UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 001-13255
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SOLUTIA INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 43-1781797
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
575 MARYVILLE CENTRE DRIVE, P.O. BOX 66760, ST. LOUIS, MISSOURI 63166-6760
--------------------------------------------------------------- ----------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(314) 674-1000
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS TO
BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING TWELVE MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
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INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATED
FILER, AN ACCELERATED FILER OR A NON-ACCELERATED FILER. SEE DEFINITION OF
"ACCELERATED FILER" AND "LARGE ACCELERATED FILER" IN RULE 12b-2 OF THE EXCHANGE
ACT (CHECK ONE):
LARGE ACCELERATED FILER ACCELERATED FILER X NON-ACCELERATED FILER .
--- --- ---
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS
DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT. YES NO X
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INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES
OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE.
OUTSTANDING AT
CLASS JUNE 30, 2006
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COMMON STOCK, $0.01 PAR VALUE 104,459,578 SHARES
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF OPERATIONS
(DOLLARS AND SHARES IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
NET SALES .......................................................... $ 765 $ 730 $ 1,443 $ 1,444
Cost of goods sold ................................................. 635 629 1,239 1,241
----- ----- ------- -------
GROSS PROFIT ....................................................... 130 101 204 203
Marketing expenses ................................................. 35 34 68 66
Administrative expenses ............................................ 23 24 44 46
Technological expenses ............................................. 12 11 24 22
Amortization expense ............................................... 1 -- 1 --
----- ----- ------- -------
OPERATING INCOME ................................................... 59 32 67 69
Equity earnings from affiliates .................................... 11 21 21 35
Interest expense (a) ............................................... (27) (22) (50) (44)
Other income, net .................................................. 4 4 7 5
Loss on debt modification .......................................... -- -- (8) --
Reorganization items, net .......................................... (18) (15) (32) (20)
----- ----- ------- -------
INCOME BEFORE INCOME TAX EXPENSE ................................... 29 20 5 45
Income tax expense ................................................. 5 7 7 13
----- ----- ------- -------
INCOME (LOSS) FROM CONTINUING OPERATIONS ........................... 24 13 (2) 32
Income from Discontinued Operations, net of tax .................... 4 1 8 3
----- ----- ------- -------
NET INCOME ......................................................... $ 28 $ 14 $ 6 $ 35
===== ===== ======= =======
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:
Income (Loss) from Continuing Operations ........................... $0.23 $0.12 ($ 0.02) $ 0.30
Income from Discontinued Operations ................................ 0.04 0.01 0.08 0.03
----- ----- ------- -------
Net Income ......................................................... $0.27 $0.13 $ 0.06 $ 0.33
===== ===== ======= =======
BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING .............. 104.5 104.5 104.5 104.5
===== ===== ======= =======
(a) Interest expense excludes unrecorded contractual interest expense of $8
for the three months ended June 30, 2006 and 2005, and $16 for the six
months ended June 30, 2006 and 2005.
See accompanying Notes to Consolidated Financial Statements.
1
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(DOLLARS IN MILLIONS)
(UNAUDITED)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
NET INCOME ................................................. $ 28 $ 14 $ 6 $ 35
OTHER COMPREHENSIVE INCOME (LOSS):
Net unrealized loss on derivative instruments .............. -- -- (1) --
Currency translation adjustments ........................... 10 (2) 12 (7)
----- ----- ----- -----
COMPREHENSIVE INCOME ....................................... $ 38 $ 12 $ 17 $ 28
===== ===== ===== =====
See accompanying Notes to Consolidated Financial Statements.
2
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2006 2005
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................... $ 265 $ 107
Trade receivables, net of allowances of $8 and $7 in 2006 and 2005 ...... 347 246
Miscellaneous receivables ............................................... 90 95
Inventories ............................................................. 263 254
Prepaid expenses and other assets ....................................... 29 34
Assets of discontinued operations ....................................... 84 69
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TOTAL CURRENT ASSETS .................................................... 1,078 805
PROPERTY, PLANT AND EQUIPMENT, net of accumulated depreciation of
$2,545 in 2006 and $2,482 in 2005 .................................. 772 770
INVESTMENTS IN AFFILIATES ............................................... 213 205
GOODWILL ................................................................ 89 76
IDENTIFIED INTANGIBLE ASSETS, net ....................................... 32 28
OTHER ASSETS ............................................................ 105 100
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TOTAL ASSETS ............................................................ $ 2,289 $ 1,984
======= =======
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable ........................................................ $ 197 $ 218
Accrued liabilities ..................................................... 245 223
Short-term debt ......................................................... 700 300
Liabilities of discontinued operations .................................. 30 26
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TOTAL CURRENT LIABILITIES ............................................... 1,172 767
LONG-TERM DEBT .......................................................... 210 247
OTHER LIABILITIES ....................................................... 260 248
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TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE ............................. 1,642 1,262
LIABILITIES SUBJECT TO COMPROMISE ....................................... 2,084 2,176
SHAREHOLDERS' DEFICIT:
Common stock (authorized, 600,000,000 shares, par value $0.01)
Issued: 118,400,635 shares in 2006 and 2005 ......................... 1 1
Additional contributed capital ...................................... 56 56
Treasury stock, at cost (13,941,057 shares in 2006 and 2005) ........ (251) (251)
Net deficiency of assets at spinoff ..................................... (113) (113)
Accumulated other comprehensive loss .................................... (82) (93)
Accumulated deficit ..................................................... (1,048) (1,054)
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TOTAL SHAREHOLDERS' DEFICIT ............................................. (1,437) (1,454)
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TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT ............................. $ 2,289 $ 1,984
======= =======
See accompanying Notes to Consolidated Financial Statements.
3
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
-----------------------
2006 2005
---- ----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES:
Net income ............................................................... 6 $ 35
Adjustments to reconcile net income to Cash From Operations:
Income from discontinued operations, net of tax ..................... (8) (3)
Depreciation and amortization ....................................... 57 56
Restructuring expenses and other charges (gains)..................... (1) --
Amortization of deferred credits .................................... (4) (4)
Other, net .......................................................... -- (1)
Deferred Income Taxes ............................................... 1 6
Equity earnings from affiliates ..................................... (21) (35)
Changes in assets and liabilities:
Income taxes payable ........................................... (1) (16)
Trade receivables .............................................. (102) (10)
Inventories .................................................... (3) (10)
Accounts payable ............................................... (14) (18)
Liabilities subject to compromise .............................. (72) (23)
Other assets and liabilities ................................... 36 (7)
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CASH USED IN OPERATING ACTIVITIES - CONTINUING OPERATIONS ................ (126) (30)
CASH PROVIDED BY OPERATING ACTIVITIES - DISCONTINUED OPERATIONS .......... 2 4
----- -----
CASH USED IN OPERATING ACTIVITIES ........................................ (124) (26)
----- -----
INVESTING ACTIVITIES:
Property, plant and equipment purchases .................................. (41) (27)
Acquisition and investment payments ...................................... (16) --
Investment and property disposals ........................................ -- 2
----- -----
CASH USED IN INVESTING ACTIVITIES - CONTINUING OPERATIONS ................ (57) (25)
CASH USED IN INVESTING ACTIVITIES - DISCONTINUED OPERATIONS .............. (2) (2)
----- -----
CASH USED IN INVESTING ACTIVITIES ........................................ (59) (27)
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FINANCING ACTIVITIES:
Net change in short-term debt obligations ................................ 350 --
Net change in cash collateralized letters of credit ...................... -- 17
Deferred debt issuance costs ............................................. (9) --
----- -----
CASH PROVIDED BY FINANCING ACTIVITIES - CONTINUING OPERATIONS ............ 341 17
----- -----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ......................... 158 (36)
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR ........................................................ 107 115
----- -----
END OF PERIOD ............................................................ $ 265 $ 79
===== =====
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash payments for reorganization items ................................... $ (31) $ (30)
===== =====
See accompanying Notes to Consolidated Financial Statements.
4
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. NATURE OF OPERATIONS AND BANKRUPTCY PROCEEDINGS
Nature of Operations
Solutia Inc., together with its subsidiaries (referred to herein as
"Solutia" or the "Company"), is a global manufacturer and marketer of a variety
of high-performance chemical-based materials. Solutia is a world leader in
performance films for laminated safety glass and after-market applications;
specialties such as water treatment chemicals, heat transfer fluids and aviation
hydraulic fluids; and an integrated family of nylon products including
high-performance polymers and fibers.
Prior to September 1, 1997, Solutia was a wholly-owned subsidiary of the
former Monsanto Company (now known as Pharmacia Corporation, a wholly-owned
subsidiary of Pfizer, Inc. ("Pharmacia")). On September 1, 1997, Pharmacia
distributed all of the outstanding shares of common stock of Solutia as a
dividend to Pharmacia stockholders (the "Solutia Spinoff"). As a result of the
Solutia Spinoff, on September 1, 1997, Solutia became an independent publicly
held company and its operations ceased to be owned by Pharmacia. A net
deficiency of assets of $113 resulted from the Solutia Spinoff.
Bankruptcy Proceedings
Overview
On December 17, 2003, Solutia Inc. and its 14 U.S. subsidiaries (the
"Debtors") filed voluntary petitions for reorganization under Chapter 11 of the
U.S. Bankruptcy Code (the "Chapter 11 Cases") in the U.S. Bankruptcy Court for
the Southern District of New York (the "Bankruptcy Court"). The cases were
consolidated for the purpose of joint administration and were assigned case
number 03-17949 (PCB). Solutia's subsidiaries outside the United States were not
included in the Chapter 11 filing.
The filing was made to restructure Solutia's balance sheet by reducing
indebtedness to appropriate levels, to streamline operations and to reduce
costs, in order to allow Solutia to emerge from Chapter 11 as a viable going
concern, and to obtain relief from the negative financial impact of liabilities
for litigation, environmental remediation and certain post-retirement benefits
(the "Legacy Liabilities") and liabilities under operating contracts, all of
which were assumed at the time of the Solutia Spinoff. These factors, combined
with the weakened state of the chemical manufacturing sector, general economic
conditions and continuing high, volatile energy and crude oil costs have been an
obstacle to Solutia's financial stability and success.
Under Chapter 11, Solutia is operating its businesses as a
debtor-in-possession ("DIP") under court protection from creditors and
claimants. Since the Chapter 11 filing, orders sufficient to enable Solutia to
conduct normal business activities, including the approval of Solutia's DIP
financing, have been entered by the Bankruptcy Court. While Solutia is subject
to Chapter 11, all transactions not in the ordinary course of business require
the prior approval of the Bankruptcy Court.
On January 16, 2004, pursuant to authorization from the Bankruptcy Court,
Solutia entered into a $525 DIP credit facility. This DIP facility consisted of
(i) a $50 multiple draw term loan; (ii) a $300 single draw term loan, which was
drawn in full on the effective date of the facility; and (iii) a $175
borrowing-based revolving credit facility, which includes a $150 letter of
credit subfacility. The DIP credit facility was subsequently amended on March 1,
2004, July 20, 2004 and June 1, 2005. A fourth amendment was entered into on
March 17, 2006, all with Bankruptcy Court approval. The fourth amendment, among
other things, (i) increased the DIP facility from $525 to $825; (ii) extended
the term of the DIP facility from June 19, 2006 to March 31, 2007; (iii)
decreased the interest rate on the term loan component of the DIP facility from
LIBOR plus 425 basis points to LIBOR plus 350 basis points; (iv) increased
certain thresholds allowing the Debtors to retain more of the proceeds from
certain dispositions
5
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
and other extraordinary receipts; (v) approved the disposition of certain assets
of the Debtors; (vi) allowed refinancing of, and certain amendments to, Solutia
Europe S.A./N.V.'s outstanding Euronotes; and (vii) amended certain financial
and other covenants. The fourth amendment also contains a number of other
modifications required to make the remaining terms of the DIP facility
consistent with the amendments set forth above.
As a consequence of the Chapter 11 filing, pending litigation against
Solutia is generally stayed, and no party may take any action to collect its
pre-petition claims except pursuant to order of the Bankruptcy Court. November
30, 2004 was the last date by which holders of pre-filing date claims against
the Debtors could file such claims. Any holder of a claim that was required to
file such claim by November 30, 2004, and did not do so may be barred from
asserting such claim against the Debtors and, accordingly, may not be able to
participate in any distribution on account of such claim. Differences between
claim amounts identified by the Debtors and claims filed by claimants will be
investigated and resolved in connection with the Debtors' claims resolution
process, and only holders of claims that are ultimately allowed for purposes of
the Chapter 11 case will be entitled to distributions. Solutia has not yet fully
completed its analysis of all the proofs of claim. Since the settlement terms of
allowed claims are subject to a confirmed plan of reorganization, the ultimate
distribution with respect to allowed claims is not presently ascertainable.
On February 14, 2006, the Debtors filed with the Bankruptcy Court their
Joint Plan of Reorganization (the "Plan") and Disclosure Statement (the
"Disclosure Statement"). The Plan and Disclosure Statement along with the
Relationship Agreement (as defined below) and the Retiree Settlement Agreement,
entered into among Solutia, the Official Committee of Unsecured Creditors (the
"Unsecured Creditors' Committee") and Official Committee of Retirees appointed
in the Debtors' Chapter 11 Cases (the "Retirees' Committee"), Monsanto Company
("Monsanto"), certain retirees and the other parties thereto (the "Retiree
Settlement"), set forth the terms of a global settlement (the "Global
Settlement") between Solutia, the Unsecured Creditors' Committee, the Retirees'
Committee, Monsanto and Pharmacia. The Global Settlement provides for, among
other things, the reallocation of certain Legacy Liabilities among Solutia,
Monsanto and Pharmacia and the treatment various constituencies in the Chapter
11 Cases will receive under the Plan. The Disclosure Statement contains a
description of the events that led up to the Debtors' bankruptcy filings, the
actions the Debtors have taken to improve their financial situation while in
bankruptcy and a current description of the Debtors' businesses. The
reallocation of liabilities between Solutia and Monsanto is set forth in a
Relationship Agreement (the "Relationship Agreement") to be entered into between
Solutia and Monsanto upon confirmation of the Plan. The Relationship Agreement
was filed with the Bankruptcy Court on February 14, 2006 as an exhibit to the
Plan.
Solutia also issued a press release on February 14, 2006 announcing the
filing of the Plan and Disclosure Statement with the Bankruptcy Court. The press
release was furnished to the Securities and Exchange Commission in a Form 8-K
filed on February 14, 2006. The Plan, including the Relationship Agreement and
Retiree Settlement Agreement, and the Disclosure Statement were furnished as
exhibits to a Form 8-K filed on February 21, 2006.
The Plan, which incorporates the Relationship Agreement and Retiree
Settlement, is subject to approval by the Bankruptcy Court in accordance with
the Bankruptcy Code as well as various other conditions and contingencies, some
of which are not within the control of Solutia, and therefore are subject to
change and are not binding upon any party. The Disclosure Statement remains
subject to change pending a hearing in the Bankruptcy Court to consider the
legal adequacy of the Disclosure Statement. Once the Disclosure Statement is
approved by the Bankruptcy Court, it will be distributed to all constituencies
entitled to vote on the Plan. Solutia cannot provide any assurance that any plan
of reorganization ultimately confirmed by the Bankruptcy Court, or any
disclosure statement ultimately approved by the Bankruptcy Court, will be
consistent with the terms of the Plan and Disclosure Statement. The previously
scheduled Disclosure Statement hearing has been cancelled and, based on comments
from the Bankruptcy Court, Solutia anticipates that a hearing on the Disclosure
Statement will not take place until after the Bankruptcy Court makes a ruling in
the JPM Proceeding (as described in Note 9).
If confirmed, the Plan will provide Solutia with significant relief from
the Legacy Liabilities Solutia was required to assume in the Solutia Spinoff.
These Legacy Liabilities included: (1) retiree medical, retiree life
6
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
insurance and retiree disability benefits ("Retiree Welfare Benefits") for those
individuals who retired or became disabled prior to the Solutia Spinoff
("Pre-Spin Retirees"); (2) environmental remediation costs related to activities
of the chemicals business of Pharmacia that occurred prior to the Solutia
Spinoff; and (3) toxic tort litigation costs relating to chemical exposure
associated with the activities of Pharmacia that occurred prior to the Solutia
Spinoff.
Under the Plan, Solutia would emerge from bankruptcy as an independent
publicly held company ("reorganized Solutia"). The Plan provides for $250 of new
investment in reorganized Solutia. This new investment will be in the form of a
rights offering to certain unsecured creditors, who will be given the
opportunity to purchase 22.7 percent of the common stock in reorganized Solutia.
Monsanto will backstop the rights offering, meaning it will commit to purchase
up to the entire $250 of stock, to the extent the stock is not purchased by
eligible unsecured creditors in the rights offering.
Of this $250 new investment, $175 would be set aside in a Voluntary
Employees' Beneficiary Association ("VEBA") Retiree Trust to fund the Retiree
Welfare Benefits for those Pre-Spin Retirees who receive these benefits from
Solutia, and $50 would be used to fund reorganized Solutia's environmental
remediation commitments in Anniston, Alabama and Sauget, Illinois, as described
below. The remaining $25 would be available for reorganized Solutia to pay any
of the Legacy Liabilities that it is retaining.
Under the Plan and Relationship Agreement, as between Monsanto and
Solutia, Monsanto would be responsible, with certain exceptions, for all current
and future tort litigation costs arising from the conduct of Pharmacia's
chemical business prior to the Solutia Spinoff, including litigation arising
from exposure to polychlorinated biphenyls ("PCBs") and other chemicals. In
addition, Monsanto would accept financial responsibility for environmental
remediation obligations at all sites for which Solutia was required to assume
responsibility as part of the Solutia Spinoff but which were never owned or
operated by Solutia. These include more than 50 sites with active remediation
projects and approximately 200 additional known sites and off-site disposal
facilities, as well as sites that have not yet been identified. Finally,
Monsanto would share financial responsibility with Solutia for off-site
remediation costs in Anniston, Alabama and Sauget, Illinois. Under this
cost-sharing mechanism, the first $50 would be paid from the proceeds of the
rights offering (as described above), Monsanto would pay the next $50 (less
amounts it has paid for remediation at these sites during the Chapter 11 Cases,
which totaled over $30 as of January 31, 2006), Solutia would be responsible for
the next $325 in costs, and any further costs would be shared equally between
Solutia and Monsanto. Under certain circumstances, Solutia would be able to
defer paying a portion of its shared responsibility with respect to the Anniston
and Sauget sites in excess of $30 in any calendar year, up to $25 in the
aggregate. Any deferred amounts would be paid by Monsanto, but subject to
repayment by Solutia at a later date. The Plan and Relationship Agreement
provide that Solutia will continue to pay its annual installment and education
fund obligations relating to the August 2003 Anniston PCBs settlement and
education fund obligations relating to the Anniston Partial Consent Decree (as
described in Note 9).
The Plan incorporates the terms of the Retiree Settlement Agreement, which
was negotiated with the Retirees' Committee, which represents more than 23,000
former employees of Pharmacia and Solutia and their dependents. Although the
Retiree Settlement Agreement includes benefit modifications, the Plan, through
the $175 from the rights offering that will be allocated to the VEBA Trust,
provides significant current funding which will greatly improve Solutia's
ability to meet these benefit obligations going forward. Under the Retiree
Settlement Agreement, retirees will retain certain company-provided medical
benefits, although the cost to retirees for such benefits will increase. Many
retirees will retain their company-provided life insurance benefits, although
some will experience a reduction in the benefit provided. The Retiree Settlement
Agreement also maintains Solutia's rights according to a separate 2001
settlement and a post-settlement retiree medical plan, under which Solutia
intends to make certain changes on or after the effective date of the Plan,
including the elimination of company-provided medical benefits for certain
groups of retirees that also are eligible for Medicare coverage.
In consideration of the benefit modifications being accepted by retirees
pursuant to the Retiree Settlement Agreement, the Plan contemplates that the
retirees would receive an allowed unsecured claim in the aggregate amount of $35
in Solutia's bankruptcy case. The common stock in reorganized Solutia received
on account of this
7
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
claim would be deposited in the VEBA Trust and used to pay Retiree Welfare
Benefits. This deposit would be in addition to the $175 that would be
contributed to the VEBA Trust from the proceeds of the rights offering. The VEBA
Trust would be a bankruptcy-remote entity and would be managed by an independent
trustee.
The Plan also provides for the assumption and extension of certain
commercial and operating agreements between Solutia and Monsanto. The Plan seeks
a release for Monsanto and Pharmacia from certain pre-Solutia Spinoff
liabilities, including those related to Retiree Welfare Benefits.
In the Disclosure Statement, Solutia estimated that the amount of allowed
general unsecured claims in its Chapter 11 case will be approximately $800 to
$1,000, the enterprise value of reorganized Solutia will be approximately $2,000
to $2,300 and the reorganization equity value of reorganized Solutia will be
approximately $700 to $1,100. However, these amounts are estimates and it is
possible that the actual general unsecured claims pool, enterprise value and
equity value of reorganized Solutia will be outside of these estimated ranges.
