments from Medicare for the same treatment. The DOJ alleges that the conditional payments were subject to reimbursement if a primary payer had responsibility to cover the treatment at issue, but no reimbursement was made to the government by any of the Abernathy participants. The DOJ is seeking recovery of these allegedly unpaid reimbursements from the defendants who paid into the Abernathy settlement fund, as well as the plaintiffs’ counsel who represented the Medicare recipients and were responsible for the distribution of the settlement funds. The DOJ did not specify the amount of damages - either generally from the defendants or specifically from us - which the government seeks in this case.
We and the other defendants filed motions to dismiss in February 2010. In September 2010, the district court granted the defendants’ motions, finding the DOJ failed to file the action within the applicable statute of limitations. As a result, judgment was entered in favor of the defendants, and we and the other defendants were dismissed from the case. The DOJ has subsequently filed a motion to reconsider the district court’s judgment, asking the court to reinstate the case. The DOJ’s motion remains pending.
Environmental Agency Enforcement Actions
On March 3, 2009, the U.S. EPA issued a Notice of Violation (“NOV”), Administrative Order (“AO”) and Reporting Requirement (“RR”) to us concerning alleged violations of the Clean Air Act arising out of an inspection conducted at our manufacturing facility in Springfield, Massachusetts. The NOV describes the U.S. EPA’s findings alleging violations of the plant’s Title V and state operating permits related to emissions of volatile organic compounds. The AO orders us to comply with its Title V permit and the National Emission Standards for Hazardous Air Pollutants, Subpart OOO (Amino/Phenolic Resins), Subpart UU (Equipment Leaks), and General Provisions. The RR requires us to submit additional information regarding certain storage vessels and associated equipment. On March 23, 2009, we met with the U.S. EPA to confer on this NOV, AO and RR. Submittals of the requested information under the RR were made as required. We have entered into a tolling agreement with the United States that provides them with additional time to evaluate its case and discuss settlement with us. The amount of a potential loss, if any, is not currently estimable.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to our security holders during the fourth quarter of 2010.
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
Our common stock trades on the New York Stock Exchange (“NYSE”) under the symbol “SOA”. The following table sets forth the high and low sales prices per share of our new common stock for the period from January 1, 2009 through December 31, 2010.
On January 31, 2011, we had 5,164 shareholders of record.
No dividends were paid by us in the years ended December 31, 2009 and 2010 and we have no current plans to do so.
Equity Compensation Plan Information
Purchases of Equity Securities by the Issuer
(1)
Shares surrendered to the Company by an employee to satisfy individual tax withholding obligations upon vesting of previously issued shares of restricted common stock.
(2)
Average price paid per share reflects the closing price of Solutia common stock on the business date the shares were surrendered by the employee stockholder to satisfy individual tax withholding obligations upon vesting of restricted common stock.
Stock Performance Graph
The following graph shows the cumulative total stockholder returns (assuming reinvestment of dividends) following assumed investment of $100 in shares of new common stock that were outstanding on February 28, 2008, the date of our emergence from Chapter 11 bankruptcy. The indices shown below are included for comparative purposes only and do not necessarily reflect our opinion that such indices are an appropriate measure of the relative performance of our new common stock. Data for periods prior to February 28, 2008 is not shown because we were in Chapter 11 bankruptcy.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Financial Summary
(1) Operating income includes net (gains) charges that affect comparability of $26 million in 2010, $32 million in 2009, $102 million in the ten months ended December 31, 2008 and ($2) million in the two months ended February 29, 2008, $41 million in 2007, and ($7) million in 2006.
(2) Income (loss) from continuing operations includes net (gains)/charges that affect comparability of $101, or $0.84 per share in 2010; $67 million, or $0.63 per share in 2009; $79 million, or $1.06 per share in the ten months ended December 31, 2008; ($1,233) million, or ($11.80) per share in the two months ended February 29, 2008; $326 million, or $3.12 per share in 2007; and $4 million, or $0.04 per share in 2006.
(3) Long-term debt excludes $659 million as of December 31, 2007 and $668 million as of December 31, 2006 of debt classified as subject to compromise in accordance with ASC 852 Reorganizations, as a result of our Chapter 11 bankruptcy filing in 2003.
(4) Working capital is defined as total current assets less total current liabilities.
(5) Interest expense includes the recognition of interest on allowed secured claims as approved by the Bankruptcy Court of $8 million in 2007. In addition, interest expense in all periods is affected by interest expense allocated to discontinued operations and in all periods prior to our emergence from bankruptcy for unrecorded contractual interest expense on unsecured debt subject to compromise.
(6) Income tax expense includes an increase (decrease) in valuation allowances of $19 million in 2010, $20 million in 2009, $2 million in the ten months ended December 31, 2008, $(252) million in the two months ended February 29, 2008, $82 million in 2007, and $35 million in 2006.
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
Overview
We are a leading global manufacturer and marketer of high-performance chemical-based materials that are used across automotive, construction, industrial and consumer applications. We report our operations in three segments: Advanced Interlayers (formerly Saflex), Performance Films (formerly CPFilms) and Technical Specialties. The reportable segment name changes in the first quarter of 2010 did not affect the organizational structure, financial results or the composition of the products within each reportable segment. Through our Advanced Interlayers segment, we produce Polyvinyl Butyral (“PVB”) and Ethyl Vinyl Acetate (“EVA”) used in the manufacture of laminated glass for automotive, architectural and solar applications in addition to the manufacture of specialized technical films for use in a wide variety of industrial applications. Our Performance Films segment manufactures, markets and distributes custom-coated window films for aftermarket automotive and architectural applications. Technical Specialties is our specialty chemicals segment, which includes the manufacture and sale of chemicals for the rubber, solar energy, process manufacturing and aviation industries. The major products by reportable segment are as follows:
See Note 18 to the accompanying consolidated financial statements for further information regarding our reportable segments.
Non-U.S. GAAP Financial Measures
Our emergence from bankruptcy required our adoption of fresh-start accounting on February 29, 2008. This resulted in our becoming a new reporting entity on March 1, 2008, with a new capital structure and a new basis in the assets and liabilities assumed. Accordingly, the financial information set forth in this report, unless otherwise expressly set forth or as the context otherwise indicates, reflects the consolidated results of operations and financial condition of Solutia Inc. and its subsidiaries for the periods following March 1, 2008 (“Successor”), and of Solutia Inc. and its subsidiaries for the periods through February 29, 2008 (“Predecessor”). One impact resulting from the adoption of fresh-start accounting is the significant change in interest expense, taxes, depreciation and amortization as triggered by our requirement to institute a new capital structure and fully re-measure our tangible and identifiable intangible assets.
This discussion and analysis includes financial information prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) along with certain non-U.S. GAAP measures and presentation. These non-U.S. GAAP measures and presentation include the use of the financial measure EBITDA and the combined presentation of the Predecessor and Successor for the twelve months ended December 31, 2008. EBITDA is defined as earnings from continuing operations before interest expense, loss on debt extinguishment, income taxes, depreciation and amortization less net income attributable to noncontrolling interest and reorganization items, net. The use of EBITDA by management, which is used to measure segment profit, enhances comparability between Successor and Predecessor periods, along with comparability with the performance of our peers. Likewise, we have combined the results of operations and the sources and uses of cash for the two months ended February 29, 2008 of the Predecessor and the ten months ended December 31, 2008 of the Successor, and compared these combined results with the corresponding periods in 2009 and 2010 to provide a more meaningful perspective on our financial and operational performance and trends than if we did not combine the results of operations and sources and uses of cash of the Predecessor and the Successor in this manner.
The presentation of EBITDA and the combined results for the twelve months ended December 31, 2008 are intended to supplement investors’ understanding of our operating performance and liquidity. However, the use of EBITDA and the combined presentation of the twelve months ended December 31, 2008 are not intended to replace net income (loss), cash flows, financial position or comprehensive income (loss), as determined in accordance with U.S. GAAP for the Predecessor and Successor periods. The Consolidated Financial Statements on or after March 1, 2008 are not comparable to the Consolidated Financial Statements prior to that date.
Summary of Significant Events
Product Changes and Expansions: As a leading provider of specialty materials used by consumers all around the world, we actively pursue opportunities to capitalize on underserved or emerging markets or geographies where we have a competitive advantage. Conversely, we periodically initiate restructuring, divestitures or shut-downs in product markets and geographies in which these characteristics do not exist. In 2010, we completed two acquisitions which complement our core product platforms, exited from several non-strategic other rubber chemicals businesses and continued the development and expansion of certain key products.
On April 30, 2010, we acquired Novomatrix, a leader in branding, marketing and the distribution of performance window films catering to the premium segment of the automotive aftermarket and architectural applications. The acquisition expands the reach of our Performance Films reporting segment into key emerging regions of Southeast Asia and the Middle East. Furthermore, we expect our manufacturing capabilities, processing expertise, technology resources and strong dealer and distribution networks to significantly benefit from the acquired brands including V-KOOLâ and HUPER OPTIKÒ. On June 1, we acquired Vistasolarâ, a leading supplier of EVA encapsulants to the photovoltaic market which enables us to expand our Advanced Interlayers product portfolio into each of the dominant photovoltaic encapsulant technologies and significantly enable rapid expansion in the photovoltaic market.
With respect to divestitures and shut-downs, due to overcapacity within the industry, a disadvantaged cost position and increasing pressure from Far Eastern producers, we discontinued production of our primary accelerators products and sold our Perkalink anti-reversion business in 2010. In January 2011, we sold certain other rubber chemicals businesses (dithiocarbamates and tetrabenzylthiuram disulfide). Our decision to exit these businesses is consistent with our strategy of focusing on businesses that are leaders or have the potential to be leaders in their respective markets coupled with a sustainable competitive advantage.
Also in 2010, we introduced new products and commenced capacity expansion efforts to further develop certain key markets. Some of the new products launched in 2010 include a Saflexâ solar absorbing interlayer for the global automotive market which reduces air conditioner load and, in turn, CO2 emissions through improved fuel economy and a Saflexâ acoustic interlayer for the European architectural market. With respect to capacity, we initiated the expansion of our Suzhou, China and Ghent, Belgium facilities, both of which we expect to be complete in 2011. The China upgrade will incorporate a second Saflexâ manufacturing line to serve the architectural, photovoltaic and automotive markets plus a new facility enabling the production of Vistasolarâ necessary to serve the growing photovoltaic market. The Belgium expansion will significantly expand our capacity to produce Saflexâ acoustic interlayer for automotive applications. In January 2011, we announced plans to expand our current Crystexâ operations in Kuantan, Malaysia which will double the capacity of this facility.
Long-term Capital Structure: In the first quarter 2010, we completed the sale of $300 million of senior unsecured notes, due 2020 (“2020 Notes”) and successfully closed a new $1,150 million senior secured credit facility (“Credit Facility”). The 2020 Notes were closed at a price of 99.5 percent of the aggregate principal amount bearing interest at 7.875 percent per annum. The Credit Facility, consisting of an $850 million term loan maturing in 2017 (“2017 Term Loan”) and a $300 million revolving credit facility maturing in 2015 (“2015 Revolver”), replaces our then existing $876 million term loan (“2014 Term Loan”) and our existing asset backed revolver (“2013 Revolver”). Completion of this refinancing significantly extends the debt maturities of the term loan and the revolver, increases our operational and strategic flexibility, and significantly lowers our interest costs. In addition to being used to repay our 2014 Term Loan, net proceeds from these financing transactions were used to partially fund the acquisition of Vistasolar and for general corporate purposes. Since completion of the refinancing, we made $132 million of debt principal payments through the date of this filing, of which $126 million was voluntary.
Summary Results of Operations: For the full year 2010, we reported $1,950 million in net sales, a 21 percent increase as compared to the same period in 2009 on higher sales volumes across all segments as partially offset by unfavorable currency exchange rate fluctuations and lower selling prices. The increase in sales volumes in 2010 was predominantly attributable to the steady improvement of the global automotive market, particularly in the Asia Pacific region, along with the positive impact of acquisitions completed in the second quarter. Gross profit for the full year 2010 increased $131 million or 27 percent as compared to the same period in 2009 on higher sales volumes and improved capacity utilization in part due to the positive impacts of certain cost reduction programs, as partially offset by higher employee incentives which were temporarily suspended in 2009. Selling, general and administrative expenses increased $36 million or 16 percent in 2010 as compared to the full year 2009, on higher selling costs required to support the increase in sales along with costs associated with the return of employee incentives. Operating income for 2010 was $331 million or 17 percent of net sales as compared to $242 million or 15 percent of net sales for the full year 2009.
Summary of Financial Condition and Liquidity: Cash provided by operations - continuing operations for 2010 was $296 million as compared to $194 million for the same period in 2009. The increase is primarily attributable to higher operating income and lower payments associated with our postretirement liabilities as partially offset by higher ex-US taxes, higher payments on our environmental remediation liabilities due to the absence of reimbursement from a fund established for this purpose upon our emergence from bankruptcy, and partial payment on our employee incentive plans. Working capital requirements for 2010 continued to decline as compared to the same period in 2009 on significantly higher sales.
Outlook
Our current operating premise is that automotive, energy solutions and the electronics markets will continue to grow globally in 2011 at higher than GDP rates, with the most significant growth in China and other emerging markets. We are not premising growth in the global architectural market, except for China where we have a lower market share in comparison with our architectural market position in other major world areas. Coupled with these volume assumptions, we are premising price increases in certain product lines due to favorable market conditions in 2011. Finally, as noted in the Summary of Significant Events, we sold certain other rubber chemicals in January 2011 which will impact full year net sales as compared to 2010. In aggregating these premises, our expectation for 2011 is net sales will increase within the range of 5 percent to 10 percent as compared to our reported net sales for 2010.
With respect to profitability, we expect operating margins to be consistent with or slightly higher than with those realized in 2010 as the positive results from restructuring actions are expected to continue and we are premising to operate at higher utilization rates to meet the demand profile. These gains will be partially offset by increased raw material and energy costs, which are premised to increase 7 percent. Further, although we expect selling expenses to increase in 2011 as compared to the prior year in support of higher net sales, our total selling, general and administrative expenses are expected to remain consistent with 2010 levels.
The incremental earnings premised in 2011 will generate additional operating cash, which will be offset by higher ex-U.S. tax payments, new product and growth related capital spending, as well as modest investments in working capital related to the revenue growth. In summary, we are currently anticipating generating cash from operations less capital spending in 2011 in the range of $150 million - $200 million from continuing operations.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. GAAP 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, we have made our best estimate 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 Committee of our Board of Directors.
We believe 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. We consider the following items to be our critical accounting policies:
§
Litigation and Other Contingencies
§
Impairment of Long-Lived Assets
§
Pension and Other Postretirement Benefits
We have other significant accounting policies but we believe 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, our 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 our 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) our past experience with similar matters. Our estimate of the environmental remediation reserve requirements typically fall within a range. If we believe no better estimate exists within a range of possible outcomes, 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 we must forecast environmental remediation activity into the future, which is highly uncertain and requires a large degree of judgment. These reserves include liabilities expected to be paid out over the next fifteen years. Therefore, the environmental reserves may materially differ from the actual liabilities if our 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 may be up to two times the amounts recorded, which would be settled through cash payments over an extended period of time.
Litigation and Other Contingencies
We are a party to legal proceedings involving intellectual property, tort, contract, antitrust, employee benefit, environmental, government investigations and other litigation, claims and legal proceedings. We routinely assess the likelihood of adverse judgments or outcomes to those matters, as well as ranges of probable losses, to the extent losses are reasonably estimable. To the extent that we conclude their occurrence is probable and the financial impact is reasonably estimable, should an adverse outcome occur, an accrual for such a contingency is recorded. When a single amount cannot be reasonably estimated but the cost can be estimated within a range, we accrue the low end of the range. In addition, we accrue for legal costs expected to be incurred with a loss contingency.
Pursuant to the Monsanto Settlement Agreement, Monsanto is responsible to defend and indemnify Solutia for any Legacy Tort Claims as that term is defined in the agreement, while Solutia retains responsibility for any tort claims relating to exposure arising from our conduct occurring after the Solutia Spinoff. Judgment is required in determining if actions where Solutia is named as a defendant are within the meaning of Legacy Tort Claims as defined by the Monsanto Settlement Agreement. To the extent Solutia has been named as defendants and have submitted the matters to Monsanto as Legacy Tort Claims and such matters are not within the meaning of Legacy Tort Claims, we could potentially be liable.
Disclosure for specific legal contingencies is provided if the likelihood of occurrence is at least reasonably possible and the exposure is considered material to the consolidated financial statements. In making determinations of likely outcomes of litigation matters, we consider many factors. These factors include, but are not limited to, past experience, scientific and other evidence, interpretation of relevant laws or regulations and the specifics and status of each matter. If the assessment of the various factors changes, the estimates may change and could result in the recording of an accrual or a change in a previously recorded accrual. Predicting the outcome of claims and litigation and estimating related costs and exposure involves substantial uncertainties that could cause actual costs to vary materially from estimates and accruals.
Income Taxes
As a multinational corporation, we are subject to taxation in many jurisdictions, and the calculation of our tax liabilities involves dealing with inherent uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. We assess the income tax positions and record tax liabilities for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. We account 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 basis of assets and liabilities at enacted rates. We base our 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. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our 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 changes in valuation allowances as a result of uncertainty regarding our ability to realize deferred tax assets in the future.
Our 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.
The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are also subject to change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Although we believe the measurement of liabilities for uncertain tax positions is reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals. If we ultimately determine that the payment of these liabilities will be unnecessary, the liability is reversed and a tax benefit is recognized during the period in which it is determined the liability no longer applies. Conversely, additional tax charges are recorded in a period in which it is determined that a recorded tax liability is less than the ultimate assessment is expected to be. If additional taxes are assessed as a result of an audit or litigation, it could have a material effect on our income tax provision and net income in the period or periods for which that determination is made.
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 under the provisions of U.S. GAAP. 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. Our 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 us to be commensurate with the risk inherent in the business model. These estimates are critical because changes to our assumptions used in the development of the impairment analyses can materially affect earnings in a given period and we must forecast cash flows into the future which is highly uncertain and requires a significant degree of judgment.
Impairment of Goodwill and Indefinite-Lived Intangible Assets
As of December 31, 2010 and 2009, we had goodwill and indefinite-lived intangible asset balances of $904 million and $658 million, respectively, which relate to our adoption of fresh-start accounting upon the emergence from bankruptcy along with certain acquisitions completed in 2010, as further discussed in Note 4 to the accompanying consolidated financial statements. We perform goodwill and indefinite-lived intangible asset impairment tests during the fourth quarter of each year but on a more frequent basis if changes in circumstances indicate the carrying value may not be recoverable during the intervening period. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; and the testing for recoverability of a significant asset group within a reporting unit. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements.
We perform the review for goodwill impairment at the reporting unit level and the test involves a two-step process. The first step is a comparison of each reporting unit’s fair value to its carrying value. The fair value of our Technical Specialties and Advanced Interlayers reporting units is determined considering both the market and income approaches. The fair value of our Performance Films reporting unit is determined utilizing the income approach. Under the market approach, fair value is based on a comparison of similar publicly traded companies and/or completed market transactions. Under the income approach, fair value is determined using an estimate of future cash flows of the reporting unit and a risk-adjusted discount rate to compute a net present value of future cash flows. The projection uses management’s best estimates of economic and market conditions over the projected period including growth rates in sales, costs, estimates of future expected changes in operating margins and cash expenditures. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements.
If the fair value of a reporting unit is less than its carrying value, there is an indication that impairment may exist and the second step must be performed to measure the amount of impairment loss. The amount of impairment is determined by comparing the implied fair value of reporting unit goodwill to the carrying value of the goodwill in the same manner as if the reporting unit was being acquired in a business combination. Specifically, we would allocate the fair value to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that would calculate the implied fair value of goodwill. If the implied fair value of goodwill is less than the recorded goodwill, we would record an impairment charge for the difference.
Other indefinite-lived intangible assets are the Company’s trademarks. Fair values used in testing for potential impairment of our trademarks are calculated by applying an estimated market value royalty rate to the forecasted revenues of the reporting unit that utilize those assets. The assumed cash flows from this calculation are discounted using a weighted average cost of capital that reflects current market conditions. The shortfall of the fair value below carrying value represents the amount of impairment.
Our fourth quarter reviews concluded that there was no goodwill or indefinite-lived intangible asset impairment in 2010 due to the substantial excess of fair value over the respective carrying value.
Pension and Other Postretirement Benefits
Measurement of the obligations under our defined benefit pension plans and our other postretirement 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. We typically use actuaries to assist us in preparing these calculations and determining these assumptions. Our annual measurement date is December 31 for our defined benefit pension plans and our OPEB plans. The below sensitivity analysis solely relates to our U.S. defined benefit pension and OPEB plans since they both comprise approximately 75 percent of our consolidated funded status on our defined benefit pension plans and OPEB plans.
The expected long-term rate of return on pension plan assets assumption was 8.25 and 8.50 percent in 2010 and 2009, 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 $1 million to pension expense.
The discount rates used to re-measure the pension plans were 5 percent and 5.25 percent at December 31, 2010 and 2009, respectively. The discount rate used to re-measure the OPEB plans was 4.75 percent for both December 31, 2010 and 2009. We establish our 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 our pension plans results in a change of approximately $11 million in the projected benefit obligation and no change in pension expense. A hypothetical 25 basis point change in the discount rate for our OPEB plans results in a change of approximately $2 million in the accumulated benefit obligation and no impact to OPEB expense.
We estimated the five-year assumed trend rate for healthcare costs in 2010 to be 8 percent with the ultimate trend rate for healthcare costs grading by 0.5 percent each year to 5 percent by 2016 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 $1 million as of December 31, 2010 and would have no impact to OPEB expense in 2010. Our 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.
Results of Operations
Consolidated Solutia
(a) See Note 18 - Segment and Geographic Data - to the accompanying consolidated financial statements for description of the computation of reportable segment profit.
The increase in 2010 net sales as compared to 2009 resulted from increased sales volumes of $302 million or 19 percent and the impact of the Vistasolar and Novomatrix acquisitions of $76 million or 5 percent, partially offset by the effect of unfavorable exchange rate fluctuations of $21 million or 1 percent and lower selling prices of $25 million or 2 percent. Higher sales volumes were realized by all of our reporting segments due to the strengthening demand across the global automotive and industrial sectors, predominantly in Europe, North America and the Asia Pacific region. The unfavorable currency impact was driven most notably by the increased strength of the U.S. dollar versus the Euro, in comparison to the prior year, due to our strong market positions in Europe by the Advanced Interlayers and Technical Specialties reporting segments. Selling prices were lower in our Advanced Interlayers and Technical Specialties reporting segments on increased pricing pressure as driven by relatively low industry utilization experienced throughout 2009.
The decrease in 2009 net sales as compared to 2008 resulted from decreased sales volumes of $387 million or 19 percent and the effect of unfavorable exchange rate fluctuations of $30 million or 2 percent, partially offset by higher selling prices of $9 million or 1 percent. Lower sales volumes were realized by all of our reporting segments due to continued weakness in demand across the global construction, automotive and industrial markets related to the deterioration in the macroeconomic environment which began in the fourth quarter of 2008. The unfavorable currency impact was driven most notably by the increased strength of the U.S. dollar versus the Euro, in comparison to the prior year, due to our strong market positions in Europe by the Advanced Interlayers and Technical Specialties reporting segments. Higher selling prices experienced in our Technical Specialties and Performance Films reporting segments were partially offset by price decreases in our Advanced Interlayers reporting segment.
The increase in 2010 operating income as compared to 2009 resulted primarily from higher net sales, the impact of the Vistasolar and Novomatrix acquisitions, improved utilization and fixed cost absorption, predominately in our Advanced Interlayers and Technical Specialties reporting segments, partially offset by higher raw material and energy costs, predominately in our Advanced Interlayers and Technical Specialties reporting segment, and the return of certain employee incentives suspended during 2009.
The increase in 2009 operating income as compared to 2008 resulted primarily from lower net charges as further described below in the Summary of Events Affecting Comparability section, lower raw material and energy costs, favorable exchange rate fluctuations, effective implementation of cost containment initiatives which resulted in better plant cost performance and lower selling, general and administrative expenses, significantly offset by lower net sales, lower fixed cost absorption, higher depreciation and amortization due to fresh-start accounting and higher share-based compensation expense.
Advanced Interlayers
The increase in 2010 net sales as compared to 2009 was a result of higher sales volumes of $117 million or 16 percent and the impact of the Vistasolar acquisition of $52 million or 8 percent, partially offset by lower average selling prices of $15 million or 2 percent and unfavorable currency exchange rate fluctuations of $16 million or 2 percent. Higher sales volumes were experienced in sheet and our proprietary resin and other intermediate chemicals due to increased demand, primarily in the global automotive market, as supplemented by growth in the solar energy market. Sales volumes in our architectural markets increased only modestly as declines in the United States were more than offset by sales volume increases in Asia Pacific and other emerging markets. Sales volumes in our European architectural market were effectively unchanged as compared to 2009. The unfavorable currency impact was driven most notably by the increased strength of the U.S. dollar versus the Euro, in comparison to the same period in 2009, due to our strong market positions in Europe. The decrease in selling prices is the consequence of declines in 2010 annual contract prices with major customers, which were primarily finalized in late 2009.
The decrease in 2009 net sales as compared to 2008 was a result of lower sales volumes of $97 million or 12 percent, lower average selling prices of $18 million or 2 percent, and unfavorable currency exchange rate fluctuations of $17 million or 2 percent. Lower sales volumes were due to weakness in demand across the global automotive and, to a lesser extent, architectural markets, which negatively impacted sales volumes of SAFLEX® plastic interlayer and proprietary resin, partially offset by higher volumes experienced in the solar energy market. The lower average selling prices were predominantly due to the weaker demand environment in 2009. The unfavorable exchange rate fluctuations occurred primarily as a result of the strengthening of the U.S. dollar in relation to the Euro in comparison to the comparable period in 2008.
The increase in 2010 segment profit in comparison to 2009 resulted primarily from higher net sales, the impact of the Vistasolar acquisition, lower net charges, which are described in detail in the Summary of Events Affecting Comparability section and improved utilization which improved our fixed cost absorption, partially offset by higher raw material costs and higher incentive expense.
The increase in 2009 segment profit in comparison to 2008 resulted primarily from lower net charges, which are described in detail in the Summary of Events Affecting Comparability section, lower raw material costs and effective implementation of cost containment initiatives and plant shutdown activities, which resulted in improved plant cost performance and lower selling, general and administrative expenses, partially offset by lower net sales and lower fixed cost absorption.
Performance Films
The increase in net sales in 2010 as compared to 2009 resulted from higher sales volumes of $43 million or 23 percent and the impact of the Novomatrix acquisition of $24 million or 13 percent. Higher sales volumes were experienced across all global markets, most significantly in the Asia Pacific region, due mainly to improved demand in the automotive markets as well as the industrial coatings and electronic sectors. Sales volumes in architectural markets were effectively flat as declines in the United States and Europe were offset by increased volumes in Asia Pacific and other emerging markets.
The decrease in 2009 net sales as compared to 2008 resulted primarily from lower sales volumes of $53 million or 22 percent, and, to a lesser extent, unfavorable currency exchange rate fluctuations of $3 million or 1 percent, partially offset by higher average selling prices of $5 million or 1 percent. With the exception of Asia Pacific, where sales volumes increased modestly in 2009, sales volumes decreased in all major geographic markets due to the severe global economic downturn and its effect on the automotive, residential housing, and commercial construction markets, but the decrease was more pronounced in Russia due to credit issues in the region.
The increase in 2010 segment profit in comparison to 2009 resulted primarily from increased net sales, the impact of the Novomatrix acquisition and lower net charges, which are described in detail in the Summary of Events Affecting Comparability section, partially offset by higher manufacturing and raw material costs, higher selling costs on products, including those associated with our Novomatrix acquisition, and higher incentive expense.
The decrease in 2009 segment profit in comparison to 2008 resulted primarily from decreased net sales as described above and lower fixed cost absorption, partially offset by effective implementation of cost containment initiatives, which resulted in lower selling, general and administrative expenses, lower raw material costs and lower net charges, which are described in detail in the Summary of Events Affecting Comparability section.
Technical Specialties
The increase in net sales for 2010 as compared to 2009 resulted from higher sales volumes of $150 million or 21 percent, partially offset by unfavorable currency exchange rate fluctuations of $5 million or 1 percent and lower average selling prices of $10 million or 1 percent. The higher sales volumes were experienced predominately by our THERMINOL® heat transfer fluid, SANTOFLEX® antidegradants and CRYSTEX® insoluable sulfur due to strengthening demand in the global automotive and industrial markets most significantly in Europe and the Asia Pacific region. The unfavorable currency impact was driven most notably by the increased strength of the U.S. dollar versus the Euro in comparison to the same period in 2009. Lower average selling prices were experienced primarily within our SANTOFLEX® antidegradants due to the supply/demand profile of that market.
The decrease in 2009 net sales as compared to 2008 resulted from lower sales volumes of $221 million or 24 percent and unfavorable currency exchange rate fluctuations of $8 million or 1 percent, partially offset by higher average selling prices of $23 million or 3 percent. Sales volumes decreased in all products within Technical Specialties due to the global economic downturn but this decrease, on a rate of decline basis, was more pronounced within SANTOFLEX® antidegradants and other rubber chemicals products. The decline in sales volumes for SANTOFLEX® antidegradants was significantly affected by increasing pressure from Far Eastern producers. The unfavorable exchange rate fluctuations occurred primarily as a result of the strengthening U.S. dollar in relation to the Euro in comparison to the comparable period in 2008. Higher average selling prices were experienced primarily within CRYSTEX® insoluble sulphur, THERMINOL® heat transfer fluids and SKYDROL® aviation hydraulic fluids. The increase in selling prices is related to our global price increases initiated in the third quarter 2008.
The increase in segment profit for 2010 as compared to 2009 resulted primarily from higher net sales and improved utilization and fixed cost absorption, partially offset by higher charges as compared to the same period in 2009 described in the Summary of Events Affecting Comparability section, higher raw material costs, predominately related to our THERMINOL® heat transfer fluids, and higher incentive expense.
The increase in 2009 segment profit in comparison to 2008 resulted primarily from higher net gains, which are described in detail in the Summary of Events Affecting Comparability section, favorable exchange rate fluctuations, effective implementation of cost containment initiatives, which resulted in improved plant cost performance and lower selling, general and administrative expenses, and lower raw material costs, partially offset by lower net sales. The favorable exchange rate fluctuation on segment profit is due to a higher percentage of our operating costs transacted in Euros than net sales in the same currency.
Unallocated and Other
Net losses on Unallocated and Other results decreased $9 million for the year ended December 31, 2010 as compared to the same period in 2009 due to lower net charges described in the Summary of Events Affecting Comparability section, lower losses on our Other Operations segment, and lower Other Unallocated Expense, net partially offset by higher Corporate Expenses and Share-Based Compensation. Lower losses from our Other Operations Segment, were driven by improved demand coupled with lower operational expenses prior to the sale. Lower Other Unallocated Expense, net is primarily due to $4 million in gains on foreign currency exposure recognized in 2010 compared to $4 million of losses for the same period in 2009. Higher Corporate Expenses were primarily due to the return of employee incentives that were temporarily suspended during 2009.
Net losses on Unallocated and Other results in 2009 increased as compared to 2008 primarily due to higher net charges described in the Summary of Events Affecting Comparability section, increased losses in our Other Operations segment, increased Share-Based Compensation and increased Other Unallocated Expense, net, partially offset by lower corporate expenses. Other Operations segment loss increased as compared to 2008 due to the global economic downturn. Share-based compensation expense increased due to management incentive and director stock compensation plans adopted upon our emergence from bankruptcy and an additional award granted early in the third quarter of 2009. Other Unallocated (expense) gain, net increased primarily due to $4 million of losses on foreign currency exposure in 2009 compared to $12 million of gains for the same period in 2008 and higher charges for environmental remediation projects. The higher charges for environmental remediation projects is due to a full year in 2009 of operations and maintenance costs on projects classified as liabilities subject to compromise prior to our emergence from bankruptcy in February 2008 in addition to increased legal spending on remediation projects in Anniston, Alabama as we sought recovery from other parties. Corporate Expenses decreased primarily due to lower discretionary expenses resulting from the implementation of certain cost reduction programs throughout 2009.
Interest Expense
Interest expense increased in 2010 versus 2009 due to higher average debt balances and increased expense related to our interest rate swap agreements. For 2010, our average debt balance was $1.5 billion compared to $1.3 billion during 2009. We realized $25 million of expense on our interest rate swap agreements in 2010 compared to expense of $0 in the same period in 2009. The expense on our swap agreements in 2010 includes $17 million in fair value declines experienced in the first seven months of the year. Offsetting this increase was a reduction in our average interest rate which dropped from 7.5 percent during 2009 to 6.6 percent during 2010 and lower amortization of debt issue costs of $12 million in 2010 versus 2009 as a result of the restructuring of our debt facility as further discussed in Note 9 to the accompanying consolidated financial statements.
For 2008, our average debt balance was $1.7 billion with an average interest rate of 8.7 percent compared to $1.3 billion with an average interest rate of 7.5 percent for 2009. Further, we experienced lower amortization of debt issue costs of $5 million in 2008 compared to 2009.
Loss on Debt Extinguishment
Loss on debt extinguishment for 2010 results from the early extinguishment of our 2014 Term Loan and 2013 Revolver where we incurred a $9 million prepayment penalty and an $80 million non-cash charge related to the write-off of deferred debt issuance costs related to the facilities. Loss on debt extinguishment in 2009 includes (i) a charge of $30 million related to the $300 million pay down on the 2014 Term Loan to write-off unamortized debt issuance costs and (ii) a charge of $8 million to write-off unamortized debt issuance costs and debt discount related to the repayment of the German term loan. Loss on debt extinguishment in 2008 included a charge of $1 million to write-off unamortized debt issuance costs related to the repayment of the Bridge.
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 us because we were in reorganization under Chapter 11 of the U.S. Bankruptcy Code. We did not record any charges in reorganization items in 2010 or 2009 due to our emergence from Chapter 11 on February 28, 2008.
Reorganization items incurred in 2008 included a $1,589 million gain from fresh-start accounting adjustments, which excludes the gain allocated to discontinued operations of $212 million, partially offset by a $104 million charge on the settlement of liabilities subject to compromise and $52 million of professional fees for services provided by debtor and creditor professionals directly related to our reorganization proceedings.
Income Tax Expense
Our income tax expense is affected by changes in the mix of income and losses in the tax jurisdictions in which we operate, unrecognized tax benefits and discrete items. The increase in income tax expense in 2010 as compared to 2009 is primarily attributable to $40 million of higher income from ex-U.S. operations along with a higher effective tax rate on this income. The effective tax rate on ex-U.S. operations in 2010 and 2009 was 17 percent and 13 percent, respectively, with the increase principally due to non-deductible costs of acquisitions and the closure of audits. Also impacting our effective tax rate on ex-U.S. operations, our 2010 and 2009 income tax expense was benefited $10 million and $8 million, respectively, due to a net reduction in contingency reserves related to uncertain tax positions plus, with respect to 2010, a reduction in a valuation allowance on an ex-U.S. entity. Our U.S. operations experienced pre-tax losses in both periods of 2010 and 2009 but no income tax benefit was recognized as a full valuation allowance has been provided against the U.S. deferred tax assets.
The decrease in income tax expense in 2009 compared to 2008 is primarily due to $202 million of income tax expense attributable to our emergence from bankruptcy and the effect of our adoption of fresh-start accounting. The remaining decrease is related to lower income tax expense attributable to a favorable mix of operations in lower tax jurisdictions, a decrease in reserves for uncertain tax positions and the implementation of tax planning. The effective tax rate on operations outside the U.S. in 2009 and 2008, after eliminating the effects of fresh start accounting was 12 percent and 38 percent, respectively.
As a result of the issuance of new common stock upon emergence from bankruptcy, we realized a change of ownership for purposes of Section 382 of the Internal Revenue Code. We do not currently expect this change to significantly limit our ability to utilize our NOL in the carryforward period, which we estimate to be approximately $1.6 billion at December 31, 2010, of which approximately $0.7 billion is currently available.
Discontinued Operations
Income (loss) from discontinued operations consists of the results of our Integrated Nylon business, Primary Accelerators business and other previously divested businesses. As described in Note 4 to the accompanying consolidated financial statements, we sold our Integrated Nylon business in June 2009 at a $76 million loss with operating results through the sale resulting in a loss of $94 million while we recognized a gain of $17 million during 2010 on settlement of contingent liabilities associated with the Alvin, Texas plant included in the sale of our Integrated Nylon business. Our loss related to Primary Accelerators increased as a result of an increase in charges related to the shutdown.
Summary of Events Affecting Comparability
Charges and gains recorded in 2010, 2009 and 2008 and other events affecting comparability have been summarized and described in the table and accompanying footnotes below (dollars in millions):
2010 Events
(a)
Severance, pension settlement and retraining costs related to the general corporate restructuring ($6 million pre-tax and $5 million after-tax).
(b)
Restructuring costs related to the closure of our Ruabon facility ($2 million pre-tax and after-tax).
(c)
Restructuring costs related to the closure of our Cologne facility ($8 million pre-tax and $6 million after-tax).
(d)
Inventory step-up related to the Novomatrix acquisition ($1 million pre-tax and after-tax).
(e)
Acquisition costs related to our agreement to purchase Vistasolar and Novomatrix ($7 million pre-tax and $6 million after-tax).
(f)
Loss on the sale of our European Plastic Products business ($5 million pre-tax and $3 million after-tax).
(g)
Gain on the sale of select assets of Perkalink ($5 million pre-tax and $4 million after-tax)
(h)
Loss on settlement of a contractual dispute ($2 million pre-tax and after-tax).
(i)
Gain on settlement of tax indemnification case ($8 million pre-tax and after-tax).
(j)
Charges related to the early extinguishment of our 2014 Term Loan and 2013 Revolver ($89 million pre-tax and $88 million after-tax).
(k)
Income tax impact has been provided on gains and charges at the tax rate in the jurisdiction in which they have been or will be realized.
2009 Events
(a)
Gain related to the reduction in the 2008 annual incentive plan ($23 million pre-tax and $20 million after-tax).
(b)
Severance, pension settlement and retraining costs related to the general corporate restructuring ($46 million pre-tax and $40 million after-tax).
(c)
Charges related to the closure of the SAFLEX® production line at our Trenton Facility ($5 million pre-tax and after-tax).
(d)
Net gains related to the closure of our Ruabon Facility ($2 million pre-tax and after-tax).
(e)
Net charges of $3 million related to consolidation of certain European manufacturing and distribution sites ($3 million pre-tax and after-tax).
(f)
Impairment of intangible assets related to the sale of our North American Plastic Products business ($1 million pre-tax and after-tax).
(g)
Impairment of intangible assets related to the sale of our Thiurams business (“Thiurams Sale”) ($1 million pre-tax and after-tax).
(h)
Gain on the Thiurams Sale ($4 million pre-tax and $3 million after-tax).
(i)
Loss on the sale of our North American Plastic Products business ($5 million pre-tax and after-tax).
(j)
Charges related to a prepayment of our 2014 Term Loan ($30 million pre-tax and after-tax).
(k)
Charges related to the early extinguishment of the German term loan ($8 million pre-tax and after-tax).
(l)
Income tax expense has been provided on gains and charges at the tax rate in the jurisdiction in which they have been or will be realized.
2008 Events
(a)
Charges resulting from the step-up in basis of our inventory in accordance with fresh-start accounting ($67 million pre-tax and $52 million after-tax).
(b)
Charges related to the closure of the our Ruabon Facility ($25 million pre-tax and after-tax).
(c)
Impairment and charges related to the closure of the SAFLEX® production line at our Trenton Facility ($10 million pre-tax and after-tax).
(d)
Gain related to the termination of a natural gas purchase contract related to the closure of our Ruabon Facility ($5 million pre-tax and after-tax).
(e)
Gain resulting from settlements of legacy insurance policies with insolvent insurance carriers ($3 million pre-tax and after-tax).
(f)
Impairment of fixed assets in other rubber chemicals business ($3 million pre-tax and $2 million after-tax).