The Plan contains details regarding how the claims of each class of
creditors and interest holders will be treated. The Plan provides for repayment
of Solutia's secured debt and debtor-in-possession financing from an exit
financing package to be arranged by Solutia and does not require termination of
Solutia's pension plans. In consideration for its contributions under the Plan,
resolution of its claim in the Chapter 11 Cases and the settlement of ongoing
and potential litigation, among other things, Monsanto would receive common
stock in reorganized Solutia. If Monsanto is required to make the full new money
investment under the rights offering, Monsanto's equity interest in reorganized
Solutia is expected to range from approximately 45 percent to 49 percent,
depending on the actual amount of allowed general unsecured claims. The holders
of allowed general unsecured claims would receive the remainder of the common
stock in reorganized Solutia, as described below.
Based on the mid-point of the equity value of reorganized Solutia
described above, the Plan provides for distributions of common stock in
reorganized Solutia to holders of allowed unsecured claims in an amount
estimated at between 48 percent and 56 percent of their allowed claims. However,
this is only an estimated range of recoveries. Solutia is unable to predict
precisely what recovery the Plan will provide to these holders of unsecured
claims or how any potential modifications to the Plan will impact these
recoveries. Therefore, actual recoveries may be materially different from these
estimates. Furthermore, the equity interests received by holders of allowed
unsecured claims will be subject to dilution as a result of the incentive stock
option plan that is expected to be adopted by Solutia pursuant to the Plan. The
ultimate ownership interests in reorganized Solutia held by Monsanto and other
holders of unsecured claims will depend on, among other factors, the amount of
allowed unsecured claims in the bankruptcy case and the number of rights
exercised by unsecured creditors in the rights offering.
The Plan does not provide for distributions to the holders of Solutia's
existing equity. Under the Plan, Solutia's existing shares of common stock, as
well as options and warrants to purchase its common stock, would be cancelled
and holders of Solutia's common stock, including options and warrants to
purchase Solutia's common stock, would receive no consideration for that stock
or those options and warrants. Although the Plan does not provide for any
distributions to holders of Solutia's existing equity, the Official Committee of
Equity Security Holders in Solutia's bankruptcy case has filed a complaint
against Pharmacia and Monsanto, and an objection to the proofs of claim filed by
Monsanto and Pharmacia in Solutia's bankruptcy, arguing that holders of
Solutia's existing equity are entitled to distribution on the basis of several
legal theories.
In order to exit Chapter 11, Solutia must propose and confirm a plan of
reorganization that satisfies the requirements of the U.S. Bankruptcy Code. As
provided by the U.S. Bankruptcy Code, Solutia had the exclusive right to propose
a plan of reorganization for 120 days following the Chapter 11 filing date. The
Bankruptcy Court has subsequently approved several extensions of the exclusivity
period, the most recent of which is set to expire on October 10, 2006. Although
Solutia expects to receive further extensions of the exclusivity period, no
assurance can be given that any such future extension requests will be granted
by the Bankruptcy Court. Moreover, although Solutia has filed the Plan which
provides for Solutia's emergence from bankruptcy as a going concern, there can
be
8
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
no assurance that the Plan, or any other plan of reorganization, will be
confirmed by the Bankruptcy Court or that any such plan will be implemented
successfully.
Basis of Presentation
These financial statements should be read in conjunction with the audited
consolidated financial statements and notes to consolidated financial statements
included in Solutia's 2005 Annual Report on Form 10-K ("2005 Form 10-K"), filed
with the Securities and Exchange Commission ("SEC") on March 15, 2006.
The consolidated financial statements have been prepared in accordance
with Statement of Position 90-7 ("SOP 90-7"), Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code, and on a going concern basis, which
assumes the continuity of operations and reflects the realization of assets and
satisfaction of liabilities in the ordinary course of business. Continuation of
the Company as a going concern is contingent upon, among other things, Solutia's
ability (i) to comply with the terms and conditions of its DIP financing; (ii)
to obtain confirmation of a plan of reorganization under the U.S. Bankruptcy
Code; (iii) to return to profitability; (iv) to generate sufficient cash flow
from operations; and (v) to obtain financing sources to meet the Company's
future obligations. These matters create uncertainty about the Company's ability
to continue as a going concern. The consolidated financial statements do not
reflect any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and classification of liabilities that
might result from the outcome of these uncertainties. Additionally, a confirmed
plan of reorganization could materially change amounts reported in the
consolidated financial statements, which do not give effect to all adjustments
of the carrying value of assets and liabilities that are necessary as a
consequence of reorganization under Chapter 11.
The accompanying unaudited consolidated financial statements reflect all
adjustments that, in the opinion of management, are necessary to present fairly
the financial position, results of operations, comprehensive income (loss), and
cash flows for the interim periods reported. Such adjustments are of a normal,
recurring nature. In addition, footnote disclosures which would substantially
duplicate the disclosures in the audited consolidated financial statements have
been omitted in the accompanying unaudited consolidated financial statements.
The results of operations for the three and six months ended June 30, 2006 are
not necessarily indicative of the results to be expected for the full year.
Certain reclassifications of prior year's financial information have been
made to conform to the 2006 presentation.
Condensed Consolidating Financial Statements
Condensed consolidating financial statements for Solutia and subsidiaries
in reorganization and subsidiaries not in reorganization as of June 30, 2006 and
December 31, 2005, and for the three and six months ended June 30, 2006 and June
30, 2005 are presented below. These condensed consolidating financial statements
include investments in subsidiaries carried under the equity method.
9
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING BALANCE SHEET AS OF JUNE 30, 2006
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
ASSETS
Current assets ............................................... $ 656 $ 512 $ (90) $ 1,078
Property, plant and equipment, net ........................... 658 114 -- 772
Investment in subsidiaries and affiliates .................... 465 216 (468) 213
Goodwill and identified intangible assets, net ............... 100 21 -- 121
Other assets ................................................. 59 46 -- 105
------------------------------------------------------------
TOTAL ASSETS .............................................. $ 1,938 $ 909 $ (558) $ 2,289
============================================================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities .......................................... $ 1,098 $ 253 $ (179) $ 1,172
Long-term debt ............................................... -- 210 -- 210
Other liabilities ............................................ 193 67 -- 260
------------------------------------------------------------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE .................. 1,291 530 (179) 1,642
LIABILITIES SUBJECT TO COMPROMISE ............................ 2,084 -- -- 2,084
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) ......................... (1,437) 379 (379) (1,437)
------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) ......... $ 1,938 $ 909 $ (558) $ 2,289
============================================================
CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2005
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
ASSETS
Current assets ............................................... $ 447 $ 430 $ (72) $ 805
Property, plant and equipment, net ........................... 674 96 -- 770
Investment in subsidiaries and affiliates .................... 388 213 (396) 205
Goodwill and identified intangible assets, net ............... 100 4 -- 104
Other assets ................................................. 62 38 -- 100
------------------------------------------------------------
TOTAL ASSETS .............................................. $ 1,671 $ 781 $ (468) $ 1,984
============================================================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities .......................................... $ 748 $ 176 $ (157) $ 767
Long-term debt ............................................... -- 247 -- 247
Other liabilities ............................................ 201 47 -- 248
------------------------------------------------------------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE .................. 949 470 (157) 1,262
LIABILITIES SUBJECT TO COMPROMISE ............................ 2,176 -- -- 2,176
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) ......................... (1,454) 311 (311) (1,454)
------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT) ............................................... $ 1,671 $ 781 $ (468) $ 1,984
============================================================
10
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE
THREE MONTHS ENDED JUNE 30, 2006
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
NET SALES ........................................ $ 633 $ 248 $(116) $ 765
Cost of goods sold ............................... 546 212 (123) 635
-----------------------------------------------------------
GROSS PROFIT ..................................... 87 36 7 130
Marketing, administrative and technological
expenses ......................................... 56 14 -- 70
Amortization expense ............................. 1 -- -- 1
-----------------------------------------------------------
OPERATING INCOME ................................. 30 22 7 59
Equity earnings (loss) from affiliates ........... 27 (1) (15) 11
Interest expense ................................. (21) (6) -- (27)
Other income, net ................................ 10 1 (7) 4
Reorganization items, net ........................ (18) -- -- (18)
-----------------------------------------------------------
INCOME BEFORE INCOME TAXES ....................... 28 16 (15) 29
Income tax expense (benefit) ..................... (1) 5 1 5
-----------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS ................ 29 11 (16) 24
Income (loss) from discontinued
operations, net of tax ........................... (1) 5 -- 4
-----------------------------------------------------------
NET INCOME ....................................... $ 28 $ 16 $ (16) $ 28
===========================================================
11
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE
SIX MONTHS ENDED JUNE 30, 2006
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
NET SALES ...................................... $ 1,190 $ 475 $(222) $ 1,443
Cost of goods sold ............................. 1,063 411 (235) 1,239
------------------------------------------------------------
GROSS PROFIT ................................... 127 64 13 204
Marketing, administrative and technological
expenses ....................................... 108 28 -- 136
Amortization expense ........................... 1 -- -- 1
------------------------------------------------------------
OPERATING INCOME ............................... 18 36 13 67
Equity earnings (loss) from affiliates ......... 52 (2) (29) 21
Interest expense ............................... (39) (11) -- (50)
Other income, net .............................. 17 3 (13) 7
Loss on debt modification ...................... (8) -- -- (8)
Reorganization items, net ...................... (32) -- -- (32)
------------------------------------------------------------
INCOME BEFORE INCOME TAXES ..................... 8 26 (29) 5
Income tax expense ............................. 1 6 -- 7
------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS ....... 7 20 (29) (2)
Income (loss) from discontinued
operations, net of tax ......................... (1) 9 -- 8
------------------------------------------------------------
NET INCOME ..................................... $ 6 $ 29 $ (29) $ 6
============================================================
12
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE
THREE MONTHS ENDED JUNE 30, 2005
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
NET SALES ............................................... $ 603 $ 227 $(100) $ 730
Cost of goods sold ...................................... 541 193 (105) 629
------------------------------------------------------------
GROSS PROFIT ............................................ 62 34 5 101
Marketing, administrative and technological
expenses ................................................ 54 15 -- 69
------------------------------------------------------------
OPERATING INCOME ........................................ 8 19 5 32
Equity earnings (loss) from affiliates .................. 32 (1) (10) 21
Interest expense ........................................ (16) (6) -- (22)
Other income, net ....................................... 5 5 (6) 4
Reorganization items, net ............................... (12) (3) -- (15)
------------------------------------------------------------
INCOME BEFORE INCOME TAXES .............................. 17 14 (11) 20
Income tax expense ...................................... 2 5 -- 7
------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS ....................... 15 9 (11) 13
Income (loss) from discontinued
operations, net of tax .................................. (1) 2 -- 1
------------------------------------------------------------
NET INCOME .............................................. 14 11 (11) 14
============================================================
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS FOR THE
SIX MONTHS ENDED JUNE 30, 2005
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
NET SALES ............................................... $ 1,195 $ 452 $(203) $ 1,444
Cost of goods sold ...................................... 1,077 381 (217) 1,241
------------------------------------------------------------
GROSS PROFIT ............................................ 118 71 14 203
Marketing, administrative and technological
expenses ................................................ 105 29 -- 134
------------------------------------------------------------
OPERATING INCOME ........................................ 13 42 14 69
Equity earnings (loss) from affiliates .................. 64 (2) (27) 35
Interest expense ........................................ (32) (12) -- (44)
Other income, net ....................................... 10 7 (12) 5
Reorganization items, net ............................... (17) (3) -- (20)
------------------------------------------------------------
INCOME BEFORE INCOME TAXES .............................. 38 32 (25) 45
Income tax expense ...................................... 2 11 -- 13
------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS ....................... 36 21 (25) 32
Income (loss) from discontinued
operations, net of tax .................................. (1) 4 -- 3
------------------------------------------------------------
NET INCOME .............................................. 35 25 (25) 35
============================================================
13
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE
SIX MONTHS ENDED JUNE 30, 2006
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
Net Cash Provided by (Used in) Operating
Activities ...................................................... $ (143) $ 19 $ -- $ (124)
Net Cash Used in Investing Activities ........................... (52) (7) -- (59)
Net Cash Provided by Financing Activities ....................... 333 8 -- 341
---------------------------------------------------------
Net Increase in Cash and Cash Equivalents ....................... 138 20 -- 158
Cash and Cash Equivalents:
Beginning of year ............................................ 18 89 -- 107
---------------------------------------------------------
End of period ................................................ $ 156 $ 109 $ -- $ 265
=========================================================
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE
SIX MONTHS ENDED JUNE 30, 2005
SOLUTIA AND SUBSIDIARIES SOLUTIA AND
SUBSIDIARIES IN NOT IN SUBSIDIARIES
REORGANIZATION REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ ------------
Net Cash Provided by (Used in) Operating
Activities ...................................................... $ (41) $ 15 $ -- $ (26)
Net Cash Used in Investing Activities ........................... (21) (6) -- (27)
Net Cash Provided by (Used in) Financing
Activities ...................................................... 24 (7) -- 17
---------------------------------------------------------
Net Increase (Decrease) in Cash and Cash
Equivalents ..................................................... (38) 2 -- (36)
Cash and Cash Equivalents:
Beginning of year ............................................ 50 65 -- 115
---------------------------------------------------------
End of period ................................................ $ 12 $ 67 $ -- $ 79
=========================================================
Recently Issued Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, ("FIN
48"). FIN 48 creates a single model to address uncertainty in tax positions and
clarifies the accounting for income taxes by prescribing the minimum recognition
threshold a tax position is required to meet before being recognized in the
financial statements. FIN 48 also provides guidance on derecognition,
measurement, classification, interest and penalties, accounting in interim
periods, disclosure and transition. In addition, FIN 48 eliminates income taxes
from the scope of Statement of Financial Accounting Standards ("SFAS") No. 5,
Accounting for Contingencies.
FIN 48 is effective for fiscal years beginning after December 15, 2006
(i.e., effective January 1, 2007 for Solutia). Differences between the amounts
recognized in the statements of financial position prior to the adoption of FIN
48 and the amounts reported after adoption will be accounted for as a cumulative
effect adjustment recorded to the beginning balance of retained earnings. The
cumulative effect adjustment would not apply to those items that would not have
been recognized in earnings, such as the effect of adopting FIN 48 on tax
positions related to business combinations. Solutia is currently evaluating the
impact of FIN 48 on the consolidated financial statements.
14
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
2. LIABILITIES SUBJECT TO COMPROMISE AND REORGANIZATION ITEMS, NET
Liabilities Subject to Compromise
Under Chapter 11 of the U.S. Bankruptcy Code, certain claims against
Solutia in existence prior to the filing of the petitions for relief under the
federal bankruptcy laws are stayed while Solutia continues business operations
as a debtor-in-possession. These estimated claims are reflected in the
Consolidated Statement of Financial Position as Liabilities Subject to
Compromise as of June 30, 2006 and December 31, 2005 and are summarized in the
table below. Such claims remain subject to future adjustments. Adjustments may
result from actions of the bankruptcy court, negotiations with claimants,
rejection or assumption of executory contracts, determination of value of any
collateral securing claims, reconciliation of proofs of claim or other events.
Solutia has received approval from the Bankruptcy Court to pay or
otherwise honor certain of its pre-petition obligations, including (i) certain
pre-petition compensation to employees and employee-equivalent independent
contractors; (ii) business expenses of employees; (iii) obligations under
employee benefit plans; (iv) employee payroll deductions and withholdings; (v)
costs and expenses incident to the foregoing payments (including payroll-related
taxes and processing costs); (vi) certain pre-petition workers' compensation
claims, premiums and related expenses; (vii) certain pre-petition trust fund and
franchise taxes; (viii) pre-petition claims of certain contractors, freight
carriers, processors, customs brokers and related parties; (ix) customer
accommodation programs; and (x) pre-petition claims of critical vendors in the
ordinary course of business. Accordingly, these pre-petition items have been
excluded from Liabilities Subject to Compromise as of June 30, 2006 and December
31, 2005, as applicable.
The amounts subject to compromise consisted of the following items:
JUNE 30, DECEMBER 31,
2006 2005
---- ----
Postretirement benefits (a) ................................. $ 1,028 $ 1,098
Litigation reserves (b) ..................................... 116 136
Accounts payable (c) ........................................ 116 118
Environmental reserves (d) .................................. 81 82
Other miscellaneous liabilities ............................. 75 74
6.72% debentures due 2037(e) ................................ 150 150
7.375% debentures due 2027(e) ............................... 300 300
11.25% notes due 2009 (f) ................................... 223 223
Other (g) ................................................... 43 43
------- -------
716 716
Unamortized debt discount and debt issuance costs ........... (48) (48)
------- -------
TOTAL DEBT SUBJECT TO COMPROMISE ....................... 668 668
------- -------
TOTAL LIABILITIES SUBJECT TO COMPROMISE ..................... $ 2,084 $ 2,176
======= =======
(a) Postretirement benefits include Solutia's domestic (i) qualified
pension plan liabilities of $462 and $501 as of June 30, 2006 and
December 31, 2005, respectively; (ii) non-qualified pension plan
liabilities of $19 as of both June 30, 2006 and December 31, 2005;
and (iii) other postretirement benefits liabilities of $547 and $578
as of June 30, 2006 and December 31, 2005, respectively. Pursuant to
a bankruptcy court order, Solutia made payments with respect to
other postretirement obligations of approximately $47 in the six
months ended June 30, 2006. Solutia also made $43 of contributions
to its qualified pension plan pursuant to IRS funding requirements
in the six months ended June 30, 2006.
(b) An automatic stay has been imposed against the commencement or
continuation of legal proceedings against Solutia outside of the
bankruptcy court process. Consequently, Solutia's accrued liability
with respect to pre-petition legal proceedings has been classified
as subject to compromise as of June 30, 2006 and December 31, 2005.
During the second quarter 2006 Solutia transferred out of
liabilities subject to compromise $20 of litigation reserves related
to the PENNDOT litigation matter that were no longer deemed
uncertain as a result of a favorable court ruling (as further
described in Note 9).
15
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
(c) Pursuant to bankruptcy court orders, Solutia settled certain
accounts payable liabilities subject to compromise in the six months
ended June 30, 2006.
(d) Represents remediation obligations related primarily to properties
that are not owned or operated by Solutia, including non-owned
properties adjacent to plant sites and certain owned offsite
disposal locations. See Note 9 for further disclosure with respect
to ongoing legal proceedings concerning environmental liabilities
subject to compromise.
(e) While operating during the Chapter 11 bankruptcy proceedings,
Solutia has ceased recording interest on its 6.72% debentures due
2037 and its 7.375% debentures due 2027. The amount of contractual
interest expense not recorded in the six months ended June 30, 2006
was approximately $16.
(f) Pursuant to a bankruptcy court order, Solutia is required to
continue payments of the contractual interest on its 11.25% notes
due 2009 as a form of adequate protection under the U.S. Bankruptcy
Code; provided, however, that Solutia's official committee of
unsecured creditors (the "Creditors' Committee") has the right at
any time, and Solutia has the right at any time after the payment of
the contractual interest made in July 2005, to seek to terminate
Solutia's obligation to continue making the interest payments.
Solutia or the Creditors' Committee could successfully terminate all
or part of Solutia's interest payment obligations only after a
showing that the noteholders are not entitled to adequate
protection, which would depend, among other things, on the value of
the collateral securing the notes as of December 17, 2003, and
whether that value is decreasing during the course of Solutia's
bankruptcy case. The amount of contractual interest paid with
respect to these notes was approximately $13 in the six months ended
June 30, 2006, and the accrued interest related to these notes was
included in Accrued Liabilities classified as not subject to
compromise as of June 30, 2006 and December 31, 2005.
(g) Represents the debt obligation incurred upon the consolidation of
the assets and liabilities of a synthetic lease structure
consolidated as part of the adoption of FASB Interpretation No. 46,
Consolidation of Variable Interest Entities. The obligation
represents the synthetic lease arrangement with respect to Solutia's
headquarters building.
Reorganization Items, Net
Reorganization items, net are presented separately in the Condensed
Consolidated Statement of Operations and represent items of income, expense,
gain or loss that are realized or incurred by Solutia because it is in
reorganization under Chapter 11 of the U.S. Bankruptcy Code.
Reorganization items, net consisted of the following items:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
Professional fees (a) ...................................... $(15) $(13) $(27) $(24)
Severance and employee retention costs (b) ................. (1) (2) (3) (8)
Adjustments to allowed claim amounts (c) ................... -- -- 2 (11)
Settlements of pre-petition claims (d) ..................... -- -- -- 29
Other ...................................................... (2) -- (4) (6)
---- ---- ---- ----
TOTAL REORGANIZATION ITEMS, NET ............................ $(18) $(15) $(32) $(20)
==== ==== ==== ====
(a) Professional fees for services provided by debtor and creditor
professionals directly related to Solutia's reorganization proceedings.