(g)
Restructuring costs related principally to severance and retraining costs ($6 million pre-tax and after-tax).
(h)
Write-down of indefinite-lived intangible assets ($3 million pre-tax and $2 million after-tax).
(i)
Gain resulting from surplus land sales ($6 million pre-tax and after-tax).
(j)
Charges related to the early extinguishment of our bridge financing ($1 million pre-tax and after-tax).
(k)
Gain resulting from the settlement of emergence related incentive and professional fees accruals ($7 million pre-tax and after-tax).
(l)
Reorganization items, net consist of the following: $104 million charge on the settlement of liabilities subject to compromise, $1,589 million gain from fresh-start accounting adjustments, and $52 million of professional fees for services provided by debtor and creditor professionals directly related to our reorganization proceedings ($1,433 million pre-tax and $1,231 million after-tax).
(m)
Income tax expense has been provided on gains and charges at the tax rate in the jurisdiction in which they have been or will be realized.
Environmental Matters
We operate global manufacturing facilities that are subject to numerous laws and government regulations concerning environmental, safety and health matters. U.S. environmental legislation that has a particular impact on us includes the Hazardous Materials Transportation Act; the Emergency Planning and Community Right to Know Act; Toxic Substances Control Act; the Resource Conservation and Recovery Act; the Clean Air Act; the Clean Water Act; and the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as Superfund). We are 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 our 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. Company policy requires that all operations fully meet or exceed legal and regulatory requirements.
Emissions of greenhouse gases due to human activities and their potential impact on climate change currently are subjects of global debate. We monitor existing and proposed legislative developments to control greenhouse gas emissions which may affect the cost and supply of energy derived from coal and other fossil fuels for our operations. Concurrently, we voluntarily work to reduce our own greenhouse gas emissions through various energy reduction projects such as the use of wind turbines which supply the electrical needs of our Newport, Wales (U.K.) plant.
We make substantial expenditures for environmental remediation activities. In almost all cases, our liability arising from historical contamination is a result of operations and other events that occurred at our facilities or as a result of their operation prior to the Solutia Spinoff. For example, we have agreed to share responsibility with Monsanto for the environmental remediation at certain locations outside our plant boundaries in Anniston, Alabama, and Sauget, Illinois, which were incurred prior to the Solutia Spinoff (the “Shared Sites”). Under this cost sharing arrangement, we are responsible for the funding of environmental liabilities at the Shared Sites from the Effective Date up to a total of $325 million after the exhaustion of funds from the special purpose entity dedicated to the Shared Sites. Thereafter, if needed, we and Monsanto will share responsibility equally. From the Effective Date through December 31, 2010, we have made cash payments of $24 million toward remediation of Shared Sites after exhaustion of the of special purpose entity funds and have accrued an additional $166 million to be paid over the life of the Shared Sites remediation activity.
At December 31, 2010, our Consolidated Statement of Financial Position included an accrual of $273 million compared to $291 million at December 31, 2009 for all environmental remediation activities that we believe to be probable and estimable. Total cash expenditures for environmental remediation activities related to recorded environmental liabilities were $26 million, $29 million and $23 million in 2010, 2009 and 2008, respectively. Of these amounts, in 2009 and 2008, $28 million and $18 million, respectively, were reimbursed to us by a special purpose entity established upon our emergence from bankruptcy, which was fully exhausted in the fourth quarter 2009. Charges taken for environmental remediation activities in 2010, 2009 and 2008 were $8 million, $10 million and $264 million (of which $257 million related to a charge resulting from our emergence from bankruptcy and the adoption of fresh-start accounting), respectively. In 2011, we anticipate our cash expenditures and charges for environmental remediation activities to be similar to the gross cash expenditures and amounts expensed in 2010.
Long-lived Assets
As discussed in Summary of Significant Events and Note 4 to the accompanying consolidated financial statements, we have executed numerous actions, including certain strategic divestitures and plant shut-downs, in order to eliminate noncore products that lack a sustainable competitive advantage. The region most significantly impacted by these actions is Europe. Accordingly, to right-size our support structure, we anticipate a relocation of our European headquarters from a building which we own to a multi-tenant building in which we lease office space sometime in the first half of 2011. While the relocation is expected to result in a reduction in our annual cash costs and expense profile, it is reasonably possible we may incur a non-cash impairment charge of approximately $10 million in the first half of 2011 if we cannot find alternative uses for the building that support the carrying value or this asset is reclassified as held-for sale. Resolution of this uncertainty is expected after an evaluation of market conditions and alternative uses for this building have been completed.
Derivative Financial Instruments
Our business operations give rise to market risk exposures that result from changes in foreign currency exchange rates, interest rates and certain commodity prices. To manage the volatility relating to these exposures, we periodically enter into various derivative transactions that enable us to alleviate the adverse effects of financial market risk. Our approved policies and procedures do not permit the purchase or holding of any derivative financial instruments for trading purposes. We are exposed to credit-related losses in the event of nonperformance by counterparties to derivative financial instruments, but we do not expect any counterparties to fail to meet their obligations. Note 3 and Note 10 to the accompanying consolidated financial statements include further discussion of our accounting policies for derivative financial instruments.
Foreign Currency Exchange Rate Risk
We manufacture and sell our products in a number of countries throughout the world and, as a result, are exposed to movements in foreign currency exchange rates. We use foreign currency derivative instruments to manage the volatility associated with foreign currency purchases of materials and other assets and liabilities created in the normal course of business. The risks are hedged primarily through the use of forward exchange contracts and purchase options with maturities of less than 18 months. We also enter into certain foreign currency derivative instruments primarily to protect against exposure related to intercompany financing transactions. Our policy prescribes the range of allowable hedging activity and what hedging instruments we are permitted to use. Because the counterparties to these contracts are major international financing institutions, credit risk arising from these contracts is not significant, and we do not anticipate any counterparty losses. Currency restrictions are not expected to have a significant effect on our cash flows, liquidity or capital resources. Major currencies affecting our business are the U.S. dollar, British pound sterling, Euro, Brazilian real, Malaysian ringgit, Singapore dollar, Chinese yuan and the Japanese yen.
At December 31, 2010, we have currency forward contracts to purchase and sell $104 million of currencies, principally the Euro, U.S. dollar and Malaysian ringgit, with average remaining maturities of three months. Based on our overall currency rate exposure at December 31, 2010, 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 $8 million.
Interest Rate Risk
Interest rate risk is primarily related to changes in interest expense from floating rate debt. During 2010, the risk on existing floating rate debt consisted primarily of our 2017 Term Loan, which bears interest at LIBOR plus 3.00 percent with a 1.50 percent LIBOR floor and our 2015 Revolver, which bears interest, at our option, at LIBOR plus 3.25 percent or the prime rate plus 2.25 percent. To limit our exposure to changes in interest expense from floating rate debt on our 2017 Term Loan, we entered into interest rate swap agreements with a total notional amount of $600 million that are operational beginning in July 2010 and decline to $200 million through December 2015. Due to the historically low LIBOR rates during the year, our LIBOR floor of 1.50 percent was in excess of any 1 percent increase in LIBOR rates. An analysis of the impact of a hypothetical increase in interest rates in relation to our 2015 Revolver has not been performed since there were no borrowings outstanding on the 2015 Revolver throughout 2010.
As more fully discussed in Note 9 to the accompanying consolidated financial statements, we fully extinguished our 2014 Term Loan and 2013 Revolver in the first quarter 2010. Prior to their extinguishment, these credit facilities required interest payable using variable rate mechanisms which we partially hedged using interest rate swap agreements with an initial total notional amount of $800 million (“2008 Swaps”). Although the 2014 Term Loan and 2013 Revolver were both fully extinguished in 2010, the 2008 Swaps remain outstanding. To neutralize the potential impact to earnings from the 2008 Swaps on interest rate changes, we entered into offsetting interest rate swap agreements that are operational beginning August 2010 with total notional amounts, operational dates and other terms that effectively mirror the 2008 Swaps.
Commodity Price Risk
Certain raw materials and energy resources used by us are subject to price volatility caused by weather, crude oil prices, supply conditions, political and economic variables and other unpredictable factors. We periodically use forward and option contracts to manage a portion of the volatility related to anticipated energy purchases, primarily natural gas used as part of domestic operations. Forward and option contracts were used by us during 2009 prior to the sale of our Integrated Nylon business; however, we did not have any commodity forward contracts at December 31, 2009 or 2010 requiring fair value treatment due to our decreased exposure to natural gas upon the divestiture of our Integrated Nylon business.
Financial Condition and Liquidity
As of December 31, 2010, our total liquidity was $466 million which was comprised of $275 million in availability under our revolving credit facility and $191 million in cash and cash equivalents.
In 2010, we extinguished our existing senior term loan facility and our existing revolving credit facility, the latter of which was limited to the amount of the borrowing base and calculated as a percentage of allowable inventory and trade receivables, replacing them with our Credit Facility consisting of a $850 million term loan (“2017 Term Loan”) and a new $300 million revolving credit facility that does not depend upon a working capital borrowing base (“2015 Revolver”). The impact of this refinancing was an increase in revolver availability of approximately $130 million. Also in 2010, we completed the sale of the 2020 Notes, resulting in an increase to liquidity of $292 million. Proceeds from this offering, along with cash on hand, were used to fund our acquisitions of Vistasolar and Novomatrix for $297 million and $73 million, respectively, which were completed in the second quarter 2010. As of December 31, 2010, we had no draws against our 2015 Revolver, but availability was reduced by letters of credit of $25 million.
Our Credit Facility allows for a reduction in the interest rate when our Net Leverage Ratio, as defined by our agreement, falls below 2.50. In the fourth quarter 2010, our Net Leverage Ratio fell below this benchmark resulting in a reduction of 25 basis points on prospective interest rates during the fourth quarter 2010 for both the 2017 Term Loan and the 2015 Revolver. Calculation of this ratio and resulting changes in the interest rate are performed on a quarterly basis.
For 2011, our anticipated use of cash includes fulfillment of our interest, postretirement, environmental, divestiture and restructuring, as more fully described in Notes 4 and 5 to the accompanying consolidated financial statements, and tax obligations, in addition to certain capital expenditures for innovative initiatives, capacity expansion and productivity enhancement and for maintenance and safety requirements. Further, to the extent it is necessary to fund growth initiatives and certain seasonal demands of our operations, an additional use of cash may be needed for working capital. New sources of liquidity, if necessary, may include additional lines of credit, financing other assets, customer receivables and/or asset sales, all of which are allowable, with certain limitations, under our existing credit agreements. Our current liquidity resources, which when coupled with future cash flows from operations are adequate to meet our projected cash requirements.
Cash Flows - Continuing Operations
Our cash flows from continuing operations attributable to operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows, are summarized in the following table:
Operating activities: Cash provided by operating activities in 2010 increased as compared to 2009 due to higher operating income, lower payments on our postretirement obligations and on our restructuring obligations, as partially offset by higher payments on our ex-US income taxes, interest, our annual incentive plan and on environmental remediation. Working capital requirements continued to decline in 2010 on significantly higher sales but the positive impact to cash provided by operating activities was less than in the prior year period as working capital requirements for 2009 were aggressively reduced in response to the decline in demand across the global construction, automotive and industrial sectors experienced throughout the global economy along with an uncertainty on the timing of a recovery. Lower payments on our postretirement obligations are due to $15 million in lower domestic pension contributions made in 2010, lower payments on our retiree healthcare and other benefits due to a lower number of participants along with a lower per incident cost, as partially offset by higher pension contributions to our foreign pension plans of $7 million. Cash payments for income taxes increased $15 million in 2010 as compared to 2009 due to higher ex-U.S. earnings in 2010 coupled with the receipt of a tax refund of $8 million in 2009 related to prior year operations in Germany. Payments on interest increased in 2010 due to higher average balances outstanding throughout the year as partially offset by a lower average interest rate. Finally, and with respect to our environmental remediation cash payments, we received $28 million in 2009 from a restricted cash fund that was established upon our emergence from bankruptcy, as reimbursement on $29 million in cash payments on our environmental remediation liabilities. With the exhaustion of this fund in 2009 and, therefore no reimbursement, we used $26 million of cash on hand to satisfy these requirements throughout 2010.
Cash provided by operating activities in 2009 increased as compared to 2008 due to lower payments on interest expense, taxes, our annual incentive plan and our other postretirement obligations in addition to significantly reduced working capital requirements and a lack of reorganization activities in 2009 as partially offset by higher cash payments on restructuring activities and pension contributions. As discussed previously, our average debt outstanding and weighted average interest rate in 2009 declined approximately $350 million and 100 basis points, respectively, as compared to 2008 which resulted in lower interest payments. Tax payments were lower in 2009 predominately due to the receipt of an income tax refund of $8 million related to prior year operations in Germany. In response to the global economic slowdown that began in the fourth quarter of 2008, we significantly reduced our 2008 annual incentive plan payout which was targeted for payment in the first quarter of 2009 and aggressively reduced our working capital requirements in order to enhance liquidity. The lower payments on other postretirement obligations resulted from the implementation of a plan amendment upon our emergence from bankruptcy resulting in lower company requirements along with the establishment of a fund restricted to pay certain liabilities assumed by us upon the Solutia Spinoff (“Legacy Liabilities”). Contributions to our U.S. pension plans increased $19 million in 2009 despite lower minimum funding requirements as we made a $39 million voluntary contribution in the fourth quarter 2009.
Investing activities: Cash used in investing activities increased in 2010 compared to the same period in 2009 due to the acquisitions of Novomatrix and Vistasolar for $73 million and $297 million, respectively and higher capital expenditures. In 2009, the majority of growth related capital projects were suspended in reaction to the global economic slowdown. With the emergence of a more stable economic environment in 2010, we invested in certain growth capital projects, most significantly the completion of our architectural acoustic project in Belgium and the initiation of PVB and EVA capacity expansions in China. Capital investment is expected to increase in 2011, as evidenced by our recent announcement to double capacity for our insoluble sulfur production in Malaysia, in order to capitalize on identified growth opportunities.
Cash used in investing activities decreased in 2009 as compared to 2008 due to lower capital expenditures of $53 million as partially offset by lower proceeds from the sale of certain assets. In 2009, the majority of growth related capital projects were suspended in reaction to the global economic slowdown. In 2008, we received proceeds of $43 million from the sale of our corporate headquarters building compared to the receipt in 2009 of $4 million from the Thiurams Sale and $2 million from the Plastic Products Sale.
Financing activities: Cash provided by financing activities was $127 million in 2010, which reflects the issuance of the 2020 Notes, the successful refinancing of our 2014 Term Loan and 2013 Revolver and the subsequent repayment of all short-term debt obligations in addition to the voluntary prepayment of $76 million on our term debt. During the first quarter 2010, we issued the 2020 Notes and extinguished our existing 2014 Term Loan and 2013 Revolver, replacing them with our 2017 Term Loan and 2015 Revolver. After a principal reduction in our existing term debt of $30 million and after deducting $36 million in debt issuance costs and a prepayment penalty, net proceeds of $232 million were used to partially fund our acquisition of Novomatrix and Vistasolar. Refinancing our existing term loan and revolver resulted in an extension of our debt maturities, greater strategic and operational flexibility and a reduction in our effective interest rate. In addition to these activities, we used excess cash provided by operations to fully repay $16 million of short-term borrowings and $82 million of principal payments on our 2017 Term Loan, including $76 million of our voluntary prepayments. During 2009, we used $119 million in cash provided by the sale of common stock, along with proceeds received on the sale of our Integrated Nylon business and cash provided by operations, to fully repay our 2013 Revolver along with $12 million on our 2014 Term Loan.
Cash used in financing activities increased in 2009 as compared to 2008 primarily due to our emergence from bankruptcy in 2008. This event required a complete recapitalization of our debt and equity structure and, after repayment of all debt obligations outstanding, resulted in net proceeds of $351 million. Of this amount, $250 million was used to establish certain funds restricted for future payments related to Legacy Liabilities and the remainder was used to pay certain secured and administrative claims and to provide additional liquidity for operations. In 2009, we completed a stock offering of 24.7 million shares of our common stock at $5 per share which resulted in net proceeds of $119 million. The proceeds from this offering, along with proceeds received on the sale of our Integrated Nylon business and cash provided by operations, were utilized to fully repay our Revolver and $12 million on our Term Loan. Also in 2009, we completed the issuance of the 2017 Notes in exchange for net proceeds, after incorporating all transaction fees, of $379 million. From these proceeds, $300 million was used to repay a portion of our Term Loan.
Working Capital - Continuing Operations
Working capital used for continuing operations is summarized as follows:
Our working capital used for continuing operations decreased in 2010 primarily due to a net decrease in cash and cash equivalents, a decrease in trade receivables and an increase in our accrued liabilities as partially offset by higher inventory balances. In the first and second quarters of 2010, our cash and cash equivalents decreased partially due to a devaluation of cash held by our ex-U.S. subsidiaries, whose balances were unusually high to partially hedge foreign currency movements on the Vistasolar and Novomatrix acquisitions denominated in local currencies, along with the utilization of excess cash necessary to fund the closing of these acquisitions. Further, in 2010, we used excess cash from operations to prepay our 2010 full year U.S. pension contributions, including a $14 million voluntary contribution, and fully repaid all short-term debt in addition to prepaying the future quarterly debt amortizing payments on our 2017 Term Debt. Lower trade receivables on significantly higher sales reflect the continued focus by management to minimize working capital requirements. Higher accrued liabilities are predominantly associated with annual incentive plans typically paid in the first quarter of each year, but were cancelled in 2009, and higher accrued losses on foreign currency and interest rate hedge agreements. Higher inventory balances are predominantly due to the acquisition of Vistasolar and Novomatrix along with higher required volumes of our TherminolÒ products necessary to meet demand requirements for the first quarter 2011.
Beginning subsequent to our emergence from bankruptcy, from time to time we sell trade receivables without recourse to third parties. These trade receivables are removed from our Consolidated Statement of Financial Position and reflected as cash provided by operating activities in the Consolidated Statement of Cash Flows at the time of sale to the third party. Uncollected trade receivables sold under these arrangements and removed from the Consolidated Statement of Financial Position were $9 million and $8 million at December 31, 2010 and 2009, respectively. The average monthly amounts of trade receivables sold were $9 million for the twelve months ended December 31, 2010.
Cash Flows - Discontinued Operations
Cash used in operating activities on discontinued operations for 2010 is comprised of $5 million used to operate Primary Accelerators, including $7 million in restructuring payments, and $17 million of settlement payments related to contingent liabilities associated with the sale of our Integrated Nylon business. For the same period in 2009, cash provided by Primary Accelerators was $5 million and cash provided by Integrated Nylon was $52 million. Throughout 2009 and up to the date of sale of our Integrated Nylon business on June 1, 2009, we aggressively worked to monetize the required working capital balances which accounts for the significant provision of cash. Cash used in investing activities in 2010 is comprised of settlement payments to the buyer of Integrated Nylon, as more fully discussed in Note 4 to the accompanying consolidated financial statements, as offset by proceeds from the sale of certain assets formerly used to operate Primary Accelerators. Cash provided by investing activities in 2009 is predominantly comprised of funds received on the sale of our Integrated Nylon business as partially offset by minimum required capital expenditures. We expect to make cash payments of approximately $15 million in 2011 for dismantling and termination payments associated with our Primary Accelerators shutdown. We do not expect to make any additional cash payments in association with our Integrated Nylon divestiture.
Cash used in operating activities for discontinued operations were $148 million in 2008 due to losses incurred from our Integrated Nylon business and restructuring payments associated with the idling of certain manufacturing lines as partially offset by a decrease in working capital balances. Cash provided by investing activities in 2008 are comprised of capital expenditures of $51 million and $2 million on Integrated Nylon and Primary Accelerators, respectively.
Debt Covenants
Our Credit Facility includes a number of customary covenants and events of default, including the maintenance of certain financial covenants that restrict our ability to, among other things, incur additional debt; make certain investments; pay dividends, repurchase stock, sell certain assets or merge with or into other companies; and enter into new lines of business. The financial covenants for all measurement periods for the year ended December 31, 2010 are a Leverage Ratio and a Fixed Charge Ratio. Below is a summary of our actual performance under these financial covenants as of December 31, 2010 along with a summary of the contractually agreed to financial covenants for each of the measurement periods in 2011.