(b) Expense provisions related to (i) employee severance costs incurred
directly as part of the Chapter 11 reorganization process and (ii) a
retention plan for certain Solutia employees approved by the bankruptcy
court.
(c) Adjustments to record certain pre-petition claims at estimated amounts of
the allowed claims.
(d) Represents the difference between the settlement amount of certain
pre-petition obligations and the corresponding amounts previously
recorded.
16
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
3. STOCK OPTION PLANS
Solutia has two stock-based incentive plans under which awards are
available for grants to officers and employees; the Solutia Inc. 2000
Stock-Based Incentive Plan ("2000 Plan") and the Solutia Inc. 1997 Stock-Based
Incentive Plan ("1997 Plan"). The 2000 Plan authorizes up to 5,400,000 shares
and the 1997 Plan up to 7,800,000 shares of Solutia common stock for grants of
non-qualified and incentive stock options, stock appreciation rights, restricted
stock awards and bonus stock awards. The shares used may be newly issued shares,
treasury shares or a combination. Under both plans, the exercise price of a
stock option must be no less than the fair market value of Solutia's common
stock on the option grant date. Additionally, the plans provide that the term of
any stock option granted may not exceed 10 years. At June 30, 2006,
approximately 2,108,795 shares from the 2000 Plan and 1,954,164 shares from the
1997 Plan remained available for grants.
During the six months ended June 30, 2006, no options were granted to
current executive officers and other senior executives as a group, or to other
employees. Total shares covered by options granted under the plans to current
executive officers and other senior executives as a group totaled 3,011,000, and
those to other employees totaled 10,016,592, through June 30, 2006. The options
granted to Solutia's executive officers and other senior executives are
primarily performance options that become exercisable upon the earlier of
achievement of specified share price targets or the ninth anniversary of the
option grant. The options granted to the other management employees are
time-based. They generally become exercisable in thirds, one-third on each of
the first three anniversaries of the option grant date.
The Solutia Inc. Non-Employee Director Compensation Plan provides
incentives to non-employee members of Solutia's board of directors. This plan
authorizes up to 400,000 shares for grants of non-qualified stock options and
for grants of deferred shares in payment of all or a portion of the annual
retainer for the non-employee directors. Only treasury shares may be used. Under
this plan, the exercise price of a stock option must be no less than the fair
market value of Solutia's common stock on the grant date and the term of any
stock option granted under the plan may not exceed 10 years. At June 30, 2006,
25,174 shares of Solutia's common stock remained available for grants under the
plan. There were no options or deferred shares granted in the six months ended
June 30, 2006 as all non-employee director compensation is now paid in cash.
As of January 1, 2006, Solutia adopted SFAS No. 123 (revised 2004),
Share-Based Payment ("SFAS No. 123(R)"), using the modified prospective method,
which requires measurement of compensation cost for all stock-based awards at
fair value on the date of grant and recognition of compensation over the service
period for awards expected to vest. The fair value of stock options is
determined using the Black-Scholes valuation model, which is consistent with
valuation techniques previously utilized for options in footnote disclosures
required under SFAS No. 123, Accounting for Stock Based Compensation, as amended
by SFAS No. 148, Accounting for Stock-Based Compensation--Transition and
Disclosure. Such value is recognized as expense over the service period, net of
estimated forfeitures, using the straight-line method under SFAS No. 123(R). The
estimation of stock awards that will ultimately vest requires judgment, and to
the extent actual results or updated estimates differ from our current
estimates, such amounts will be recorded as a cumulative adjustment in the
period estimates are revised. Additionally, Solutia believes that its plan of
reorganization will provide for cancellation of its existing shares of common
stock, as well as options and warrants to purchase its common stock, and that it
is unlikely that holders of options to purchase Solutia's common stock will
receive any consideration for those options in such a plan of reorganization.
There were no options granted or exercised during the six months ended
June 30, 2006. Accordingly, no compensation cost with respect to such activities
was recognized in the Statement of Consolidated Operations in the six months
ended June 30, 2006. However, to the extent that the remaining service periods
of unvested options granted prior to January 1, 2006 extend past the adoption
date of SFAS No. 123(R), the residual unamortized fair value originally
calculated for footnote disclosures required under SFAS No. 123, net of
estimated forfeitures, is now recognized on a straight-line basis over such
remaining periods. Compensation cost and all related effects within the
Statement of Consolidated Operations and Statement of Consolidated Cash Flows
associated with these unvested
17
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
options was less than $1 during the six months ended June 30, 2006.
Additionally, there was less than $1 of total unrecognized compensation cost
related to these unvested options as of June 30, 2006 to be recognized over a
weighted-average recognition period of less than one year.
Prior to January 1, 2006, Solutia applied SFAS No. 123 as amended by SFAS
No. 148, which allowed Solutia to continue following the guidance of Accounting
Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to
Employees, for measurement and recognition of stock-based transactions with
employees. Accordingly, no compensation cost was recognized for Solutia's option
plans in the Statement of Consolidated Operations during such periods, as all
options granted under the plans had an exercise price equal to the market value
of Solutia's stock on the date of the grant. The effect would have been less
than $1 on net income and no change on income per share had the determination of
compensation cost for these plans been based on the fair value at the grant
dates for awards under these plans, consistent with SFAS No. 123, for the six
months ended June 30, 2005.
A summary of Solutia's stock option plans for the six months ended June
30, 2006 is as follows:
WEIGHTED-
WEIGHTED- AVERAGE AGGREGATE
AVERAGE REMAINING INTRINSIC
OPTIONS EXERCISE PRICE CONTRACTUAL LIFE VALUE (A)
---------------------------------------------------------------
Outstanding at January 1, 2006 ................ 17,323,551 $ 15.80 -- --
Granted .................................... -- 0.00 -- --
Exercised .................................. -- 0.00 -- --
Expired .................................... (947,076) 15.33 -- --
---------------------------------------------------------------
Outstanding at March 31, 2006 ................ 16,376,475 $ 15.82 1.7 $ (253)
Granted .................................... -- 0.00 -- --
Exercised .................................. -- 0.00 -- --
Expired .................................... (2,667,774) 16.49 -- --
---------------------------------------------------------------
Outstanding at June 30, 2006 .................. 13,708,701 $ 15.68 1.8 $ (209)
===============================================================
Exercisable at June 30, 2006 .................. 13,415,802 $ 15.96 1.7 $ (208)
(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 Solutia's common stock as of the
reporting date.
4. ACQUISITION AND DIVESTITURE
Discontinued Operations
On May 23, 2006, Solutia's wholly-owned subsidiary, Solutia Europe
S.A./N.V. ("SESA"), agreed to sell its pharmaceutical services business to
Dishman Pharmaceuticals & Chemicals Ltd. ("Dishman") pursuant to a Stock and
Asset Purchase Agreement dated as of May 23, 2006 between SESA and Dishman.
Under the terms of the agreement, Dishman has agreed to purchase 100 percent of
the stock of the pharmaceutical services business, as well as certain other
assets used in the pharmaceutical services business, for approximately $75,
subject to certain purchase price adjustments. Dishman has also agreed to assume
substantially all of the liabilities relating to the pharmaceutical services
business, other than certain liabilities that arise prior to the closing of the
transaction and liabilities under certain employment agreements. SESA has
agreed, subject to certain exceptions, that for a period of three years after
the closing of the transaction neither it nor its affiliates will compete with
the business of the pharmaceutical services business or solicit for employment
certain employees of the pharmaceutical services business and their current
affiliates. The transaction is anticipated to close in the third quarter 2006.
18
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
The pharmaceutical services business is a component of the Performance
Products segment. Based upon the current transaction terms, Solutia expects to
record a gain on the sale of the pharmaceutical services business in the range
of approximately $45 to $55. Further, approximately (euro) 40 million, or
approximately $50, of the proceeds from the sale are required to pay down the
(euro) 200 million facility entered into on July 26, 2006 and closed on August
1, 2006 (as described in Note 13).
As the transaction is expected to close in the third quarter 2006, the
assets and liabilities of the discontinued operations have been classified as
current in the Consolidated Statement of Financial Position at June 30, 2006 and
December 31, 2005. The carrying amounts of assets and liabilities from
discontinued operations consisted of the following:
JUNE 30, DECEMBER 31,
2006 2005
---- ----
ASSETS:
Trade receivables .................................................... $ 8 $ 7
Miscellaneous receivables ............................................ 2 1
Inventories .......................................................... 20 13
Prepaid expenses and other assets .................................... 2 1
Property, plant and equipment, net ................................... 35 34
Identified intangible assets, net .................................... 7 7
Other assets ......................................................... 10 6
----- -----
Assets of discontinued operations ........................... $ 84 $ 69
===== =====
LIABILITIES:
Accounts payable ..................................................... $ 3 $ 4
Accrued liabilities .................................................. 21 17
Other liabilities .................................................... 6 5
----- -----
Liabilities of discontinued operations ...................... $ 30 $ 26
===== =====
The operating results of the pharmaceutical services business have been
reported separately as discontinued operations, net of tax, in the Consolidated
Statement of Operations for each period presented. Net sales and income from
discontinued operations are as follows:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
Net sales .............................................. $ 15 $17 $ 37 $36
Income (loss) before income taxes ...................... (1) 1 3 4
Income tax expense (benefit) ........................... (5) -- (5) 1
---- --- ---- ---
INCOME FROM DISCONTINUED OPERATIONS .................... $ 4 $ 1 $ 8 $ 3
==== === ==== ===
Acquisition
On March 1, 2006, pursuant to a stock purchase agreement among Solutia,
Vitro S.A. de C.V. ("Vitro") and Vitro Plan S.A. de C.V. ("Vitro Plan"), a
wholly-owned subsidiary of Vitro, Solutia acquired Vitro Plan's 51 percent stake
in Quimica M, S.A. de C.V. ("Quimica") (originally formed in 1996 as a joint
venture between Vitro, Vitro Plan, and Monsanto) for approximately $20 in cash.
As a result of this acquisition, Solutia became the sole owner of Quimica and
its plastic interlayer plant located in Puebla, Mexico. Pursuant to the purchase
agreement, Solutia also entered into supply agreements with Vitro Flex S.A. de
C.V. and Vitro Automotriz S.A. de C.V. to provide their
19
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
requirements for most SAFLEX(R) plastic interlayer products for up to five
years. This acquisition reflects Solutia's commitment to meet the growing global
demand for its SAFLEX(R) and VANCEVA(R) plastic interlayer products.
The allocation of purchase price to the assets and liabilities acquired or
assumed resulted in Solutia's acquisition or assumption of total current assets
of $18, non-current assets of $32, goodwill of $5, amortizable contract-based
intangible assets of $4, current liabilities of $11 and non-current liabilities
of $7. The contract-based intangible assets are being amortized over their
estimated useful lives of 5 years. Results of operations for Quimica were
included in Solutia's results of operations from the acquisition date in the
Performance Products segment. The results of operations for the acquired
business were not material to Solutia's consolidated results of operations.
5. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Goodwill of $89 and $76 at June 30, 2006 and December 31, 2005,
respectively, was allocated to the Performance Products segment. This $13
increase in goodwill as of June 30, 2006 was a result of the Quimica acquisition
(as further described in Note 4), of which $5 resulted from the 2006 acquisition
and $8 resulted from the original acquisition in 1996 that was previously
accounted for under the equity method of accounting.
Identified Intangible Assets
Identified intangible assets generally are comprised of (i) amortizable
contract-based intangible assets with finite useful lives, and (ii)
indefinite-lived trademarks not subject to amortization. These intangible assets
are summarized in aggregate as follows:
JUNE 30, 2006 DECEMBER 31, 2005
---------------------------------- --------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
VALUE AMORTIZATION VALUE VALUE AMORTIZATION VALUE
---------------------------------- --------------------------------
Amortized intangible assets .................. $ 12 $ (6) $ 6 $ 8 $ (6) $ 2
Trademarks ................................... 26 -- 26 26 -- 26
---------------------------------- --------------------------------
TOTAL IDENTIFIED INTANGIBLE
ASSETS ....................................... $ 38 $ (6) $ 32 $ 34 $ (6) $ 28
================================== ================================
There were no changes to amortizable lives or methods during the six
months ended June 30, 2006. In addition, amortization expense for the net
carrying amount of finite-lived intangible assets is estimated to be $2 annually
from 2006 through 2010.
6. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
JUNE 30, DECEMBER 31,
INVENTORIES 2006 2005
---- ----
Finished goods ...................................... $ 219 $ 236
Goods in process .................................... 149 131
Raw materials and supplies .......................... 100 93
----- -----
Inventories, at FIFO cost ........................... 468 460
Excess of FIFO over LIFO cost ....................... (205) (206)
----- -----
TOTAL INVENTORIES ................................... $ 263 $ 254
===== =====
Inventories at FIFO approximate current cost.
20
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
ACCRUED LIABILITIES 2006 2005
---- ----
Wages and benefits ...................................... $ 43 $ 54
Accrued rebates and sales returns/allowances ............ 18 22
Accrued interest ........................................ 26 23
Other ................................................... 158 124
------ ------
TOTAL ACCRUED LIABILITIES ............................... $ 245 $ 223
====== ======
7. INVESTMENT IN AFFILIATE
At June 30, 2006, Solutia participated in one principal 50/50 joint
venture, Flexsys Group, comprised of interests in Flexsys Holding B.V., Flexsys
America L.P. and Flexsys Rubber Chemicals Ltd. (collectively "Flexsys"), for
which Solutia applies the equity method of accounting. Summarized financial
information for 100 percent of the Flexsys joint venture is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------------------------
2006 2005 2006 2005
---- ---- ---- ----
Net sales ............................. $ 161 $ 174 $ 316 $ 334
Gross profit .......................... 47 60 93 112
Operating income ...................... 32 30 60 61
Net income ............................ 21 22 40 46
8. RESTRUCTURING RESERVES
Solutia recorded approximately $1 of asset write-downs recorded within
Reorganization Items, net in the Performance Products segment during the three
months ended June 30, 2006. In addition, Solutia recorded approximately $1 of
severance and retraining costs in the three months ended June 30, 2006
principally in Marketing and Administrative expenses involving headcount
reductions recorded primarily in the Performance Products segment.
Solutia recorded approximately $2 of decommissioning and dismantling costs
in the six months ended June 30, 2006 as a result of the shut-down of its
acrylic fibers business in 2005, and approximately $2 of asset write-downs.
These costs were all recorded within Reorganization Items, net with
approximately $3 in the Integrated Nylon segment and approximately $1 in the
Performance Products segment. In addition, Solutia recorded approximately $3 of
severance and retraining costs in the six months ended June 30, 2006 with
approximately $2 in Reorganization Items, net, and approximately $1 in Marketing
and Administrative expenses involving headcount reductions recorded throughout
the organization.
21
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
A summary of restructuring activity during the three and six months ended
June 30, 2006 is as follows:
DECOMMISSIONING/ EMPLOYMENT ASSET WRITE-
DISMANTLING REDUCTIONS DOWNS TOTAL
-----------------------------------------------------------------
Balance at December 31, 2005 .............. $ 2 $ 2 $ -- $ 4
Charges taken ........................... 2 2 1 5
Amounts utilized ........................ (2) (3) (1) (6)
-----------------------------------------------------------------
Balance at March 31, 2006 ................. $ 2 $ 1 $ -- $ 3
Charges taken ........................... -- 1 1 2
Amounts utilized ........................ (1) (1) (1) (3)
-----------------------------------------------------------------
BALANCE AT JUNE 30, 2006 .................. $ 1 $ 1 $ -- $ 2
=================================================================
Solutia cannot forecast the level of future restructuring charges due to
the inherent uncertainty involved in operating as a debtor-in-possession under
Chapter 11 bankruptcy protection.
9. CONTINGENCIES
Litigation
Because of the size and nature of its business, Solutia is a party to
numerous legal proceedings. Most of these proceedings have arisen in the
ordinary course of business and involve claims for money damages. In addition,
at the time of its spinoff from Pharmacia, Solutia assumed the defense of
specified legal proceedings and agreed to indemnify Pharmacia for obligations
arising in connection with those proceedings. Solutia has determined that these
defense and indemnification obligations to Pharmacia are pre-petition
obligations under the U.S. Bankruptcy Code that Solutia is prohibited from
performing, except pursuant to a confirmed plan of reorganization. As a result,
Solutia has ceased performance of these obligations. Solutia's cessation of
performance may give rise to a pre-petition unsecured claim against Solutia
which Pharmacia may assert in Solutia's Chapter 11 bankruptcy case. This
estimated unsecured claim amount was classified as a liability subject to
compromise as of June 30, 2006 and December 31, 2005 in the amount of $116 and
$136, respectively.
Solutia's 2003 Form 10-K/A described a number of legal proceedings in
which Solutia was a named defendant or was defending solely due to its
indemnification obligations referred to above. Solutia is prohibited from
performing with respect to these obligations, and developments, if any, in these
matters are currently managed by other named defendants. Accordingly, Solutia
has ceased reporting on the status of those legal proceedings. The legal
proceedings which are in this category are (i) Owens v. Monsanto; (ii) Payton v.
Monsanto; (iii) other Anniston cases; and (iv) premises based asbestos
litigation.
Following is a summary of legal proceedings that Solutia or certain of its
equity affiliates continue to manage that could result in an outcome that is
material to the consolidated financial statements:
LEGAL PROCEEDINGS IN SOLUTIA'S BANKRUPTCY CASE
JPMORGAN ADVERSARY PROCEEDING
On May 27, 2005, JPMorgan, as indenture trustee for Solutia's debentures
due 2027 and 2037 (the "Prepetition Indenture"), filed an adversary proceeding
(the "JPM Proceeding") against Solutia in Solutia's bankruptcy case. In its
adversary proceeding, JPMorgan asserted five causes of action seeking
declaratory judgments to establish the validity and priority of the purported
security interest of the holders of the 2027 and 2037 debentures, and one cause
of action pursuant to section 363 of the Bankruptcy Code asserting that the
alleged
22
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
security interests lacked adequate protection. The JPM Proceeding relates to
Solutia's 2002 and 2003 refinancings of its credit facilities. When Solutia
refinanced its credit facilities in 2002, the 2027 and 2037 debentures obtained
a pro rata secured interest in certain of Solutia's assets as a result of the
application of the "equal and ratable" provisions of the Prepetition Indenture.
On October 8, 2003, Solutia restructured its credit facilities, reduced its
outstanding secured indebtedness below the threshold level that initially
triggered the "equal and ratable" provisions of the Prepetition Indenture and,
as a result, the 2027 and 2037 debentures returned to their original unsecured
status. JPMorgan alleges that the October 8, 2003 refinancing had no effect on
the security interests and liens that were created in 2002, and argues further
that, even if it did, those liens should be reinstated as a matter of equity.
The Unsecured Creditors' Committee and the Ad Hoc Solutia Trade Claims Committee
have intervened in the JPM Proceeding in support of Solutia and the Ad Hoc
Committee of Solutia Noteholders has intervened in the JPM Proceeding in support
of JPMorgan. Trial of the JPM Proceeding concluded on July 10, 2006. Post-trial
briefs are expected to be submitted by the parties by August 9, 2006. The
Bankruptcy Court has indicated that it will take at least six weeks after
submission of the post-trial briefs to make a ruling in the JPM Proceeding.
EQUITY COMMITTEE ADVERSARY PROCEEDING AGAINST MONSANTO AND PHARMACIA
On March 7, 2005, the Official Committee of Equity Security Holders
("Equity Committee") in Solutia's bankruptcy case filed a complaint against
Pharmacia and Monsanto and objections to the proofs of claim filed by Pharmacia
and Monsanto in Solutia's bankruptcy case (the "Equity Committee Complaint"). In
the Equity Committee Complaint, the Equity Committee seeks to avoid certain
obligations assumed by Solutia at the time of its spinoff from Pharmacia. The
Equity Committee Complaint alleges, among other things, that the Solutia Spinoff
was a fraudulent transfer under the Bankruptcy Code because Pharmacia forced
Solutia to assume excessive liabilities and insufficient assets such that
Solutia was destined to fail from its inception. Pharmacia and Monsanto filed a
motion to dismiss the Equity Committee Complaint for, among other things, lack
of standing or, in the alternative, to stay the adversary proceeding. On August
4, 2005, the Debtors filed with the Bankruptcy Court their Statement and
Reservation of Rights in Response to Equity Committee's Complaint and Objection
to Claims, in which the Debtors expressed their view that the issues and
disputes raised in the Equity Committee Complaint would be resolved through the
Plan confirmation process. During a hearing held on April 11, 2006 the
Bankruptcy Court issued a bench ruling denying Pharmacia and Monsanto's motion
to dismiss the Equity Committee Complaint. The Ad Hoc Committee of Solutia
Noteholders and the Ad Hoc Solutia Trade Claims Committee have intervened in
this adversary proceeding in support of the Equity Committee. The Unsecured
Creditors' Committee has intervened, and Solutia intends to intervene, in this
adversary proceeding as neutral parties due to the importance of this proceeding
with respect to Solutia's bankruptcy case. The case is proceeding and the
Bankruptcy Court has set this matter for trial to commence on September 11,
2006.
LEGAL PROCEEDINGS OUTSIDE SOLUTIA'S BANKRUPTCY CASE
ANNISTON PARTIAL CONSENT DECREE
On August 4, 2003, the U.S. District Court for the Northern District of
Alabama approved a Partial Consent Decree in an action captioned United States
of America v. Pharmacia Corporation (p/k/a Monsanto Company) and Solutia. This
Partial Consent Decree provides for Pharmacia and Solutia to sample certain
residential properties and remove soils found on those properties if PCBs are at
a level of 1 part per million ("ppm") or above, to conduct a Remedial
Investigation and Feasibility Study to provide information for the selection by
the EPA of a cleanup remedy for the Anniston, Alabama PCB site, and to pay EPA's
past response costs and future oversight costs related to this work. The decree
also provided for the creation of an educational trust fund of approximately $3
to be funded over a 12-year period to provide supplemental educational services
for school children in west Anniston.
A subsequent dispute arose between the EPA and Solutia regarding the scope
and application of the automatic stay arising as a result of Solutia's Chapter
11 filing to the remaining obligations under the Partial Consent Decree. On
April 19, 2004, the District Court held that the Partial Consent Decree enforces
police and regulatory powers under the Comprehensive Environmental Response,
Compensation, and Liability Act ("CERCLA") and, as a
23
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
result, the automatic stay provisions of the U.S. Bankruptcy Code are
inapplicable to Solutia's obligations under the Partial Consent Decree. On April
30, 2004, the United States Bankruptcy Court for the Southern District of New
York entered a Stipulation and Agreed Order in which the EPA and Solutia
stipulated that the automatic stay is applicable to certain of the Partial
Consent Decree's requirements. Solutia filed a motion asking the District Court
to reconsider its order and to bring it into accord with the Stipulation and
Agreed Order consented to by the EPA and entered by the Bankruptcy Court. On
September 9, 2004, the District Court denied Solutia's motion and declared that
the automatic stay is inapplicable to Solutia's obligations under the Consent
Decree to perform site work. Solutia appealed this ruling to the Eleventh U.S.
Circuit Court of Appeals, which dismissed the appeal for lack of jurisdiction.
On June 30, 2005, the United States District Court for the Northern
District of Alabama issued an order (the "PCB Order") authorizing co-defendants
Pharmacia and Solutia to "suspend" performance of the PCB clean-up at the
Anniston site under the Anniston Consent Decree, upon the filing of a motion by
either defendant requesting that relief. The PCB Order found that Solutia and
Pharmacia entered into the Anniston Consent Decree, and that the court approved
that Anniston Consent Decree, based on the understanding that the defendants'
rights to pursue other liable parties for contribution would not be impaired by
the EPA. The PCB Order further found that the EPA's planned settlements with
certain Anniston foundries would thus deprive the defendants of one of the
material considerations for entering into the Anniston Consent Decree.
In July 2006, Solutia and Pharmacia reached an agreement with EPA that
clarifies the extent of remaining obligations under the Anniston Consent Decree
and the coordination of that work with the Lead Site clean-up being performed by
others, and by which Solutia and Pharmacia will forego the opportunity to
suspend their obligations under the Anniston Consent Decree pursuant to the PCB
Order. Solutia and Pharmacia preserved their rights under this agreement to
continue to argue that the contribution protection afforded certain other
potentially responsible parties performing Lead Site clean-up should not be
effective as to Solutia and Pharmacia.
PENNDOT CASE
Solutia's Annual Report on Form 10-K (as amended) for the year ended
December 31, 2003 described a case then pending in the Commonwealth Court of
Pennsylvania by the Commonwealth of Pennsylvania against Pharmacia seeking
damages for PCB contamination in the Transportation and Safety Building ("T&S
Building") in Harrisburg, Pennsylvania, that it claimed necessitated the
demolition of the T&S building. Solutia was not a named defendant in this
litigation and therefore took no action to stay the litigation in connection
with its Chapter 11 proceedings. Solutia assumed the defense of this litigation
at the time of its spin-off from Pharmacia. Solutia determined that its
obligation to defend and indemnify Pharmacia with regard to this litigation was
a pre-petition obligation that Solutia was prohibited from performing, except
pursuant to a confirmed plan of reorganization. Therefore, Solutia ceased
defending Pharmacia with respect to this litigation. Solutia did, however,
provide a $20 letter of credit to secure a portion of Pharmacia's obligations
with respect to an appeal bond issued with respect to the case.
On May 25, 2006 the Supreme Court of Pennsylvania issued its ruling on the
appeal in this case, reversing in whole and remanding in part the decision of
the trial court against Pharmacia. With respect to those claims that were
reversed and remanded, the Supreme Court of Pennsylvania significantly limited
the amount of damages that could be awarded. Based upon this ruling, Solutia
recognized a gain in its Consolidated Statement of Operations during the second
quarter 2006 from the reversal of a significant portion of the existing
litigation reserve with respect to this matter.
FLEXSYS RELATED LITIGATION
Antitrust authorities in the United States, Europe and Canada are
continuing to investigate past commercial practices in the rubber chemicals
industry. Flexsys, Solutia's joint venture with Akzo Nobel N.V. ("Akzo"),
remains a subject of such investigation and continues to fully cooperate with
the authorities in the ongoing investigation. In addition, a number of purported
civil class actions on behalf of consumers have been filed against Flexsys and
other producers of rubber chemicals.
State court actions against Flexsys. Solutia is presently aware of nine
purported class actions that remain pending in various state courts against
Flexsys and other producers of rubber chemicals seeking actual and treble
damages under state law. Seven of these cases purport to be on behalf of all
retail purchasers of tires in the respective states since as early as 1994 and
two of the cases purport to be on behalf of all retail purchasers of any product
containing rubber chemicals during the same period. Solutia is not named as a
defendant in any of these cases. All of these cases remain pending in various
procedural stages and no substantive discovery or other actions have taken
place.
Canadian actions against Flexsys. In May 2004, two purported class actions
were filed in the Province of Quebec, Canada, against Flexsys and other rubber
chemical producers alleging that collusive sales and marketing activities of the
defendants damaged all persons in Quebec during the period July 1995 through
September 2001. Plaintiffs seek statutory damages of (CAD) $14.6 along with
exemplary damages of (CAD) $0.000025 per person. In May 2005 a case was filed in
Ontario, Canada against Flexsys and other rubber chemical producers alleging the
same claims as in the Quebec cases and seeking damages of (CAD) $95 on behalf of
all persons in Canada injured by the alleged collusive activities of the
defendants. In August 2005, a similar case was filed in British Columbia seeking
unspecified damages under a variety of theories on behalf of all purchasers of
rubber chemicals and products containing rubber chemicals in British Columbia.
No responses are yet due nor have any been filed by defendants in any of these
cases. Solutia is not a named defendant in any of these cases.
24
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Federal court actions by indirect purchasers of rubber chemicals. On
January 14, 2006, Solutia became aware of a newly filed case, Pearman, Benson
and Immerman v. Crompton Corp., Flexsys, Solutia, et al., in the United States
District Court for the Eastern District of Tennessee at Greenville, purportedly
filed on behalf of consumers in 37 states of products produced with rubber
chemicals for the period 1994 through the present under the Tennessee Trade
Practices Act. Solutia was initially named in the suit but was voluntarily
dismissed without prejudice on February 3, 2006. On April 28, 2006, Solutia
received notice that this case was voluntarily dismissed, without prejudice, by
the plaintiffs.
Federal court actions alleging violations of federal securities laws.
Between approximately July and September 2003, six purported shareholder class
actions were filed in the U.S. District Court for the Northern District of
California against Solutia, its then and former chief executive officers and its
then chief financial officer. The complaints were consolidated into a single
action called In Re Solutia Securities Litigation, and a consolidated complaint,
which named two additional defendants, Solutia's then current and past
controllers, was filed. The consolidated complaint alleged that from December
16, 1998 to October 10, 2002, Solutia's accounting practice of incorporating
Flexsys's results into Solutia's financial reports violated federal securities
laws by misleading investors as to Solutia's actual results and causing inflated
prices to be paid by purchasers of Solutia's publicly traded securities during
the period. The plaintiffs sought damages and any equitable relief that the
court deemed proper. The consolidated action was automatically stayed with
respect to Solutia by virtue of Section 362(a) of the U.S. Bankruptcy Code. In
March 2005 the court issued a final order dismissing with prejudice the
complaint against the individual defendants, which became final when the
plaintiffs failed to file an appeal of the dismissal within the applicable
appeals period, and the case was dismissed without prejudice as against Solutia
pending resolution of the bankruptcy case.
Shareholder Derivative Suits. Two purported shareholder derivative suits
were filed in the Missouri Circuit Court for the Twenty-First Judicial Circuit
of St. Louis County against certain of Solutia's current and past directors,
chief executive officers, chief financial officer and former vice chairman.
Solutia is included as a nominal defendant. The plaintiffs seek damages on
behalf of Solutia for the individual defendants' alleged breaches of fiduciary
duty, abuse of control, gross mismanagement, waste of corporate assets and
unjust enrichment, arising out of Flexsys' alleged participation in the
price-fixing of rubber chemicals and Solutia's incorporation of Flexsys's
purportedly inflated financial results arising from the alleged price-fixing
into Solutia's financial statements. These two shareholder derivative suits were
consolidated into a single action, In re Solutia Inc. Derivative Litigation. On
December 29, 2003, the court entered an Order in the consolidated action staying
the litigation with respect to all defendants, including Solutia. In August
2004, the court involuntarily dismissed the case for lack of prosecution. In
late 2004, plaintiffs' filed a motion to reinstate the actions which motion
remains pending with no further action yet taken by plaintiffs.
CASH BALANCE PLAN LITIGATION
Since October 2005, three cases have been filed by participants in the
Solutia Inc. Employees' Pension Plan alleging that the Pension Plan: (1)
violates the Employee Retirement Income Security Act of 1974 ("ERISA")
prohibitions on reducing rates of benefit accrual based on age; (2) results in
the impermissible forfeiture of accrued benefits under ERISA; (3) violates
ERISA's present value calculation rules for determining lump sum distributions;
and (4) violates the minimum accrual requirements of ERISA. The cases were
captioned Davis, et. al. v. Solutia, Inc. Employees' Pension Plan,
Scharringhausen, et. al. v. Solutia, Inc. Employees' Pension Plan, et al. and
Juanita Hammond, et. al. v. Solutia, Inc. Employees' Pension Plan. None of the
Debtors, and, except for the Solutia Inc. Employee Benefits Plans Committee
which was named in the Scharringhausen case, no individual or entity other than
the Pension Plan, has been named as a defendant in any of these cases. The
plaintiffs in each of these cases sought to obtain injunctive and other
equitable relief (including money damages awarded by the creation of a common
fund) on behalf of themselves and the nationwide putative class of similarly
situated current and former participants in the Pension Plan for whose pension
benefits the Pension Plan is responsible. The Pension Plan, and
25
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
in the case of the Scharringhausen case, the Employee Benefits Plans Committee,
moved to dismiss all three actions for plaintiffs' failure to exhaust
administrative remedies and failure to join necessary and indispensable parties.
The Scharringhausen plaintiffs have moved to intervene in the Davis
action and to consolidate the Davis, Scharringhausen and Hammond cases. The
Hammond plaintiff has moved to consolidate the three cases and the Pension Plan
has responded by agreeing that it should not be required to defend itself
against three cases. The Davis plaintiffs have intervened in the Scharringhausen
and Hammond cases and moved to stay or dismiss those later-filed cases, rather
than consolidating them with the Davis case. The plaintiffs' counsel in the
Davis, Scharringhausen and Hammond cases each have sought appointment as interim
lead class counsel. In response to these motions, on April 24, 2006 the
Scharringhausen plaintiffs voluntarily dismissed their case.
On June 2, 2006, the Hammond plaintiffs agreed to stay their action
pending exhaustion of administrative remedies with respect to count (4), above.
Thereafter the Hammond and Davis plaintiffs also each withdrew their respective
motions to consolidate and to stay or dismiss. In addition, the Hammond and
Davis plaintiffs each withdrew their motions to appoint interim class counsel
and have advised the court that they are cooperating in the representation of
the putative class. The Pension Plan's motions to dismiss in both the Hammond
and Davis cases remain pending.
The Pension Plan intends to continue to vigorously defend itself against
any and all claims asserted in the Davis and Hammond litigation.
GE LITIGATION
On January 3, 2006, Solutia received notice that an action captioned
Michael Abbatiello et al. v. Monsanto Company, Pharmacia Corporation and Solutia
Inc. (the "Abbatiello Case"), was filed on December 26, 2005 in the Supreme
Court of the State of New York. The action was filed on behalf of 590 current
General Electric employees who work at its Schenectady, New York plant and
states eleven separate causes of action alleging that General Electric purchased
various PCB containing products from Pharmacia which were used in the
manufacture of a variety of products including electric motors, generators, gas
turbines, wire and cable, insulating materials and microwave tubes. PCBs were
later detected in various locations, including retention ponds, ground water,
and water treatment centers on the approximately 628 acre site. On May 10, 2006,
Solutia received notice that an action, captioned Alan Abele, et al. v. Monsanto
Company, Pharmacia Corporation and Solutia Inc., (the "Abele Case" and, together
with the Abbatiello Case, the "GE Litigation") was filed on March 15, 2006 in
the Supreme Court of the State of New York. The action was filed on behalf of
486 former General Electric employees who were employed at General Electric's
Schenectady, NY plant and states eleven separate causes of action based on
claims identical to those made on behalf of current General Electric employees
in the Abbatiello Case. The plaintiffs in each of the GE Litigation cases are
seeking $1,000 in compensatory damages and $1,000 in punitive damages for each
cause of action for a total of $2,000. The GE Litigation is automatically stayed
as to Solutia pursuant to Section 362 of the U.S. Bankruptcy Code.
At the time of the spinoff from Pharmacia, Solutia assumed liability for,
among other things, litigation liabilities related to chemical products formerly
manufactured, released or used by Pharmacia prior to the spinoff, including the
costs of toxic tort lawsuits alleging exposure to PCBs. Solutia also agreed to
defend Pharmacia against, and indemnify Pharmacia for, such liability. Upon
filing for Chapter 11 protection, Solutia determined that its defense and
indemnification obligations to Pharmacia with respect to such litigation
liabilities were pre-petition obligations under the U.S. Bankruptcy Code and
that Solutia was therefore prohibited from performing, except pursuant to a
confirmed plan of reorganization. As a result, after filing for Chapter 11
protection, Solutia ceased performance of its defense obligations and those
defense obligations have been managed by Monsanto during Solutia's Chapter 11
Case. Because such litigation was no longer being managed by Solutia, Solutia
became unable to provide complete status updates and, as a result, Solutia
disclosed that it would cease reporting on those litigation matters. The GE
Litigation falls within the scope of litigation liabilities described above.
Accordingly, Monsanto is managing this litigation and Solutia will be unable to
provide complete status updates on the GE Litigation. Therefore, Solutia will
cease reporting on the status of the GE Litigation.
26
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
OTHER LEGAL PROCEEDINGS
Dickerson v. Feldman. On October 7, 2004, a purported class action
captioned Dickerson v. Feldman, et al. was filed in the United States District
Court for the Southern District of New York against a number of defendants,
including former officers and employees of Solutia and Solutia's Employee
Benefits Plans Committee and Pension and Savings Funds Committee. Solutia was
not named as a defendant. The action alleged breach of fiduciary duty under
ERISA and sought to recover alleged losses to the Solutia Inc. Savings and
Investment Plan ("SIP Plan") during the period from December 16, 1998 to the
date the action was filed. The investment of SIP Plan assets in Solutia's common
stock is alleged to have been imprudent because of the risks and liabilities
related to Solutia's legacy environmental and litigation liabilities and because
of Flexsys's alleged involvement in the matters described above under "Flexsys
Related Litigation." The action sought monetary payment to the SIP Plan to
recover the losses resulting from the alleged breach of fiduciary duties, as
well as injunctive and other appropriate equitable relief, reasonable attorney's
fees and expenses, costs and interest. In addition, the plaintiff in this action
filed a proof of claim for $269 against Solutia in the U.S. Bankruptcy Court for
the Southern District of New York.
The plaintiff sought to withdraw the reference of their ERISA claim from
the Bankruptcy Court to the District Court so that the proof of claim and the
class action could be considered together by the District Court. On February 11,
2005, Solutia filed an objection to the motion to withdraw the reference. On
March 11, 2005, the District Court denied without prejudice Dickerson's motion
to withdraw the reference. The Dickerson plaintiffs subsequently amended their
initial complaint to add several current officers and directors of Solutia as
defendants. On July 5, 2005, the defendants filed motions to dismiss Dickerson's
amended complaint. In early September, 2005, Dickerson filed an amended proof of
claim against Solutia increasing Dickerson's claim from $269 to $290, based on
his amended complaint. Dickerson also filed a motion for class certification of
his proof of claim.
On March 30, 2006, the District Court granted the defendants' motion to
dismiss on grounds that the Dickerson plaintiffs lacked standing to sue and that
the complaint failed to state a claim on which relief may be granted. The
dismissal of Dickerson's cause of action resulted in dismissal of the entire
purported class action, including claims asserted on behalf of the unnamed
purported class members. On April 3, 2006 Dickerson filed an appeal of this
dismissal with the United States Court of Appeals for the Second Circuit.
Solutia Inc. v. FMC Corporation. On October 14, 2003, Solutia filed an
action captioned Solutia Inc. v. FMC Corporation ("FMC") in Circuit Court in St.
Louis County, Missouri, against FMC over the failure of purified phosphoric acid
technology provided by FMC to Astaris, the 50/50 joint venture formed by Solutia
and FMC, which was sold to Israeli Chemicals Limited in 2005. On February 20,
2004, Solutia voluntarily dismissed the state court action and filed an
adversary proceeding against FMC in the Bankruptcy Court. FMC filed with the
Bankruptcy Court a motion to withdraw the reference. The motion was granted,
and, as a result, the matter is now pending in the U.S. District Court for the
Southern District of New York. FMC filed a motion to dismiss Solutia's action
based upon an alleged lack of standing. On March 29, 2005, the New York District
Court granted in part and denied in part FMC's motion to dismiss. Specifically,
the court dismissed with prejudice three of Solutia's causes of action for
breach of contract. The New York District Court denied FMC's motion to dismiss
Solutia's other causes of action for breach of warranty, breach of fiduciary
duty, negligent misrepresentation, fraud and fraud in the inducement. In this
action, FMC does not have a counterclaim against Solutia or Astaris.
On July 31, 2006, the District Court entered its order regarding FMC's
motion for summary judgment, ruling that Solutia's breach of fiduciary duty
claim would be allowed to proceed, but only on a limited basis. The Court
overruled the parties' motions for summary judgment on the remaining claims. The
Court also ruled that there will be a bench trial on the four claims remaining
in the case.
The sale of substantially all of the assets of Astaris to Israeli
Chemicals Limited, as further described in Solutia's Annual Report on Form 10-K
for the year ended December 31, 2005, did not affect the claims asserted by
Solutia against FMC in this proceeding. Solutia is vigorously pursuing this
action.
Ferro Antitrust Investigation. Competition authorities in Belgium and
several other European countries are investigating past commercial practices of
certain companies engaged in the production and sale of butyl benzyl phthalates
("BBP"). One of the BBP producers under investigation by the Belgian Competition
Authority ("BCA") is Ferro Belgium sprl, a European subsidiary of Ferro
Corporation ("Ferro"). Ferro's BBP business in Europe was purchased from Solutia
in 2000. Solutia received an indemnification notice from Ferro and has exercised
its right, pursuant to the purchase agreement relating to Ferro's acquisition of
the BBP business from Solutia, to assume and
27
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
control the defense of Ferro in proceedings relating to these investigations. On
July 7, 2005, the BCA Examiner issued a Statement of Objections regarding its
BBP investigation in which Solutia Europe S.A/N.V. ("Solutia Europe"), a
European non-Debtor subsidiary of Solutia, along with Ferro Belgium sprl and two
other producers of BBP, is identified as a party under investigation with
respect to its ownership of the BBP business from 1997 until the business was
sold to Ferro in 2000. Solutia Europe's written comments to the Statement of
Objections were submitted on August 31, 2005 and presented at an oral hearing
before the BCA on September 6, 2005. The Examiner submitted its Reasoned Report
to the BCA on December 22, 2005. Solutia is not named as a party under
investigation in the Reasoned Report. Solutia Europe will have an opportunity to
submit comments to the BCA on the Reasoned Report in writing and at a subsequent
oral hearing on a date that has not yet been determined by the BCA. Solutia and
Solutia Europe are fully cooperating with the BCA in this investigation.
Environmental Liabilities
Environmental compliance and remediation costs and other environmental
liabilities incurred by Solutia generally fall into two broad categories: (a)
those related to properties currently owned or operated by Solutia and (b) those
related to properties that are not owned by Solutia, including non-owned
properties adjacent to plant sites and certain owned offsite disposal locations.