We were in compliance with all applicable covenants as of December 31, 2010. See Note 9 to the accompanying consolidated financial statements for additional information on our debt covenants.
Capital Expenditures
Capital expenditures are projected to be in the range of $120 million to $130 million during 2011 of which $85 million to $95 million of the projected range is attributable to new products and expansion and productivity projects while the remainder is attributable to maintenance and right-to-operate projects.
Pension Contributions
We sponsor several defined benefit pension plans whereby we made cash contributions of $68 million, $76 million and $54 million to the plans during 2010, 2009 and 2008, respectively. We expect to contribute approximately $50 million in cash to these pension plans during 2011 but actual contributions to the plans may differ as a result of a variety of factors, including changes in laws that impact funding. Our ultimate cash flow impact required to satisfy these outstanding liabilities will depend on numerous variables, including future changes in actuarial assumptions, legislative changes to pension funding laws, market conditions and if we choose to satisfy these requirements in the form of stock contributions.
Off-Balance Sheet Arrangements
See Note 16 to the accompanying consolidated financial statements for a summary of off-balance sheet arrangements as of December 31, 2010.
Contingencies
See Note 16 to the accompanying consolidated financial statements for a summary of our contingencies as of December 31, 2010.
Commitments
Our current subsidiaries CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc. and future subsidiaries as defined by the Credit Facility, subject to certain exceptions are guarantors of our obligations under the 2017 Term Loan and 2015 Revolver (“Credit Facility Guarantors”). Our current subsidiaries CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc., S E Investment LLC and future subsidiaries as defined by the 2017 Notes and 2020 Notes (collectively “the Notes”), subject to certain exceptions are guarantors of our obligations under the Notes. Solutia Business Enterprises Inc. and Solutia Inter-America, previous guarantors of the Notes, were merged into Solutia Inc. during 2010. The Credit Facility and the related guarantees are secured by liens on substantially all of our and the Credit Facility Guarantors’ present and future assets.
The following table summarizes our contractual obligations and commercial commitments as of December 31, 2010.
(a)
Unconditional purchase obligations primarily represent minimum non-cancelable future commitments to purchase raw materials and energy.
(b)
Standby letters of credit contractually expiring in 2011 are generally anticipated to be renewed or extended by extensions with existing standby letters of credit providers.
(c)
Represents estimated future minimum funding requirements for funded pension plans and other postretirement plans and estimated future benefit payments for unfunded pension and other postretirement plans.
(d)
We have $31 million recorded in other liabilities on the Consolidated Statement of Financial Position for which it is not reasonably possible to predict when it may be paid.
Recently Issued Accounting Standards
See Note 3 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 pages 39 and 40 is incorporated by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL SECTION - TABLE OF CONTENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Solutia Inc.:
We have audited the accompanying consolidated statement of financial position of Solutia Inc. and subsidiaries (the "Company") as of December 31, 2010 and 2009, and the related consolidated statements of operations, equity (deficit), comprehensive income (loss) and cash flows for the twelve months ended December 31, 2010, the twelve months ended December 31, 2009, the ten months ended December 31, 2008 (Successor Company), and for the two months ended February 29, 2008 (Predecessor Company). Our audits also included the financial statement schedule listed in the Index at Item 15. We also have audited the Company's internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management’s Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Novomatrix Pte. Ltd (Novomatrix) and Etimex Solar GmbH (Vistasolar), which were acquired on April 30, 2010 and June 1, 2010, respectively, and whose financial statements constitute 3 percent and 11 percent, respectively, of total assets and 1 percent and 3 percent, respectively, of net sales as of and for the year ended December 31, 2010. Accordingly, our audit did not include the internal control over financial reporting at Novomatrix or Vistasolar. The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedule and an opinion on the Company's internal control over financial reporting 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 and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide 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.
As discussed in Note 1 to the consolidated financial statements, on November 29, 2007, the Bankruptcy Court entered an order confirming the plan of reorganization, which became effective on February 28, 2008. Accordingly, the accompanying consolidated financial statements have been prepared for the Successor Company as a new entity with assets, liabilities and a capital structure having carrying values not comparable with prior periods as described in Note 1 to the consolidated financial statements.
In our opinion, Successor Company consolidated financial statements referred to above present fairly, in all material respects, the financial position of Solutia Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the twelve months ended December 31, 2010 and 2009, and the ten months ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Further in our opinion, the Predecessor Company consolidated financial statements referred to above present fairly, in all material respects, the results of its operations and its cash flows for the two months ended February 29, 2008, 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. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As discussed in Note 4 to the consolidated financial statements, the Company sold its integrated nylon business on June 1, 2009 and exited its primary accelerators business in the third quarter of 2010. The assets, liabilities, results of operations, and cash flows of the integrated nylon and primary accelerators businesses are presented as discontinued operations in the consolidated financial statements.
/s/ Deloitte & Touche LLP
St. Louis, Missouri
February 24, 2011
SOLUTIA INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(Dollars in millions, except per share amounts)
(a)
Predecessor excludes unrecorded contractual interest expense of $5 in the two months ended February 29, 2008.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(Dollars in millions)
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC.
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Dollars in millions, except per share amounts)
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in millions)
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC.
CONSOLIDATED STATEMENT OF EQUITY (DEFICIT)
(Dollars in millions)
See accompanying Notes to Consolidated Financial Statements.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts or otherwise noted)
1. Background and Basis for Presentation
Solutia Inc., together with its subsidiaries, is a global manufacturer of performance materials and specialty chemicals used in a broad range of consumer and industrial applications, including polyvinyl butyral interlayers for glass lamination and photovoltaic module encapsulation and ethylene vinyl acetate ("EVA") films for photovoltaic module encapsulation; aftermarket performance films for automotive and architectural applications; advanced film component solutions for solar and electronic technologies and technical specialties products including insoluble sulfur, PPD antidegregants, heat transfer fluids and aviation hydraulic fluids.
Unless the context requires otherwise, the terms “Solutia”, “Company”, “we” and “our” herein refer to Solutia Inc. and its subsidiaries.
Prior to September 1, 1997, Solutia was a wholly-owned subsidiary of the former Monsanto Company (now known as Pharmacia Corporation (“Pharmacia”), a 100 percent 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, we became an independent publicly held company and our operations ceased to be owned by Pharmacia.
On December 17, 2003, we and our U.S. subsidiaries filed voluntary petitions for Chapter 11 protection (the “Chapter 11 Case”) to obtain relief from the negative financial impact of liabilities for litigation, environmental remediation and certain postretirement benefits (the "Legacy Liabilities") and liabilities under operating contracts, all of which were assumed at the time of the Solutia Spinoff. Our subsidiaries outside the United States were not included in the Chapter 11 filing. On February 28, 2008 (the “Effective Date”), we consummated our reorganization under Chapter 11 of the U.S. Bankruptcy Code (the “Bankruptcy Code”) and emerged from bankruptcy pursuant to our Fifth Amended Joint Plan of Reorganization (the “Plan”).
The consolidated financial statements for the period in which we were in bankruptcy were prepared in accordance with Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 852 Reorganizations (“ASC 852”). The consolidated financial statements were also prepared 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. Upon our emergence from bankruptcy, we adopted fresh-start accounting in accordance with ASC 852. However, due to the proximity of the Effective Date to the February month end, for accounting convenience purposes, we have reported the effects of fresh-start accounting as if they occurred on February 29, 2008. Our emergence from bankruptcy resulted in our becoming a new reporting entity on March 1, 2008, which has a new capital structure, a new basis in the identifiable assets and liabilities assumed and no retained earnings or accumulated losses. Accordingly, the Consolidated Financial Statements on or after March 1, 2008 are not comparable to the Consolidated Financial Statements prior to that date. The financial information set forth in this report, unless otherwise expressly set forth or as the context otherwise indicates, reflects the consolidated results of operations and financial condition of Solutia Inc. and its subsidiaries for the periods following March 1, 2008 (“Successor”), and of Solutia Inc. and its subsidiaries for the period through February 29, 2008 (“Predecessor”).
Reclassifications
We reclassified $38 and $1 for the twelve months ended December 31, 2009 and the ten months ended December 31, 2008, respectively, from interest expense to loss on debt extinguishment to conform to the 2010 presentation. The reclassifications had no impact to reported net income (loss) for each respective period.
2. Fresh-Start Accounting
Fresh-start accounting reflects our value as determined in the Plan. Under fresh-start accounting, our asset values were re-measured using fair value and were allocated in accordance with the ASC 805 Business Combinations. The excess of reorganization value over the fair value of tangible and identifiable intangible assets was recorded as goodwill. In addition, fresh-start accounting also requires that all liabilities, other than deferred taxes, should be stated at fair value or at the present values of the amounts to be paid using appropriate market interest rates. Deferred taxes are determined in conformity with ASC 740 Income Taxes (“ASC 740”).
To facilitate the calculation of the enterprise value of the Successor, management developed a set of financial projections using a number of estimates and assumptions. The enterprise value, and corresponding equity value, was based on these financial projections in conjunction with various valuation methods, including (i) a comparison of us and our projected performance to comparable companies; (ii) a review and analysis of several recent transactions of companies in similar industries to ours and (iii) a calculation of the present value of our future cash flows under our projections. Utilizing these methodologies, the enterprise value was determined to be within a certain range and, using the mid-point of the range, the equity value of the Successor was estimated to be $1 billion.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
All estimates, assumptions, valuations, appraisals and financial projections, including the fair value adjustments, the financial projections, the enterprise value and equity value, are inherently subject to significant uncertainties and the resolution of contingencies beyond our control. Accordingly, there can be no assurance that the estimates, assumptions, valuations, appraisals and the financial projections will be realized and actual results could vary materially.
Reorganization items, net are presented separately in the Consolidated Statement of Operations and represent items of income, expense, gain or loss that we realized or incurred due to our reorganization under the Bankruptcy Code. A summary of these items is as follows:
(a)
The discharge of claims and liabilities primarily relates to allowed general, unsecured claims in our Chapter 11 Case, such as (1) claims due to the rejection or modification of certain executory contracts, (2) claims relating to changes in postretirement healthcare benefits and the rejection of our non-qualified retirement plans and (3) claims relating to the restructuring of financing arrangements.
(b)
We revalued our assets and liabilities at estimated fair value as a result of fresh-start accounting. This resulted in a $1,801 pre-tax gain, of which $212 is recognized in income (loss) from discontinued operations on the Consolidated Statement of Operations, primarily reflecting the fair value of newly recognized intangible assets, the elimination of our LIFO reserve and the increase in the fair value of tangible property and equipment.
(c)
Professional fees for services provided by debtor and creditor professionals directly related to our reorganization proceedings.
We did not incur any reorganization items in the twelve months ended December 31, 2010 and 2009 or the ten months ended December 31, 2008.
3. Significant Accounting Policies
Basis of Consolidation
The consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). These statements pertain to Solutia and its majority-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP 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 and assumptions affect many items in the financial statements. These include restructuring reserves, environmental reserves, self-insurance reserves, valuations of goodwill and other identified intangible assets, employee benefit plans, income tax liabilities and assets and related valuation allowances, inventory obsolescence, asset impairments, valuation of share-based compensation, litigation and other contingencies and the allocation of corporate costs to segments. Significant estimates and assumptions are also used to establish the fair value and useful lives of depreciable tangible and finite-lived intangible assets. Actual results may differ from those estimates and assumptions, and such results may affect income, financial position or cash flows.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and temporary investments with maturities of three months or less when purchased.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Trade Receivables
The provision for losses on uncollectible trade receivables is determined on the basis of past collection experience, current economic and market conditions and a review of the current status of each customer’s trade receivable balance.
Inventory Valuation
Inventories are stated at cost or market, whichever is less, with cost being determined using standards, which approximate actual cost. Variances, exclusive of unusual volume and operating performance, are capitalized into inventory when material. Standard cost includes direct labor and raw materials, and manufacturing overhead based on normal capacity. Effective in 2010, the cost of all consolidated inventories is determined using the FIFO method. For further detail, see Note 7 - Detail of Certain Balance Sheet Accounts.
We record abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) as current period charges.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost and depreciated on a straight-line basis over their respective estimated useful lives. In connection with our adoption of fresh-start accounting, we adjusted the net book values of property and equipment to their estimated fair values and revised the estimated useful life of machinery and equipment. The estimated useful lives for major asset classifications are as follows:
Goodwill and Intangible Assets
Goodwill reflects the excess of the reorganization value of the Successor over the fair value of tangible and identifiable intangible assets, net of liabilities resulting from our adoption of fresh-start accounting. Goodwill and other intangible assets with indefinite lives are not amortized but are tested for impairment as of November 30 of each year or more frequently when an event occurs or circumstances change such that it is reasonably possible that impairment may exist.
We test goodwill for impairment by first comparing the carrying value of each reporting unit, including goodwill, to its fair value. The fair value of our Technical Specialties and Advanced Interlayers reporting units is determined considering both the market and income approaches. The fair value of our Performance Films reporting unit is determined utilizing the income approach. Under the market approach, fair value is based on a comparison of similar publicly traded companies and/or completed market transactions. Under the income approach, fair value is determined using an estimate of future cash flows of the reporting unit and a risk-adjusted discount rate to compute a net present value of future cash flows. If the fair value is determined to be less than carrying value, a second step is performed to compute the amount of impairment, if any. Impairment of goodwill is measured as the excess of the carrying amount of goodwill over the net fair values of recognized and unrecognized assets and liabilities of the reporting unit. We test intangible assets with indefinite lives for impairment through comparison of the fair value of the intangible asset with its carrying amount. The fair value of intangible assets with indefinite lives is determined using an estimate of future cash flows attributable to the asset and a risk-adjusted discount rate to compute a net present value of future cash flows. The shortfall of the fair value below carrying value represents the amount of impairment. See Note 6 - Goodwill and Other Intangible Assets - for further discussion of the annual impairment test.
Intangible assets that have finite useful lives are amortized over their determinable useful lives on a straight-line basis and assessed for impairment in accordance with our Impairment of Long-Lived Assets accounting policy. The estimated useful lives are as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
On a quarterly basis, the useful lives of these assets are evaluated to determine whether events or circumstances warrant a revision to the remaining period of amortization. If an estimate of the useful life is changed, the remaining carrying amount of the asset will be amortized prospectively over the revised remaining useful life.
Impairment of Long-Lived Assets
Impairment tests of long-lived assets are performed when conditions indicate the carrying amount may not be recoverable. Impairment tests are based on a comparison of undiscounted cash flows to the recorded value of the asset. If 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 based on current law and existing technology. 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.
Litigation and Other Contingencies
We are a party to legal proceedings involving intellectual property, tort, contract, antitrust, employee benefit, environmental, government investigations and other litigation, claims and legal proceedings. We routinely assess the likelihood of adverse judgments or outcomes to those matters, as well as ranges of probable losses, to the extent losses are reasonably estimable. Potential losses are recorded to the extent that we conclude their occurrence is probable and the financial impact, should an adverse outcome occur, is reasonably estimable. When a single amount cannot be reasonably estimated but the cost can be estimated within a range, we accrue the low end of the range. In addition, we accrue for legal costs expected to be incurred with a loss contingency.
Disclosure for specific legal contingencies is provided if the likelihood of occurrence is at least reasonably possible and the exposure is considered material to the consolidated financial statements. In making determinations of likely outcomes of litigation matters, we consider many factors. These factors include, but are not limited to, past experience, scientific and other evidence, interpretation of relevant laws or regulations and the specifics and status of each matter. If the assessment of the various factors changes, the estimates may change and could result in the recording of an accrual or a change in a previously recorded accrual.
Self-Insurance and Insurance Recoveries
We maintain self-insurance reserves to reflect our 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, our historical experience and certain case specific reserves as required, including estimated legal costs. The maximum extent of the self-insurance provided by us is dependent upon a number of factors including the facts and circumstances of individual cases and the terms and conditions of the commercial policies. We have purchased commercial insurance in order to reduce our exposure to workers’ compensation, product, general, automobile and property liability claims. 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.
Foreign Currency Translation
The local currency has been used as the functional currency for nearly all worldwide locations and is 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.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Derivative Financial Instruments
All derivatives excluding those which qualify for exception, 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 respective entity’s functional currency. We have 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.
Interest rate caps and swaps are used to manage interest rate exposures on variable rate debt instruments. To the extent interest rate caps and swaps qualify for hedge accounting, we designate them as cash flow hedges and 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 interest expense in the Consolidated Statement of Operations in the period during which the hedged transaction affects earnings. The mark-to-market gains or losses on swaps not designated as cash flow hedges, as well as the ineffective portions of hedges, are recognized in interest expense immediately.
Revenue Recognition
Our primary revenue-earning activities involve producing and delivering goods. Revenues are considered to be earned when we have completed the process by which we are entitled to such revenues. Criteria used for revenue recognition are persuasive evidence that an arrangement exists, delivery has occurred, selling price is fixed or determinable and collection is reasonably assured.
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.
Distribution Costs
We include inbound freight charges, purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs and the other costs of our distribution network in cost of goods sold in the Consolidated Statement of Operations.
Income Taxes
We account 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. We determine the appropriateness of valuation allowances in accordance with the “more likely than not” recognition criteria.
We recognize tax positions in the Consolidated Statement of Financial Position as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with tax authorities assuming full knowledge of the position and all relevant facts. Accrued interest and penalties related to unrecognized tax benefits are included in income tax expense in the Consolidated Statement of Operations.
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. To the extent that stock options, non-vested restricted stock and warrants are anti-dilutive or the performance and market conditions on the shares have not been met as of the end of the reporting period, they are excluded from the calculation of diluted earnings per share.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Share-Based Compensation
We measure compensation cost for all share−based awards at fair value on the date of grant. The fair value of stock options is determined using the Black−Scholes valuation model. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method.
Recently Issued and Adopted Accounting Standards
In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06 Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 amends ASC 820 Fair Value Measurements and Disclosures (“ASC 820”) to require new disclosures related to transfers into and out of Levels 1 and 2 of the fair value hierarchy and additional disclosures about purchases, sales, issuances and settlements related to Level 3 measurements. The guidance also clarifies existing fair value measurement disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The additional disclosure requirements are effective for the first reporting period beginning after December 15, 2009, except for the additional disclosure requirements related to Level 3 measurements which are effective for fiscal years beginning after December 15, 2010. Accordingly, we adopted the requirements of this guidance effective January 1, 2010. The adoption of the additional requirements of ASU 2010-06 did not have any impact on our consolidated financial statements and the additional disclosure requirements can be found at Note 12 - Pension Plans and Other Postretirement Benefits.
In September 2009, the FASB issued ASU 2009-12 Fair Value Measurements and Disclosures (Topic 820): Investments in Certain Entities that Calculate Net Asset Value per Share (“ASU 2009-12”), which amends ASC 820 to provide clarification on the measurement and disclosure of investments in certain entities that calculate net asset value per share (“NAV”). The measurement and disclosure requirements of ASU 2009-12 are effective for the first reporting period ending after December 15, 2009. Accordingly, we adopted the requirements of this guidance effective October 1, 2009. The adoption of the guidance did not have any impact on our consolidated financial statements and the additional disclosure requirements can be found at Note 12 - Pension Plans and Other Postretirement Benefits.
In June 2009, the FASB issued the ASC to serve as the sole source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the Securities and Exchange Commission (“SEC”) and its staff. The ASC changes the referencing of financial standards but is not intended to change U.S. GAAP. This standard is effective for interim or annual financial periods ending after September 15, 2009. Since the ASC did not alter existing U.S. GAAP, it did not have any impact on our consolidated financial statements.
In March 2008, the FASB issued guidance, referenced in ASC 815 Derivatives and Hedging (“ASC 815”), which requires enhanced disclosures about a company’s derivative instruments and hedging activities and was effective for fiscal years beginning after November 15, 2008. The adoption of ASC 815 on January 1, 2009 did not have any impact on our consolidated financial statements and the additional disclosures can be found at Note 10 - Derivatives and Risk Management.
4. Acquisitions, Divestitures and Discontinued Operations
Acquisitions
On April 30, 2010, we purchased 100 percent of the shares of Novomatrix Pte. Ltd. (“Novomatrix”) for $73, subject to a working capital adjustment. Novomatrix is a leader in branding, marketing, and distributing performance window films catering to the premium segment in the automotive and architectural markets. The Novomatrix acquisition allows us to support our growth strategy for our Performance Films reporting segment by expanding our product offerings and global footprint into key emerging regions through Novomatrix’s well-established network in Southeast Asia and the Middle East.
On June 1, 2010, we purchased 100 percent of the shares of Etimex Solar GmbH (“Vistasolar”) for $294 and $3 of incremental working capital. Vistasolar is a leading supplier of EVA encapsulants to the photovoltaic market which enables us to expand our Advanced Interlayers product portfolio into each of the dominant photovoltaic encapsulant technologies.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
The Novomatrix and Vistasolar acquisitions were accounted for as business combinations, and accordingly, the assets and liabilities of the acquired entities were recorded at their estimated fair value. The purchase price allocation for Novomatrix is subject to adjustments, principally driven by the working capital true-up mechanism. Possible other Novomatrix adjustments to recorded fair value may include those relating to deferred tax assets and liabilities and adjustments to the amount of recorded goodwill as a result of a final working capital true-up. The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of both acquisitions, including the impact of fourth quarter 2010 refinements to preliminary allocations.
Goodwill resulting from both acquisitions is not deductible for tax purposes. See Note 6 - Goodwill and Other Intangible Assets for further information, including allocation of goodwill by segment. Goodwill largely consists of expected growth synergies through the application of each company’s innovative technologies and expansion of distribution channels in emerging markets in addition to cost synergies resulting from manufacturing and supply chain work process improvements.
The following table presents the weighted average life in years and the gross carrying value of the identified intangible assets included in net identified intangible assets within the Consolidated Statement of Financial Position on the date of acquisition of Novomatrix and Vistasolar. The fair value of the identified intangible assets was determined using Level 3 inputs as defined by U.S. GAAP under the fair value hierarchy, which included valuation reports prepared by third party appraisal firms.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Effective May 1, 2010 and June 1, 2010, results from the operations of Novomatrix and Vistasolar, respectively, have been included in our Consolidated Statement of Operations. We incurred $7 of acquisition related costs, including legal and accounting fees, in 2010. These costs were recorded in selling, general and administrative expenses during the first half of the year.
A summary of the net sales for both acquisitions included in our Consolidated Statement of Operations subsequent to the date of acquisition is as follows:
Each of the acquisitions has been integrated into existing operating segments which utilize a shared cost structure. Accordingly, it is not practical to calculate the net income and net income per share attributable to each since the date of acquisition.
The following pro forma financial information presents the combined results of operations of Solutia as if Novomatrix and Vistasolar had been included in our Consolidated Statement of Operations for the entire twelve months ended December 31, 2010 and 2009. The pro forma results below are not necessarily indicative of what actually would have occurred had the acquisitions been in effect for the periods presented and should not be taken as representation of our future consolidated results of operations. Pro forma results, including the assumption of additional interest expense of approximately $25 in conjunction with assumed higher debt levels in 2009, are as follows:
Divestitures
Perkalink®
On November 8, 2010, we entered into an agreement to sell our Perkalink® anti-reversion agent business for $5 effective November 3, 2010. We recognized a gain of $5 in other operating income, net related to this sale in our Technical Specialties reporting segment.
Plastic Products
On September 1, 2010, we sold the remaining portion of our plastic products business, which was based in Europe, for $3 resulting in the recognition of a loss of $5 in other operating income, net related to this sale in Unallocated and Other.
On August 28, 2009, we entered into an agreement to sell the North American portion of our plastic products business for $2 effective August 1, 2009. As a result, we recognized a loss of $5 in other operating income, net during 2009 in Unallocated and Other.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Thiurams
On November 24, 2009, we announced the sale of our customer list and technology related to select products in our PERKACIT® ultra accelerators product line (“Thiurams Sale”) for $4, which resulted in a gain of $4 recorded in other operating income, net during 2009 in the Technical Specialties reportable segment. As part of the Thiurams Sale, we entered into an agreement with the buyer to produce the select products through March 31, 2010 (“Tolling Agreement”) for $4. At the end of the Tolling Agreement, we ceased manufacturing at the Akzo Nobel facility in Cologne, Germany (“Cologne Facility”) where we operated as a guest. As a result of our exit from the Cologne Facility in 2010, certain restructuring charges were incurred, which are discussed in further detail in Note 5 - Impairment of Long-Lived Assets and Restructuring Reserves.
Discontinued Operations
Primary Accelerators
On April 22, 2010, due to overcapacity within the industry, a disadvantaged cost position and increasing pressure from Far Eastern producers, we announced our decision to exit our Primary Accelerators business and to cease manufacturing of SANTOCURE® primary accelerator products at the Monsanto Company (“Monsanto”) facility in Antwerp, Belgium, where we operated as a guest. Our decision to exit this business is consistent with our portfolio strategy of focusing on businesses that are leaders in their global markets and that have sustainable competitive advantages. Manufacturing of these products, which had previously been included in our Technical Specialties reportable segment, ceased in the third quarter 2010. Accordingly, we have reported the results of Primary Accelerators as a discontinued operation and restated prior periods to reflect this presentation.
A summary of the net sales and income (loss) from discontinued operations related to our Primary Accelerators business is as follows:
Included in the results of discontinued operations in 2010 is $44 of pre-tax expenses related to the shutdown of this business. The shutdown expenses include $6 for impairment of long-lived assets using a Level 3 fair value measurement as defined by U.S. GAAP under the fair value hierarchy. We anticipate recognizing severance related expenses of $1 to $3 in the next six to twelve months to complete the shutdown of this business although there can be no assurance as to what the ultimate expenses will be.
In December 2010, we sold selected assets of this business for $5. As a result of the sale, we recognized a pre-tax gain of $5 in loss from discontinued operations in 2010.
The assets and liabilities of our Primary Accelerators business, classified as discontinued operations, consist of the following:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Integrated Nylon
On June 1, 2009, we sold substantially all the assets and certain liabilities, including environmental remediation and pension liabilities of active employees, of our Integrated Nylon business to S.K. Capital Partners II, L.P. (“Buyer”), a New York-based private equity firm, resulting in the realization of a loss of $76, which was recorded in income (loss) from discontinued operations in 2009. Prior to the completion of the sale, but upon the receipt of a definitive sales agreement, we wrote the carrying value of fixed assets down from $48 to their estimated fair value of zero, resulting in a $31 loss, net of tax, which was also recorded in income (loss) from discontinued operations. The fair value of these long-lived assets was developed using the definitive sales agreement, which is a Level 2 fair value measurement under the fair value hierarchy.
At the time of the sale, we agreed to reimburse the Buyer for indirect residual costs incurred by them resulting from a disputed contractual matter with a guest at the Integrated Nylon plant in Alvin, Texas. Our estimate of the loss associated with the damages and cost reimbursements associated with this contingent liability was accrued in 2009. On April 20, 2010, we entered into a settlement agreement that resolved all outstanding matters with the guest in exchange for payment by us of $17. Separately, we entered into an agreement with the Buyers whereby our liability for indirect residual costs at the plant was settled in exchange for payment by us of $4. Each settlement became effective and was paid in 2010. Based on the terms of the settlements, we recognized a gain of $17 in 2010 in income (loss) from discontinued operations.
In 2008, we performed an impairment test by estimating the fair value of our Integrated Nylon asset group by weighting estimated sales proceeds and discounted cash flows that the asset group could be expected to generate through the time of an assumed sale. This test resulted in an impairment charge of $461, which was recorded in income (loss) from discontinued operations for the ten months ended December 31, 2008.
A summary of the net sales and income (loss) from discontinued operations related to our Integrated Nylon business is as follows:
The carrying amounts of assets and liabilities for Integrated Nylon, classified as discontinued operations, consist of the following:
As part of the sales agreement with the Buyer, we retained a 2 percent ownership interest in this asset group, which we account for using the cost method. During the twelve months ended December 31, 2010, we recognized dividend income of $6 in other income, net associated with this investment.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Resins, Additives and Adhesives Businesses
On January 31, 2003, we sold the resins, additives and adhesives businesses. In 2007, a reserve was recognized in income (loss) from discontinued operations in the Consolidated Statement of Operations to provide for a potential liability for on-going tax audits of these businesses for the years 2000 through 2004. During 2009 and 2008, changes related to the tax audits for our 100 percent owned subsidiary, Solutia Deutschland GmbH, resulted in a $1 gain for both the twelve months and ten months ended December 31, 2009 and 2008, respectively, in income (loss) from discontinued operations.
5. Restructuring Reserves
In an effort to maintain competitiveness across our businesses and the geographic areas in which we operate and to enhance the efficiency and cost effectiveness of our support operations, we periodically initiate certain restructuring activities which result in charges for costs associated with exit or disposal activities, severance and/or impairment of long-lived assets. A summary of these activities for 2010, 2009 and 2008 is as follows:
Cologne Facility Closure
As a result of the Thiurams Sale (see Note 4 - Acquisitions, Divestitures and Discontinued Operations), we ceased manufacturing at the Cologne Facility in 2010 upon expiration of the Tolling Agreement. A summary of the charges associated with this project recorded within our Technical Specialties reportable segment during the year ended and cumulative through December 31, 2010 is as follows:
Based on current information, no further charges are expected.
General Corporate
In the fourth quarter of 2008, we initiated a general corporate restructuring targeted to increase the efficiency and cost effectiveness of our support operations. Throughout 2009, this project expanded in scope to include a reduction in operational personnel in order to more appropriately match our organization with production levels. A summary of the employee reduction charges associated with this project during the year ended December 31, 2010 and cumulative charges through December 31, 2010 are as follows:
In addition to the employee reduction charges recorded in selling, general and administrative expenses, we incurred $1 of charges in Unallocated and Other in 2009 for future contractual payments related to the relocation of certain regional support operations from Singapore to Shanghai, China. Based upon current information, we do not expect to incur any additional charges.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Ruabon Facility Closure
Due to overcapacity within the industry, a disadvantaged cost position and increasing pressure from Far Eastern producers, we ceased the manufacturing of certain rubber chemicals at our facility in Ruabon, Wales, United Kingdom (“Ruabon Facility”) in the third and fourth quarters of 2008 with a current expected final closure of the plant in 2014. A summary of the charges and changes in estimates associated with this project during the year ended December 31, 2010 and cumulative charges through December 31, 2010 as recorded in cost of goods sold are as follows:
(a)
We reduced the future contractual payment reserve by $5 due to a renegotiation of the lease and operating agreement with our third party operator. The new lease and operating agreement, which is effective from September 1, 2009 through December 31, 2013, reduced the services to be provided and increased certain fees allowing the contract to provide an economic benefit.
To complete the closure process, based on current information, we expect to incur an additional $2 in charges as an increase to cost of goods sold within our Technical Specialties reportable segment for other restructuring costs including demolition.
Trenton Sheet Facility Closure
In an effort to balance our North America production with customer demand, in the fourth quarter of 2008, we announced the closure of our SAFLEX® manufacturing line at our facility in Trenton, Michigan (“Trenton Facility”) in 2009. During the twelve months ended December 31, 2009 and ten months ended December 31, 2008, we incurred charges of $5 and $10 in cost of goods sold.
Plastic Products Manufacturing Relocation
To improve our cost position, we relocated the manufacturing operations of our plastic products business in 2008 from Ghent, Belgium to Oradea, Romania. During the ten months ended December 31, 2008, $2 of costs, categorized as other restructuring costs within Unallocated and Other, was charged to cost of goods sold for this restructuring event. As discussed in Note 4 - Acquisitions, Divestitures and Discontinued Operations, this business was subsequently sold in 2010.
Restructuring Summary
The following table summarizes the above noted restructuring charges, amounts utilized to carry out those plans and amounts remaining at December 31, 2010:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
We expect $5 of restructuring liabilities as of December 31, 2010 to be utilized within the next twelve months.
6. Goodwill and Other Intangible Assets
Goodwill
Goodwill by reportable segment is as follows:
The goodwill recognized during the twelve months ended December 31, 2010 in the Advanced Interlayers and Performance Films reportable segments relates to the Vistasolar and Novomatrix acquisitions, respectively, as discussed in Note 4 - Acquisitions, Divestitures and Discontinued Operations. We do not have any goodwill that is deductible for tax purposes.
Identified Intangible Assets
Identified intangible assets are comprised of (i) amortizable customer relationships, unpatented technology, contract-based intangible assets, trade names and patents and (ii) indefinite-lived trademarks not subject to amortization. These intangible assets are summarized in aggregate as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
The fiscal year 2010 and 2009 annual goodwill and indefinite-lived intangible assets tests were performed as of November 30, 2010 and 2009, and no indication of impairment existed as of either date. During the ten months ended December 31, 2008, we recorded an impairment charge of $3 within our Performance Films reportable segment to reflect a write down of trademarks. The charge was recorded in selling, general, and administrative expenses in the Consolidated Statement of Operations and was determined after comparing the fair value, estimated by discounting future cash flows attributable to this asset, to its carrying value. The impairment charge was precipitated by an expectation of a lower percentage of projected cash flows attributable to trademark branded window film products, which became apparent during the fourth quarter of 2008 in conjunction with the completion of our annual budget and long-range plan process
Completion of our annual budget and long-range plan in the fourth quarter of 2010 resulted in us reclassifying one trademark with a carrying value of $7 from indefinite-lived to amortizable. Consequently, in the fourth quarter of 2010, we began amortizing this asset over a ten year life.
Amortization expense and its allocation to cost of goods sold and selling, general and administrative expenses recognized in the Consolidated Statement of Operations is as follows:
We expect amortization expense for intangible assets to be approximately $39 annually from 2011 through 2015.
7. Detail of Certain Balance Sheet Accounts
Components of inventories were as follows:
At December 31, 2009, approximately 30 percent of all inventories were valued using the LIFO method. On January 1, 2010, we changed our method of accounting for inventories in the United States, excluding supplies, from determining cost using the LIFO method to determining cost using the FIFO method. All of our other operations will continue to be valued at cost, determined by the FIFO method. We believe this change is preferable as the FIFO method better reflects the current value of inventories on the Consolidated Statement of Financial Position. Furthermore, the application of the FIFO method provides a uniform costing method across our global operations. Prior financial statements have not been retroactively adjusted due to immateriality. The cumulative effect of the change in accounting principle of $1 was recorded as an increase to cost of goods sold as of January 1, 2010.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
In connection with the adoption of fresh-start accounting, inventories were recorded at the selling price less cost to sell resulting in the elimination of the LIFO reserve and a step-up in basis of $67 at the Effective Date. The $67 step-up in basis was charged to cost of goods sold in the Successor Consolidated Statement of Operations during the ten months ended December 31, 2008.
Components of property, plant and equipment were as follows:
Components of accrued liabilities were as follows:
8. Income Taxes
The components of income (loss) from continuing operations before income taxes were as follows:
The components of income tax expense recorded in continuing operations were as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Income tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 35 percent to income (loss) from continuing operations before income taxes as a result of the following:
(a)
During the two months ended February 29, 2008, a non-consolidated equity affiliate surrendered a prior year loss that was used to offset a foreign subsidiary’s taxable income in the United Kingdom.
A tax benefit of $21 included in taxes related to foreign earnings was entirely offset by an increase in tax contingency adjustment.
We have been granted tax holidays in Malaysia and China. The Malaysia holidays expire in 2012 and 2013, and the China holidays phase out between 2009 and 2012. The aggregate benefits on income tax expense were $14 and $11 in the twelve months ended December 31, 2010 and 2009, respectively, $6 in the ten months ended December 31, 2008 and $1 in the two months ended February 29, 2008.
State income taxes and U.S. permanent book/tax differences are predominately offset by changes in the valuation allowance and are reported, net of valuation allowance offset, with "Other" increase (reduction) in income taxes in the schedule above.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Deferred income tax balances were related to:
Deferred tax assets are reduced by valuation allowances resulting in our best estimate of the amount of deferred tax assets that are more likely than not to be realized. The valuation allowances are affected by items not included in our components of income tax expense from continuing operations, including certain changes in estimated foreign tax credit carryforwards available and in unrecognized tax benefits, the tax effects of undistributed earnings of foreign subsidiaries not indefinitely reinvested, the tax effects of discontinued operations, deferred tax items recorded to accumulated other comprehensive loss and the completion of income tax returns.
For each tax-paying component and within a particular tax jurisdiction, (i) all current deferred tax liabilities and assets are offset and presented as a single amount and (ii) all noncurrent deferred tax liabilities and assets are offset and presented as a single amount. This approach results in the following classification on the Consolidated Statement of Financial Position as of December 31, 2010 and 2009:
At December 31, 2010, 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 2029. At December 31, 2010, foreign tax credit carryforwards available upon election to reduce possible future U.S. income taxes were estimated to be approximately $139, which will expire in 2018 through 2020. Income taxes and remittance taxes have not been recorded on $103 of undistributed earnings of subsidiaries because we intend to reinvest those earnings indefinitely. It is not practicable to estimate the tax effect of remitting these earnings to the U.S.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Net Operating Loss and Valuation Allowance
At December 31, 2010, various federal, state and foreign net operating loss carryforwards were available to offset future taxable income. These net operating losses expire from 2011 through 2028 or have an indefinite carryforward period. A full valuation allowance has been provided against the U.S. deferred tax assets. The valuation allowance will be retained until there is sufficient positive evidence to conclude that it is more likely than not that the deferred tax assets will be realized.
As a result of the issuance of our common stock upon emergence from bankruptcy, we realized a change of ownership for purposes of Section 382 of the Internal Revenue Code. We do not currently expect this change to significantly limit our ability to utilize our U.S. net operating loss carryforward, which we estimated to be approximately $1,600 at December 31, 2010, of which approximately $700 was available without limitation. As discussed in Note 15 - Capital Stock, during the third quarter of 2009, our Board of Directors approved a net operating loss shareholder rights plan (“Rights Plan”) which is intended to reduce the likelihood of an additional ownership change within the meaning of Section 382 of the Internal Revenue Code and thereby preserve our ability to utilize our U.S. net operating loss carryforward.
Unrecognized Tax Benefits
The total amount of unrecognized tax benefits, inclusive of interest and penalties, at December 31, 2010 and 2009 was $167 and $155, respectively. The increase in this amount is mainly the result of tax positions with respect to events in the current year offset by the closure of tax audits, statute of limitation expirations and currency exchange fluctuations. Included in the balance at December 31, 2010 and 2009 were $68 and $54, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax rate.
We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense. As of December 31, 2010, we accrued $4 for interest and $4 for penalties. As of December 31, 2009 the amount accrued was $5 for interest and $6 for penalties.
A reconciliation of the beginning and ending amount of unrecognized tax benefits (exclusive of interest and penalties) is as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
We file income tax returns in the United States and various state and foreign jurisdictions. We are no longer subject to U.S. federal and state and local income tax examinations by tax authorities for years before 2002. With few exceptions, we are no longer subject to foreign income tax examinations by tax authorities for years before 2006. It is reasonably possible that within the next twelve months as a result of the resolution of Federal, state and foreign examinations and appeals, and the expiration of various statutes of limitation that the unrecognized tax benefits that would affect the effective tax rate will decrease by a range of $0 to $33 and the unrecognized tax benefits that would not affect the effective tax rate will decrease by a range of $0 to $3.
9. Debt Obligations
On the Effective Date, we recapitalized our debt concurrent with our emergence from bankruptcy by entering into certain financing agreements to borrow up to $2.05 billion from a syndicate of lenders (the “Financing Agreements”). The Financing Agreements consisted of (i) a $450 senior secured asset-based revolving credit facility (“2013 Revolver”), which we voluntarily reduced to $350 in 2009, (ii) a $1.2 billion senior secured term loan facility (“2014 Term Loan”) and (iii) a $400 senior unsecured bridge facility (“Bridge”), which was repaid in August 2008 with proceeds from the stock offerings discussed in Note 15 - Shareholders’ Equity. Proceeds from the Financing Agreements and existing cash were used to (i) repay the debtor-in-possession credit facility, (ii) retire Solutia Services International S.C.A./Comm. V.A.’s Facility Agreement due 2011, (iii) retire the Flexsys term loan and revolving credit facility due 2012, (iv) pay certain secured and administrative claims and (v) provide additional liquidity for operations.