For the owned and operated sites, Solutia had an accrued liability of $78 and
$71 as of June 30, 2006 and December 31, 2005, respectively, for solid and
hazardous waste remediation, which represents Solutia's best estimate of the
underlying obligation. In addition, this balance also includes post-closure
costs at certain of Solutia's operating locations. This liability is not
classified as subject to compromise in the Statement of Consolidated Financial
Position because, irrespective of the bankruptcy proceedings, Solutia will be
required to comply with environmental requirements in the conduct of its
business, regardless of when the underlying environmental contamination
occurred. However, Solutia ultimately expects to seek recovery against other
potentially responsible parties at certain of these locations.
Solutia had an accrued liability of $81 as of June 30, 2006 and $82 as of
December 31, 2005 for properties not owned or operated by Solutia. This
liability is classified as subject to compromise in the Statement of
Consolidated Financial Position as of both June 30, 2006 and December 31, 2005,
as Solutia currently believes it constitutes a pre-petition claim that will be
discharged in the bankruptcy process. Under the Plan and Relationship Agreement,
as between Monsanto and Solutia, Monsanto will accept financial responsibility
for environmental remediation obligations at all sites for which Solutia was
required to assume responsibility at the Solutia Spinoff but which were never
owned or operated by Solutia. This includes more than 50 sites with active
remediation projects and approximately 200 additional known sites and off-site
disposal facilities, as well as sites that have not yet been identified.
Finally, Monsanto will share financial responsibility with Solutia for off-site
remediation costs in Anniston, Alabama and Sauget, Illinois. The EPA and/or
Pharmacia are currently contesting the enforceability of the automatic stay
provisions with respect to the Anniston, Alabama location (as more fully
described in the Anniston Partial Consent Decree disclosure above). Remediation
activities are currently being funded by Monsanto for certain of these
properties not owned or operated by Solutia. Monsanto's funding of these
remediation activities may give rise to a claim against Solutia which Monsanto
may assert in Solutia's Chapter 11 bankruptcy case. In addition, Solutia has not
adjusted its recorded environmental liabilities classified as subject to
compromise for ongoing remediation activities at these sites since the inception
of Solutia's bankruptcy case.
In addition to the bankruptcy proceedings, Solutia's environmental
liabilities are also subject to changing governmental policy and regulations,
discovery of unknown conditions, judicial proceedings, method and extent of
remediation, existence of other potentially responsible parties and future
changes in technology. Solutia believes that the known and unknown environmental
matters, including matters classified as subject to compromise for which Solutia
may ultimately assume responsibility, when ultimately resolved, which may be
over an extended period of time, could have a material effect on the
consolidated financial position, liquidity and profitability of Solutia.
28
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Impact of Chapter 11 Proceedings
During the reorganization process, substantially all pending litigation
against Solutia and its subsidiaries that filed for reorganization under Chapter
11 ("Debtors") is stayed, as well as the majority of all other pre-petition
claims. Exceptions would generally include pre-petition claims addressed by the
bankruptcy court, as well as fully secured claims. Such claims may be subject to
future adjustments. Adjustments may result from actions of the bankruptcy court,
negotiations, assumption or rejection of executory contracts, determination as
to the value of any collateral securing claims, proofs of claims or other
events. Additional pre-filing claims not currently reflected in the consolidated
financial statements may be identified through the proof of claim reconciliation
process. The amount of pre-filing claims ultimately allowed by the bankruptcy
court with respect to contingent claims may be materially different from the
amounts reflected in the consolidated financial statements. Generally, claims
against Debtors arising from actions or omissions prior to their filing date may
be subject to compromise in connection with a plan of reorganization. The
ultimate resolution of all of these claims may be settled through negotiation as
compared to court proceedings, with the result being that Solutia may retain
certain obligations currently classified as subject to compromise in the
Statement of Consolidated Financial Position.
10. PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
Components of Net Periodic Benefit Cost
For the three and six months ended June 30, 2006 and 2005, Solutia's
pension and healthcare and other benefit costs were as follows:
PENSION BENEFITS
----------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
Service costs for benefits earned ...................... $ 1 $ 1 $ 2 $ 3
Interest costs on benefit obligation ................... 16 17 32 35
Assumed return on plan assets .......................... (15) (16) (30) (33)
Prior service costs .................................... -- 1 -- 1
Recognized net loss .................................... 1 3 3 6
---- ---- ---- ----
TOTAL .................................................. $ 3 $ 6 $ 7 $ 12
==== ==== ==== ====
HEALTHCARE AND OTHER BENEFITS
-----------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2006 2005 2006 2005
---- ---- ---- ----
Service costs for benefits earned ...................... $ 1 $ 2 $ 2 $ 3
Interest costs on benefit obligation ................... 7 8 15 17
Prior service costs .................................... (2) (2) (5) (5)
Recognized net loss .................................... 1 3 2 7
---- ---- ---- ----
TOTAL .................................................. $ 7 $ 11 $ 14 $ 22
==== ==== ==== ====
Employer Contributions
According to IRS funding rules, Solutia will be required to make
approximately $179 in pension contributions to its U.S. qualified pension plan
in 2006 assuming Congress extends the interest rate relief provision currently
proposed. If this relief is not granted, required contributions in 2006 would be
approximately $195. Approximately $43 of these required 2006 contributions were
made in the six months ended June 30, 2006. Solutia also expects to be required
to fund approximately $5 in pension contributions for its foreign pension plans
in 2006.
29
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
11. DEBT OBLIGATIONS
Solutia amended its DIP financing facility on March 17, 2006 with
bankruptcy court approval. This amendment, among other things, (i) increased the
DIP facility from $525 to $825; (ii) extended the term of the DIP facility from
June 19, 2006 to March 31, 2007; (iii) decreased the interest rate on the term
loan component of the DIP facility from LIBOR plus 425 basis points to LIBOR
plus 350 basis points; (iv) increased certain thresholds allowing the Debtors to
retain more of the proceeds from certain dispositions and other extraordinary
receipts; (v) approved the disposition of certain assets of the Debtors; (vi)
allowed refinancing of, and certain amendments to, Solutia Europe S.A./N.V.'s
outstanding Euronotes; and (vii) amended certain financial and other covenants.
The amendment also contains a number of other changes and other modifications
required to make the remaining terms of the DIP facility consistent with the
amendments set forth above.
Solutia analyzed the modifications of the DIP facility in March 2006 in
accordance with the provisions of Emerging Issues Task Force ("EITF") No. 02-04,
Determining Whether a Debtor's Modification or Exchange of Debt Instruments is
within the Scope of FASB Statement No. 15, and EITF No. 96-19, Debtor's
Accounting for a Modification or Exchange of Debt Instruments, and recorded a
charge of approximately $8 to record the write-off of debt issuance costs and to
record the DIP facility as modified at its fair value. In addition, $1 of
unamortized debt issuance costs associated with the DIP facility were written
off at the time of modification in March 2006.
See Note 13 for description of events related to Solutia's Euronotes that
occurred subsequent to June 30, 2006.
12. SEGMENT DATA
Solutia, together with its subsidiaries, is a global manufacturer and
marketer of a variety of high-performance chemical-based materials, which are
used in a broad range of consumer and industrial applications. Solutia manages
its business in two segments: Performance Products and Integrated Nylon. The
Performance Products segment is a world leader in performance films for
laminated safety glass and after-market applications, and specialties such as
water treatment chemicals, heat transfer fluids and aviation hydraulic fluid.
The Integrated Nylon segment consists of an integrated family of nylon products
including high-performance polymers and fibers. The major products by reportable
segment are as follows:
PERFORMANCE PRODUCTS INTEGRATED NYLON
SAFLEX(R) and VANCEVA(R) plastic Nylon intermediate "building block"
interlayer chemicals
Polyvinyl butyral for KEEPSAFE(R) and Nylon resins and polymers, including
KEEPSAFE MAXIMUM(R) laminated window VYDYNE(R) and ASCEND(R)
glass
LLUMAR(R), VISTA(R), GILA(R) and FORMULA Carpet fibers, including the WEAR-DATED(R)
ONE(R) professional and retail window films and ULTRON(R) brands
Industrial nylon fibers
THERMINOL(R) heat transfer fluids
30
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
DEQUEST(R) water treatment chemicals
SKYDROL(R) aviation hydraulic fluids
and SKYKLEEN(R) brand of aviation
solvents
ASTROTURF(R), CLEAN MACHINE(R) and
CLEARPASS(R) entrance matting and
automotive spray suppression flaps
31
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Solutia evaluates the performance of its operating segments based on
segment earnings before interest expense and income taxes ("EBIT"), which
includes marketing, administrative, technological and amortization expenses,
gains and losses from asset dispositions and restructuring charges, and other
income and expense items that can be directly attributable to the segment.
Certain expenses and other items that are managed outside the segments are
excluded. These unallocated items consist primarily of corporate expenses,
certain equity earnings from affiliates, other income and expense items,
reorganization items, gains and losses from asset dispositions and restructuring
charges that are not directly attributable to the operating segment. There were
no inter-segment sales in the periods presented below.
Segment data from continuing operations for the three and six months ended
June 30, 2006 and 2005 are as follows:
THREE MONTHS ENDED JUNE 30,
------------------------------------------------
2006 2005
------------------------- ------------------
NET PROFIT NET PROFIT
SALES (LOSS) SALES (LOSS)
----- ------ ----- ------
SEGMENT:
Performance Products................ $308 $ 46 $298 $ 36
Integrated Nylon.................... 457 4 432 14
---- ------ ---- ------
SEGMENT TOTALS...................... 765 50 730 50
RECONCILIATION TO CONSOLIDATED TOTALS:
Corporate gains (expenses)...... 7 (14)
Equity earnings from affiliates. 12 20
Interest expense................ (27) (22)
Other income, net............... 3 1
Reorganization items, net....... (16) (15)
CONSOLIDATED TOTALS: ---- ----
NET SALES....................... $765 $730
==== ------ ==== -----
INCOME BEFORE INCOME TAXES...... $ 29 $ 20
====== =====
SIX MONTHS ENDED JUNE 30,
------------------------------------------------
2006 2005
------------------- ------------------
NET PROFIT NET PROFIT
SALES (LOSS) SALES (LOSS)
----- ------ ----- ------
SEGMENT:
Performance Products................ $ 594 $ 88 $ 566 $ 69
Integrated Nylon.................... 849 (10) 878 13
------ ------- ----- ------
SEGMENT TOTALS...................... 1,443 78 1,444 82
RECONCILIATION TO CONSOLIDATED TOTALS:
Corporate expenses.............. (13) (25)
Equity earnings from affiliates. 21 33
Interest expense................ (50) (44)
Other income, net............... 3 1
Loss on debt modification....... (8) --
Reorganization items, net....... (26) (2)
CONSOLIDATED TOTALS: ------ ------
NET SALES....................... $1,443 $1,444
====== ------- ====== ------
INCOME BEFORE INCOME TAXES $ 5 $ 45
======= ======
32
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
13. SUBSEQUENT EVENTS
Euronotes Refinancing
As described in a Form 8-K filed on August 1, 2006, on July 26, 2006,
Solutia's indirect wholly-owned subsidiary Solutia Services International
S.C.A./Comm. V.A., a subsidiary of Solutia's wholly-owned subsidiary Solutia
Europe S.A./N.V. ("SESA"), entered into a (euro) 200 million Facility Agreement
(the "Facility Agreement") guaranteed by SESA and CPFilms Vertriebs GmbH, a
subsidiary of SESA. Closing of the credit facility contemplated by the Facility
Agreement, which at signing remained subject to the satisfaction of a number of
conditions precedent, occurred on August 1, 2006. SESA used the proceeds of the
new credit facility to refinance all of its (euro) 200 million of 10 percent
Senior Secured Notes (the "Euronotes") on August 1, 2006 at a prepayment premium
of 3 percent, as required pursuant to the Euronotes, for a total redemption
amount of approximately (euro) 215 million, including accrued interest. The
Euronotes were refinanced to reduce the interest rate, extend the term of the
indebtedness and facilitate certain dispositions by Solutia, including the
potential sale of its pharmaceutical services business described in Note 4.
The Facility Agreement has a five-year term, with a termination date of
July 31, 2011 and an adjustable rate structure which is EURIBOR plus a margin
which currently yields a rate of approximately 5.75 to 6.50 percent. The margin
is subject to adjustment upon the occurrence of certain events specified in the
Facility Agreement or upon SESA and its subsidiaries attaining certain financial
benchmarks. The new credit facility consists of a (euro) 160 million term loan
B1 and a (euro) 40 million term loan B2. The (euro) 40 million term loan B2 is
expected to be repaid from the proceeds of the sale of Solutia's pharmaceutical
services business (as further described in Note 4); accordingly, this amount has
been classified as current in the Consolidated Statement of Financial Position
as of June 30, 2006. The new loan is secured by substantially all of the assets
of SESA and its subsidiaries (excluding Flexsys Holding B.V. and Carbogen Amcis
AG). The Facility Agreement also contains other customary terms and conditions,
including certain financial covenants relating to the performance of SESA and
its subsidiaries.
14. CONSOLIDATING CONDENSED FINANCIAL STATEMENTS
CPFilms Inc., Monchem International, Inc., Monchem, Inc., Solutia Systems,
Inc., Solutia Investments, LLC and Solutia Business Enterprises, Inc.,
wholly-owned subsidiaries of Solutia (the "Guarantors"), are guarantors of
Solutia's 11.25% Senior Secured Notes due 2009 (the "Notes"). In connection with
the completion of the October 2003 credit facility, Solutia Investments, LLC and
Solutia Business Enterprises, Inc. became guarantors of the Notes through
cross-guarantor provisions. Solutia's obligations under the October 2003
facility were paid in full with the proceeds of the DIP facility dated January
16, 2004, which payment did not affect the Guarantors' obligations in respect of
the Notes. Certain other wholly-owned subsidiaries of Solutia (the "DIP
Guarantors") guaranteed the final DIP facility (as well as a smaller, interim
DIP facility put in place as of December 19, 2003), but the DIP Guarantors were
not required by the cross-guarantor provisions to guarantee the Notes.
The Guarantors fully and unconditionally guarantee the Notes on a joint
and several basis. The following condensed consolidating financial statements
present, in separate columns, financial information for: Solutia Inc. on a
parent only basis carrying its investment in subsidiaries under the equity
method; Guarantors on a combined, or where appropriate, consolidated basis,
carrying investments in subsidiaries which do not guarantee the debt (the
"Non-Guarantors") under the equity method; Non-Guarantors on a combined, or
where appropriate, consolidated basis; eliminating adjustments; and consolidated
totals as of June 30, 2006 and December 31, 2005, and for the three and six
months ended June 30, 2006 and 2005. The eliminating adjustments primarily
reflect intercompany transactions, such as interest income and expense, accounts
receivable and payable, advances, short and long-term debt, royalties and profit
in inventory eliminations. Solutia has not presented separate financial
statements and other disclosures concerning the Guarantors as such information
is not material and would substantially duplicate disclosures included elsewhere
in this report.