During the second quarter of 2009, $74 of senior unsecured term debt, due 2011, at a price of 95 percent of its original principal amount was issued by our 100 percent owned German subsidiary, Flexsys Verkauf GmbH (the “Senior Term Loan”). Net proceeds of $66, after incorporating the original issue discount and debt issuance fees, were used to pay down our 2013 Revolver. On June 25, 2009, we repaid the Senior Term Loan utilizing a portion of the $119 of proceeds from our 2009 stock offering discussed in Note 15 - Shareholders’ Equity. As a result of the early payment, we incurred a non-cash charge of $8 to loss on debt extinguishment to write-off unamortized debt issue costs and debt discount related to the Senior Term Loan.
In the fourth quarter of 2009, we issued $400 of 8.75 percent senior unsecured notes, due 2017 (“2017 Notes”). A portion of the $391 net proceeds received from the 2017 Notes were used to pay down $300 of principal on the 2014 Term Loan. As a result of the early payment, we incurred a $30 non-cash charge to loss on debt extinguishment to write-off unamortized debt issue costs related to the 2014 Term Loan. In conjunction with the issuance of the 2017 Notes, we amended our Revolver and Term Loan to provide greater operational and strategic flexibility in addition to increasing our liquidity and leverage covenant cushion.
In the first quarter of 2010, we issued $300 of 7.875 percent notes due 2020 (“2020 Notes”), which resulted in net proceeds to us of $292, after deducting underwriting discounts and fees. In addition, we extinguished our existing $1.2 billion 2014 Term Loan and $350 2013 Revolver, replacing them with a $1,150 senior secured credit facility (“Credit Facility”). The Credit Facility consists of an $850 term loan maturing in 2017 (“2017 Term Loan”) and a $300 revolving credit facility maturing in 2015 (“2015 Revolver”). As a result of the early extinguishment of our 2014 Term Loan and 2013 Revolver, we incurred an $80 non-cash charge related to the write-off of deferred debt issuance costs on our 2014 Term Loan and 2013 Revolver and a $9 prepayment penalty for the early extinguishment of the 2014 Term Loan. These amounts were recorded in loss on debt extinguishment for the twelve months ended December 31, 2010.
Throughout 2010, we made principal payments of $82 on the 2017 Term Loan, of which $76 was voluntary. Our long-term debt consisted of the following as of December 31, 2010 and 2009:
We had no short-term borrowings at December 31, 2010 and $16 at December 31, 2009, comprised of other lines of credit.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
The weighted average interest rate on our total debt outstanding was 6.4 percent and 7.7 percent at December 31, 2010 and December 31, 2009, respectively. Our weighted average interest rate on short-term debt outstanding was 2.1 percent at December 31, 2009.
The 2017 Term Loan was issued at 99.5 percent of the principal amount bearing interest at LIBOR plus an applicable margin based upon our net leverage ratio, with a 1.50 percent LIBOR floor. In November 2010, our applicable margin decreased from 3.25 percent to 3 percent as our net leverage ratio fell below 2.5. We are required to pay 1 percent of the principal of the 2017 Term Loan annually via quarterly payments, which has been fully satisfied through maturity due to our voluntary prepayments. The 2015 Revolver bears interest, at our option, at LIBOR plus an applicable margin based upon our net leverage ratio, with no LIBOR floor or the prime rate plus 2.25 percent with no prime rate floor. Based upon our current net leverage ratio, our margin on our 2015 Revolver is 3.25 percent. LIBOR-based interest for the 2017 Term Loan and 2015 Revolver is payable on the last day of each relevant interest period (defined as one, two, three or six months or other periods available to all lenders under each facility) and, in the case of any interest period longer than three months, on each successive date three months after the first day of such interest period. Prime-based interest for the 2015 Revolver is payable quarterly in arrears. CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc. and future subsidiaries, as defined by the Credit Facility, subject to certain exceptions (the “Credit Facility Guarantors”), are guarantors of our obligations under the Credit Facility. The Credit Facility and related guarantees are secured by liens on substantially all of our and the Credit Facility Guarantors’ present and future assets.
The 2017 Notes were issued at par bearing interest at 8.75 percent and require semi-annual interest payments. The 2020 Notes were issued at 99.5 percent of par and require semi-annual interest payments. Our current subsidiaries CPFilms Inc., Flexsys America L.P., Flexsys America Co., Monchem International, Inc., Solutia Overseas, Inc. S E Investment LLC and future subsidiaries as defined by the 2017 Notes and 2020 Notes (collectively “the Notes”), subject to certain exceptions, are guarantors (“Note Guarantors”) of the Notes as of December 31, 2010. Solutia Business Enterprises Inc. and Solutia Inter-America, Inc., previous guarantors of the 2017 Notes, 2020 Notes and 2017 Term Loan, were merged into Solutia Inc. during 2010.
The Credit Facility and the Notes include a number of customary covenants and events of default, including the maintenance of certain financial covenants that restrict our ability to, among other things, incur additional debt; make certain investments; pay dividends, repurchase stock, sell certain assets or merge with or into other companies; enter into new lines of business and prepay, redeem or exchange our debt. The Credit Facility also includes the maintenance of the following financial covenants: (i) total leverage ratio and (ii) fixed charge coverage ratio as defined by the Credit Facility. We were in compliance with all applicable covenants as of December 31, 2010.
Maryville Notes
In the second quarter of 2008, we completed the sale and leaseback of our corporate headquarters for $43 and repaid the balance outstanding on the promissory notes on our corporate headquarters with a portion of the sale proceeds.
10. Derivatives and Risk Management
Our business operations give rise to market risk exposures that result from changes in foreign currency exchange rates, interest rates and certain commodity prices. To manage the volatility relating to these exposures, we periodically enter into various derivative transactions that enable us to mitigate the adverse effects of financial market risk. We evaluate hedge effectiveness at inception and on an ongoing basis. If a derivative is no longer expected to be effective or if the hedged transaction is no longer probable of occurring, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded into earnings.
Our approved policies and procedures do not permit the purchase or holding of any derivative financial instruments for trading purposes. Management of counterparty credit risk is achieved through diversification and credit rating reviews of the firms with whom we transact.
Interest Rate Risk
We occasionally enter into interest rate swap contracts to manage interest rate exposures. In 2008, we entered into interest rate swap agreements with a total notional amount of $800 (“2008 Swaps”) in order to secure a fixed interest rate on a portion of our then existing floating interest rate term debt. Through the first quarter 2009, we designated the 2008 Swaps as cash flow hedges and any changes in fair value were recorded to accumulated other comprehensive loss, a component of equity. Thereafter, and as more fully described below, we discontinued hedge accounting on the 2008 Swaps because these derivatives were no longer expected to be effective.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
The 2008 Swaps have declining total notional amounts of $800 to $150 which are operational from the second quarter of 2010 through the first quarter of 2014. As these derivatives were no longer expected to be effective, we discontinued hedge accounting in the first quarter 2009 and all subsequent changes in fair value are recognized as interest expense in the Consolidated Statement of Operations. After assessing existing interest rate market conditions and to neutralize the impact to earnings, in the third quarter of 2010, we entered into interest rate swap agreements that offset the 2008 swaps. The offsetting swaps are operational beginning in the third quarter of 2010 with total notional amounts, operational dates and other terms that effectively mirror the 2008 Swaps. Further, to mitigate the exposure to variable interest rates on the 2017 Term Loan, we entered into interest rate swap agreements with a total notional amount of $600 (“2010 Swaps”) that are operational beginning in the third quarter of 2010 in order to secure a fixed interest rate on a portion of the floating interest rate term debt. The total notional amount of the 2010 Swaps declines to $200 through the fourth quarter of 2015. The 2010 Swaps were designated as cash flow hedges and therefore any changes in fair value were recorded to accumulated other comprehensive loss.
Foreign Currency Exchange Rate Risk
We use foreign currency derivative instruments to manage the volatility associated with foreign currency purchases of materials and other assets and liabilities created in the normal course of business and to protect against exposure related to intercompany financing transactions. These risks are hedged primarily through the use of forward exchange contracts and purchased options with maturities of less than 18 months. We have chosen not to designate these instruments as hedges to allow the changes in the fair value of these instruments to largely offset the remeasurement of the underlying assets and liabilities in the Consolidated Statement of Operations. We had currency forward contracts to purchase and sell $104 and $167 of currencies comprised principally of the Euro, U.S. Dollar and Malaysian Ringgit as of December 31, 2010 and 2009, respectively.
Commodity Price Risk
We periodically enter into a limited number of commodity forward contracts in order to reduce cash flow exposure to changes in the price of certain raw materials and energy resources. In 2009, we entered into commodity forward contracts related to our Integrated Nylon business. At December 31, 2010 and 2009, we had no such contracts outstanding requiring fair value treatment.
Our derivatives recorded at their respective fair values at December 31, 2010 and 2009 in the Consolidated Statement of Financial Position are summarized as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
A summary of the gains and losses on our derivative instruments for the years ended December 31, 2010 and 2009 included in the Consolidated Statement of Operations and Consolidated Statement of Financial Position is as follows:
(a) - We reclassified $7 and $1 of losses from accumulated other comprehensive loss to interest expense during the years ended December 31, 2010 and 2009, respectively, related to the 2008 Swaps.
As of December 31, 2010, deferred losses of $9 related to 2008 Swaps and the 2010 Swaps, currently classified in accumulated other comprehensive loss are expected to be reclassified into earnings as interest expense over the next twelve months.
11. Financial Instruments and Risk Management
The following tables present our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
(a)
Includes cash invested in money market funds.
(b)
Includes foreign currency forward and options contracts which are valued using an income approach based on the present value of the forward rate less the contract rate multiplied by the notional amount.
(c)
Includes interest rate caps and swaps which are valued using counterparty quotes, which use discounted cash flows and the then-applicable forward interest rates.
The recorded amounts of cash, trade receivables, accounts payable and short-term debt approximate their fair values at both December 31, 2010 and 2009, due to the short maturity of these instruments. The estimated fair value of our long-term debt at December 31, 2010 is $1,530 compared to the recorded amount of $1,463. The estimated fair value of our long-term debt at December 31, 2009 was $1,309 compared to the recorded amount of $1,276 (including current portion of long-term debt). The fair values are estimated by various banks based upon trading levels on the date of measurement.
12. Pension Plans and Other Postretirement Benefits
During our Chapter 11 Case, we amended our U.S. qualified pension plan (“U.S. Plan”) in 2004 and 2005 to cease future benefit accruals for union and non-union participants, respectively, in these plans which eliminated service costs for benefits earned as a pension benefit cost. Furthermore, we amended our U.S. postretirement plan in accordance with the Plan for retiree participants and established a VEBA retiree trust at the Effective Date. The postretirement plan amendments, which became effective on the Effective Date, reduces the eligible charges covered by the postretirement plan and establishes a lifetime maximum benefit. This action resulted in a curtailment of the U.S. postretirement plan due to the changes in medical benefits provided to retiree participants in our U.S. postretirement plan. The net result of this action was a $109 gain recorded in accumulated other comprehensive loss in the Consolidated Statement of Financial Position as of February 29, 2008. The VEBA retiree trust, valued at $184 as of December 31, 2010 and funded at emergence by proceeds from the sale of our new common stock and a contribution of the retirees’ allowed unsecured claim, effectuates full defeasance of the remaining healthcare and other benefits liabilities assumed by us at the Solutia Spinoff.
In preparation for the sale of our Integrated Nylon business, we divided our U.S. Plan into the following three plans, effective February 28, 2009: (i) Nylon Pension Plan; (ii) Solutia Pension Plan; and (iii) Solutia Union Pension Plan. The Nylon Pension Plan covers all active employees of the Integrated Nylon business. In accordance with the terms of the sale agreement as further described in Note 4 - Acquisitions, Divestitures and Discontinued Operations, the Nylon Pension Plan was assumed by the Buyer at the completion of the sale.
As a result of the division of the U.S. Plan into three plans, we were required to perform a funded analysis in accordance with the Pension Protection Act of 2006 (“PPA”). The result of this analysis is the Solutia Pension Plan and the Solutia Union Pension Plan are prohibited by the PPA from paying out lump sum benefits, until such time as plan assets rise above the 60 percent funding level for up to half a lump sum or above the 80 percent funding level for a full lump sum. As of December 31, 2010, the Solutia Pension Plan was permitted to pay out half lump sums.
We use a measurement date of December 31 for our pension and other postretirement benefit plans.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Net Periodic Cost
For the twelve months ended December 31, 2010 and 2009, the ten months ended December 31, 2008 and the two months ended February 29, 2008 our pension and healthcare and other benefit costs were as follows:
The estimated amount of net actuarial loss (gain) that will be amortized from accumulated other comprehensive loss into net periodic costs during the year ended December 31, 2011 is $12 and $(7) for our Pension Benefits and our Healthcare and Other Benefits, respectively.
Curtailments and Settlements
For the twelve months ended December 31, 2010, we recorded a settlement charge of $2 resulting from the significant amount of lump sum distributions in Belgium, associated with a reduction of salaried personnel throughout 2010. As a result of the assumption of the Nylon Pension Plan by the Buyer, we recognized a settlement charge of $20 which was recorded in income (loss) from discontinued operations for the twelve months ended December 31, 2009. For the twelve months ended December 31, 2009, we recorded a settlement charge of $11 resulting from the significant amount of lump sum distributions, predominantly in the U.S. and Belgium, associated with a reduction of salaried personnel prior to February 28, 2009 and union personnel throughout 2009. All reductions were driven by restructuring activities as more fully discussed in Note 5 - Impairment of Long-Lived Assets and Restructuring Reserves. We recorded a pension settlement charge of $1 in the two months ended February 29, 2008 resulting from the significant amount of lump sum distributions from our Belgium retirement plan.
Actuarial Assumptions
The significant weighted average actuarial assumptions used to determine net periodic cost for our pension, healthcare and other benefit plans were as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
(a)
The rate of compensation increase in all periods relates specifically to our foreign pension plans. The rate of compensation increase is not applicable to the valuation of U.S. pension plans due to the cessation of future benefit accruals in prior years for participants in the U.S. pension plans.
We establish our discount rates 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 plan assets assumption is based on the target asset allocation policy and the expected future rates of return on assets for each specific plan.
A 1 percent change in the assumed health care cost trend rates would have the following effect as of December 31, 2010:
Our 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.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Benefit Obligations
Components of the changes in the benefit obligation of our pension, healthcare and other benefit plans were as follows:
The significant weighted average actuarial assumptions used to estimate the projected benefit obligation for our pension, healthcare and other benefit plans were as follows:
(a)
The rate of compensation increase for all periods relates specifically to our foreign pension plans. The rate of compensation increase is not applicable to the valuation of U.S. pension plans due to the cessation of future benefit accruals in prior years for participants in the U.S. pension plans.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Plan Assets
Plan investments, whether equity or debt securities, real estate, or other, are measured at their fair value as of the measurement date. Components of the changes in fair value of plan assets of our plan assets were as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
At December 31, 2010, plan investments were valued as follows:
(a)
Common collective trusts are comprised of shares or units in commingled funds that are not publicly traded. The underlying assets in these funds (primarily equity and fixed income securities) are valued using a market approach with either unadjusted quotes in active markets (Level 1) or quoted prices for similar assets or other observable inputs (Level 2).
(b)
Corporate bonds consist of fixed income securities issued by U.S. and non-U.S. corporations. These assets are valued using a bid evaluation process with bid data provided by independent pricing sources.
(c)
Government agency securities consist of bills, notes, bonds, and other fixed income securities issued directly by the U.S. Treasury or other government-sponsored enterprises. These assets are valued using a bid evaluation process with bid data provided by independent pricing sources.
(d)
Asset backed securities are comprised of securities collateralized by a specified pool of underlying assets. These assets are valued using a bid evaluation process with bid data provided by independent pricing sources.
(e)
Cash equivalents consist of money market accounts valued at $1.00 per unit.
(f)
Multi-asset common collective trusts are comprised of shares or units in commingled funds that are not publicly traded. The underlying assets in these funds are equity securities, bonds, mutual funds and term deposits and are valued using a market approach with either unadjusted quotes in active markets (Level 1) or quoted prices for similar assets or other observable inputs (Level 2).
(g)
Private equity funds represent limited partnership interests which are valued by the general partners based on the underlying assets in each fund. Changes in fair value for the twelve months ended December 31, 2010 for these assets were comprised of sales and settlements of $1.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
At December 31, 2009, plan investments were valued as follows:
(a)
Common collective trusts are comprised of shares or units in commingled funds that are not publicly traded. The underlying assets in these funds (primarily equity and fixed income securities) are valued using a market approach with either unadjusted quotes in active markets (Level 1) or quoted prices for similar assets or other observable inputs (Level 2).
(b)
Corporate bonds consist of fixed income securities issued by U.S. and non-U.S. corporations. These assets are valued using a bid evaluation process with bid data provided by independent pricing sources.
(c)
Federal agency securities consist of bills, notes, bonds, and other fixed income securities issued directly by the U.S. Treasury or other government-sponsored enterprises. These assets are valued using a bid evaluation process with bid data provided by independent pricing sources.
(d)
Asset backed securities are comprised of securities collateralized by a specified pool of underlying assets. These assets are valued using a bid evaluation process with bid data provided by independent pricing sources.
(e)
Cash equivalents consist of money market accounts valued at $1.00 per unit.
(f)
Multi-asset common collective trusts are comprised of shares or units in commingled funds that are not publicly traded. The underlying assets in these funds are equity securities, bonds, mutual funds and term deposits and are valued using a market approach with either unadjusted quotes in active markets (Level 1) or quoted prices for similar assets or other observable inputs (Level 2).
(g)
Private equity funds represent limited partnership interests which are valued by the general partners based on the underlying assets in each fund. Changes in fair value for the twelve months ended December 31, 2009 for these assets were comprised of unrealized losses of less than $1.
The weighted-average asset allocation for our pension and other postretirement plans and the target allocation for 2010, by asset category, follows:
Our pension plan asset 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.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Our other postretirement benefits plan asset investment strategy is to invest in short-term, well-diversified, high quality investment instruments, with a primary objective of capital preservation.
Funded Status
The funded status of our plans is measured as the difference between the plan assets at fair value and the projected benefit obligation. The funded status of our principal pension, healthcare and other benefit plans at December 31, 2010 and 2009 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:
The accumulated postretirement benefit obligation exceeds plan assets for all of our other postretirement benefit plans.
We actively manage funding of our domestic qualified pension plans in order to meet the requirements of the IRS and the Pension Benefits Guarantee Corporation (a U.S. federal agency). We contributed $50, $14 of which was voluntary, in the twelve months ended December 31, 2010, $65 in the twelve months ended December 31, 2009, $31 in the ten months ended December 31, 2008 and $15 in the two months ended February 29, 2008 to the qualified pension plans in accordance with IRS funding rules. According to current IRS funding rules, we estimate that we will be required to make approximately $39 in pension contributions to our U.S. qualified pension plans in 2011. In addition, we contributed $18 in the twelve months ended December 31, 2010, $11 in the twelve months ended December 31, 2009, $6 in the ten months ended December 31, 2008 and $2 in the two months ended February 29, 2008, respectively, to fund our foreign pension plans. Moreover, we expect to be required to fund $8 in pension contributions for our foreign pension plans in 2011.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Estimated Future Benefit Payments
Based on current information, estimated benefit payments expected to be made over the next five years and the cumulative five year period thereafter are as follows:
We have available as of December 31, 2010, pension and other postretirement benefit plan assets of $729 and $184, respectively, to fund these future estimated benefit payments.
13. Employee Savings Plans
Substantially all of our U.S. employees are eligible to participate in the Solutia Savings and Investment Plans (“SIP”), a 401(k) plan with matching contributions being invested in the same manner as participants’ personal SIP contributions. For the twelve months ended December 31, 2009, our matching contributions were suspended, subject to any agreements with our unions. Effective in January of 2010, the employer match was reinstated at 50 percent on the first 7 percent of a participant’s qualified contributions with an additional performance match to be determined based upon Company performance. Our cash contributions related to the employer match were $8, of which $4 related to the additional performance match, for the twelve months ended December 31, 2010, $2 in the twelve months ended December 31, 2009, $15 in the ten months ended December 31, 2008 ($8 of which pertains to our Integrated Nylon business) and $3 in the two months ended February 29, 2008 ($2 of which pertains to our Integrated Nylon business). Our SIP matching contribution percentage for eligible employees was 100 percent on the first 7 percent of a participant’s qualified contributions during 2009 and 2008.