33
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2006
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES ............................................... $ 574 $ 56 $ 250 $(115) $ 765
Cost of goods sold ...................................... 517 26 213 (121) 635
----------------------------------------------------------------
GROSS PROFIT ............................................ 57 30 37 6 130
Marketing expenses ...................................... 19 8 8 -- 35
Administrative expenses ................................. 16 3 4 -- 23
Technological expenses .................................. 11 -- 1 -- 12
Amortization expense .................................... -- -- 1 -- 1
----------------------------------------------------------------
OPERATING INCOME ........................................ 11 19 23 6 59
Equity earnings (loss) from affiliates .................. 51 15 (2) (53) 11
Interest expense ........................................ (22) -- (12) 7 (27)
Other income, net ....................................... 6 4 7 (13) 4
Reorganization items, net ............................... (18) -- -- -- (18)
----------------------------------------------------------------
INCOME BEFORE INCOME TAXES .............................. 28 38 16 (53) 29
Income tax expense (benefit) ............................ (1) -- 5 1 5
----------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS ....................... 29 38 11 (54) 24
Income (loss) from discontinued
operations, net of tax .................................. (1) -- 5 -- 4
----------------------------------------------------------------
NET INCOME .............................................. $ 28 $ 38 $ 16 $ (54) $ 28
================================================================
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
THREE MONTHS ENDED JUNE 30, 2006
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET INCOME .............................................. $ 28 $ 38 $ 16 $ (54) $ 28
OTHER COMPREHENSIVE INCOME:
Currency translation adjustments ........................ 10 7 8 (15) 10
----------------------------------------------------------------
COMPREHENSIVE INCOME .................................... $ 38 $ 45 $ 24 $ (69) $ 38
================================================================
34
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2005
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES ...................................... $ 549 $ 52 $ 229 $(100) $ 730
Cost of goods sold ............................. 515 25 195 (106) 629
----------------------------------------------------------------------
GROSS PROFIT ................................... 34 27 34 6 101
Marketing expenses ............................. 19 6 9 -- 34
Administrative expenses ........................ 16 2 6 -- 24
Technological expenses ......................... 10 1 -- -- 11
----------------------------------------------------------------------
OPERATING INCOME (LOSS) ........................ (11) 18 19 6 32
Equity earnings (loss) from affiliates ......... 42 11 (1) (31) 21
Interest expense ............................... -- -- (13) (9) (22)
Other income, net .............................. (1) (9) 12 2 4
Reorganization items, net ...................... (13) -- (2) -- (15)
----------------------------------------------------------------------
INCOME BEFORE INCOME TAXES ..................... 17 20 15 (32) 20
Income tax expense ............................. 2 -- 5 -- 7
----------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS .............. 15 20 10 (32) 13
Income (loss) from discontinued
operations, net of tax ......................... (1) -- 2 -- 1
----------------------------------------------------------------------
NET INCOME ..................................... $ 14 $ 20 $ 12 $ (32) $ 14
======================================================================
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
THREE MONTHS ENDED JUNE 30, 2005
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET INCOME ..................................... $ 14 $ 20 $ 12 $ (32) $ 14
OTHER COMPREHENSIVE INCOME:
Currency translation adjustments ............... (2) (6) (9) 15 (2)
----------------------------------------------------------------------
COMPREHENSIVE INCOME ........................... $ 12 $ 14 $ 3 $ (17) $ 12
======================================================================
35
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2006
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES ....................................... $ 1,081 $105 $ 479 $(222) $ 1,443
Cost of goods sold .............................. 1,010 50 413 (234) 1,239
-------------------------------------------------------------------
GROSS PROFIT .................................... 71 55 66 12 204
Marketing expenses .............................. 38 14 16 -- 68
Administrative expenses ......................... 29 5 10 -- 44
Technological expenses .......................... 22 1 1 -- 24
Amortization expense ............................ -- -- 1 -- 1
-------------------------------------------------------------------
OPERATING INCOME (LOSS) ......................... (18) 35 38 12 67
Equity earnings (loss) from affiliates .......... 96 28 (3) (100) 21
Interest expense ................................ (40) -- (23) 13 (50)
Loss on debt modification ....................... (8) -- -- -- (8)
Other income, net ............................... 10 8 15 (26) 7
Reorganization items, net ....................... (32) -- -- -- (32)
-------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE ................ 8 71 27 (101) 5
Income tax expense .............................. 1 -- 6 -- 7
-------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 7 71 21 (101) (2)
Income (loss) from discontinued operations ...... (1) -- 9 -- 8
-------------------------------------------------------------------
NET INCOME ...................................... $ 6 $ 71 $ 30 $(101) $ 6
===================================================================
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
SIX MONTHS ENDED JUNE 30, 2006
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET INCOME ...................................... $ 6 $ 71 $ 30 $(101) $ 6
OTHER COMPREHENSIVE INCOME (LOSS):
Net unrealized loss on derivative
instruments ..................................... (1) -- -- -- (1)
Currency translation adjustments ................ 12 9 10 (19) 12
-------------------------------------------------------------------
COMPREHENSIVE INCOME ............................ $ 17 $ 80 $ 40 $(120) $ 17
===================================================================
36
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2005
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET SALES .................................. $ 1,100 $ 92 $ 455 $(203) $ 1,444
Cost of goods sold ......................... 1,033 41 384 (217) 1,241
------------------------------------------------------------------------
GROSS PROFIT ............................... 67 51 71 14 203
Marketing expenses ......................... 38 12 16 -- 66
Administrative expenses .................... 30 4 12 -- 46
Technological expenses ..................... 20 1 1 -- 22
------------------------------------------------------------------------
OPERATING INCOME (LOSS) .................... (21) 34 42 14 69
Equity earnings (loss) from affiliates ..... 110 24 (2) (97) 35
Interest expense ........................... (32) -- (26) 14 (44)
Other income, net .......................... (1) 11 21 (26) 5
Reorganization items, net .................. (18) -- (2) -- (20)
------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES ................. 38 69 33 (95) 45
Income tax expense ......................... 2 -- 11 -- 13
------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS .......... 36 69 22 (95) 32
Income (loss) from discontinued
operations, net of tax ..................... (1) -- 4 -- 3
------------------------------------------------------------------------
NET INCOME ................................. $ 35 $ 69 $ 26 $ (95) $ 35
========================================================================
CONDENSED CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME
SIX MONTHS ENDED JUNE 30, 2005
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
NET INCOME ................................. $ 35 $ 69 $ 26 $ (95) $ 35
OTHER COMPREHENSIVE INCOME:
Currency translation adjustments ........... (7) (10) (16) 26 (7)
------------------------------------------------------------------------
COMPREHENSIVE INCOME ....................... $ 28 $ 59 $ 10 $ (69) $ 28
========================================================================
37
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING BALANCE SHEET
JUNE 30, 2006
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................... $ 144 $ 10 $ 111 $ -- $ 265
Trade receivables, net ....................................... 12 189 146 -- 347
Intercompany receivables ..................................... 113 729 108 (950) --
Miscellaneous receivables .................................... 58 1 31 -- 90
Inventories .................................................. 133 34 110 (14) 263
Prepaid expenses and other current assets .................... 17 -- 9 3 29
Assets of discontinued operations ............................ -- -- 84 84
-------------------------------------------------------------
TOTAL CURRENT ASSETS ......................................... 477 963 599 (961) 1,078
PROPERTY, PLANT AND EQUIPMENT, NET ........................... 575 83 114 -- 772
INVESTMENTS IN AFFILIATES .................................... 2,414 243 12 (2,456) 213
GOODWILL ..................................................... -- 72 17 -- 89
IDENTIFIED INTANGIBLE ASSETS, NET ............................ 2 26 4 -- 32
INTERCOMPANY ADVANCES ........................................ 128 1,238 737 (2,103) --
OTHER ASSETS ................................................. 59 -- 46 -- 105
-------------------------------------------------------------
TOTAL ASSETS ................................................. $ 3,655 $2,625 $1,529 $(5,520) $ 2,289
=============================================================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable ............................................. $ 147 $ 8 $ 44 $ (2) $ 197
Intercompany payables ........................................ 70 8 145 (223) --
Accrued liabilities .......................................... 160 14 71 -- 245
Short-term debt .............................................. 650 -- 50 -- 700
Intercompany short-term debt ................................. 1 -- 185 (186) --
Liabilities of discontinued operations ....................... 1 -- 29 -- 30
-------------------------------------------------------------
TOTAL CURRENT LIABILITIES .................................... 1,029 30 524 (411) 1,172
LONG-TERM DEBT ............................................... -- -- 210 -- 210
INTERCOMPANY LONG-TERM DEBT .................................. -- -- 426 (426) --
OTHER LIABILITIES ............................................ 193 1 66 -- 260
-------------------------------------------------------------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE .................. 1,222 31 1,226 (837) 1,642
LIABILITIES SUBJECT TO COMPROMISE ............................ 3,870 410 22 (2,218) 2,084
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock ................................................. 1 -- -- -- 1
Additional contributed capital ............................... 56 -- -- -- 56
Treasury stock ............................................... (251) -- -- -- (251)
Net (deficiency) excess of assets at spinoff and subsidiary
capital .................................................... (113) 2,184 281 (2,465) (113)
Accumulated other comprehensive loss ......................... (82) -- -- -- (82)
Accumulated deficit .......................................... (1,048) -- -- -- (1,048)
-------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) ......................... (1,437) 2,184 281 (2,465) (1,437)
-------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) ......... $ 3,655 $2,625 $1,529 $(5,520) $ 2,289
=============================================================
38
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2005
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................................... $ 1 $ 15 $ 91 $ -- $ 107
Trade receivables, net ...................................... 7 118 121 -- 246
Intercompany receivables .................................... 115 754 89 (958) --
Miscellaneous receivables ................................... 67 -- 28 -- 95
Inventories ................................................. 142 31 94 (13) 254
Prepaid expenses and other assets ........................... 23 -- 8 3 34
Assets of discontinued operations ........................... -- -- 69 -- 69
---------------------------------------------------------------
TOTAL CURRENT ASSETS ........................................ 355 918 500 (968) 805
PROPERTY, PLANT AND EQUIPMENT, NET .......................... 589 84 97 -- 770
INVESTMENTS IN AFFILIATES ................................... 2,291 209 13 (2,308) 205
GOODWILL .................................................... -- 72 4 -- 76
IDENTIFIED INTANGIBLE ASSETS, NET ........................... 2 26 -- -- 28
INTERCOMPANY ADVANCES ....................................... 128 1,238 703 (2,069) --
OTHER ASSETS ................................................ 62 -- 38 -- 100
---------------------------------------------------------------
TOTAL ASSETS ................................................ $ 3,427 $2,547 $1,355 $(5,345) $ 1,984
===============================================================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable ............................................ $ 167 $ 9 $ 43 $ (1) $ 218
Intercompany payables ....................................... 108 12 111 (231) --
Accrued liabilities ......................................... 143 13 67 -- 223
Short-term debt ............................................. 300 -- -- -- 300
Intercompany short-term debt ................................ -- -- 182 (182) --
Liabilities of discontinued operations ...................... 1 -- 25 -- 26
---------------------------------------------------------------
TOTAL CURRENT LIABILITIES ................................... 719 34 428 (414) 767
LONG-TERM DEBT .............................................. -- -- 247 -- 247
INTERCOMPANY LONG-TERM DEBT ................................. -- -- 401 (401) --
OTHER LIABILITIES ........................................... 201 -- 47 -- 248
---------------------------------------------------------------
TOTAL LIABILITIES NOT SUBJECT TO COMPROMISE ................. 920 34 1,123 (815) 1,262
LIABILITIES SUBJECT TO COMPROMISE ........................... 3,961 407 21 (2,213) 2,176
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock ................................................ 1 -- -- -- 1
Additional contributed capital .............................. 56 -- -- -- 56
Treasury stock .............................................. (251) -- -- -- (251)
Net (deficiency) excess of assets at spinoff and
subsidiary capital ........................................ (113) 2,106 211 (2,317) (113)
Accumulated other comprehensive loss ........................ (93) -- -- -- (93)
Accumulated deficit ......................................... (1,054) -- -- -- (1,054)
---------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) ........................ (1,454) 2,106 211 (2,317) (1,454)
---------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY DEFICIT) ......... $ 3,427 $2,547 $1,355 $(5,345) $ 1,984
===============================================================
39
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2006
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
CASH PROVIDED BY (USED IN) OPERATIONS ...................... $(121) $ (23) $ 20 $ -- $(124)
--------------------------------------------------------------
INVESTING ACTIVITIES:
Property, plant and equipment purchases .................... (26) (3) (14) -- (43)
Acquisition, net of cash acquired .......................... (23) -- 7 -- (16)
--------------------------------------------------------------
CASH USED IN INVESTING ACTIVITIES .......................... (49) (3) (7) -- (59)
--------------------------------------------------------------
FINANCING ACTIVITIES:
Net change in short-term debt obligations .................. 350 -- -- -- 350
Deferred debt issuance costs ............................... (9) -- -- -- (9)
Changes in investments and advances from (to) affiliates ... (28) 21 7 -- --
--------------------------------------------------------------
CASH PROVIDED BY FINANCING ACTIVITIES ...................... 313 21 7 -- 341
--------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........... 143 (5) 20 -- 158
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR .......................................... 1 15 91 -- 107
--------------------------------------------------------------
END OF PERIOD .............................................. $ 144 $ 10 $ 111 $ -- $ 265
===============================================================
40
SOLUTIA INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2005
PARENT ONLY NON- CONSOLIDATED
SOLUTIA INC. GUARANTORS GUARANTORS ELIMINATIONS SOLUTIA INC.
------------ ---------- ---------- ------------ ------------
CASH PROVIDED BY (USED IN) OPERATIONS ................ $ (65) $ 24 $ 15 $ -- $ (26)
------------------------------------------------------------------
INVESTING ACTIVITIES:
Property, plant and equipment purchases .............. (18) (4) (7) -- (29)
Other investing activities ........................... 1 -- 1 -- 2
------------------------------------------------------------------
CASH USED IN INVESTING ACTIVITIES .................... (17) (4) (6) -- (27)
------------------------------------------------------------------
FINANCING ACTIVITIES:
Net change in cash collateralized letters of
credit ............................................. 17 -- -- -- 17
Changes in investments and advances from (to)
affiliates ......................................... 19 (13) (6) -- --
------------------------------------------------------------------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ...... 36 (13) (6) -- 17
------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..... (46) 7 3 -- (36)
CASH AND CASH EQUIVALENTS:
BEGINNING OF YEAR .................................... 43 7 65 -- 115
------------------------------------------------------------------
END OF PERIOD ........................................ $ (3) $ 14 $ 68 $ -- $ 79
==================================================================
41
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This section includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These forward-looking statements include all statements
regarding expected future financial position, results of operations,
profitability, cash flows and liquidity. Important factors that could cause
actual results to differ materially from the expectations reflected in the
forward-looking statements herein include, among others, Solutia's ability to
develop, confirm and consummate a Chapter 11 plan of reorganization; Solutia's
ability to reduce its overall leveraged position; the potential adverse impact
of Solutia's Chapter 11 filing on its operations, management and employees, and
the risks associated with operating businesses under Chapter 11 protection;
Solutia's ability to comply with the terms of its debtor-in-possession ("DIP")
financing facility; customer response to Solutia's Chapter 11 filing; general
economic, business and market conditions; customer acceptance of new products;
raw material and energy costs or shortages; limited access to capital resources;
currency and interest rate fluctuations; increased competitive and/or customer
pressure; gain or loss of significant customers; compression of credit terms
with suppliers; exposure to product liability and other litigation; changes in
cost of environmental remediation obligations and other environmental
liabilities; changes in accounting principles generally accepted in the U.S.;
ability to implement cost reduction initiatives in a timely manner; geopolitical
instability; and changes in pension and other postretirement assumptions.
OVERVIEW
Summary of Significant Second Quarter 2006 Events
Reorganization Strategy
In the second quarter 2006, Solutia continued its stated reorganization
strategy with a focus on the principal objectives of (i) managing the businesses
to enhance Solutia's performance; (ii) making changes to Solutia's asset
portfolio to maximize the value of the estate; (iii) achieving reallocation of
"legacy liabilities"; and (iv) negotiating an appropriate capital structure.
Solutia took steps in 2006 to enhance its financial performance including using
the tools of bankruptcy and making changes to its asset portfolio, as explained
below. Solutia also continues to pursue a reallocation of legacy liabilities in
the bankruptcy proceeding through negotiations with the other constituents in
the bankruptcy case. Solutia will also be working in 2006 to establish a proper
capital structure upon emergence from bankruptcy. However, as a result of the
numerous uncertainties and complexities inherent in Solutia's bankruptcy
proceedings, its ability and timing of emergence from bankruptcy are subject to
significant uncertainty.
PERFORMANCE ENHANCEMENT
Solutia benefited in the second quarter of 2006 from several actions
implemented earlier in the bankruptcy reorganization process designed to enhance
its performance. These included implementing significant general and
administrative expense reductions; increasing performance-based compensation and
benefits programs; enacting key senior management changes; initiating a cost
reduction program at Solutia's operating sites focused on actions such as lean
manufacturing techniques, yield improvement, maintenance savings and utilities
optimization; and implementing an enterprise-wide procurement effort.
As described in Note 13 to the accompanying consolidated financial
statements, on July 26, 2006, Solutia Europe S.A./N.V. ("SESA"), entered into a
(euro) 200 million facility agreement that closed on August 1, 2006. SESA used
the proceeds of the new credit facility to refinance all of its (euro) 200
million of 10 percent Euronotes due 2008 (the "Euronotes") on August 1, 2006. It
is projected this new financing will result in significant interest savings for
Solutia, as well as allow Solutia greater flexibility to divest non-core assets,
such as Solutia's pharmaceutical services business described below.
42
PORTFOLIO EVALUATION
Solutia's stated strategy is to build a portfolio of high-potential
businesses that can consistently deliver returns in excess of Solutia's cost of
capital. As part of this strategy, Solutia made several changes to re-shape its
asset portfolio in 2004 and 2005 and continued these efforts in the second
quarter 2006. On May 23, 2006, SESA agreed to sell its pharmaceutical services
business to Dishman Pharmaceuticals & Chemicals Ltd. ("Dishman") pursuant to a
Stock and Asset Purchase Agreement dated as of May 23, 2006 between SESA and
Dishman. Under the terms of the agreement, Dishman has agreed to purchase 100
percent of the stock of the pharmaceutical services business, as well as certain
other assets used in the pharmaceutical services business, for approximately $75
million, subject to certain purchase price adjustments. The transaction is
anticipated to close in the third quarter 2006 and based upon the current
transaction terms, Solutia expects to record a gain on the sale of the
pharmaceutical services business in the range of approximately $45 million to
$55 million. See Note 4 to the accompanying consolidated financial statements
for additional information regarding sale of the pharmaceutical services
business.
REALLOCATION OF LEGACY LIABILITIES
On February 14, 2006, the Debtors filed with the Bankruptcy Court their
Plan of Reorganization (the "Plan") and Disclosure Statement (the "Disclosure
Statement") providing for, among other things, the reallocation of certain
Legacy Liabilities among Solutia, Monsanto and Pharmacia and the treatment
various constituencies in the Chapter 11 Cases will receive under the Plan. See
Note 1 to the accompanying consolidated financial statements for further
description of the Plan and Disclosure Statement, as well as a summary of
developments in Solutia's ongoing Chapter 11 bankruptcy case.
Summary Results of Operations
The discussions below and the accompanying consolidated financial
statements have been prepared in accordance with Statement of Position 90-7,
Financial Reporting by Entities in Reorganization Under the Bankruptcy Code
("SOP 90-7"), and on a going concern basis, which assumes the continuity of
operations and reflects the realization of assets and satisfaction of
liabilities in the ordinary course of business. However, as a result of the
Chapter 11 bankruptcy proceedings, such realization of assets and liquidation of
liabilities are subject to a significant number of uncertainties.
Results of Operations - Second Quarter 2006 Compared with Second Quarter 2005
Net sales and operating income of Solutia for the three months ended June
30, 2006 and 2005 are as follows:
(dollars in millions) 2006 2005
---- ----
Net Sales ................................................................ $ 765 $ 730
===== =====
Operating Income:
Performance Products Segment Profit .................................. $ 46 $ 36
Integrated Nylon Segment Profit ...................................... 4 14
Less: Corporate Gains (Expenses) ................................ 7 (14)
Less: Equity (Earnings) Loss from Affiliates, Other (Income)
Expense and Reorganization Items included in Segment Profit ..... 2 (4)
----- -----
Operating Income ......................................................... $ 59 $ 32
===== =====
Gains (Charges) included in Operating Income ............................. $ 19 $ --
===== =====
The $35 million, or 5 percent, increase in net sales as compared to the
second quarter 2005 was primarily a result of higher average selling prices of
approximately 6 percent, partially offset by lower sales volumes of
approximately 1 percent. The $27 million increase in operating income as
compared to the second quarter 2005
43
resulted primarily from higher net sales and higher one-time net gains, which
are described in greater detail in the Results of Operations section below,
partially offset by higher raw material and energy costs.
Results of Operations - Six Months Ended June 30, 2006 Compared with Six Months
Ended June 30, 2005
Net sales and operating income of Solutia for the six months ended June
30, 2006 and 2005 are as follows:
(dollars in millions) 2006 2005
---- ----
Net Sales ..................................................................... $ 1,443 $ 1,444
======= =======
Operating Income:
Performance Products Segment Profit ....................................... $ 88 $ 69
Integrated Nylon Segment Profit (Loss) .................................... (10) 13
Less: Corporate Expenses ............................................. (13) (25)
Less: Equity (Earnings) Loss from Affiliates, Other (Income)
Expense and Reorganization Items included in Segment Profit (Loss) ... 2 12
------- -------
Operating Income .............................................................. $ 67 $ 69
======= =======
Gains (Charges) included in Operating Income .................................. $ 10 $ --
======= =======
Net sales in the six months ended June 30, 2006 remained consistent with
the comparable period in 2005 consisting of higher average selling prices of
approximately 6 percent offset by lower sales volumes of approximately 5 percent
and unfavorable currency exchange rate fluctuations of approximately 1 percent.
The $2 million decrease in operating income as compared to the six months ended
June 30, 2005 resulted primarily from unfavorable manufacturing variances
resulting principally from manufacturing interruptions and higher raw material
and energy costs, partially offset by one-time net gains in 2006, which are
described in greater detail in the Results of Operations section below.
Financial Information
Summarized financial information concerning Solutia and subsidiaries in
reorganization and subsidiaries not in reorganization as of and for the three
and six months ended June 30, 2006 is presented as follows:
SOLUTIA AND SOLUTIA AND
SUBSIDIARIES IN SUBSIDIARIES NOT SUBSIDIARIES
(dollars in millions) REORGANIZATION IN REORGANIZATION ELIMINATIONS CONSOLIDATED
-------------- ----------------- ------------ ------------
Three Months Ended June 30, 2006:
- ---------------------------------
Net Sales ............................................ $ 633 $ 248 $ (116) $ 765
Operating Income ..................................... 30 22 7 59
Net Income ........................................... 28 16 (16) 28
Six Months Ended June 30, 2006:
- -------------------------------
Net Sales ............................................ $ 1,190 $ 475 $ (222) $ 1,443
Operating Income ..................................... 18 36 13 67
Net Income ........................................... 6 29 (29) 6
As of June 30, 2006:
- --------------------
Total Assets ......................................... $ 1,938 $ 909 $ (558) $ 2,289
Liabilities not Subject to Compromise ................ 1,291 530 (179) 1,642
Liabilities Subject to Compromise .................... 2,084 -- -- 2,084
Total Shareholders' Equity (Deficit) ................. (1,437) 379 (379) (1,437)
44
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
There were no changes in the six months ended June 30, 2006 with respect
to Solutia's critical accounting policies, as presented on pages 33 through 36
of Solutia's 2005 Form 10-K.
RESULTS OF OPERATIONS--SECOND QUARTER 2006 COMPARED WITH SECOND QUARTER 2005
PERFORMANCE PRODUCTS
THREE MONTHS ENDED
JUNE 30,
-------------------
(dollars in millions) 2006 2005
---- ----
Net Sales ................................................................... $ 308 $298
===== ====
Segment Profit .............................................................. $ 46 $ 36
===== ====
Charges and Reorganization Items included in Segment Profit ............. $ (2) $ --
===== ====
The $10 million, or 3 percent, increase in net sales as compared to the
second quarter 2005 resulted primarily from higher sales volumes of
approximately 2 percent, an increase in average selling prices of approximately
2 percent, partially offset by unfavorable currency exchange rate fluctuations
of approximately 1 percent. Higher volumes were experienced in SAFLEX(R) and
VANCEVA(R) plastic interlayer products and LLUMAR(R) professional film products,
partially offset by lower volumes in THERMINOL(R) heat transfer fluids. Higher
average selling prices were experienced in SAFLEX(R) and VANCEVA(R) plastic
interlayer products and THERMINOL(R) heat transfer fluids.
The $10 million, or 28 percent, increase in segment profit in comparison
to the second quarter 2005 resulted primarily from higher net sales and
favorable manufacturing variances resulting from improved capacity utilization,
partially offset by higher raw material and energy costs. In addition, segment
profit in the second quarter 2006 was affected by $1 million of restructuring
charges including primarily severance and retraining costs and $1 million of
reorganizations items consisting primarily of certain asset write-downs.
INTEGRATED NYLON
THREE MONTHS ENDED
JUNE 30,
-------------------
(dollars in millions) 2006 2005
---- ----
Net Sales ................................................................... $ 457 $432
======= ====
Segment Profit .............................................................. $ 4 $ 14
======= ====
Charges and Reorganization Items included in Segment Profit ............. $ -- $ --
======= ====
The $25 million, or 6 percent, increase in net sales as compared to the
second quarter 2005 resulted primarily from higher average selling prices of
approximately 9 percent, partially offset by lower sales volumes of
approximately 3 percent. Average selling prices increased in all businesses as a
result of favorable market conditions and in response to the escalating cost of
raw materials. Sales volumes were impacted by the exit from the unprofitable
acrylic fibers operations, as well as a portion of the nylon industrial fibers
operations, both in the second quarter 2005. Further, lower sales volumes were
experienced within the carpet business, partially offset by higher sales volumes
in intermediate chemicals and nylon plastics and polymers.
The $10 million, or 71 percent, decrease in segment profit in comparison
to the second quarter 2005 resulted principally from unfavorable manufacturing
costs and higher raw material costs, partially offset by higher net sales. In
addition, 2005 segment profit included $7 million to shut-down principally the
acrylic fibers operations including $5 million of asset write-downs and $2
million of decontamination costs, offset by a $7 million gain from the reversal
of the LIFO reserve associated with the inventory sold and written off as part
of the business shut-down.