14. Share-Based Compensation
All previous equity interests, including shares authorized for grant and options outstanding as of the date of our emergence were cancelled upon the Effective Date. On the Effective Date, pursuant to the Plan, we adopted the Solutia Inc. 2007 Management Long-Term Incentive Plan (“2007 Management Plan”). The 2007 Management Plan, as amended by our stockholders at its annual meeting on April 21, 2010 (“Amended and Restated 2007 Management Plan”), authorizes us to issue up to 10,840,000 shares of our common stock for grants of non-qualified and incentive stock options, stock appreciation rights, restricted stock, restricted stock units and other stock awards. The shares used may be newly issued shares, treasury shares except for shares forfeited for taxes, or a combination. As of December 31, 2010, 3,802,577 shares from the Amended and Restated 2007 Management Plan remain available for grants.
Also on the Effective Date, we adopted the Solutia Inc. 2007 Non-Employee Director Stock Compensation Plan (“2007 Director Plan”). The 2007 Director Plan authorizes up to 250,000 shares of our common stock for grants of stock options, stock appreciation rights, restricted stock, restricted stock units and other stock awards. The shares used may be newly issued shares, treasury shares or a combination. As of December 31, 2010, 114,302 shares from the 2007 Director Plan remain available for grants.
Stock Options
We granted options to purchase a total of 1,037,625, 20,000, and 2,946,544 shares of common stock to eligible employees under the 2007 Management Plan during the twelve months ended December 31, 2010, 2009 and ten months ended December 31, 2008, respectively. No options were granted under our 2007 Director Plan for any periods presented. The options (i) have an exercise price of not less than 100 percent of the fair market value of the common stock on the grant date, (ii) become exercisable in three or four equal installments on the first, second, third, and fourth (if applicable) anniversary of the grant date, subject to the employee’s continued employment and (iii) expire on the tenth anniversary of the grant date.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
We determine the fair value of stock options at the grant date using a Black-Scholes model, which requires us to make several assumptions including risk-free interest rate, expected dividends and volatility. The risk-free rate is based on the U.S. Treasury yield curve in effect for the expected term of the options at the time of grant. The dividend yield on our common stock is assumed to be zero since we do not pay dividends and have no current plans to do so. Due to our Chapter 11 Case, our historical volatility data and employee stock option exercise patterns were not considered in determining the volatility data and expected life assumptions. Instead, the volatility assumptions were based on (i) historical volatilities of the stock of comparable chemical companies whose shares are traded using daily stock price returns equivalent to the expected term of the options and (ii) implied volatility. The expected life of an option was determined based on a simplified assumption that the option will be exercised evenly from the time it becomes exercisable to expiration.
The weighted average fair value of options granted during the twelve months ended December 31, 2010 and 2009 and the ten months ended December 31, 2008 was determined based on the following weighted average assumptions:
A summary of stock option activity for the twelve months ended December 31, 2010 and 2009 and ten months ended 2008 is as follows:
(a)
Intrinsic value for stock options is calculated based on the difference between the exercise price of the underlying awards and the quoted market price of our common stock as of the applicable reporting date. If the exercise price of the underlying awards is higher than the quoted market price of our common stock as of the reporting date, the intrinsic value of the award is $0.
During the twelve months ended December 31, 2010 and 2009 and the ten months ended December 31, 2008, we recognized $5, $6 and $5 of compensation expense related to our stock options, respectively, of which $1 was allocated to discontinued operations for 2009 and 2008. Pre-tax unrecognized compensation expense for stock options, net of estimated forfeitures, was $6 as of December 31, 2010 and will be recognized as expense over a remaining weighted average period of 1.9 years.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Restricted Stock Awards
We granted 639,860 shares and 36,447 shares of restricted stock awards to eligible employees under the Amended and Restated 2007 Management Plan and to our non-employee directors under the 2007 Director Plan, respectively, during the twelve months ended December 31, 2010. Approximately half of the shares granted under the Amended and Restated 2007 Management Plan during the year ended December 31, 2010 vest upon completion of a service condition and the remaining one half of the shares vest based upon the attainment of certain performance and market conditions (“2010 Performance Shares”). The service condition shares vest 100 percent in April 2014 and the Performance Shares vest in April 2013 if attainment of the performance and market conditions is achieved. The actual vesting of the Performance Shares could range from zero to 175 percent of the targeted number of shares depending upon actual performance. Of the shares granted under the 2007 Director plan, 6,227 represent an initial equity retainer that vests in three equal installments on the anniversary of the grant. The remaining balance of the shares, representing annual equity retainers, vest in three equal installments, with the first installment vesting as of the date of the grant and the remaining vesting equally on the first and second anniversary of the grant date. We granted 2,417,859 shares of restricted stock awards to eligible employees under the 2007 Management Plan during the twelve months ended December 31, 2009. Approximately two thirds of the shares granted under the 2007 Management Plan during the year ended December 31, 2009 vest upon completion of a service condition and the remaining one third of the shares vest based upon the attainment of certain performance and market conditions (“2009 Performance Shares”). The service condition shares vest 40 percent in both July 2010 and 2011 and 20 percent in July 2012. The performance and market condition shares vest in February 2012 if attainment of the performance and market conditions is achieved. During the ten months ended December 31, 2008, we granted 1,508,815 shares and 46,160 shares of restricted stock awards to eligible employees under the 2007 Management Plan and to our non-employee directors under the 2007 Director Plan, respectively. The shares granted during the ten months ended December 31, 2008 vest ratably over a three year service period.
A summary of restricted stock award activity for the twelve months ended December 31, 2010, and 2009 and the ten months ended December 31, 2008 is as follows:
During the twelve months ended December 31, 2010 and 2009 and the ten months ended December 31, 2008, we recognized $15, $13 and $8 of compensation expense related to our restricted stock awards, respectively, of which, $1 was allocated to discontinued operations for 2009 and 2008. Pre-tax unrecognized compensation expense for restricted stock awards, net of estimated forfeitures, was $16 as of December 31, 2010 and will be recognized as expense over a remaining weighted average period of 1.8 years.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Other Stock Awards
During the twelve months ended December 31, 2009, our independent directors each received 8,134 shares, or 56,938 shares in aggregate, as the annual equity retainer portion of their 2009 director compensation. For the twelve months ended December 31, 2009, we recognized less than $1 of compensation expense on these awards.
15. Shareholders' Equity
After the Effective Date, our common stock (“New Common Stock”) trades on the New York Stock Exchange (“NYSE”) under the symbol “SOA”. Our common stock prior to filing for Bankruptcy (“Old Common Stock”) was traded on the NYSE under the symbol “SOI”. Our New Common Stock traded on a “when-issued” basis on the NYSE from December 20, 2007 until shortly after the Effective Date, at which time our New Common Stock began trading on a “regular way” basis.
On the Effective Date, all of our Old Common Stock was canceled pursuant to the Plan and we issued 59,749,686 shares of New Common Stock, par value $0.01 per share, of the newly reorganized Solutia in satisfaction of various creditor claims and stockholder interests. In addition, on the Effective Date, we issued warrants to purchase an aggregate of 4,481,250 shares of New Common Stock to holders of Old Common Stock based on a holder’s pre-petition stock ownership, provided that such holder held at least 24 shares of the Old Common Stock (the “Warrants”). Subject to the terms of the warrant agreement, Warrant holders are entitled to purchase shares of New Common Stock at an exercise price of $29.70 per share. The Warrants have a five-year term in which they may be exercised for cash or on a net issuance basis and will expire on February 27, 2013.
During the third quarter 2009, our Board of Directors approved a Rights Plan which is intended to reduce the likelihood of an ownership change within the meaning of Section 382 of the Internal Revenue Code and thereby preserve our ability to utilize certain net operating loss carryforwards and other tax benefits. Our adoption of the Rights Plan effectively attaches one right (“Right”) to each outstanding share of our common stock, to stockholders of record at the close of business on July 28, 2009. If the Rights are triggered, each Right may entitle the holder of the Right to purchase our common stock at a discount to its market price, subject to certain exceptions as set forth in the Rights Plan.
In the second quarter 2009, we completed a public offering (“2009 Stock Offering”) of 24,738,641 shares of common stock, including the over-allotment option as exercised by the underwriters of the offering. Net proceeds from the 2009 Stock Offering were $119. In the third quarter 2008, we completed two public offerings, which in aggregate, resulted in the issuance of 33,021,976 total shares of common stock with net proceeds of $422.
No dividends were paid by the Predecessor in the two months ended February 29, 2008 or by the Successor in the twelve months ended December 31, 2010 and 2009 and the ten months ended December 31, 2008 and we have no current plans to do so.
We have 100 million shares of preferred stock, par value $0.01 per share, authorized. As of December 31, 2010 and 2009 there were no preferred shares issued or outstanding.
16. Commitments and Contingencies
Commitments
Commitments, principally in connection with uncompleted additions to property, were approximately $29 and $5 at December 31, 2010 and 2009, respectively. In addition, we were contingently liable under letters of credit totaling $29 and $49 as of December 31, 2010 and 2009, respectively. The letters of credit included $1 which were cash collaterized both at December 31, 2010 and 2009, 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, 2010 and 2009. Our future minimum payments under operating leases and various unconditional purchase obligations are as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Contingencies
Litigation
We are a party to legal proceedings, which have arisen in the ordinary course of business and involve claims for monetary damages. As of December 31, 2010 and December 31, 2009, we accrued approximately $3 and $2, respectively, for legal costs to defend ourselves in legal matters.
Except for the potential effect of an unfavorable outcome with respect to our Legacy Tort Claims litigation, it is our opinion that the aggregate of all claims and lawsuits will not have a material adverse impact on our consolidated financial statements.
Legacy Tort Claims Litigation
Pursuant to the Amended and Restated Settlement Agreement effective February 28, 2008, entered into by us and Monsanto in connection with our emergence from Chapter 11 (the “Monsanto Settlement Agreement”), Monsanto is responsible to defend and indemnify us for any Legacy Tort Claims as that term is defined in the Monsanto Settlement Agreement, while we retain responsibility for tort claims, if any, which may arise out of our conduct after our spinoff from Pharmacia, which occurred on September 1, 1997. We or our 100 percent owned subsidiary, Flexsys, have been named as defendants in the following actions, and have submitted the matters to Monsanto as Legacy Tort Claims. However, to the extent these matters relate to post Solutia Spinoff conduct or such matters are not within the meaning of Legacy Tort Claims as defined in the Monsanto Settlement Agreement, we could potentially be liable.
Putnam County, West Virginia Litigation. In December 2004, a purported class action lawsuit was filed in the Circuit Court of Putnam County, West Virginia against Flexsys, Pharmacia, Monsanto and Akzo Nobel (Solutia is not a named defendant) alleging exposure to dioxin from Flexsys’ Nitro, West Virginia facility, which is now closed. The relevant production activities at the facility occurred during Pharmacia’s ownership and operation of the facility and well prior to the creation of the Flexsys joint venture between Pharmacia (whose interest was subsequently transferred to us in the Solutia Spinoff) and Akzo Nobel. The plaintiffs are seeking damages for loss of property value, medical monitoring and other equitable relief.
Beginning in February 2008, Flexsys, Monsanto, Pharmacia, Akzo Nobel and another third party were named as defendants in approximately seventy-five individual lawsuits, and Solutia was named in two individual lawsuits, filed in various state court jurisdictions by residents or former residents of Putnam County, West Virginia. The largely identical complaints allege that the residents were exposed to potentially harmful levels of dioxin particles from the Nitro facility. Plaintiffs did not specify the amount of their alleged damages in their complaints. In 2009, over fifty additional nearly identical complaints were filed by individual plaintiffs in the Putnam County area, which named Solutia and Flexsys as defendants, and one additional complaint was filed in January 2011.
The claims in this matter concern alleged conduct occurring while Flexsys was a joint venture between us and Akzo Nobel, and any potential damages in these cases would be evenly apportioned between us and Akzo Nobel to the extent such claims are determined not to be Legacy Tort Claims.
Escambia County, Florida Litigation. In June 2008, a group of approximately fifty property owners and business owners in the Pensacola, Florida area filed a lawsuit in the Circuit Court for Escambia County, Florida against Monsanto, Pharmacia, Solutia and the plant manager at Solutia's former Pensacola plant, an Integrated Nylon asset that was included in the divestiture of our Integrated Nylon business. The lawsuit, entitled John Allen, et al. v. Monsanto Company, et al., alleges that the defendants are responsible for elevated levels of PCBs in the Escambia River and Escambia Bay due to past and continuing releases of PCBs from the Pensacola plant. The plaintiffs seek: (1) damages associated with alleged decreased property values caused by the alleged contamination and (2) remediation of the alleged contamination in the waterways. Plaintiffs did not specify the amount of their alleged damages in their complaint. Plaintiffs have subsequently amended their complaint to add additional plaintiffs to the litigation, such that 111 property and business owners are now named as plaintiffs.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
St. Clair County, Illinois and Related Litigation. In February 2009, a purported class action lawsuit was filed in the Circuit Court of St. Clair County, Illinois against Solutia, Pharmacia, Monsanto and two other unrelated defendants alleging the contamination of the plaintiff’s property from PCBs, dioxins, furans and other hazardous substances emanating from the defendants’ facilities in Sauget, Illinois (including our W.G. Krummrich site in Sauget, Illinois). The proposed class action is comprised of residents who live within a two-mile radius of the Sauget facilities. The plaintiffs are seeking damages for medical monitoring and the costs associated with remediation and removal of contaminants from their property. This action is one of several lawsuits (primarily filed by the same plaintiffs’ counsel) over the past year regarding alleged historical contamination from the W.G. Krummrich site.
In addition to the purported class action lawsuit, twenty additional individual lawsuits have been filed since February 2009 against the same defendants (including Solutia) comprised of claims from over one thousand individual residents of Illinois who claim they suffered illnesses and/or injuries as well as property damages as a result of the same PCBs, dioxins, furans and other hazardous substances allegedly emanating from the defendants’ facilities in Sauget. In June 2010, a group of approximately 1,200 plaintiffs also filed wrongful death claims in a lawsuit in St. Clair County arising out of alleged contamination from the defendants’ facilities. Moreover, four additional individual lawsuits comprised of claims from twelve plaintiffs were filed between January and April 2010 in Madison County, Illinois, alleging that plaintiffs suffered illnesses resulting from exposure to benzene, PCBs, dioxins, furans and other hazardous substances. Lastly, in June 2010, a second purported class action lawsuit was filed in the Circuit Court of St. Louis City, Missouri against the same defendants alleging the contamination of the plaintiffs’ property from PCBs, dioxins, furans and other hazardous substances emanating from the defendants’ facilities in Sauget, Illinois and from our now-closed Queeny plant in St. Louis. The plaintiffs are seeking damages for medical monitoring and the costs associated with remediation and removal of alleged contaminants from their property. The proposed class members include residents exclusively within the state of Missouri.
Upon assessment of the terms of the Monsanto Settlement Agreement and other defenses available to us, we believe the probability of an unfavorable outcome to us on the Putnam County, West Virginia; Escambia County, Florida; and St. Clair County, Illinois and related litigation against us is remote and, accordingly, we have not recorded a loss contingency. Nonetheless, if it were subsequently determined these matters are not within the meaning of Legacy Tort Claims, as defined in the Monsanto Settlement Agreement, or other defenses to us were unsuccessful, it is reasonably possible we would be liable for an amount which cannot be estimated but which could have a material adverse effect on our consolidated financial statements.
Resolution of Tax Indemnification
During the second quarter 2010, we received a favorable settlement in a tax indemnification case related to income taxes we paid on a business for periods prior to our acquisition. The settlement resulted in an $8 gain recorded in other income, net within Unallocated and Other during the year ended December 31, 2010.
Environmental Liabilities
In the ordinary course of business, we are subject to numerous environmental laws and regulations covering compliance matters or imposing liability for the costs of, and damages resulting from, cleaning up sites, past spills, disposals and other releases of hazardous substances. We have incurred, and we may in the future incur, liabilities to investigate and clean up waste or contamination at our current facilities, properties adjacent to our current facilities or facilities operated by third parties at where we may have disposed of waste or other materials. Under some circumstances, the scope of our liability may extend to damages to natural resources for which we have accrued $2 as of December 31, 2010 and 2009, exclusive of the balances noted below. In almost all cases, our potential liability arising from historical contamination is based on operations and other events occurring at our facilities or as a result of their operation prior to the Solutia Spinoff.
Further, under terms of the Monsanto Settlement Agreement and our Plan, we have agreed to share responsibility with Monsanto for the environmental remediation at certain locations outside our plant boundaries in Anniston, Alabama, and Sauget, Illinois which were also incurred prior to the Solutia Spinoff (the “Shared Sites”). Under this cost-sharing arrangement, we are responsible for the funding of environmental liabilities at the Shared Sites from the Effective Date up to a total of $325 after the exhaustion of funds from the special purpose entity dedicated to the Shared Sites. Thereafter, if needed, we and Monsanto will share responsibility equally. From the Effective Date through December 31, 2010, we have made cash payments of $24 million toward remediation of Shared Sites after exhaustion of the special purpose entity funds and have accrued an additional $166 million to be paid over the life of the Shared Sites remediation activity.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Reserves for environmental remediation that we believe to be probable and estimable are recorded appropriately as current and long-term liabilities in the Consolidated Statement of Financial Position. These reserves include liabilities expected to be paid out within fifteen years. The amounts charged to pre-tax earnings for environmental remediation and related charges are included in cost of goods sold and are summarized below:
(a) For the twelve months and ten months ended December 31, 2009 and 2008, allowable expenditures of $28 and $18, respectively, were reimbursed to us by a special purpose entity established with proceeds of stock issued by us on the Effective Date.
In addition to accrued environmental liabilities, there are costs which have not met the definition of probable, and accordingly, are not recorded in the Consolidated Statement of Financial Position. These loss contingencies are monitored regularly for a change in fact or circumstance that would require an accrual adjustment. These matters involve significant unresolved issues, including the interpretation of applicable laws and regulations, the outcome of negotiations with regulatory authorities and alternative methods of remediation. Because of these uncertainties, the potential liability for existing environmental remediation may range up to two times the amount recorded, which would be settled through cash payment over an extended period of time.
Except as noted below, we believe that these matters, when ultimately resolved, which may be over an extended period of time, will not have a material adverse effect on our Consolidated Statement of Financial Position, but could have a material adverse effect on our Consolidated Statement of Operations in any given period. Our significant sites are described in more detail below.