45
CORPORATE EXPENSES
THREE MONTHS ENDED
JUNE 30,
--------------------
(dollars in millions) 2006 2005
---- ----
Corporate Expenses (Gains)................................................... $ (7) $14
==== ===
Gains (Charges) included in Corporate Expenses .......................... $ 20 $--
==== ===
With the exception of a $20 million one-time gain in 2006, corporate
expenses remained consistent in comparing the three months ended June 30, 2006
and 2005, respectively, with benefits from cost reduction measures offsetting
inflationary increases in corporate expenses. The $20 million one-time gain
resulted from the reversal of a litigation reserve with respect to a litigation
matter that was decided favorably in the second quarter 2006 (as further
described in Note 9 of the accompanying consolidated financial statements).
EQUITY EARNINGS (LOSS) FROM AFFILIATES
THREE MONTHS ENDED
JUNE 30,
-------------------
(dollars in millions) 2006 2005
---- ----
Equity Earnings from Affiliates not included in Reportable Segment
Profit .............................................................. $ 12 $20
---- ---
Equity Earnings (loss) from Affiliates included in Reportable Segment
Profit .............................................................. $ (1) $ 1
---- ---
Equity Earnings from Affiliates ............................................. $ 11 $21
==== ===
Gains (charges) included in Equity Earnings (Loss) from Affiliates .......... $ (1) $ 5
==== ===
Equity earnings (loss) from affiliates decreased by $10 million in the
second quarter 2006 as compared to the second quarter 2005. This decline was a
primarily a result of the sale of the Astaris joint venture in the fourth
quarter 2005 and lower selling prices and sales volumes at the Flexsys joint
venture in the second quarter 2006 in comparison to the second quarter 2005. In
addition, the second quarter 2006 results included a $1 million restructuring
charge from the Flexsys joint venture, while the 2005 results included a
one-time, non-operational gain of $5 million recognized by the Flexsys joint
venture.
REORGANIZATION ITEMS, NET
THREE MONTHS ENDED
JUNE 30,
-------------------
(dollars in millions) 2006 2005
---- ----
Reorganization Items, net ............................................ $(18) $(15)
==== ====
Reorganization items, net are presented separately in the Consolidated
Statement of Operations and represent items of income, expense, gain, or loss
that are realized or incurred by Solutia because it is in reorganization under
Chapter 11 of the U.S. Bankruptcy Code. Reorganization items incurred in the
second quarter 2006 included $15 million of professional fees for services
provided by debtor and creditor professionals directly related to Solutia's
reorganization proceedings; $1 million of expense provisions for (i) employee
severance costs incurred directly as part of the Chapter 11 reorganization
process and (ii) a retention plan for certain Solutia employees approved by the
bankruptcy court; and $2 million of other reorganization charges primarily
involving costs incurred with the shut-down of certain non-strategic businesses.
Reorganization items incurred in the second quarter 2005 included $13 million of
professional fees for services provided by debtor and creditor professionals
directly related to Solutia's reorganization proceedings and $2 million of
expense provisions for (i) employee severance costs incurred directly as part of
the Chapter 11 reorganization process and (ii) a retention plan for certain
Solutia employees approved by the bankruptcy court.
46
INCOME TAX EXPENSE
THREE MONTHS ENDED
JUNE 30,
-----------------------
(dollars in millions) 2006 2005
---- ----
Income Tax Expense ..................................................... $ 5 $ 7
===== =====
Solutia's income tax expense in the second quarter 2006 and 2005 was
primarily a result of foreign income taxes. As a result of Solutia's Chapter 11
filing, Solutia did not record any U.S. income tax expense or benefit for
domestic operations (including temporary differences) during the three months
ended June 30, 2006 and 2005. Consequently, the changes in federal and state
deferred tax assets were offset by corresponding changes in valuation
allowances. See Note 14 of Solutia's 2005 Form 10-K for additional information
concerning the Company's deferred tax assets and changes in valuation allowances
due to Solutia's Chapter 11 filing.
DISCONTINUED OPERATIONS
THREE MONTHS ENDED
JUNE 30,
-----------------------
(dollars in millions) 2006 2005
---- ----
Income from Discontinued Operations, net of tax ........................ $ 4 $ 1
===== =====
Income from discontinued operations consists of the results of Solutia's
pharmaceutical services business. As described in Note 4 to the accompanying
consolidated financial statements, on May 23, 2006, SESA agreed to sell its
pharmaceutical services business to Dishman Pharmaceuticals & Chemicals Ltd.
("Dishman"). The transaction is anticipated to close in the third quarter 2006.
Included in the results of discontinued operations in the three months ended
June 30, 2006 was a tax gain of $5 million for the reversal of a valuation
allowance previously established for the potential inability to fully utilize
net operating losses from the CarboGen subsidiary of the pharmaceutical services
business. However, independent of the aforementioned sales transaction, the
CarboGen and AMCIS subsidiaries of the pharmaceutical services business were
merged into one legal entity in the second quarter 2006 with the current
assumption of the net operating losses from CarboGen being able to be fully
utilized in the future as part of the combined entity.
RESULTS OF OPERATIONS--SIX MONTHS ENDED JUNE 30, 2006 COMPARED WITH SIX MONTHS
ENDED JUNE 30, 2005
PERFORMANCE PRODUCTS
SIX MONTHS ENDED
JUNE 30,
-----------------------
(dollars in millions) 2006 2005
---- ----
Net Sales .............................................................. $ 594 $ 566
===== =====
Segment Profit ......................................................... $ 88 $ 69
===== =====
Charges and Reorganization Items included in Segment Profit ........ $ (3) $ (7)
===== =====
The $28 million, or 5 percent, increase in net sales as compared to the
six months ended June 30, 2005 resulted primarily from higher sales volumes of
approximately 5 percent and an increase in average selling prices of
approximately 2 percent, partially offset by unfavorable currency exchange rate
fluctuations of approximately 2 percent. Higher volumes were experienced in
SAFLEX(R) and VANCEVA(R) plastic interlayer products and LLUMAR(R) and VISTA(R)
professional film products, partially offset by lower volumes in THERMINOL(R)
heat transfer fluids. Higher average selling prices were experienced in
SAFLEX(R) and VANCEVA(R) plastic interlayer
47
products and THERMINOL(R) heat transfer fluids. 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 second quarter 2005.
The $19 million, or 28 percent, increase in segment profit in comparison
to the six months ended June 30, 2005 resulted principally from higher net sales
and favorable manufacturing variances resulting from improved capacity
utilization, partially offset by higher raw material and energy costs. Segment
profit in 2006 included $2 million of severance and retraining costs and $1
million for certain asset write-downs. In addition, segment profit in the six
months ended June 30, 2005 was affected by $7 million of reorganization items,
which consisted primarily of adjustments to record certain pre-petition claims
at estimated amounts of the allowed claims.
INTEGRATED NYLON
SIX MONTHS ENDED
JUNE 30,
----------------------
(dollars in millions) 2006 2005
---- ----
Net Sales .................................................................... $ 849 $ 878
===== =====
Segment Profit (Loss) ........................................................ $ (10) $ 13
===== =====
Charges and Reorganization Items included in Segment Profit (Loss) ...... $ (3) $ (11)
===== =====
The $29 million, or 3 percent, decrease in net sales as compared to the
six months ended June 30, 2005 resulted primarily from lower sales volumes of
approximately 12 percent, partially offset by higher average selling prices of
approximately 9 percent. Sales volumes were impacted by the exit from the
unprofitable acrylic fibers operations, as well as a portion of the nylon
industrial fibers operations, both in the second quarter 2005. Further, lower
sales volumes were experienced within the carpet and nylon industrial business,
partially offset by higher sales volumes in intermediate chemicals and nylon
plastics and polymers. Average selling prices increased in all businesses as a
result of favorable market conditions and in response to the escalating cost of
raw materials.
The $23 million decrease in the segment profit in comparison to the six
months ended June 30, 2005 resulted primarily from lower net sales, unfavorable
manufacturing costs and higher raw material costs. The unfavorable manufacturing
costs were precipitated by a manufacturing interruption incurred at the Alvin,
Texas facility, resulting in a significant turnaround being accelerated in its
timing, as well as extended in its duration. Segment profit in 2006 included
approximately $2 million of decommissioning and dismantling costs as a result of
the shut-down of its acrylic fibers business in 2005 and $1 million of asset
write-downs. In addition, 2005 segment profit included reorganization items of
$11 million comprised of $10 million principally to shut-down the acrylic fibers
operations and $1 million of other restructuring charges. The shut-down costs
included $11 million of asset write-downs, $4 million of severance and
retraining costs and $2 million of decontamination costs, partially offset by a
$7 million gain from the reversal of the LIFO reserve associated with the
inventory sold and written off as part of the business shut-down.
CORPORATE EXPENSES
SIX MONTHS ENDED
JUNE 30,
----------------------
(dollars in millions) 2006 2005
---- ----
Corporate Expenses .......................................................... $ 13 $ 25
===== =====
Gains (Charges) included in Corporate Expenses .......................... $ 11 $ --
===== =====
With the exception of $11 million of net gains recorded in 2006, corporate
expenses remained consistent in comparing the six months ended June 30, 2006 to
the comparable period in 2005, with benefits from cost reduction measures
offsetting inflationary increases in corporate expenses. The net gains include a
$20 million one-time gain that resulted from the reversal of a litigation
reserve with respect to a litigation matter that was decided favorably in the
second quarter 2006 (as further described in Note 9 of the accompanying
consolidated financial statements), partially offset by a $9 million
environmental charge that was precipitated by the notification by a third-party
of its intent to terminate a tolling agreement at one of Solutia's facilities
outside the U.S. that will likely result in the cessation of operations at that
site.
48
EQUITY EARNINGS FROM AFFILIATES
SIX MONTHS ENDED
JUNE 30,
----------------------
(dollars in millions) 2006 2005
---- ----
Equity Earnings from Affiliates not included in Reportable Segment Profit ... $ 21 $ 33
----- -----
Equity Earnings from Affiliates included in Reportable Segment Profit ....... $ -- $ 2
----- -----
Equity Earnings from Affiliates ............................................. $ 21 $ 35
===== =====
Gains (charges) included in Equity Earnings (Loss) from Affiliates ..... $ (1) $ 5
===== =====
Equity earnings (loss) from affiliates decreased by $14 million in
comparison to the six months ended June 30, 2005. This decline was primarily a
result of the sale of the Astaris joint venture in the fourth quarter 2005 and
lower selling prices and sales volumes at the Flexsys joint venture in the six
months ended June 30, 2006 in comparison to the same period in 2005. In
addition, results in the six months ended June 30, 2006 included a $1 million
restructuring charge from the Flexsys joint venture, while the results for the
six months ended June 30, 2005 included a one-time, non-operational gain of $5
million incurred by the Flexsys joint venture.
INTEREST EXPENSE
SIX MONTHS ENDED
JUNE 30,
----------------------
(dollars in millions) 2006 2005
---- ----
Interest Expense ............................................................ $ 50 $ 44
===== =====
Charges included in Interest Expense ................................... $ (1) $ --
===== =====
The $6 million, or 14 percent, increase in interest expense in 2006 in
comparison to the six months ended June 30, 2005 resulted principally from
higher debt outstanding in the six months ended June 30, 2006 than in the
comparable period of 2005.
REORGANIZATION ITEMS, NET
SIX MONTHS ENDED
JUNE 30,
----------------------
(dollars in millions) 2006 2005
---- ----
Reorganization Items, net ................................................... $ (32) $ (20)
===== =====
Reorganization items, net are presented separately in the Consolidated
Statement of Operations and represent items of income, expense, gain, or loss
that are realized or incurred by Solutia because it is in reorganization under
Chapter 11 of the U.S. Bankruptcy Code. Reorganization items incurred in the six
months ended June 30, 2006 included: $27 million of professional fees for
services provided by debtor and creditor professionals directly related to
Solutia's reorganization proceedings; $3 million of expense provisions related
to (i) employee severance costs incurred directly as part of the Chapter 11
reorganization process and (ii) a retention plan for certain Solutia employees
approved by the bankruptcy court; a $2 million net gain from adjustments to
record certain pre-petition claims at estimated amounts of the allowed claims;
and $4 million of other reorganization charges primarily involving costs
incurred with exiting certain non-strategic businesses. Reorganization items
incurred in the six months ended June 30, 2005 included: a $29 million net gain
representing the difference between the settlement amount of certain
pre-petition obligations and the corresponding amounts previously recorded; $24
million of professional fees for services provided by debtor and creditor
professionals directly related to Solutia's reorganization proceedings; $11
million of net charges for adjustments to record certain pre-petition claims at
estimated amounts of the allowed claims; $8 million of expense provisions
related to (i) employee severance costs
49
incurred directly as part of the Chapter 11 reorganization process and (ii) a
retention plan for certain Solutia employees approved by the bankruptcy court;
and $6 million of other reorganization charges primarily involving costs
incurred with the exit from the acrylic fibers business.
INCOME TAX EXPENSE
SIX MONTHS ENDED
JUNE 30,
------------------------
(dollars in millions) 2006 2005
---- ----
Income Tax Expense .......................................................... $ 7 $ 13
===== =====
Solutia's income tax expense in the six months ended June 30, 2006 and
2005 was primarily a result of foreign income taxes. As a result of Solutia's
Chapter 11 filing, Solutia did not record any U.S. income tax expense or benefit
for domestic operations (including temporary differences) during the six months
ended June 30, 2006 and 2005. Consequently, the changes in federal and state
deferred tax assets were offset by corresponding changes in valuation
allowances. See Note 14 of Solutia's 2005 Form 10-K for additional information
concerning Solutia's deferred tax assets and changes in valuation allowances due
to Solutia's Chapter 11 filing.
DISCONTINUED OPERATIONS
SIX MONTHS ENDED
JUNE 30,
------------------------
(dollars in millions) 2006 2005
---- ----
Income from Discontinued Operations, net of tax ............................. $ 8 $ 3
===== =====
Income from discontinued operations consists of the results of Solutia's
pharmaceutical services business. As described in Note 4 to the accompanying
consolidated financial statements, on May 23, 2006, SESA agreed to sell its
pharmaceutical services business to Dishman Pharmaceuticals & Chemicals Ltd.
("Dishman"). The transaction is anticipated to close in the third quarter 2006.
Included in the results of operations in the six months ended June 30, 2006 was
a tax gain of $5 million as described further in the Discontinued Operations
portion of the Results of Operations section for the three months ended June 30,
2006 above.
50
SUMMARY OF EVENTS AFFECTING COMPARABILITY
In the six months ended June 30, 2006 and 2005 certain events affecting
comparability were recorded in Reorganization Items, net in the Statement of
Consolidated Operations. A comparison of reorganization items for these periods
is provided in the above Results of Operations section, as well as Note 2 to the
accompanying consolidated financial statements. Charges recorded in the six
months ended June 30, 2006 and 2005 and other events affecting comparability
recorded outside of reorganization items have been summarized in the table below
(dollars in millions).
2006
----------------------------------------------------------------
PERFORMANCE INTEGRATED CORPORATE/
INCREASE/(DECREASE) PRODUCTS NYLON OTHER CONSOLIDATED
-------- ----- ----- ------------
IMPACT ON:
Cost of goods sold.......................... $ -- $ -- $ 9 $ 9 (a)
-- -- (20) (20) (b)
Marketing and administrative expenses....... 1 -- -- 1 (c)
----------------------------------------------------------------
OPERATING INCOME IMPACT..................... (1) -- 11 10
Interest expense ........................... -- -- (1) (1) (d)
Equity earnings from affiliates............. -- -- (1) (1) (e)
Loss on debt modification................... -- -- (8) (8) (d)
----------------------------------------------------------------
PRE-TAX INCOME STATEMENT IMPACT............. $ (1) $ -- $ 1 --
==============================================
Income tax impact........................... 2 (f)
-----
AFTER-TAX INCOME STATEMENT IMPACT........... $ 2
======
2006 EVENTS
a) Environmental charge precipitated by the notification by a
third-party of its intent to terminate a tolling agreement at one of
Solutia's facilities outside the U.S. that will likely result in the
cessation of operations at that site ($9 million pre-tax and $7
million after-tax).
b) One-time gain resulting from the reversal of a litigation reserve
with respect to a litigation matter that was decided favorably in
the second quarter 2006, as further described in Note 9 of the
accompanying consolidated financial statements ($20 million pre-tax
and after-tax).
c) Restructuring costs related principally to severance and retraining
costs ($1 million pre-tax and after-tax).
d) Solutia recorded a charge of approximately $8 million (pre-tax and
after-tax) to record the write-off of debt issuance costs and to
record the DIP facility as modified at its fair value. In addition,
$1 million (pre-tax and after-tax) of unamortized debt issuance
costs associated with the DIP facility were written off at the time
of modification in March 2006. See the Financial Condition and
Liquidity section below for further description of the DIP facility
amendment.
e) Restructuring charges at Flexsys, Solutia's 50 percent owned joint
venture ($1 million pre-tax and after-tax).
f) With the exception of items (a) and (c) above, which primarily
relate to ex-U.S. operations, the above items are considered to have
like pre-tax and after-tax impact as the tax benefit or expense
realized from these events is offset by the change in valuation
allowance for U.S. deferred tax assets resulting from uncertainty as
to their recovery due to Solutia's Chapter 11 bankruptcy filing.
51
2005
-----------------------------------------------------------------
PERFORMANCE INTEGRATED CORPORATE/
INCREASE/(DECREASE) PRODUCTS NYLON OTHER CONSOLIDATED
- ---------------------------------------- -------- ----- ----- ------------
IMPACT ON:
Cost of Goods Sold...................... $-- $-- $-- $--
-----------------------------------------------------------------
OPERATING INCOME IMPACT................. -- -- -- --
Equity earnings from affiliates......... -- -- 5 5 (a)
-----------------------------------------------------------------
PRE-TAX INCOME STATEMENT IMPACT......... $-- $-- $ 5 5
Income tax impact....................... --
===============================================
--------------
AFTER-TAX INCOME STATEMENT IMPACT....... $ 5
==============
2005 EVENTS
a) One-time, non-operational gain recognized by the Flexsys joint
venture ($5 million pre-tax and after-tax).
FINANCIAL CONDITION AND LIQUIDITY
As discussed in Note 1 to the accompanying consolidated financial
statements, Solutia is operating as a debtor-in-possession under Chapter 11 of
the U.S. Bankruptcy Code. As a result of the uncertainty surrounding Solutia's
current circumstances, it is difficult to predict Solutia's actual liquidity
needs and sources at this time. However, based upon current and anticipated
levels of operations during the continuation of the bankruptcy proceedings,
Solutia believes that its liquidity and capital resources will be sufficient to
maintain its normal operations at current levels. Solutia's access to additional
financing while in the Chapter 11 bankruptcy process may be limited.
Financial Analysis
Solutia used its existing cash on-hand to finance operating needs and
capital expenditures during the six months ended June 30, 2006. Cash used in
continuing operations was $126 million in the six months ended June 30, 2006, a
change of $96 million from $30 million used in continuing operations for the
comparable period of 2005. This change in cash used in operations in comparing
the six months ended June 30, 2006 and 2005 was primarily attributable to higher
pension contributions of approximately $43 million and changes in working
capital items, including a significant increase in trade receivables resulting
from a considerable increase in net sales in the latter part of the second
quarter 2006.
Capital spending increased $14 million to $41 million in the six months
ended June 30, 2006, compared to $27 million in the comparable period of 2005.
The expenditures in the six months ended June 30, 2006 were primarily to fund
certain growth initiatives in the Performance Products segment, as well as
various capital improvements and certain cost reduction projects.
Net cash used for the acquisition of Quimica (as described in Note 4 to
the accompanying consolidated financial statements) totaled $16 million and
consisted of approximately $20 million cash paid, less approximately $4 million
of cash acquired. There were no acquisitions in the six months ended June 30,
2005.
Total debt of $1,578 million as of June 30, 2006, including $668 million
subject to compromise and $910 million not subject to compromise, increased by
$363 million as compared to $1,215 million at December 31, 2005, including $668
million subject to compromise and $547 million not subject to compromise. This
increase in total debt resulted primarily from $350 million of additional
borrowings from Solutia's DIP facility in the six months ended June 30, 2006, of
which $300 million resulted from the March 2006 amendment to the DIP facility
(as described below). In addition, as a result of the Chapter 11 filing, Solutia
was in default on all its debt agreements as of June 30, 2006, with the
exception of its DIP credit facility and Euronotes.
52
Solutia's working capital decreased by $132 million to $(94) million at
June 30, 2006, compared to $38 million at December 31, 2005. The change was
primarily a result of higher short-term debt, partially offset by higher cash
on-hand and an increase in trade receivables resulting from higher net sales.
Solutia had a shareholders' deficit of $1,437 million at June 30, 2006
compared to $1,454 million at December 31, 2005. The $17 million decrease in
shareholders' deficit resulted primarily from the $11 million decrease in
accumulated other comprehensive loss coupled with the $6 million net income in
the six months ended June 30, 2006.
The weighted average interest rate on Solutia's total debt outstanding was
approximately 8.8 percent at June 30, 2006 and 8.7 percent at December 31, 2005.