Anniston, Alabama: On Aug. 4, 2003, the U.S. District Court for the Northern District of Alabama approved a Revised Partial Consent Decree, pursuant to which Pharmacia and Solutia are obligated to perform, among other things, residential cleanup work and a remedial investigation/feasibility study (“RI/FS”) as a result of PCB contamination from our Anniston plant, which occurred prior to the Solutia Spinoff. The residential cleanup of available properties was completed in 2010 and an interim institutional control program will be evaluated and developed if needed in 2011 to address future changes to residential properties. Furthermore, the Anniston Plant Site RI/FS was approved by the United States Environmental Protection Agency (“USEPA”) in 2010 and we expect that Record of Decision setting out the required remedies to be issued in 2011. The RI/FS for the non-residential properties and the creeks/floodplain are ongoing but it is probable that some level of remediation and/or sediment removal will be required in the future. We have accrued for this liability based upon our understanding of the level and extent of contamination in these areas, the remedial effort likely to be required by various governmental organizations and estimated costs associated with similar remediation projects. We may recover some of our investigation and remediation costs from parties, against whom we filed a cost recovery action in July 2003 but because the eventual outcome of these proceedings is uncertain, our environmental liability at December 31, 2010 does not incorporate this potential reimbursement. State and Federal Natural Resource Damage Trustees have asserted a claim for potential natural resource damage and advised us that they are preparing to undertake an assessment as to the nature and extent of such damages. These Trustees have requested we consider entering into a cooperative agreement to perform a damage assessment and discussions on such an agreement are ongoing. As of December 31, 2010, we have accrued $112 for all environmental remediation projects in the Anniston, Alabama area which represents our best estimate of the ultimate liability. Timing of the remediation will not be established until we complete the RI/FS, a Record of Decision is issued by the United States Environmental Protection Agency (“USEPA”), and a consent decree is negotiated and entered by the court to cover the selected remediation, which will take several years.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Sauget, Illinois: A number of industries, including our W.G. Krummrich Plant, have operated and disposed of wastes in Sauget, Illinois. Areas of contamination from these industrial operations, which for our W.G. Krummrich Plant occurred prior to the Solutia Spinoff, have been classified as part of either the Sauget Area 1 Sites or the Sauget Area 2 Sites. We conducted a RI/FS for the Sauget Area 1 Sites under an Administrative Order on Consent issued on January 21, 1999. Although an extensive removal action for one of the Sauget Area 1 Sites was conducted under a Unilateral Administrative Order issued on May 31, 2000, the cost and timing of any additional required remedial actions will be established only after a Record of Decision is issued by the USEPA, and a consent decree is negotiated and entered by the court to cover the selected remediation. We have an agreement with two other potentially responsible parties (“PRPs”) to enter into an allocation proceeding upon issuance of the Record of Decision to resolve our respective shares of the liability for the Sauget Area 1 Sites. With respect to the Sauget Area 2 Sites, we, in coordination with 19 other PRPs, are also required to conduct a RI/FS for the Sauget Area 2 Sites under an Administrative Order on Consent issued effective November 24, 2000. We submitted the revised RI/FS report with these PRPs based on interim allocations and have agreed, upon issuance of the Record of Decision, to participate in an allocation proceeding to fully resolve each PRP’s share of the liability for the investigation and remediation costs. For each of the Sauget Area 1 and 2 Sites, we anticipate the USEPA and Illinois Environmental Protection Agency (“IEPA”) to issue a Record of Decision with final action for the landfill/impoundment covers within the next two years. However, although an interim groundwater remedy has been installed pursuant to a Unilateral Administrative Order issued on October 3, 2002, it is uncertain when the USEPA and IEPA will issue a final remedy for the groundwater operable unit. Our ultimate exposure at these sites will depend on the final remedial actions to be taken and on the level of contribution from other PRPs. In addition, several PRPs, including Solutia and Pharmacia, received in June 2009 from the U.S. Department of the Interior, on behalf of various federal and state natural resource trustees, a notice of intent to perform and an invitation to cooperate in a natural resource damage assessment for the Sauget Industrial Corridor. Our best estimate of the ultimate cost of all remedial measures that will be required at the Sauget, Illinois area sites is $68 for which we have accrued as of December 31, 2010.
W. G. Krummrich Site: We entered into a Consent Order under the U.S. Resource Conservation and Recovery Act of 1976, as amended, effective May 3, 2000, to investigate and remediate soil and groundwater contamination from our manufacturing operations at the W.G. Krummrich Plant, which occurred prior to the Solutia Spinoff. We conducted an extensive corrective measures study and a Final Decision was issued by the USEPA in February 2008 setting out the required corrective measures to be completed. Due to the complexity of the contamination issues at this site, certain of the corrective measures will be performed in phases with the final remediation approach and timing for some of the corrective measures being determined only after investigation and pilot testing phases are completed and fully evaluated. Our best estimate of the ultimate cost of the remaining corrective measures that will be required at the W.G. Krummrich Site is $23 which we have accrued as of December 31, 2010.
We also have accruals for remedial obligations at several of our current or former manufacturing sites which we have owned or operated since the Solutia Spinoff. Our best estimate of the ultimate cost of all corrective measures that will be required at these sites is $70 which we have accrued as of December 31, 2010.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
17. Supplemental Data
Supplemental income statement and cash flow data from continuing operations were as follows:
18. Segment and Geographic Data
We are 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. Our operations are managed and reported in three reportable segments consisting of Advanced Interlayers (formerly Saflex), Performance Films (formerly CPFilms) and Technical Specialties. The reportable segment name changes in 2010 did not affect the organizational structure, financial results or the composition of the products within each reportable segment.
The Advanced Interlayers reportable segment is a global manufacturer of interlayers for laminated glass and encapsulants for the photovoltaic market. The Performance Films reportable segment is a manufacturer of performance films for after-market applications which add functionality to glass. The Technical Specialties reportable segment is a global manufacturer of specialty chemicals for the rubber, solar energy, process manufacturing and aviation industries. The major products by reportable segment are as follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
The performance of our operating segments is evaluated based on segment profit, defined as earnings from continuing operations before interest expense, loss on debt extinguishment, income taxes, depreciation and amortization less net income attributable to noncontrolling interests and reorganization items, net (“EBITDA”). Segment profit includes selling, general and administrative, research, development and other operating expenses, gains and losses from asset dispositions and restructuring charges, net income attributable to noncontrolling interests and other income and expense items that can be directly attributable to the segment. Certain operations, expenses and other items that are managed outside the reportable segments are reported as Unallocated and Other. Unallocated and Other is comprised of corporate expenses, adjustments to our LIFO valuation reserve, adjustments to our environmental liabilities, equity earnings from affiliates, other income and expense items including currency gains/losses, gains and losses from asset dispositions and restructuring charges that are not directly attributable to the reportable segments in addition to operating segments that do not meet the quantitative threshold for determining reportable segments. There were no inter-segment sales in the periods presented below.
Our 2010, 2009 and 2008 segment information follows:
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Our net sales by geographic region, based upon geographic region which product was shipped to, for 2010, 2009 and 2008 follows:
With the exception of China, no foreign country, individual customer, or customer group represented greater than 10 percent of net sales for the twelve months ended December 31, 2010 and 2009, ten months ended December 31, 2008 or two months ended February 29, 2008. During 2010 and 2009, China represented approximately 13 percent and 12 percent, respectively, of annual consolidated net sales for each period.
Our property, plant and equipment by geographic region for 2010 and 2009 follow:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
With the exception of Belgium, no individual foreign country represented greater than 10 percent of property, plant and equipment as of December 31, 2010 or December 31, 2009. During 2010 and 2009, Belgium represented 24 percent and 26 percent, respectively, of net property, plant and equipment.
19. Earnings (Loss) Per Share
The following table presents the net income (loss) used in the basic and diluted earnings (loss) per share and reconciles weighted average number of shares used in the basic earnings (loss) per share calculation to the weighted average number of shares used to compute diluted earnings (loss) per share.
During the twelve months ended December 31, 2010 and 2009 and ten months ended December 31, 2008, the following shares were not included in the computation of earnings (loss) per share since the result would have been anti-dilutive.
(a) Upon the Effective Date, we issued warrants to purchase an aggregate of 4,481,168 shares to holders of our stock at the time of the Chapter 11 Case. These warrants have an exercise price of $29.70 and expire on February 27, 2013.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
20. Quarterly Data -- Unaudited
Charges and gains recorded in 2010 and 2009 and other events affecting comparability have been summarized below for income (loss) from continuing operations before taxes.
Loss from continuing operations in the three months ended March 31, 2010 included charges of $89 related to the early extinguishment of our 2014 Term Loan and 2013 Revolver, $4 of acquisition costs associated with Vistasolar and Novomatrix, $3 for severance, pension settlements and retaining costs in connection with the general corporate restructuring, $3 related to the closure of the Cologne Facility and $1 related to the closure of our Ruabon Facility. Income from continuing operations in the three months ended June 30, 2010 included charges of $3 related to the closure of the Cologne Facility, $3 of acquisition costs associated with Vistasolar and Novomatrix, $1 for severance, pension settlements and training costs in connection with the general corporate restructuring, $1 related to the closure of our Ruabon Facility and $1 due to a step-up in inventory for the Novomatrix acquisition, partially offset by a gain of $8 recognized in conjunction with the settlement of a tax indemnification case. Income from continuing operations in the three months ended September 30, 2010 included charges of $5 for loss on the sale of the European Plastic Products business and $1 associated with closure of the Cologne Facility. Income from continuing operations for the three months ended December 31, 2010 included charges of $2 for severance, pension settlements and retaining costs in connection with the general corporate restructuring, $2 for the settlement of a contractual dispute and $1 related to the closure of the Cologne facility, offset by a gain of $5 on the sale of selected assets of the Perkalink business.
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Loss from continuing operations in the three months ended March 31, 2009 included a $23 gain related to the reduction in the 2008 annual incentive plan, substantially offset by charges of $17 for severance and retraining costs related to the general corporate restructuring, $4 related to the closure of our production line at the Trenton Facility and $1 related to the closure of our Ruabon Facility. The income from continuing operations for the three months ended June 30, 2009, included charges of $8 related to the repayment of the Senior Term Loan to write-off unamortized debt issuance costs and debt discount, $5 for severance and retraining costs related to the general corporate restructuring and $1 related to the closure of our production line at the Trenton Facility, partially offset by a $4 gain related to a change in estimate for the restructuring reserve related to the Ruabon Facility. Income from continuing operations in the three months ended September 30, 2009 included charges of $6 related to net pension plan settlements, $6 for the loss resulting from the Plastic Products Sale and $4 for severance and retraining costs related to the general corporate restructuring. The income from continuing operations in the three months ended December 31, 2009 included charges of $30 related to write-off of unamortized debt issuance costs from the $300 pay down on the 2014 Term Loan, $9 for severance and retraining costs related to the general corporate restructuring, $5 related to net pension plan settlements, $3 for Performance Films European consolidation efforts and $1 related to the closure of our Ruabon Facility, partially offset by a $3 gain related to the Thiurams Sale.
Under ASC 260 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.
21. Condensed Consolidating Financial Statements
In accordance with SEC regulation S-X Rule 3-10 “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered,” we are providing condensed consolidating financial statements as the Notes are fully and unconditionally guaranteed on a joint and several basis.
The following consolidating financial statements present, in separate columns, financial information for: (i) Solutia, on a parent-only basis, carrying its investment in subsidiaries under the equity method; (ii) Note Guarantors on a combined basis (“Guarantors”), carrying investments in subsidiaries which do not guarantee the debt (the “Non-Guarantors”) under the equity method; (iii) Non-Guarantors on a combined basis; (vi) eliminating entries and (v) consolidated totals as of December 31, 2010 and December 31, 2009, and for the twelve months ended December 31, 2010 and 2009, the ten months ended December 31, 2008, and the two months ended February 29, 2008. The eliminating entries 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 INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Operations
Twelve Months Ended December 31, 2010
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Operations
Twelve Months Ended December 31, 2009
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Operations
Ten Months Ended December 31, 2008
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Operations
Two Months Ended February 29, 2008
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Balance Sheet
December 31, 2010
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Balance Sheet
December 31, 2009
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Cash Flows
Twelve Months ended December 31, 2010
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Cash Flows
Twelve Months ended December 31, 2009
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Cash Flows
Ten Months Ended December 31, 2008
SOLUTIA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in millions, except per share amounts or otherwise noted)
Condensed Consolidating Statement of Cash Flows
Two Months Ended February 29, 2008
22. Subsequent Events
In January 2011, we made a $50 voluntary payment on our 2017 Term Loan.
On January 31, 2011, we sold the remaining portion of our PERKACIT® ultra accelerators business for $27. As a result of the sale, we anticipate recording a gain of approximately $16 in our Technical Specialties reporting segment in other operating income.
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, 2010, 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 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, 2010, Solutia’s disclosure controls and procedures are effective. 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 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, 2010. Solutia excluded from its assessment the internal control over financial reporting at Novomatrix and Vistasolar, which were acquired on April 30, 2010 and June 1, 2010, respectively. Novomatrix and Vistasolar reflect total assets constituting 3 percent and 11 percent, respectively, and revenues of constituting 1 percent and 3 percent, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2010. Solutia will include Novomatrix and Vistasolar in its evaluation of the design and effectiveness of internal control over financial reporting as of December 31, 2011.
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, 2010.
Solutia’s independent auditors have issued an attestation report on Solutia’s internal control over financial reporting. This report appears on pages 47-48.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Annual Incentive Plan
On February 23, 2011, our ECDC approved the performance measures for the 2011 annual incentive plan (the “2011 AIP”).
The 2011 AIP provides an annual incentive-based bonus opportunity for almost all of our employees, including executive officers. The Annual Plan is administered by the ECDC. The Annual Plan is based on a bonus pool concept. There are separate bonus pools, funded 100% on the results of the performance measures for the enterprise, for enterprise-level participants and 50% on the enterprise performance measures and 50% on the performance measures for the applicable business unit, for the business unit participants. Our Named Executive Officers participate in the enterprise-level pool.
The ECDC established financial and strategic performance measures for the enterprise pool and a weighting of each such measure as follows: revenue (25%); earnings per share (25%); cash from continuing operations, excluding excess funding into our U.S. pension plans (25%); and safety and business development strategic measures (25%). The ECDC determines a threshold (0.50x), target (1.0x) and maximum (2.5x) funding level (1.5x maximum for the strategic measure) for each performance measure. If the threshold level of performance level is not met with respect to any particular performance measure, there is no funding of the bonus pool for that particular performance measure. The target level of funding or a 1.0x funding factor is the aggregate of all target bonuses for the participants in the 2011 AIP.
The target incentive is a percentage of annual base salary and varies by participant level in the organization. Our Named Executive Officers have the following target incentives: Mr. Quinn: 150%; Messrs. Voss and Sullivan: 100%; and Messrs. DeBolt and Berra: 75%. Actual performance against each of the established performance measures determines an overall funding factor (after applying the appropriate weighting to each measure) that is applied to each individual’s target (1.0x) incentive.
Each participant’s target bonus is multiplied by the relevant overall funding factor that was used to determine the size of the bonus pools from which the participant’s bonus is paid. For our Named Executive Officers, target awards are based 75% on business performance and 25% on individual performance. The individual total award can range from 0% to a maximum of 150% of the adjusted target award. For our Named Executive Officers, their minimum, target and maximum bonus is set forth below:
Awards under the 2011 AIP will be paid no later than two and one-half months following the end of the 2011 calendar year.
Awards under our Amended and Restated 2007 Management Long-Term Incentive Plan
On February 23, 2011 our ECDC approved grants of stock options, restricted stock awards and performance shares under our Amended and Restated 2007 Management Long-Term Incentive Plan (the “Equity Incentive Plan”) to certain employees of the Company including executive officers. Awards to the Named Executive Officers in the amounts listed below:
The stock options vest over a four year period at a rate of 25% per year on the anniversary of the date of the grant.
The restricted stock vest over a four year period at a rate of 25% per year on the anniversary of the date of the grant.
The performance shares vest on the third year anniversary of the date of the grant subject to the achievement of performance goals, described below, during the Performance Period. The Performance Period runs from January 1, 2011 up to and including December 31, 2013.
Total Shareholder Return: Fifty percent of the Performance Shares shall vest 100% at target if the total shareholder return (“TSR”) equals the 55th percentile of a group of companies listed below, for the Performance Period. A threshold level of 25% of the target shares shall vest if the TSR equals the 40th percentile. A maximum of 175% shall vest if TSR equals the 75th percentile or higher. Vested Performance Shares will be interpolated for the percentile achieved at the end of the Performance Period. The TSR shall include reinvested dividends over the Performance Period and shall be calculated using the average closing price of the Company’s common stock and the average closing price of the common stock of the companies in the group listed below within a ninety calendar day period, which would include all trading days within that ninety day calendar period, immediately preceding the beginning date of the Performance Period and the ending date of the Performance Period.
Relative Return on Capital: Fifty percent of the Performance Shares shall vest 100% at target if the three year average return on capital (“ROC”) equals the 55th percentile of the group of companies listed below for the Performance Period. A threshold level of 25% of the target shares shall vest if the three year average ROC equals the 40th percentile. A maximum of 175% shall vest if the three year average ROC equals the 75th percentile or higher. Vested Performance Shares will be interpolated for the percentile achieved at the end of the Performance Period. ROC is subject to a $1 billion cumulative EBITDA threshold before any payouts occur.
The group of companies (a subset of the S&P Chemical Index) means: Dow Chemical Company, E.I. du Pont de Nemours and Company, PPG Industries Inc., Ashland Inc., Ecolab Inc., Eastman Chemical Company, The Lubrizol Corporation, RPM International Inc., Cytec Industries Inc., Valspar Corporation, Rockwood Holdings, Inc., Cabot Corporation, FMC Corporation, PolyOne Corporation, Albemarle Corporation, International Flavors & Fragrances, Inc., Sigma-Aldrich Corporation, OM Group, Inc. Olin Corporation, NewMarket Corporation, Stepan Company, A. Schulman Inc., H.B. Fuller Company, Sensient Technologies Corporation, Minerals Technologies Inc., Zep Inc., Quaker Chemical Corporation, The Sherwin-Williams Company, LSB Industries Inc., STR Holdings, Inc, Calgon Carbon Corporation, Balchem Corporation, and Arch Chemicals Inc. The ECDC may adjust the group of companies if, during the Performance Period, a company in this group is acquired or ceases to be publicly traded.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We incorporate by reference the information under the headings “Director Biographies,” “Board Committees” and “Code of Ethics for Senior Financial Officers” appearing in the section entitled “The Board of Directors and Corporate Governance” and the information appearing in the section entitled “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement to be distributed to stockholders in connection with our 2011 annual meeting.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
We incorporate by reference the information under the heading “Compensation Discussion and Analysis”, “Executive Compensation & Development Committee Report,” “Summary Compensation Table”, “Grant of Plan-Based Awards for the Year Ended December 31, 2010”, “Option Exercises and Stock Vested for the Year Ended December 31, 2010”, “Pension Benefits”, “Employment Agreements with Named Executive Officers” and “Potential Payments upon Termination of Employment or Change-in-Control” appearing in the section entitled “Executive Compensation”, and “Director Compensation for the Year Ended December 31, 2010” appearing in the section entitled “The Board of Directors and Corporate Governance” in our Proxy Statement to be distributed to stockholders in connection with our 2011 annual meeting.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
We incorporate by reference the information appearing under the sections entitled “Beneficial Stock Ownership of Directors, Executive Officers and Persons Owning more than 5 Percent of Common Stock” in our Proxy Statement to be distributed to stockholders in connection with our 2011 annual meeting.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
We incorporate by reference the information under the headings “Related Party Transaction Policy and Procedures” and “Director Independence” appearing in the section entitled “The Board of Directors and Corporate Governance” in our Proxy Statement to be distributed to stockholders in connection with our 2011 annual meeting.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
We incorporate by reference the information in the section entitled “Ratification of the Appointment of Independent Public Accounting Firm” in our Proxy Statement to be distributed to stockholders in connection with our 2011 annual meeting.
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 47 of this report.
2.
The following supplemental schedule for the years ended December 31, 2010, 2009 and 2008
II--Valuation and Qualifying Accounts
3.
Exhibits--See the Exhibit Index beginning at page 110 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. 10.1 through 10.12, 10.14 and 10.15. The following exhibits listed in the Exhibit Index are filed with this Form 10-K:
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: February 24, 2011
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.
Signature
Title
Date
/s/ Jeffry N. Quinn
Jeffry N. Quinn
President, Chief Executive Officer and Chairman
of the Board (Principal Executive Officer)
February 24, 2011
/s/ James M. Sullivan
James M. Sullivan
Executive Vice President and Chief Financial
Officer (Principal Financial Officer)
February 24, 2011
/s/ Timothy J. Spihlman
Timothy J. Spihlman
Vice President and Controller (Principal
Accounting Officer)
February 24, 2011
* Robert K. deVeer, Jr.
Director
February 24, 2011
* James P. Heffernan
Director
February 24, 2011
* W. Thomas Jagodinski
Director
February 24, 2011
* William T. Monahan
Director
February 24, 2011
* Robert A. Peiser
Director
February 24, 2011
* William C. Rusnack
Director
February 24, 2011
*Gregory C. Smith
Director
February 24, 2011
*Paul J. Berra, III, by signing his name hereto, does sign this document on behalf of the above noted individuals, pursuant to powers of attorney duly executed by such individuals which have been filed as an Exhibit to this Form 10-K.
/s/ Paul J. Berra, III
Paul J. Berra, III, Attorney-in-Fact
SCHEDULE II
SOLUTIA INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2010, TWELVE MONTHS ENDED DECEMBER 31, 2009,
TEN MONTHS ENDED DECEMBER 31, 2008, AND TWO MONTHS ENDED FEBRUARY 29, 2008
(Dollars in Millions)
EXHIBIT INDEX
These exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K.