Excluding debt subject to compromise, with the exception of the 11.25 percent
notes due 2009 on which the bankruptcy court has permitted continued payments of
the contractual interest, the weighted average interest rate on total debt was
9.5 percent at June 30, 2006 compared to 9.8 percent at December 31, 2005. While
operating as a debtor-in-possession during the Chapter 11 proceedings, Solutia
has ceased paying interest on its 6.72 percent debentures due 2037 and its 7.375
percent debentures due 2027. The amount of contractual interest expense not
recorded in each of the six months ended June 30, 2006 and 2005 was
approximately $16 million.
At June 30, 2006, Solutia's total liquidity was $350 million in the form
of $85 million of availability under the DIP credit facility and approximately
$265 million of cash on-hand, of which $109 million was cash of Solutia's
subsidiaries that are not parties to the Chapter 11 proceedings. In comparison,
Solutia's total liquidity at December 31, 2005 was $238 million in the form of
$131 million of availability under the DIP credit facility and approximately
$107 million of cash on-hand, of which $89 million was cash of Solutia's
subsidiaries that are not parties to the Chapter 11 bankruptcy proceedings. The
increase in cash on-hand was primarily a result of the DIP amendment in March
2006 and will be used for ongoing operations and to fund upcoming mandatory
pension contributions as described below.
According to IRS funding rules, Solutia will be required to make
approximately $179 million in pension contributions to its U.S. qualified
pension plan in 2006 assuming Congress extends the interest rate relief
provision currently proposed. If this relief is not granted, required
contributions in 2006 would be approximately $195 million. Approximately $43
million of these required 2006 contributions were made in the six months ended
June 30, 2006. Solutia also expects to be required to fund approximately $5
million in pension contributions for its foreign pension plans in 2006.
Amendment to DIP Financing Agreement
On March 17, 2006, Solutia amended its DIP financing facility with
bankruptcy court approval. This amendment, among other things, (i) increased the
DIP facility from $525 million to $825 million; (ii) extended the term of the
DIP facility from June 19, 2006 to March 31, 2007; (iii) decreased the interest
rate on the term loan component of the DIP facility from LIBOR plus 425 basis
points to LIBOR plus 350 basis points; (iv) increased certain thresholds
allowing the Debtors to retain more of the proceeds from certain dispositions
and other extraordinary receipts; (v) approved the disposition of certain assets
of the Debtors; (vi) allowed refinancing of, and certain amendments to, SESA's
outstanding Euronotes; and (vii) amended certain financial and other covenants.
The amendment also contains a number of other changes and other modifications
required to make the remaining terms of the DIP facility consistent with the
amendments set forth above.
Euronotes Refinancing
As described in a Form 8-K filed on August 1, 2006, on July 26, 2006,
Solutia's indirect wholly-owned subsidiary Solutia Services International
S.C.A./Comm. V.A., a subsidiary of SESA, entered into a (euro) 200 million
Facility Agreement (the "Facility Agreement") guaranteed by SESA and CPFilms
Vertriebs GmbH, a subsidiary of SESA. Closing of the credit facility
contemplated by the Facility Agreement, which at signing remained subject to the
satisfaction of a number of conditions precedent, occurred on August 1, 2006.
SESA used the proceeds of the new credit facility to refinance all of the
Euronotes on August 1, 2006, at a prepayment premium of 3 percent, as required
pursuant to the Euronotes, for a total redemption amount of approximately (euro)
215 million, including accrued interest. The Euronotes were refinanced to reduce
the interest rate, extend the term of the indebtedness and facilitate certain
dispositions by Solutia, including the sale of its pharmaceutical services
business described below.
53
The Facility Agreement has a five-year term, with a termination date of
July 31, 2011 and an adjustable rate structure of EURIBOR plus a margin which
currently yields a rate of approximately 5.75 to 6.50 percent. The margin is
subject to adjustment upon the occurrence of certain events specified in the
Facility Agreement or upon SESA and its subsidiaries attaining certain financial
benchmarks. The new credit facility consists of a (euro) 160 million term loan
B1 and a (euro) 40 million term loan B2. The (euro) 40 million term loan B2 is
expected to be repaid from the proceeds of the sale of Solutia's pharmaceutical
services business (as further described in Note 4 to the accompanying
consolidated financial statements); accordingly, this amount has been classified
as current in the Consolidated Statement of Financial Position as of June 30,
2006. The new loan is secured by substantially all of the assets of SESA and its
subsidiaries (excluding Flexsys Holding B.V. and Carbogen Amcis AG). The
Facility Agreement also contains other customary terms and conditions, including
certain financial covenants relating to the performance of SESA and its
subsidiaries.
PENNDOT Letter of Credit
As a result of the favorable ruling in the PENNDOT litigation matter
described in Note 9 to the accompanying consolidated financial statements, in
August 2006, Monsanto, which is managing the defense obligations of Pharmacia,
released the $20 million letter of credit that Solutia posted to secure a
portion of Pharmacia's obligations with respect to an appeal bond issued in
relation to this case.
CONTINGENCIES
See Note 9 to the accompanying consolidated financial statements for a
summary of Solutia's contingencies as of June 30, 2006.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FACTORS
There have been no material changes in market risk exposures during the
six months ended June 30, 2006 that affect the disclosures presented in the
information appearing under "Derivative Financial Instruments" on page 47 of
Solutia's Form 10-K for the year-ended December 31, 2005.
ITEM 4. CONTROLS AND PROCEDURES
During the period covered by this Form 10-Q, Solutia carried out an
evaluation, under the supervision and with the participation of Solutia's
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of Solutia's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 ("Exchange Act")). Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that, as of
the end of the period covered by this Form 10-Q, Solutia's disclosure controls
and procedures are effective in timely alerting them to material information
relating to Solutia and its consolidated subsidiaries that is required to be
included in Solutia's periodic SEC filings. 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 quarterly period
ended June 30, 2006 that have materially affected, or are reasonably likely to
materially affect, the Company's internal controls over financial reporting.
54
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
LEGAL PROCEEDINGS IN SOLUTIA'S BANKRUPTCY CASE
- ----------------------------------------------
JPMorgan Adversary Proceeding. As described in Solutia's Annual Report on
Form 10-K for the year ended December 31, 2005 (the "2005 Form 10-K") and
Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 (the "First
Quarter 10-Q"), on May 27, 2005, JPMorgan as indenture trustee under the
indenture for Solutia's debentures due 2027 and 2037 (the "Prepetition
Indenture"), filed an adversary proceeding (the "JPM Proceeding") against
Solutia in the Chapter 11 Cases. In its adversary proceeding, JPMorgan asserted
five causes of action seeking declaratory judgments to establish the validity
and priority of the purported security interest of the holders of the 2027 and
2037 debentures, and one cause of action pursuant to section 363 of the
Bankruptcy Code asserting that the alleged security interests lacked adequate
protection. The Unsecured Creditors' Committee and the Ad Hoc Solutia Trade
Claims Committee have intervened in the JPM Proceeding in support of Solutia and
the Ad Hoc Committee of Solutia Noteholders has intervened in the JPM Proceeding
in support of JPMorgan. Trial of the JPM Proceeding concluded on July 10, 2006.
Post-trial briefs are expected to be submitted by the parties by August 9, 2006.
The Bankruptcy Court has indicated that it will take at least six weeks after
submission of the post-trial briefs to make a ruling in the JPM Proceeding.
Equity Committee Adversary Proceeding. As described in the 2005 Form 10-K
and First Quarter 10-Q, on March 7, 2005, the Equity Committee filed a complaint
against Pharmacia and Monsanto and objections to the proofs of claim filed by
Pharmacia and Monsanto in Solutia's bankruptcy case (the "Equity Committee
Complaint"). In the Equity Committee Complaint, the Equity Committee seeks to
avoid certain obligations assumed by Solutia at the time of its spinoff from
Pharmacia. The Equity Committee Complaint alleges, among other things, that the
Solutia Spinoff was a fraudulent transfer under the Bankruptcy Code because
Pharmacia forced Solutia to assume excessive liabilities and insufficient assets
such that Solutia was destined to fail from its inception. The Ad Hoc Committee
of Solutia Noteholders and the Ad Hoc Solutia Trade Claims Committee have
intervened in this adversary proceeding in support of the Equity Committee. The
Unsecured Creditors' Committee has intervened, and Solutia intends to intervene,
in this adversary proceeding as neutral parties due to the importance of this
proceeding with respect to Solutia's bankruptcy case. The case is proceeding and
the Bankruptcy Court has set this matter for trial to commence on September 11,
2006.
ANNISTON PARTIAL CONSENT DECREE
- -------------------------------
Solutia's 2005 Form 10-K described a Partial Consent Decree (the "Anniston
Consent Decree") approved by the U.S. District Court for the Northern District
of Alabama in the case captioned United States of America v. Pharmacia
Corporation (p/k/a Monsanto Company) and Solutia which requires Pharmacia and
Solutia to sample certain residential properties and remove soils found on those
sites if polychlorinated biphenyls ("PCBs") are above a certain level, conduct a
Remedial Investigation and Feasibility Study to help determine a cleanup remedy
for the Anniston, Alabama PCB site and pay the Environmental Protection Agency's
("EPA") past response costs and future oversight costs related to the foregoing
work. The 2005 Form 10-K also discussed negotiations and proceedings among EPA,
Solutia and Pharmacia, and other potentially responsible parties ("PRPs") with
respect to the Anniston lead site, EPA's intention to enter into an
Administrative Order on Consent with the lead site PRPs which would deny
Pharmacia and Solutia contribution rights against the lead site PRPs with
respect to PCB cleanup and a related order issued by the United States District
Court for the Northern District of Alabama issued an Order (the "PCB Order")
authorizing co-defendants Pharmacia and Solutia to "suspend" performance of the
PCB clean-up at the Anniston site under the Anniston Consent Decree, upon the
filing of a motion by either defendant requesting that relief.
In July 2006, Solutia and Pharmacia reached an agreement with the EPA that
clarifies the extent of remaining obligations under the Anniston Consent Decree
and the coordination of that work with the Lead Site clean-up being performed by
others, and by which Solutia and Pharmacia will forego the opportunity to
suspend their obligations under the Anniston Consent Decree pursuant to the PCB
Order. Solutia and Pharmacia preserved their rights under this agreement to
continue to argue that the contribution protection afforded certain other
potentially responsible parties performing Lead Site clean-up should not be
effective as to Solutia and Pharmacia.
55
CASH BALANCE PLAN LITIGATION
- ----------------------------
As described in the 2005 Form 10-K and First Quarter 10-Q, since October
2005, three cases have been filed by participants in the Solutia Inc. Employees'
Pension Plan alleging that the Pension Plan: (1) violates the Employee
Retirement Income Security Act of 1974 ("ERISA") prohibitions on reducing rates
of benefit accrual based on age; (2) results in the impermissible forfeiture of
accrued benefits under ERISA; (3) violates ERISA's present value calculation
rules for determining lump sum distributions; and (4) violates the minimum
accrual requirements of ERISA. The cases were captioned Davis, et. al. v.
Solutia, Inc. Employees' Pension Plan, Scharringhausen, et. al. v. Solutia, Inc.
Employees' Pension Plan, et al. and Juanita Hammond, et. al. v. Solutia, Inc.
Employees' Pension Plan. None of the Debtors, and, except for the Solutia Inc.
Employee Benefits Plans Committee which was named in the Scharringhausen case,
no individual or entity other than the Pension Plan, has been named as a
defendant in any of these cases. The Scharringhausen plaintiffs voluntarily
dismissed their case on April 24, 2006.
On June 2, 2006, the Hammond plaintiffs' agreed to stay their action
pending exhaustion of administrative remedies with respect to count (4), above.
Thereafter the Hammond and Davis plaintiffs also each withdrew their respective
motions to consolidate and to stay or dismiss. In addition, the Hammond and
Davis plaintiffs each withdrew their motions to appoint interim class counsel
and have advised the court that they are cooperating in the representation of
the putative class. The Pension Plan's motions to dismiss in both the Hammond
and Davis cases remain pending. The Pension Plan intends to continue to
vigorously defend itself against any and all claims asserted in the Davis and
Hammond litigation.
GE LITIGATION
- -------------
Solutia's 2005 Form 10-K and First Quarter 10-Q described a case captioned
Michael Abbatiello et al. v. Monsanto Company, Pharmacia Corporation and Solutia
Inc. (the "Abbatiello Case"), which was filed on December 26, 2005 in the
Supreme Court of the State of New York on behalf of 590 current General Electric
employees who work at its Schenectady, New York plant stating eleven separate
causes of action alleging that General Electric purchased various PCB containing
products from Pharmacia which were used in the manufacture of a variety of
products including electric motors, generators, gas turbines, wire and cable,
insulating materials and microwave tubes. PCBs were later detected in various
locations, including retention ponds, ground water, and water treatment centers
on the approximately 628 acre site. On May 10, 2006, Solutia received notice
that another action, captioned Alan Abele, et al. v. Monsanto Company, Pharmacia
Corporation and Solutia Inc. (the "Abele Case" and, together with the Abbatiello
Case, the "GE Litigation"), was filed on March 15, 2006 in the Supreme Court of
the State of New York on behalf of 486 former General Electric employees who
were employed at General Electric's Schenectady, NY plant asserting eleven
separate causes of action and alleging claims identical to those made on behalf
of current General Electric employees in the Abbatiello Case. As in the
Abbatiello Case, the plaintiffs in the Abele Case are seeking $1 billion in
compensatory damages and $1 billion in punitive damages for each cause of
action. The GE Litigation is automatically stayed as to Solutia pursuant to
Section 362 of the U.S. Bankruptcy Code.
At the time of the spinoff from Pharmacia, Solutia assumed liability for,
among other things, litigation liabilities related to chemical products formerly
manufactured, released or used by Pharmacia prior to the spinoff, including the
costs of toxic tort lawsuits alleging exposure to PCBs. Solutia also agreed to
defend Pharmacia against, and indemnify Pharmacia for, such liability. Upon
filing for Chapter 11 protection, Solutia determined that its defense and
indemnification obligations to Pharmacia with respect to such litigation
liabilities were pre-petition obligations under the U.S. Bankruptcy Code and
that Solutia was therefore prohibited from performing, except pursuant to a
confirmed plan of reorganization. As a result, after filing for Chapter 11
protection, Solutia ceased performance of its defense obligations and those
defense obligations have been managed by Monsanto during Solutia's Chapter 11
Case. Because such litigation was no longer being managed by Solutia, Solutia
became unable to provide complete status updates and, as a result, Solutia
disclosed that it would cease reporting on those litigation matters. The GE
Litigation falls within the scope of litigation liabilities described above.
Accordingly, Monsanto is managing this litigation and Solutia will be unable to
provide complete status updates on the GE Litigation. Therefore, Solutia will
cease reporting on the status of the GE Litigation.
PENNDOT CASE
- ------------
Solutia's Annual Report on Form 10-K (as amended) for the year ended
December 31, 2003 described a case then pending in the Commonwealth Court of
Pennsylvania by the Commonwealth of Pennsylvania against Pharmacia seeking
damages for PCB contamination in the Transportation and Safety Building ("T&S
Building") in Harrisburg, Pennsylvania, that it claimed necessitated the
demolition of the T&S building. Solutia was not a named defendant in this
litigation and therefore took no action to stay the litigation in connection
with its Chapter 11 proceedings. Solutia assumed the defense of this litigation
at the time of its spin-off from Pharmacia. Solutia determined that its
obligation to defend and indemnify Pharmacia with regard to this litigation was
a pre-petition obligation that Solutia was prohibited from performing, except
pursuant to a confirmed plan of reorganization. Therefore, Solutia ceased
defending Pharmacia with respect to this litigation. Solutia did, however,
provide a $20 million letter of credit to secure a portion of Pharmacia's
obligations with respect to an appeal bond issued with respect to the case.
On May 25, 2006 the Supreme Court of Pennsylvania issued its ruling on the
appeal in this case, reversing in whole and remanding in part the decision of
the trial court against Pharmacia. With respect to those claims that were
reversed and remanded, the Supreme Court of Pennsylvania significantly limited
the amount of damages that could be awarded. As a result of this ruling,
Monsanto has released the $20 million letter of credit that Solutia posted to
secure a portion of Pharmacia's obligations with respect to an appeal bond
issued with respect to the case.
56
SOLUTIA INC. V. FMC CORPORATION
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Solutia's 2005 Annual Report described an action captioned Solutia Inc. v.
FMC Corporation ("FMC") in Circuit Court in St. Louis County, Missouri, against
FMC over the failure of purified phosphoric acid technology provided by FMC to
Astaris, the 50/50 joint venture between Solutia and FMC. On July 31, 2006, the
District Court entered its order regarding FMC's motion for summary judgment,
ruling that Solutia's breach of fiduciary duty claim would be allowed to
proceed, but only on a limited basis. The Court further overruled the parties'
motions for summary judgment on the remaining claims. The Court also ruled that
there will be a bench trial on the four claims remaining in the case.
ITEM 5. OTHER INFORMATION
Euronotes Refinancing
As previously disclosed in a Form 8-K filed with the Securities and
Exchange Commission (the "SEC") on June 30, 2006, Solutia delivered a redemption
notice and certificate (the "Notice") to the holders of its (euro) 200 million
10.00 percent Senior Secured Notes due 2008 (the "Euronotes") issued by Solutia
Europe S.A./N.V. ("SESA"), Solutia's wholly owned subsidiary, in accordance with
the terms and conditions of the Euronotes. Delivery of the Notice obligated SESA
to redeem the Euronotes on August 1, 2006 at a 3 percent premium.
As described in a Form 8-K filed on August 1, 2006, on July 26, 2006,
Solutia's indirect wholly-owned subsidiary Solutia Services International
S.C.A./Comm. V.A. ("SSI"), a subsidiary of SESA, entered into a (euro) 200
million Facility Agreement (the "Facility Agreement") between SSI as borrower,
SESA and CPFilms Vertriebs GmbH, as original guarantors, Citigroup Global
Markets Limited, as arranger, the financial institutions listed therein, as the
original lenders, Citibank International plc as agent for the finance parties
and Citibank N.A. as security agent for the secured parties. Closing of the
credit facility contemplated by the Facility Agreement, which at signing
remained subject to the satisfaction of a number of conditions precedent,
occurred on August 1, 2006. SESA used the proceeds of the new credit facility to
refinance of all of the Euronotes on August 1, 2006, at a prepayment premium of
3 percent, as required pursuant to the Euronotes, for a total redemption amount
of approximately (euro) 215 million, including accrued interest. The Euronotes
were refinanced to reduce the interest rate, extend the term of the indebtedness
and allow for certain dispositions by Solutia, including the sale of its
pharmaceutical services business.
The Facility Agreement has a five-year term, with a termination date of
July 31, 2011 and an adjustable rate structure of EURIBOR plus a margin which
currently yields a rate of approximately 5.75 to 6.50 percent. The margin is
subject to adjustment upon the occurrence of certain events specified in the
Facility Agreement or upon SESA and its subsidiaries attaining certain financial
benchmarks. The new credit facility consists of a (euro) 160 million term loan
B1 and a (euro) 40 million term loan B2. The (euro) 40 million term loan B2 is
expected to be repaid from the proceeds of the sale of Solutia's pharmaceutical
services business described in Note 4 to the accompanying consolidated financial
statements. The new loan is secured by substantially all of the assets of SESA
and its subsidiaries (excluding Flexsys Holding B.V. and Carbogen Amcis AG). The
Facility Agreement also contains other customary terms and conditions, including
certain financial covenants relating to the performance of SESA and its
subsidiaries.
The foregoing description of the Facility Agreement does not purport to be
complete and is qualified in its entirety by reference to the Facility
Agreement, a copy of which is attached hereto as Exhibit 10.1.
ITEM 6. EXHIBITS
See the Exhibit Index at page 59, of this report.
57
SIGNATURE
Pursuant to the requirements 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.
--------------------------
(Registrant)
/s/ TIMOTHY J. SPIHLMAN
--------------------------------------
(Vice President and Controller)
(On behalf of the Registrant and as
Principal Accounting Officer)
Date: August 2, 2006
58
EXHIBIT INDEX
These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of
Regulation S-K.
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.1 (Euro) 200,000,000 Facility Agreement dated July 26, 2006 between
Solutia Europe S.A./N.V., Solutia Services International
S.C.A./Comm. V.A., the guarantors listed therein, Citigroup Global
Markets Limited, as mandated lead arranger, the financial
institutions listed therein, as the original lenders, Citibank
International plc as agent for the finance parties and Citibank
N.A. as security agent for the secured parties
10.2 Share and Asset Purchase Agreement entered into on May 23, 2006
between Solutia Europe S.A./N.V. and Dishman Pharmaceuticals &
Chemicals Ltd.*
11 Omitted--Inapplicable; see "Consolidated Statement of Operations"
on page 1
31(a) Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31(b) Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32(a) Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32(b) Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
*Confidential treatment has been requested pursuant to Rule 24b-2 under the
Securities Exchange Act of 1934, as amended, for portions of this exhibit that
contain confidential commercial and financial information.
59